The end of July was marked with the spectacle of a blue moon – the unusual occurrence of a second full moon during the month. The last time this happened was in 2012 and the next will be in 2018, so enjoy the moment. Once in a blue moon, as the saying goes. The month end also marked the 4th time this year stocks have posted positive monthly gains. After a nerve wracking June, when many investors were wringing their hands, stocks have turned positive, and everyone can breathe a momentary sigh of relief. Measured by the S&P 500, stock prices for the month are up 2.36%, and 3.59% year to date.
Blue moon, or not, 2015 is proving to be a fickle year in the financial markets. I find it interesting that stocks are the only asset class we work with that is providing a substantive contribution to portfolio returns. Bonds are largely drifting sideways. MLP’s and REIT’s are struggling with the spiraling oil/gas prices and the looming threat of a Federal Reserve interest rate hike.
In support of holding or even moving overweight in stocks – earnings for the 2Q have been robust, with roughly 73% of companies reporting above estimates, according to FactSet Research. Health care and financial stocks have been posting up attractive growth, while energy stocks continue to disappoint. Wall Street analysts were busy revising earnings forecasts downward, and generally dimmed their outlook for the 3Q. In my opinion, this is constructive in a contrarian way. At the point in time when analysts collectively favor stocks, we ought to consider reducing our exposure.
Global issues have been stirring up confusion. The Greece “crisis” was averted at the last minute. The outcome avoided the re-creation of a shelved currency and the potential me-too syndrome for other weaker economies in the Euro-zone. China, the world’s second largest economy, is experiencing some controlled trauma. Stock prices, measured by the FXI (iShares China Large-Cap) are off 20% since mid-April. Not a good thing when the Communist Party/leadership is trying to create a consumer based economy. According to FactSet Research, companies in the S&P 500 in aggregate generate about 9% of sales from the Asia Pacific region, most of which comes from China and Japan. (FactSet Earnings Insight, 7/31/15, p.9). Iran is complex, but one can guess, with a somewhat higher probability, that 1) economic output from Iran will improve with the lifting (partial lifting) of sanctions and 2) their nuclear ambitions will at best be slowed. The other obvious outcome is the return of Iranian oil to the already over-supplied export markets.
The domestic economic growth outlook is so-so at best, modestly supporting recent earnings traction, with hopes pinned on an improved Q4. I continue to favor U.S. companies and in my opinion, we should expect a lower than average return from stocks at this point. I’ve mentioned this in the past. The issue is not so much the market multiple as earnings growth. More and more, revenue growth is stalling out and the potential for continued margin expansion is limited. Dividend growth (as opposed to yield) strategies are often effective. We will investigate options here, though with a rising rate backdrop, growth stocks have stolen the market’s heart and have been the backbone of our returns.
Due to the ongoing uncertainty in the oil patch, we are going to reduce our exposure to energy stocks. The reasoning is simply that the outlook is cloudy, at best. If oil prices are in the current range one year from now, the inevitable dividend and cap ex cuts will have taken their toll on stock prices. I prefer to focus on stocks and sectors where our research is constructive and the stocks have some directionality. This would include health care and financials, and some consumer stocks. In the fixed income area, including municipal and corporate bonds, there is value but expected returns are low. A Fed rate hike is coming, but in my opinion, this will not happen until late 2015 or even 2016 due to the general softness in the economic data. Finally, I think as fixed income surrogates, the MLP’s and REIT’s will rebound. Unlike traditional fixed income they can increase their distributions.
Seasonally, stocks go on vacation too, and euphemistically “move sideways” during the latter part of the summer. In my opinion, some extra cash and some patience at this point will smooth the way. If you would like to review your portfolio or your asset allocation with us, please do not hesitate to reach out – we always look forward to hearing from you.
Bruce Hotaling, CFA
The views and opinions stated herein are those of Bruce Hotaling, are as of this date, and are subject to change without notice. Information contained in this report was received from sources believed to be reliable, but accuracy is not guaranteed. Investments are subject to market risk, including the possibility of loss of principal. Past performance does not guarantee future results. The S&P 500 is an unmanaged index of 500 widely held stocks. Investors cannot invest directly in an index. The PE ratio (price/earnings) is a common measure of relative stock valuation. This note contains forward-looking statements, predictions and forecasts (“forward-looking statements”) concerning our beliefs and opinions in respect of the future. Forward-looking statements necessarily involve risks and uncertainties, and undue reliance should not be placed on them. There can be no assurance that forward-looking statements will prove to be accurate, and actual results and future events could differ materially from those anticipated in such statements.