Investment Perspectives

Transcription

1 Investment Perspectives JANNEY MONTGOMERY SCOTT LLC Time to Panic? By Mark Luschini, Chief Investment Strategist twitter.com/luschini_janney After almost two-and-a-half years of rising stock prices without so much as a 1% correction an unusually long period, given that there have only been four rallies in the history of the S&P 5 Index that have lasted longer without one we are deep into the midst of a pullback. Since corrections are defined as a decline of 1% or more, the S&P 5 Index would have to fall from its recent peak of 1,85 or so to 1,665 to qualify. Even if that point were to be reached, the return for investors from the beginning of 213 would still be approximately 17% before dividends. Chart A: S&P 5 Index for the past 3 years Market rally, no correction factors intersecting, leaving the stock market vulnerable to a sell-off. The first was valuation, and the fact that roughly 75% of the market s return in 213 was attributed to the price-to-earnings ratio of the market expanding from 12 to 15 times expected earnings. While valuation alone does not always suffocate stock prices (after all, they can easily move from fair to overbought conditions), it does raise a cautionary flag. This is where other factors can combine to make it combustible. Chart B: S&P 5 Index forward P/E ratio P/E ratio expansion In the meantime, the stock market is down mid-single digits, and there is no shortage of causes given to it by various pundits. Since we have articulated in the past our reasons for expecting a correction, we are not spooked by its occurrence, nor has it unseated our view that its passing will not leave a permanent scar on the return potential we envision for equities in 214. That doesn t mean, however, that we are complacent or will stand idly by without handicapping the nature of the decline. The view we expressed for expecting a correction was predicated upon two The second variable for us was sentiment about economic conditions. While we posited in our Outlook 214 publication that the U.S. economy was poised to accelerate this year, this increasingly consensus view was corroborated by the data produced in the waning months of 213. Consequently, as news kept getting better, it became harder to impress expectations. (Continued on page 2) INVESTMENT PERSPECTIVES JANNEY MONTGOMERY SCOTT LLC 1

2 (Continued from page 1) Chart C: Citigroup Economic Surprise Index, U.S We opined that it would not necessarily take bad news to disrupt the market, but rather less-than-impressively good news. That package was delivered in the last several weeks, as economic releases have softened comparably with reports from prior months, and fissures in the emerging markets which have long existed have widened. Much attention has been given to the latter, for fear that we might be seeing a replay of We don t think so. Compared to the 199s, current account conditions are better, while foreign currency debt is lower. Clearly, certain economies will be vulnerable, such as Turkey, Argentina, and South Africa, but that should not endanger the rest of the global economy. Chart D: Foreign currency debt Positive economic surprises have rolled over China is being criticized for its shadow banking system, and recent problems there have not dissuaded concerns that an event could trigger more significant credit problems. But, so long as China s growth rate remains elevated, these potential problems, should they occur, will not be systemic. Together, the emerging markets story has transitioned from a must own to one that is highly nuanced demanding a more selective approach to securing rewarding outcomes. Countries whose fiscal positions are strong, or are underwriting reforms to change structural deficiencies (count Vietnam, Mexico, and even China among them), are those we believe hold the most promise, with Russia, Poland, and select southeastern Asia alongside. Turbulence in the stock market will likely persist, as concerns over an emerging market crisis and China linger, or until a turnaround in U.S. economic data re-strengthens investor conviction. In the meantime, strategic investors should stay the course as the upshot is that this period should pass as the synchronized global economic expansion overtakes near-term bearishness to give way to a resumption of the equity rally. Investors who have been sidelined, or have been waiting opportunistically for a chance to buy at more favorable valuations, should begin a process of layering into the markets, at these levels and lower. We favor cyclical sectors such as industrials, business-facing tech companies, and financials domestically. Also, strong consideration should be given to European equities as the economic news, counter to what has recently been the case in the U.S., has been producing a patternsequential improvement. Finally, the Japanese equity market should not be overlooked on a currency-hedged basis. The reforms of Prime Minster Abe and his regime stand a good chance of sparking a longer-lasting growth, and therefore add a source of non-trivial returns to a globally diversified portfolio. (Source: BCA Research 214) INVESTMENT PERSPECTIVES JANNEY MONTGOMERY SCOTT LLC 2

