The Monster Under the Bed
In President Franklin D. Roosevelt’s inaugural address from 1933, he famously said, “the only thing we have to fear is fear itself,” and while the world’s circumstances are vastly different today than they were in 1933, fear is fear. We are all actively conditioned by our recent experience. Someone returning home from the latest horror movie is far more likely to be afraid someone might be lurking in the dark, than someone returning home from a cheery birthday party.
Today, we are over six years beyond the nadir of the stock market’s most recent catastrophe, but somehow investors have become conditioned. We all know corrections in prices come along from time to time, it’s part of the equation when investing in stocks. Yet, it is curious so many investors readily embrace fear and rarely pop up on the surf board and enjoy the ride.
For the month of May, stocks rose 1.05% as measured by the S&P 500 and are now up 3.23% for the year. This is good news as there is a tendency for some seasonality in stock prices (sell in May and go away) this time of year. The buying opportunity this year was in late January when stocks came under a wave of pressure, and again in mid-March. The broad market has been in a relatively narrow band, trending with a positive slope, and behaving well by most measures.
Looking under the hood, large stocks have outperformed small. Growth stocks have bested value stocks in each cap category and stocks with dividends have lagged. The market is rewarding earnings growth in a low rate environment. According to FactSet Research, over 71% of companies beat their earnings estimates for 1Q2015. Some recent stability in oil prices bodes well for further improvement to forward looking estimates in energy, industrials and materials and analysts are signaling a pick-up in their estimates.
Economic data supports improved earnings forecasts. European economies are on the upswing due to QE. Inflation is in check, commodity prices (with the high US $) are down and there is an apparent surplus of oil. The labor market continues to repair itself although the total volume of labor is down, as is productivity. The housing market is by far the bright spot. New home sales are nearing a post-crisis high. Prices are rising, the inventory of homes for sale is limited, and financing is more accessible than any time since the financial crisis.
For stocks to continue to work, many investors are expecting to see GDP in the 2.5-3% range for 2015. If this happens, the growth will have to come in the second half of the year. The US $ is picking up strength, again, and this favors stocks with a majority of their earnings from domestic sources. According to the Yardeni model, stocks are priced well with an earnings yield north of 5% versus a US 10-year Treasury in the 2% range. Across our portfolios, we remain focused on consumer discretionary, health care, technology and financials.
Of all the known concerns out there, the one thing that remains a market impacting event is the seemingly inevitable increase in interest rates by the Federal Reserve. According to a report by J.P Morgan (Short-Term Fixed Income 2015 Outlook, 11/26/14) the Fed’s pending actions may not have the desired effect. “The success of normalization will be judged by the Fed’s ability to back away from the extraordinary policies of recent years, to raise short-term interest rates, un-bloat its balance sheet and breathe life back into the Fed funds market. Doing this will require the Fed to navigate markets that are structured very differently than when it last hiked rates over a decade ago.” One of the big questions is whether, due to regulatory changes, a glut of liquidity in money markets and future U.S. Treasury financing needs, the outcome can be put into place, as intended?
Our approach is to watch over the investment landscape carefully and avoid horror movies at all costs. This generally allows us to take notice when true change is in the air and divert the impulse to panic when things start to get a little scary. In my opinion, stocks remain the asset class of choice this year, and we are staying the course. Please feel free to call if you have questions or would like to review your portfolio.
Bruce Hotaling, CFA, Managing Partner
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.