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Porcupine

Stock prices were back-and-forth all month. On the final day, prices (measured by the S&P 500) jumped up, and stocks ended .69% higher for the month and 1.3% higher for the quarter. It was a “noisy” month to end a “noisy” quarter. A chart of the stock market looks like the profile of a crosscut saw. This push-pull behavior is a little like a hangover from the uber-strong returns from 2013. It has been quite some time, October 2011 to be precise, since stocks last saw a 10%+ correction.

I am not suggesting this is about to happen, though there are aspects of the market that appear to be in flux. One noticeable aspect is the tone of the market. It’s becoming a little prickly. Investors are on edge, sentiment readings are down. The pundits dogpile each piece of breaking news.

Unease over the upcoming earnings season is apparent, and earnings are the most significant stock price driver. There will no doubt be considerable mention of the cold and snowy weather much of the country experienced. Another factor that may influence reported earnings is the value of the dollar. Fortunately, both are temporary factors and should not have a long term impact on future earnings or stock prices.

Another recent change are the downward revisions by Wall Street analysts to upcoming earnings estimates. Materials, financials and the consumer sector have seen the largest drops in expected earnings growth. Overall, when the quarter began, earnings were expected to grow at 4.3%. Currently, estimates have been revised to decline -1.2% for the quarter, quite a substantial revision.

Much of the information analysts utilize is provided by the companies themselves. Companies issue guidance to say they think their earnings will be either better or worse than what the analysts have projected. Recent guidance has been overwhelmingly negative. There are times when companies “sandbag” their earnings to lower market expectations. It is unlikely such a large proportion of the market is trying to game the market’s reaction to their earnings. Although general market indexes are up one day, down the next, sub-segments of the markets may be re-aligning themselves. For example, value stocks, at each market cap level, outperformed growth stocks in March. The S&P 500 Value ETF (IVE) returned 1.26% while the S&P 500 Growth ETF (IVW) returned -1.9%. The best performing sectors of the US market are utilities (+8%) and Health Care (+4%) while the laggards are Consumer Discretionary (-3.8%) and Industrials (-1%).

My instinct is not to chase the turn in the market leadership, at this juncture. It could well be a head-fake. I believe the higher growth names, most of which remain reasonably priced, will regain favor. At the same time, if earnings guidance does not normalize, and if the shift to value continues, we will reassess both our growth stock holdings and the overall percentage of stocks in our portfolios.

On the economic front, recent reports were again Goldilocks. One strong indicator is the Ford Truck data, reflecting strength in small businesses and construction. Another important economic indicator that continues to impress is the initial jobless claims. It is not clear how weather may impact upcoming data, but job growth numbers have been persistent. In addition to jobs, inflation data has also been supportive, as measured by the CPI and PCE. There are, in fact, compelling arguments that the current 2% target for inflation may be too low. It can be a constructive aspect of economic growth, particularly helpful to the “average” investor, with some leverage, or the small business owner seeking some pricing power.

Janet Yellen is now firmly in the Federal Reserve’s driver’s seat. Investors have digested the fact the Federal Reserve will continue the wind-down of its bond purchasing (Quantitative Easing). Watching the Fed is an anchor activity for Wall Street types. The un-wind has caused some stock market agita. Price volatility, measured by the VIX has increased since the end of last year. Yet interestingly, the Fed’s reduced purchases of bonds, initially seen as pushing bond yields higher, has not been the case. To everyone’s chagrin, the bond markets have performed well in the face of the continued un-wind of the QE by the Federal Reserve.

The biggest news maker this month was the publication of “Flash Boys” by Michael Lewis showing the underbelly of the stock market, and how the high frequency traders have been manipulating access to information on order flow. Most investors had some idea their orders were not being executed “fairly” though they had no sense as to why. I think the good news is the FBI is investigating high-speed trading for possible insider trading (if that’s truly what it is). The SEC has apparently initiated an investigation as well.

In my opinion, the level of technology now supporting stock trading has become so complex, and is controlled by such a broad spectrum of players, there is inherent instability in the market’s trading process. This may or may not be linked to the “flash crash” we experienced back on May 6, 2010, when the Dow Jones Industrials index plummeted nearly 1000 points, and then recovered. The SEC’s report on the flash crash points to the compounding effect of the high-frequency traders played in the incident. This is a long way from the days of the stock specialist, who would stand on the floor of the NYSE, gather bids and offers and match the orders. In my opinion, some thoughtful regulation is imperative, before we experience a confidence impairing breakdown.

As usual, I am available to discuss the market backdrop in greater detail if you like. Please feel free to call.

Bruce Hotaling, CFA

Managing Partner

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