By David Nelson, CFA
Investor concern has been rising and reflected in the sideways price action over the last several weeks. We’ve rounded up the usual suspects including valuation, politics, military action and the Fed as potential assassins to a bull market now entering its 9th year.
Before we break out the cyanide capsules it’s important to note that we’re less than 2% from all-time highs. In previous posts we’ve discussed some of the early warning signs but the more likely explanation is that we’ve simply pulled forward some of the year’s return and stocks are in a holding pattern waiting for the next catalyst.
WTI Crude 1 Year
Not a recommendation for Energy stocks but earnings growth in the S&P for Q1 will get a significant tail wind from the oil patch as prices have averaged about $10 per barrel higher than the same quarter last year. With estimates for the broad index (SPY) hovering between 9%-10% EPS growth, the set up as we head into the first reports is better than we’ve seen in recent years. The bad news is that stocks are forward looking and have already priced it in.
The struggle in U.S. markets highlights investor concern on several fronts. The failure of the GOP healthcare package forced investors to rethink their calculus regarding market friendly proposals like tax reform; repatriation and even an infrastructure spend. With the timeline pushed out the potential earnings boost also goes on holiday and a likely explanation for recent price action.
Irrational Bond Market
Seemingly confused Bonds have made irrational moves over the last week. Following Wednesday’s FOMC minutes stocks gave up strong gains as it became apparent that balance sheet normalization was going to begin sooner than expected. I joined Danielle DiMartino Booth, former advisor Federal Reserve Bank of Dallas on CNBC’s Power Lunch to discuss the release and a potential time line for letting the current balance sheet of $4.5 Trillion run off, possibly hitting $2 Trillion in 5 years. I found the price action in the treasury markets counter intuitive.
Yields went into a tail spin post the release falling even further the following day with investors fully aware that Fed re-investment of maturing bonds was coming to an end. Again, counter intuitive was the price action following Friday’s weaker than expected employment report coming in at just 98,000 well below consensus. After an initial slide yields climbed all day closing at over 2.38% the high for the week. Investors are going to be reluctant to add equity exposure until the bond market makes up its mind.
Geo-Political Risks
The chemical bombing in Syria and the U.S. response taking out the Syrian base believed to be the launching site of the attack, is a grim reminder that we face geo-political risks in every corner of the planet. As of this writing, a U.S. Naval strike group is headed toward the western Pacific as a potential show of force in advance of another North Korean missile test.
Shoot first ask questions later
Military action along with terrorist events often causes a shoot first ask questions later reaction from investors. Emotional sales following an event are almost always a mistake as it rarely leads to a change in economic activity. Last week’s reaction in the futures market following the U.S. launch of 59 Tomahawk cruise missiles at a Syrian airfield is a case in point. A lot of money was lost as markets had all but recovered by Friday’s open.
Potential major breakout in international stocks
After more than a decade of underperformance international stocks are on the cusp of breaking out to all-time highs. In the face of political, currency, Brexit and now possibly Frexit risks, the EAFE MSCI (EFA) index is approaching highs not seen since pre the financial crisis.
Emerging markets have performed even better year to date but still have a way to go before a major breakout. Value sensitive investors have some alternatives if they find U.S. markets a little too rich. I’ve had major concerns regarding the future of the EU which is of course a major component of the EAFE but price is truth and shouldn’t be ignored. Most of the world’s markets are in the black this year in both local and U.S. Dollar terms. Maybe we’re not the only game in town anymore.
*At the time of this article some funds managed by David Nelson were long SPY & EFA
