Back in Business Again

by Jason Norris, CFAExecutive Vice President of Research

Back in Business Again

It has been a volatile year for equities and as we head into the holiday season, that doesn’t look to dissipate. After the 12 percent sell-off investors went through over the past few months (Fed rate hike concerns, China market crash, Greek debt issues and the constant geo-political flare-ups), the S&P 500 has rallied back, culminating with its best week of the year. While 2014 proved to be a narrow market, 2015 is even more so. When you look at the 10 largest U.S. companies (see table below), you notice the majority of them, have enjoyed significantly greater returns than the 3 percent for the S&P 500.

Source: FactSet data through Nov 20, 2015

What is even more dramatic is that three stocks were responsible for all of this return: Amazon, Alphabet/Google and Facebook.

There have been prior periods of large cap driven markets, coupled with a handful of names driving that performance. But what we have experienced this year is less than a handful of mega cap names delivering all the index returns.

One thing to note on this narrow focus is the emphasis on “growth.” The sell-off we experienced this summer was a classic “growth” scare. Investors believed that due to the strong dollar and the slowdown in China would cause global economic growth to slow. While we’ve seen some stabilization in the equity market, there is still concern over global economic growth. As such, investors have been willing to “pay up” for growth companies and avoid cheaper names that are tied to the face of economic growth. For instance, the three stocks mentioned earlier trade at substantial premiums to the overall market.

Source: FactSet data through Nov 20, 2015

Investors are paying a lot more for a  dollar of earnings for a select few names due to the concern over growth. This has resulted in growth stocks returning roughly 7 percent this year, while value stocks are down 2 percent.

Takeaways for the Week:

• Different “styles” can come in and out of favor, the key is to remain focused on the long term and not chase short-term performance
• As the global economy improves, value stocks should regain some leadership in 2016

Our Takeaways for the Week

Disclosures

Mind the Gap

by Jason Norris, CFAExecutive Vice President of Research

Volatility in the second quarter reigned in both equity and bond markets. Interest rates rose close to half-of-a–percent, resulting in negative returns for bonds. While U.S. equities were volatile, they ended the quarter relatively flat. International markets were roiled in June with China equities moving into bear market territory following a parabolic run and as for Greece…

In the face of this uncertainty, we are still constructive on equities for the back half of 2015. The U.S. economy is slowly improving. Excluding energy, corporate profits should still exhibit high single-digit growth and equities are still relatively inexpensive. Therefore, with the Fed set to raise interest rates later this year, bonds will continue to face a headwind, thus equities warrant an overweight versus fixed income.

While headlines reported a healthy increase of 223,000 new jobs in the month of June, analyst expectations were a bit higher. Also, previous reports were revised lower and the labor participation rate declined, which resulted in a lower unemployment rate of 5.3 percent, which is a seven year low.

One of the major disconnects in the job market is that there are close to 5.4 million job openings currently in the U.S. This is the highest level we’ve seen since January of 2001. We believe this will provide a tailwind throughout 2015 in the labor market.

There are a lot of mixed data in Thursday’s report that can help us assess if it’s too hot, too cold, or just right. Therefore we do believe that our call that the Fed will raise rates later this year has not changed.

Grexit, Greferendum, Grapituation and Gratigue

Frankie Valli sang it best in 1978, “Grease is the word.” After missing a payment to the IMF on June 30, Greece headlines have rattled markets in the last few weeks and that volatility are here to stay with the possibility of a pending referendum on July 5 and a debt payment due to the ECB July 20. The key issue we are focusing on include whether or not the Greek contagion will affect other nations in southern Europe. Whether we have yet to see if the Germans will let the Greeks leave the Eurozone or if they will be “hopelessly devoted.” What has changed since 2010 is that Greek debt is now held by government agencies, such as the IMF and ECB, not banks. In 2010, 140 billion euros of Greek debt was held by global banks, with over 100 billion of that amount being held by European banks. The amount held by banks has dropped by over 100 billion with the European banks, on the hook for less than 20 billion.*

We don’t want to handicap the pending referendum (on whether vote for or against austerity) by the Greek people and current polls show a dead heat. What we do believe is that volatility will continue in July, fueled by Greece and earnings season; however, by year-end this Greek drama will be in the rear-view mirror.

Our Takeaways for the Week

• U.S. economic growth is improving and corporate profits will follow suit
• Greek headlines are just that, more headline risk than fundamental risk to the global markets

*Euro to US Dollar exchange rate was +0.13367 percent at time of publication.

Disclosures

Take Your Time

by Ralph Cole, CFA Executive Vice President of Research

Take Your Time

Greece and Euro Area finance ministers reached a tentative agreement Friday to buy time for Greece to get their financial house in order. The EU has agreed to provide liquidity for up to four additional months if Greece provides a sufficient list of measures they are willing to undertake.¹

Greece will have a primary budget surplus in 2015 which means they will have a budget surplus - if you don’t count debt payments. While this may seem unrealistic, it does mean the Greek government could continue to operate if they stop paying their creditors. However, this would not be in the best interest of anyone. Greek bonds would drop in value, as would some of the bonds of other peripheral countries. This situation is known as financial contagion. Greece in and of itself is not a huge economy (it is approximately the size of Indiana), but the world is trying to judge the effectiveness the European Union. Can they hold it together?

We believe that the EU can indeed keep it together in the near-term. In the future, it may be in the best interest of some countries, Greece as one example, to move out of the Eurozone. If a country finds itself politically unable to work within the confines of the European Union, they may want to exit the agreement in order to control their own budgets and currency. The EU would rather have this happen during a time of strength, rather than at a time of ongoing economic stress.

Waiting on a Friend (Fed)

The Federal Reserve board meeting minutes were released Wednesday and markets deemed them to be dovish; meaning that the Fed is afraid of raising rates too soon and choking off a fragile recovery. The surprise to us is that people continue to refer to this as a recovery. Both U.S. GDP and the S&P 500 are at all-time highs and the U.S. passed through recovery territory years ago. While nothing is a foregone conclusion, we believe the Fed will raise rates later this year. There will be a lot of hand wringing over the first Fed rate hike (there always is), but we believe the economy is on very sound footing and can handle higher rates. While it could happen in June, it will most likely happen in the second half of the year. This topic will be discussed ad nauseam throughout the year, but we view tightening as a positive. A rate hike will be a signal to the markets that the financial crisis is officially behind us and extraordinary measures of liquidity are no longer needed.

Takeaways for the Week:

• The Greek debt story is not over, but they do have more time
• We expect the Fed to raise rates later this year

¹ Source: Bloomberg

Disclosures