It would certainly appear so given that the S&P 500 broke decisively into new high ground above the 1900 level after the Memorial Day holiday, putting twelve weeks of mostly sideways action punctuated by a sharp 5% dip and several other bouts of weakness firmly in the rear view mirror. On the surface the so-called correction or period of consolidation seemed mild with the broad market holding up well, but underneath there was a vicious rotation out of everything that had been going up nicely and was now considered too bubbly into stodgy defensive issues. Even the slightest earnings miss or hint of slowing revenues was harshly punished. The more growth oriented NASDAQ had corrected over 9% and small cap stocks 11%. Growth was out and value was in, even to the point of a considerable migration out of the U.S. into languishing European stocks and emerging market equities that had been beaten down by the Fed taper and were now considered cheap. All in all, it was very curious behavior, especially in view of the glowing forecasts for a stronger U.S. economy.
While the stock market is shaping up for a possible another leg up, the bond market is telling us that it doesn’t share the consensus view of a stronger economy and higher interest rates ahead. While the consensus calls for the benchmark 10 year Treasury yield to rise above 3% by year end, many calling for 3.25% or 3.5%, and even higher rates next year after the end of QE and the Fed starts tightening, the bond market has surprised everyone by moving in the opposite direction. After topping 3% in January the 10 year Treasury has now fallen to 2.45% with every indication of going even lower. The stock market bulls have come up with at last count 11 different reasons why interest rates have gone in the wrong direction, but have so far steadfastly refused to accept the simple explanation that the bond market expects a stagnant economy and is increasingly doubtful that the Fed will be able to withdraw monetary stimulus from the economy anytime in the foreseeable future. With any more data like the revised GDP numbers showing that the economy actually contracted by 1.0% in Q1, more indications that the expected housing recovery is failing to get off the ground, and that consumer spending fell flat in April, business economists will be forced to cut their rosey GDP forecasts, cautious company guidance will give way to downward revisions of sales and earnings forecasts, and the Fed may even have to taper the taper.
Meanwhile, in the halls of academia the concept of “secular stagnation” coupled with fears of deflation are steadily gaining ground, as is the realization that growing inequality is sapping the ability of consumers to propel the economy forward. When economists introduce into their models the fact that income gains are confined entirely to the top 20% while the 80% are struggling to get by, they will realize that the vaunted wealth effect of rising asset prices no longer translates into rising consumer confidence and consumer spending, and without consumer spending businesses have no incentive to make productive investments. When it becomes clear to all, as I believe it must, that the U.S. economy as presently configured is in no position to rise above 2% to 2.5% growth for as far ahead as anyone can see, and will likely average considerably less than that, markets will likewise have to adjust to the realization that interest rates will also remain very low for the foreseeable future. This is so different from the present expectation of stock market participants that it is bound to have significant repercussions there as well. I am not sure how the stock market will react at first. Much will depend upon how the Fed reacts. I am inclined to believe that the Fed will remain highly accommodative, and that this will be bullish for stocks despite a sluggish economy, but the transition from the present rosey outlook for a steadily strengthening economy to one mired in low growth and high unemployment could create a good deal of turmoil as trader sentiment changes and portfolios are adjusted to the new reality.
Meanwhile, in the halls of academia the concept of “secular stagnation” coupled with fears of deflation are steadily gaining ground, as is the realization that growing inequality is sapping the ability of consumers to propel the economy forward. When economists introduce into their models the fact that income gains are confined entirely to the top 20% while the 80% are struggling to get by, they will realize that the vaunted wealth effect of rising asset prices no longer translates into rising consumer confidence and consumer spending, and without consumer spending businesses have no incentive to make productive investments. When it becomes clear to all, as I believe it must, that the U.S. economy as presently configured is in no position to rise above 2% to 2.5% growth for as far ahead as anyone can see, and will likely average considerably less than that, markets will likewise have to adjust to the realization that interest rates will also remain very low for the foreseeable future. This is so different from the present expectation of stock market participants that it is bound to have significant repercussions there as well. I am not sure how the stock market will react at first. Much will depend upon how the Fed reacts. I am inclined to believe that the Fed will remain highly accommodative, and that this will be bullish for stocks despite a sluggish economy, but the transition from the present rosey outlook for a steadily strengthening economy to one mired in low growth and high unemployment could create a good deal of turmoil as trader sentiment changes and portfolios are adjusted to the new reality.
