You may want to turn some lights on, because it’s looking pretty bleak on Wall Street right now.
With markets caught in the hands of policy makers and speculators, we’re finding a significant lack of direction in the short term ahead. The start of earnings season was a breath of fresh air this week; with Alcoa and other financial heavyweights reporting, the outlooks didn’t just sound good, but were also a relief from the daily press-conference drama that Wall Street has gotten addicted to these days. This week, we decided to take a step back and summarize the complexity – if such a thing is even possible – of the world’s capital markets. Here are some points worth keeping in mind as we attempt to steer through the chaos:
– Chinese stocks skyrocketed for some weeks, and then slammed the breaks on Friday when regulators decided to curb margin trading, in order to reduce bubble risk. Combining this with the ongoing GDP growth slowdown, read that sentence again – it’s a bit scarier than it sounds. Bubble risks being curbed by regulators, via margin trading? At what point did fundamentals and stock prices decouple? We’re waiting to find out. China has tremendous market potential, but as we mentioned in January, this is a rally we’re comfortable sitting on the sidelines for until markets become a bit more transparent. Continued downturns could catalyze an emerging sector pullback, and we’ll be keeping an eye on news from this region moving ahead.
– Meanwhile, the Eurozone’s chugging faster by the week – with QE being declared as a success by Draghi (hey, we have no complaints!), GDP growth rates are increasing, confidence indexes are higher, and the weak Euro continues to aid exports. Then comes a newswire stating Greece’s payment is due next week, and the markets collapse.
When will this drama end?
Steve Forbes’ commentary this month summed it all up – ‘such a move [by Greece to exit] the Eurozone would, perversely, be welcome by European governments’, as it would be an object lesson for Greek voters. As Wall Street’s banks work behind the scenes to restructure debt and policy makers grind it out, we reemphasize staying invested in the Eurozone’s structural change story, and to avoid panicking if short term turmoil hits due to a Greek exit. We’re hoping for a conclusion soon, preferably by ripping the band-aid off – whatever the decision – so markets get some clarity.
– Meanwhile, in the US, with unemployment rates reaching Fed target levels and inflation showing some signs of increasing (core prices have climbed 1.8% over the past year, according to the WSJ), the impending rate increase remains front and center on Wall Street’s minds. It’s worth remembering that the writers at Barron’s, this week, pointed out the horror stories from Japan, where continued low rates – that were meant to stimulate economic growth – led people to save more than spend (the opposite of the desired effect), and consequently rendered monetary policy pretty much useless. The polarization seen between the finest minds in economics on the current monetary policy is just unbelievable, as is the complicated nature of predicting the outcomes. As a result, we reemphasize focusing on sectors decoupled from this – and those include both small caps, as well as growth stocks, for reasons noted in our 4/13 column.
What it means for you: The world’s markets continue to be driven by press conferences and policies more than corporate performance and economic growth. The Bank of America’s Capital Market Outlook this week states that ‘stocks look attractive in relative terms‘. The word ‘relative’ is key in our opinion – where else would you get any yield? Per Fidelity’s Business Cycle Approach, the energy sector outperforms during a late business cycle phase. However, if we start seeing an oil price increase and a consequent energy sector outperformance, is there a reason to be worried? We think not. Our approach is for the long term, and due to the conditions described above, we’re looking at practically the most unconventional market in recent history, in our opinion – and therefore, conventional theory in tackling it gets thrown out the window. Trying to time the market and outcomes today means essentially betting on people, rather than stock fundamentals or structural themes. That’s not our style. Also, at this point, we really can’t say Wall Street didn’t warn us of short term turmoil when interest rates do move up. Per our posts on 2/8 and 2/1, we emphasize financials and consumer discretionary stocks respectively, along with the energy sector, as 1-2 year plays. Alongside, our opinion is that Germany will play a much bigger role than expected in the coming months in driving world economic growth; we’ll be elaborating on this point in detail next week. Importantly, the critical role of capital markets in shaping society keeps us optimistic. All roads end up in the same direction if you stay invested – and we believe there’s significant light ahead. In our opinion, financial markets are too smart for short-term policies or people to distract them from their long run objectives. Therefore, we’re going to keep focus on the ongoing earnings season, while drowning out any chaos. Our recommendation? Watch the details as companies report earnings to dissect their underlying business strength, and keep cool while policy makers and speculators battle it out on Wall Street in the coming weeks.