3 Emerging Stress? By Guy LeBas, Chief Fixed Income Strategist twitter.com/lebas_janney With strong buying in the final trading day of January, the first month of 214 has proven to be the best-performing month for the Treasury markets in nearly two years. Economic data in the U.S. has been mixed, though there s little evidence that the underlying currents have deteriorated. The Fed has, at its first policy meeting of the year, offered few surprises and continued tapering its monthly bond purchases. And yet Treasuries are in high demand, with yields falling and the latest round of auctions benefitting from near-record demand. The real narrative behind falling yields in our view is capital outflows from emerging markets. Emerging markets investments include both stocks and bonds issued by and in countries outside of the U.S., Western Europe, and developed Asia. Emerging market economies are generally faster-growing than developed economies, but they re also more volatile, and, importantly for our discussion, very subject to capital flows. For the U.S. economy, which has more than $35 trillion of public and private debt outstanding, it s hard for buyers of dollar assets to meaningfully move the value of the currency or the markets as a whole. For any individual emerging market economy, there may only be billions of dollars of debt and equities outstanding, which makes it much easier for buyers or sellers to shift the value of an emerging economy currency or financial market. Chart E: The value of emerging market bonds and stocks have been falling since October $125 $45 The smaller size of emerging economies means that capital flows can play a large and persistent role in pushing around emerging markets. Over the past decade, inflows to 12 of the largest emerging markets (excluding China) via direct investment, investment in bonds and stocks, and lending have totaled around $1.2 trillion. Since the summer of 213, there s been an estimated $5 billion of outflows of the same, triggering sharp slides in the value of emerging market debt and equity which accelerated in the last week. These outflows represent just 4% of the total inflows over the prior decade, which suggests that the capital flows and emerging market performance could get worse before they get better. We don t separate bonds from stocks when it comes to emerging markets, because, in times of stress, the two tend to be highly correlated. The final stage of outflows won t likely hit until firms start pulling real investment projects out of emerging market countries. Where the emerging market declines come into play with the U.S. bond markets is a question of where those flows out of EM went. The short answer, at least in part, is into dollar-denominated assets and, in particular, into the safety of high-quality bonds. That grouping includes Treasuries, but also investment-grade corporates and, to a lesser degree, municipals. Inflows to taxable bond funds through January 29th have measured $11.1 billion after months of consistent outflows since summer 213 (data from Lipper). Although interest rates are low by historical standards, stress around the globe continues to drive demand in the U.S. bond markets. It also serves to prove that, when it comes to the markets, a consensus view can be easily derailed. $12 $43 $115 $41 $11 $15 Emerging Market Bond ETF (Left Axis) Emerging Market Equity ETF (Right Axis) $1 Dec-12 Mar-13 Jun-13 Sep-13 Dec-13 $39 $37 $35 (Source: Janney FI Strategy) INVESTMENT PERSPECTIVES JANNEY MONTGOMERY SCOTT LLC 3

