It’s interesting – a single word was predominantly responsible for billions of dollars moving worldwide within a matter of seconds as Janet Yellen delivered the Fed statement in Washington on Wednesday. Shakespeare would have been proud; valuation professors in MBA schools may want to consider adding ‘English’ to the curriculum along with DCF, comparables, etc. on how to value stocks, considering the way the markets have reacted to official statements these days.
Anyway, enough fun on the subject – the path is clear to start focusing on economics and company fundamentals again, given an accommodative Fed policy for the next few months. We recommend caution and a long term approach due to three major observations: monetary policy divergence worldwide is causing unsettling capital flows, extremely volatile oil prices are providing no real clarity on direction, and we’re in a delicate situation where markets are fairly valued and the same trades are now being discussed by everyone (long dollar, long Europe, long Apple, etc.). It’s a good time to take a step back and think; possibly take some chips off the table if you’re thinking short term gains, but definitely stay invested for the long term due to fundamental economic strength. Here are two subjects we’re looking into the details for this week:
– Commercial lending: The 2008 crisis completely changed the horizon for high risk lending by banks. Given the new Dodd-Frank regulations and balance sheet reduction requirements, obtaining loans has become noticeably more intense for small companies looking to get off the ground. However, there’s an interesting situation forming to deal with this. Highlighted by the WSJ this week, Goldman Sachs, Credit Suisse, and other banks are now forming specialty lenders known as ‘business development corporations’ – through which they can now lend in a more efficient way to small companies with no credit ratings – ‘one of the fastest growing segments of the US market’, according to the paper. Does this method have the potential for bubble creation, similar to the 2000s, where poorly-vetted sub-prime mortgages laid the foundations for disaster? Sure. But remember – small businesses (with less than 500 workers) employ close to 90% of the US labor force, according to the Small Business & Entrepreneurship Council. Keeping this sector moving is pretty critical for the US – and with obtaining loans as difficult as is, we’ll take whatever we can get. Meanwhile, according to JP Morgan’s ‘Eye on the Market’ report, commercial bank loan growth is also accelerating – at nearly 8% YoY in 2015, rising steadily since the depths of -10% in 2010. The bottom-line: Small businesses can succeed if they get capital – and it’s looking like they slowly are. Our favorite proxy for domestic small cap growth is the Russell 2000 index – we reiterate our recommendation from earlier this year that the IWM ETF remains a good place to be, given domestic economic strength, increasing capital access for small businesses, and shelter from volatile currency movements.
– Biotechnology: Since we recommended this field earlier this year, the sector (represented by the IBB ETF) is up over 15% – in less than 3 months. Our opinion is that this is not a bubble; the field is literally one of the only ones showing solid growth potential – and that’s why the market has been clamoring to get into it. Take the example of last week’s Alzheimer’s breakthrough by Biogen – it’s pretty fascinating to know that such breakthroughs could completely alter lives. Ask yourself the question – if you have millions of dollars, what else would you want (for yourself)? We’re betting living longer is a thought that has entered several peoples’ minds. It certainly has for noted venture capitalists like Peter Theil, who’s aiming for 120 years, according to Bloomberg. The biotech sector is red hot for capital, and while such short term parabolic returns may signal potential correction, you know the quest for longer life expectancy and better health is not going anywhere. Stay invested for the long term – we have solid expectations that it’ll pay off.
What it means for you: As the Fed meeting dust clears, stocks have some room to run with the accommodative monetary policy, but stay prepared for significant volatility given potential interest rate hikes later in the year. Frankly, with the immense impact of such meetings on valuations, predicting short term returns is nearly meaningless, in our opinion. We reiterate watching and investing in structural trends such as the ones mentioned above and in our columns below by looking at least 2-3 years out, while investing the bulk of your money in passive ETFs such as SPY and VXUS. Keep looking into the details while thinking big picture, and be part of the smart money by winning in the long term on Wall Street.
