I had breakfast with a good friend this weekend.
He runs a small hedge fund that actually managed to get through the financial crisis relatively unscathed thanks to shorting most of the big financial institutions before the Lehman debacle including a big short in Countrywide.
My friend has also delivered great performance over the past half dozen years as he has been an unequivocal bull since the recession officially ended in June of 2009.[ad#Google Adsense 336×280-IA]What was disconcerting about our conversation is my friend is getting bearish for the first time since the financial crisis.
What’s worse is he confirmed some of my current feelings about the market.
Our concerns are concentrated in three key areas and investors should keep an eye on these items in the months ahead as bad news from any of these areas could cause a market selloff.
The Federal Reserve and Interest Rates:
The credit markets have seen considerable turmoil over the past few weeks.
The 10-year treasury yield has moved some 60 basis points since the end of January and hit a 2015 high of 2.28% last Wednesday before selling off a bit Friday. The volatility in the German 10 year Bund market has been even greater over the past few weeks. Remember it was the so-called “Taper Tantrum” in 2013 that caused the last major decline in the market.
More importantly, the market has lost an important driver of its six yearlong rally. The Federal Reserve finished its last “quantitative easing” program in October of last year and is no longer pumping the liquidity into the market that has been a significant tailwind for equities since early 2009.
In addition, the Federal Reserve is off the “money printing” bandwagon while its brethren in Japan and Europe are still fully committed to their own easing programs. This has been a key driver of the strength of the U.S. dollar since last summer and is a key reason for no year-over-year earnings growth in the S&P 500 in the first quarter as well as a drop off in export sales.
The Economy Is Not Rebounding:
Last year the economy contracted just over two percent in the first quarter primarily due to one of the worst winters in the last few decades. The economy quickly rebounded as pent up demand was released and the economy grew better than four percent on an annual basis in each the second and third quarters of 2014.
Once again, it appears the economy slightly contracted in the first quarter thanks partly again to a colder than usual winter as well as a port strike on the west coast. The markets have been signaling that investors believe a repeat of 2014 will happen in the second and third quarters of this year as the market has risen some six percent since the end of January.
Unfortunately, the same sort of rebound is not playing out so far. Retail sales have been either down or flat for four of the last five months as the gasoline “tax cut” is not showing up in faster consumer spending outside of restaurant sales getting a boost. Both consumer sentiment and industrial production figures have also recently come in significantly below expectations. Export growth has fallen precipitously due to the strong dollar increasing the trade deficit and lowering GDP forecasts.
The current consensus for second quarter GDP growth continues to be cut and now stands at approximately 2.5%. The Atlanta Fed is calling for just 0.7% growth in the second quarter after nailing its projections for the first quarter. If their current forecast comes through it will mean the economy basically will have flat-lined in the first half of 2015, hardly something the market is pricing in right now.
Greece has been on investors’ radars since 2010 when the possibility of its default and withdraw from the Euro caused major ripples across global markets and was a key trigger point for “QE2”. Since then, the country has continually managed to renegotiate with the European Union, usually at the last minute and everyone is assuming Greece will “kick the can” down the road one more time in current negotiations.
However, the current ongoing discussions in front of the latest debt deadline feels different. The election of the far left party Syriza and their clumsy negotiating tactics along with Germany and others being fed up with yet another bailout makes each round feel more strained than the last. The good news if things actually fall apart, the continent is much better prepared to deal with any fallout. However, if this “Grexit” finally does come to pass it still has the potential to disrupt the global markets, just not to the same extent that it would have in 2010 or 2011.
The market feels like it is at an inflection point right now with no current earnings growth, a poor economy in the first half of the year and falling export growth. This is especially true with the market trading at 18 times trailing earnings and the Federal Reserve no longer in “quantitative easing” mode.
Now is the time to [consider] more heavily weight companies that can sustain increases in both growth and earnings despite the tepid global and domestic economy. Selecting these types of companies whose stock is selling at reasonable valuations is critical to outperforming the market in the quarters ahead.
Buying large cap growth stocks like Gilead Sciences (NASDAQ: GILD) and Apple (NASDAQ: AAPL) while maintaining a good slug of cash within one’s portfolio is the way to go in the quarter or two ahead until investors receive some sort of confirmation that the worries listed have started to recede.
— Bret Jensen[ad#ia-bret]
Source: Investors Alley
Positions: Long AAPL, GILD