The past 7 days’ financial news was enough to keep market connoisseurs continuously occupied, and pretty happy. Among emerging markets, India’s budget release showed a balanced approach to deficit reduction and spending, and China lowered its interest rates to join the rest of the international central bank herd. Meanwhile towards the west, Warren Buffett’s annual letter got dissected, European data showed positive signs, the Dow announced it was adding Apple to the menu, and the US jobs report blew through expectations. Alongside, NASDAQ’s conquering of the tech-bubble mark on Monday was fun to note, but pretty insignificant – considering adjusted for inflation, it’s still nearly 40% off the 2000 peak. All in all, we’re pretty content with where the global economy stands from a long term perspective, but note some temporary caution required. Here are 4 subjects on Wall Street to keep an eye on:
– The onset of rising interest rates: Since 2008, investors have fled to stocks for yield. Friday’s jobs report continues to show stellar growth in employment. We do recognize that wages didn’t grow significantly – but we believe that it’s only a matter of time – and among several data points, BMO Private Bank’s Jack Ablin summarized a key observation very well: ‘strikes at oil refineries, west coast ports, and pay increases at Walmart and TJX are showing that bargaining rights for workers are increasing’. The labor market is tightening, and the Fed’s aims are well on track to being met, in our opinion. All these factors point to a rate hike sooner than later – likely in the summer. As the required return on assets will increase when this happens, future cash flows from companies (used to determine stock prices) will get discounted more, and stocks should, theoretically, come down. A healthy pullback is much needed, and we think the time has come to lower expectations from the S&P 500 for some weeks.
– Private valuations: The frothiness in the private sector continues to worry us. Company valuations, along with young, fast money and real estate price growth in the Bay area, as well as the cyclical nature of the technology industry is leading us to believe that any minor company busts will lead to VCs tightening their belts, and also catalyze consequent pullbacks in the biotech and tech sector. Consider that IBB, the iShares Nasdaq Biotech ETF, is up 12% YTD and has a P/E of 33 (according to iShares). That’s pretty unsustainable, in our opinion, in the short term. While not a major risk, we think this subject is worth keeping an eye on (even more than oil volatility – a subject that keeps dominating headlines).
– Apple’s impact: This magical, life-changing company has enough cash on its balance sheet to make a material reduction in Greece’s debt. As if we don’t love the company enough, how epic would it be for Tim Cook to swoop in and literally save the Eurozone? Anyway, back to the point. With its inclusion in the Dow index starting March 18th, Apple will represent approximately 4% of the Dow and S&P 500 index, and nearly 10% of NASDAQ’s market weight. There’s no hiding from this giant anymore. Historically, the stock hasn’t done much (in the few weeks) after big product launches, and with the iWatch event this week, a pullback for the stock (due to any product disappointment or simply as a breather from its colossal run-up in the past 3 months) could lead the markets down too.
– The Eurozone ahead: We reiterate buying (currency hedged) European stock ETFs; even with the run up this year, the region remains undervalued. The MSCI Europe Index shows a forward P/E of 15.9, compared to 16.8 for the MSCI World Index and 17.6 for the MSCI USA Index. Eastern European PMI data and German manufacturing is showing significant improvement, and inflation expectations are increasing for later this year – countering the threat of deflation. Meanwhile, rising corporate profits from the weak euro and low oil prices should help multinationals in the coming quarters. Bank of America’s Capital Markets Outlook last week noted that ‘the austerity that held back global growth after 2010 is slowly fading, especially in Europe’. Importantly, we note that quantitative easing begins there this week. Bespoke Investment Group had an interesting observation that we can extrapolate to the region: During the multiple initiatives in the US in recent years, the S&P 500 rallied 36.4% during the 1st round of quantitative easing, 24.1% after the announcement of the 2nd round of easing until the end, and during the 3rd round, according to the WSJ, over 25%. Whether QE is good for growth remains a polarizing question among economists, but it has certainly shown to be good for stocks – and we can expect something similar from Europe ahead.
What it means for you: The yellow traffic light is a confusing one – neither red or green; in different countries it either means slow down, or get set to go. But one thing’s for sure – we can think of it as depicting temporary caution – and that’s what we’re taking away right now from the data. In the short term, we see a breather in the S&P 500 – mainly due to the 1st point above. But structurally, the US economy is showing solid strength, making a case for buying on the dips if you want to capitalize on the rebounds. Other than the passive ETFs (such as SPY and VXUS) that we recommend for the long term with the bulk of your assets, we reiterate investing in the consumer discretionary sector, the transportation sector, and Europe for possible outperformance over the market in the coming year. In the meantime, stay invested and in sync with the details on Wall Street.