This difficult and important transition to a new reality makes me very cautious about how the stock market will behave over the balance of this year and into the next, but I am not prepared to make any predictions, nor do I believe it is possible for anyone to make a worthwhile prediction of what the market will do more than a few days ahead. I learned long ago that one must set aside any preconceived notions of what lies ahead and simply follow where the market leads day by day ready always to adjust one’s strategy abruptly on short notice.
I tip toed back into the market the week before last when it became apparent that the harshly punished growth stocks were beginning to come back and the more growth oriented NASDAQ was again taking the lead from the more conservative S&P500. The initial moves were into ARRS and GILD, and then after last week’s breakthrough I went in more deeply with ACT, ALXN, FB, PCLN and SLXP, all issues with good liquidity and strong earnings prospects. More concentration in the recently punished biotech sector than I would like, but that’s where the earnings seem most secure and the setups look sound. I also like DVN and EOG in the oil E&P sector as well as SLB in the oil service sector but am holding off for a dip in the price of crude that seems overdue. Some of the smaller oil E&P companies are tempting, especially ATHL and BCEI, but in this environment it is probably better to stick with larger producers like EOG and DVN. Chips are on the upswing but highly cyclical; AVGO, CAVM and MU are worth watching but the rapidity of technological change makes the entire sector kaleidoscopic in nature and almost impossible to keep up with. There are numerous exciting small tech firms like PANW, DATA, CRTO, SPLK, WDAY but the market is too nervous and fickle to deal with them right now. KORS is an exciting “aspirational” retailer but the market hates it and the entire retail sector is under a cloud right now, as is the restaurant sector where CMG and SBUX look promising over the longer run. Airlines are doing well and LUV should be watched as it moves into Washington’s Reagan National Airport with a lot of new slots. In the financial sector banks have an ROE problem, but BX is an excellent private equity firm doing everything right and poised to harvest some large profits.
So there is plenty to choose from but patience is required, timing is everything, and losses should be cut even more quickly than normal (say 4%) because the market is apt to be erratic and full of surprises.
I tip toed back into the market the week before last when it became apparent that the harshly punished growth stocks were beginning to come back and the more growth oriented NASDAQ was again taking the lead from the more conservative S&P500. The initial moves were into ARRS and GILD, and then after last week’s breakthrough I went in more deeply with ACT, ALXN, FB, PCLN and SLXP, all issues with good liquidity and strong earnings prospects. More concentration in the recently punished biotech sector than I would like, but that’s where the earnings seem most secure and the setups look sound. I also like DVN and EOG in the oil E&P sector as well as SLB in the oil service sector but am holding off for a dip in the price of crude that seems overdue. Some of the smaller oil E&P companies are tempting, especially ATHL and BCEI, but in this environment it is probably better to stick with larger producers like EOG and DVN. Chips are on the upswing but highly cyclical; AVGO, CAVM and MU are worth watching but the rapidity of technological change makes the entire sector kaleidoscopic in nature and almost impossible to keep up with. There are numerous exciting small tech firms like PANW, DATA, CRTO, SPLK, WDAY but the market is too nervous and fickle to deal with them right now. KORS is an exciting “aspirational” retailer but the market hates it and the entire retail sector is under a cloud right now, as is the restaurant sector where CMG and SBUX look promising over the longer run. Airlines are doing well and LUV should be watched as it moves into Washington’s Reagan National Airport with a lot of new slots. In the financial sector banks have an ROE problem, but BX is an excellent private equity firm doing everything right and poised to harvest some large profits.
So there is plenty to choose from but patience is required, timing is everything, and losses should be cut even more quickly than normal (say 4%) because the market is apt to be erratic and full of surprises.
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