2015’s first quarter delivered action packed headlines for the stock markets, and volatility to levels not seen in several months. Policy makers were the key drivers of the market moves, primarily through central bank actions. As we mentioned last week, the concept of measuring an asset purely on economic fundamentals, such as supply and demand, seems as outdated as the Jurassic Era – monetary policies and geopolitics are just as critical for valuing markets at the moment.
Nevertheless, if Jurassic Park can make a comeback (yeah, it’s releasing this summer), so can the markets – and we’ll see if they get back to basics as the year goes on. In our opinion, one can initiate tactical, short-term trades by projecting policies, dissecting investor sentiment, and through timing. For sustainable returns in the long term, however, we believe that any investment needs a solid fundamental thesis. So, our approach is to find investment ideas that are undervalued due to short term mispricing, and then invest in them for the long term. With that background, here’s a recap of where we find ourselves at the end of the first quarter of 2015:
Macro: Our favorites outlined in January, including India (+2.8%), Germany (+22%), Indonesia (+4.4%), the Philippines (+10.5%), Mexico (+2.5%), and South Korea (+6.8%), have delivered solid returns in Q1. Albeit in local currencies, again, we feel strong fundamentals are on each country’s side for the long term, with favorable demographics and domestic growth potential – and therefore, our attempt is to disassociate from currency risk – as in the long term, the comparative advantages from each economy will balance out. For Q2, we’re adding France, Spain, and Greece to our watchlist, along with Nigeria – which we’ll be writing more about next week. We had also projected that WTI crude oil would bottom in the low $40s – we think this support level will hold, but at this point, it is of limited importance, as the stocks and sectors affected are already at bargain levels. The dollar will continue to remain strong in light of central bank actions worldwide, and we believe companies less impacted by international revenues will remain sheltered, and outperform those that look beyond the borders.
The United States Economy: In January, we outlined our two compelling questions for the year: Would wages grow, and would capex increase?
Following the cues from America’s largest employers – including Walmart and McDonald’s, we think the answer to the 1st question is yes, given solid data as well from small business sentiment, commercial lending, and increasing [voluntary] quit rates; for example, the ‘hard to fill [positions]’ rate is at approximately 30% – nearly the highest in a decade, according to Bloomberg Businessweek. Regarding capex, we’re not yet seeing a clear direction, although we reiterate that companies are capable of spending due to the strength of their balance sheets, but are just waiting to pull the trigger – again, due to uncertainty in policies ahead. It’s also worth highlighting that the personal savings rate in the US hit multi-year highs at 5.8% in January, per CNBC – meaning the savings from low gas prices are not translating into spending – yet. It’s a question of when, and we reiterate investing in our favorite sector for the year – Consumer Discretionary – via XLY, which, up 5% so far, is still undervalued in our opinion.
It’s also worth noting a structural change that we believe is flying under the radar. The baby boomer workforce is transitioning to the millennials – and consequently, the hierarchy, stability, and long-term relationships that drove employee loyalty and defined the S&P 500 titans over the past 3 decades will give way to the entrepreneurial, disruptive, non-binding mentality that millennials bring. Consequently, companies will need to adapt, and we think reducing their size and tailoring their business segments will be high on their priority list. Spin-offs, M&A activity, and greater employee ownership will occur during this transition, and the financial sector (via XLF), will reap the benefits, among other reasons outlined in our column on February 8th. So far, this sector is underperforming the S&P 500 and is down 2% this year – the bargain continues, and we reiterate buying this with a 1-2 year horizon.
Stock Market Activity: In January, we outlined increasing activism and volatility as among the important themes to watch for this year. So far, the two remain on track – activist funds continued to thrive in first quarter, as saturated markets, low bond yields and sluggish global growth kept investors scouring for returns. Meanwhile, as we projected in January, the heightened volatility has led to actively managed funds returning 2.8% in Q1, according to Lipper, significantly outperforming the S&P 500’s 0.9% return. Also, seeing how passive ETFs continue to grow in popularity, there’s a case to be made for the market getting dumber – indicating more asset mispricing as investors buy and sell in bulk. Our projection is that active management’s outperformance, along with volatility, will increase as the year goes on in light of potential interest rate hikes in the 2nd half of the year.
What it means for you: The first quarter delivered some serious news, but little change in the US markets, with the S&P 500 returning 0.9%. The MSCI World Index was up over 2%, indicating opportunities continue to exist globally. We’ve set ourselves up for an extremely interesting span ahead, with monetary policy decisions and consequent investor over-reactions defining the landscape. The key, in our opinion, will be to keep our cool while others don’t. Being part of the smart money is sometimes alot simpler than you may think. Stay invested, think long term, and get ready to pounce with us on the pieces of fine art that get thrown out with the kitchen sink as the bulls and bears enter the rink on Wall Street in the coming weeks.
