Myth and Market
The January Effect is a myth. It’s actually made up of not just one, but several old yarns intended to make sense of seasonal stock price patterns. As can be imagined, variations of the myth have taken on outsized significance for some investors. One version is that the prices of stocks in January tend to rise more than in the other months of the year. A second is that smaller cap stocks tend to outperform larger cap stocks during January. The last variation is an old stock market bull-bear fable which says, “as goes January, so goes the year.”
The myth persists, in spite of regular debunking. Consider 2014, for instance. Stock prices, measured by the S&P 500, dropped an alarming 3.5% in January. Then, they proceeded to post 5 consecutive months of positive returns and ended the year up a solid 13.5%. So, the first half of last year shows the “as goes January” form of the myth is a little flimsy. January 2015 began just like 2014, with the S&P 500 tumbling 2.9%. Small stocks, measured by the iShares Core Small Cap ETF, fell 3.6%, overturning another version of the January Effect myth. The final form of the myth, that prices in January tend to rise more than other months of the year, is also suspect. It seems somewhat implausible to imagine a year in which every succeeding month’s returns would somehow be lower than January’s -2.9%.
The recent turbulence in the oil patch is clearly not a myth. Geo-politics aside, I think the supply and demand equation will normalize, and more quickly than many have been forecasting. Best guess is somewhere between $107 a barrel (June of 2014) and $50 a barrel today. Substantial production will likely be shut down. This has and will lead to lay-offs and continued cuts to capital expenditures by many energy companies and the economic impact in the isolated oil producing regions will be sharp. The good news, according to AAA, is the average price of a gallon of gas is $2.04, down 40% since September 2014. For consumers this is a substantial tailwind and I would expect to see a steady pick-up in spending on other consumer discretionary items (clothing, furniture, electronics).
4Q 2014 earnings season is well under way and the results have been quite good, with the exception of the energy patch. According to FactSet Research, the Energy sector is showing a 21.5% decline in earnings. Apart from energy, U.S. companies are tending to beat their estimates at a record clip. FactSet data shows 78% of companies have reported EPS above estimates and above their 5-year average. Health care and technology stocks have led earnings and revenue “beat rates” according to Bespoke Investments. The news investors are having difficulty with is the tendency for companies to lower their outlook. It’s not clear if they are sand-bagging, or flashing a yellow light? The negative guidance spread is troubling. Interestingly, it’s the consumer staples stocks that have shown the highest incidence of downward guidance revisions – and this is curious in the face of the drop in energy prices.
For the full year 2015, analyst expectations are for record earnings. Presently, FactSet top-down earnings forecasts for 2015 and 2016 are 124.73 (16.9 P/E) and 135.58 (15.2 P/E). The market is no longer “cheap” and its ability to support these multiples is contingent on growth. So far, sound economic data continues to roll in. Inflation is non-existent and will likely fall further with the low energy prices. GDP figures are in the 2.6% range, not impressive, but good enough considering the strong dollar and the vacuous fiscal policy. Finally, the jobs numbers are sensational. As Bespoke reports, the weekly jobless claims number of 265K was only the second print below 275K in the last 40 years – when the population was 50% lower than today.
Our portfolio manager Jean Rosenbaum recently attended the 10th Economic Forecast conference at the University of Delaware, featuring James Bullard, President of the Federal Reserve Bank of St. Louis. She said Bullard’s main points were 1) the US$ is at its trade weighted average and while it feels as though we’ve had a big move, it’s just come off a very low level, 2) US long term rates have fallen recently due to (QE) quantitative easing by the ECB, and 3) there is some urgency to return the policy rate to normal, meaning the US needs to raise rates – the 1994 rate rising cycle was too fast and the 2004-06 cycle was too gradual, so something in between is favored. Another myth, “don’t fight the Fed” has been in investor’s minds for years. In my opinion, I hope the Fed’s thinking tempers and is responsive to the data, not a preconceived normal level. The risk inherent in raising rates too fast is far greater than raising them too slowly.
It was Groundhog Day Monday and in case you missed it, Punxsutawney Phil did in fact see his shadow. Accordingly, this inconveniently forecasts six more weeks of winter weather. It’s always better to keep one’s expectations in check, and I suppose this applies equally well to the weather, or to stock prices. It could be Phil’s shadow is a more useful myth than one would think. In the meantime, please let me know if you would like to schedule a meeting to review your portfolio. You should also expect to receive your 1099’s shortly, and bear in mind they frequently tend to be revised as stock and bond related data is corrected.
Bruce Hotaling, CFA
The views and opinions stated herein are those of Bruce Hotaling, are 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 & P500 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.