4 Chart G: Results in February following the worst January outcomes It Ain t Over til It s Over By Gregory M. Drahuschak, Market Strategist As soon as the final bell sounded January 31, the financial press aggressively focused on the cliché, As January goes, so goes the full year. Turmoil with emerging market currencies sent the market careening lower January 24, which positioned the market for a difficult final week of the month. Despite this, however, the final week ended only with factional losses for the S&P 5 and the Nasdaq Composite, while the utility, transportation, semiconductor, and biotech indexes ended with gains. Nonetheless, as illustrated in Chart A, the entire month of January ended as the 13th weakest January since Chart F: 13 weakest January periods since As Chart G indicates, the market s results in the months of February immediately following the worst January outcomes are mixed Investors, however, are generally more interested in what the market s full-year result might be, following losses in January. Since 1974, January has been a down month 12 times. As Chart H shows, the S&P 5 ended the year up six times, which seemingly throws out the notion that a down January is a sure-fire signal of losses for the entire year. Chart H: Full year after down January But, as is true for most season patterns, annual results following a down January vary widely depending on the number of years considered or specific time segments. On balance, we find that the January cliché the press latched upon is a far less-than-reliable guide upon which to base an investment judgment. However, we do find the historical results for various periods within the presidential election cycle to be moderately useful. Mid-term election years, on average, see the market hit a low for the year late in January, rally through late April, and then slide to a secondary low in August that is revisited early in October before rallying strongly into the New Year. So far, the market is performing in line with the pattern of mid-term election years. (Continued on page 5) INVESTMENT PERSPECTIVES JANNEY MONTGOMERY SCOTT LLC 4

5 (Continued from page 4) In prior reports, we repeatedly cited earnings as the key determinant of the market s outcome for this year. On this score there is some earlyyear concern. As of the end of January, roughly 5% of the S&P 5 companies had reported results for the 4th quarter. Of these, 75% topped consensus earnings expectations and 67% beat consensus revenue estimates. Data compiled by Standard & Poor s in recent weeks, however, have shown a consistent decline in the estimated full-year earnings. In the last four weeks, the consensus earnings number has fallen sequentially from $ four weeks ago to $119.63, $119.23, and $ this week. This is not a major percentage drop, but the market may be concerned about the direction and the possibility that it might continue. One day after the Chicago Purchasing Manager Index was reported to be below expectations, this month opened with the ISM Index of manufacturing at 51.3, which was five points lower than expected and 4.3 points lower than the prior month. The big negative was the drop in new orders from 64.4 to The production and employment components also were notably lower, but like the overall index number, these measures remained in an expansion mode. The order backlog, however, slipped 3.5 points to 48. The ISM report along with other recently released data have been softer than desired, which added some increased fundamental concerns. Some of this might be attributed to extreme weather in January. Negative year-over-year auto sales, however, probably were at least partly weather-related. Like many others, we had suspected for weeks that the market was susceptible to a correction, but the market continued moving higher. January and the opening part of February finally may have changed sentiment sufficiently to produce the widely anticipated pullback. For long-term investors, other than where there are fundamental concerns, major shifts in existing portfolios are unnecessary. Additional weakness which technical conditions suggest could send the S&P 5 toward 17 would represent, in our view, the opportunity to become substantially more aggressive buyers in anticipation of a solid rally as we move through this year. Our title-line reference to the quote made famous by Yogi Berra that it ain t over til it s over is appropriate, we think, in two regards. The corrective action begun in January probably has not run its course but the bull market is not over either. Successfully navigating through the next few months we think will make a major difference in the 214 results of individual portfolios. JANNEY MONTGOMERY SCOTT LLC 1717 Arch Street, Philadelphia, PA Member: NYSE FINRA SIPC 214, Janney Montgomery Scott LLC The information is sent to you for informative purposes only and in no event should be construed as a representation by us or as an offer to sell, or solicitation of an offer to buy any securities. The factual information given herein is taken from sources that we believe to be reliable, but is not guaranteed by us as to accuracy or completeness. Opinions expressed are subject to change without notice and do not take into account the particular investment objectives, financial situation or needs of individual investors. Employees of Janney Montgomery Scott LLC or its affiliates may, at times, release written or oral commentary, technical analysis or trading strategies that differ from the opinions expressed within. Past performance is not indicative of future results. From time to time, Janney Montgomery Scott LLC and/or one or more of its employees may have a position in the securities discussed herein. INVESTMENT PERSPECTIVES JANNEY MONTGOMERY SCOTT LLC 5