Assumed to be postulated by Aristotle, “horror vacui” roughly translates to “nature abhors a vacuum.” The financial market equivalent would be “horror incertae,” or “markets abhor uncertainty.”
Markets Abhor Uncertainty
Opening for Business
Following a stimulus-induced surge from March lows, blue-chip stocks that had mounted over a 30-percent advance have consolidated gains so far in May.
"The Bad News Won't Stop but the Markets Keep Rising"
“The Bad News Won’t Stop, but Markets Keep Rising,” read the headline of the business section of the NY Times this week. I have received many questions from many clients and friends over the past couple of weeks regarding this notion.
Market Letter First Quarter 2015
Please click here to find our Market Letter First Quarter 2015. We hope you find our economic insights interesting and informative.
Exit Stage Left
by Jason Norris, CFA
Executive Vice President of Research
Exit Stage Left Wednesday’s release of The Federal Reserve’s meeting minutes raised more of a hawkish tone. On the surface, the minutes may be viewed as negative; however, due to an improving labor market and an indication of a better growth environment we would welcome an increase in the Federal funds rate next year. As expected, the Fed did formally end its quantitative easing (QE) program with its final active purchase of mortgage-backed securities and government bonds. This is a positive sign for the equity markets and the U.S. economy at large. Coincidentally, U.S. Gross Domestic Product (GDP) data was released this week showing a solid 3.5 percent growth rate, which was better than most expectations. Our forecast has been for the U.S. economy to pick up steam throughout the year, and this data has confirmed that call. This information has supported stocks, yet it has a minimal effect on the bond market with the 10-year treasury yielding 2.3 percent.
Signals Third quarter earnings reports have reinforced our belief of continued economic growth. Seventy percent of the companies in the S&P 500 index have reported earnings to date and the results have shown year-over-year earnings-per-share growth of nine percent and revenue growth of four percent. Healthcare and technology companies have led the way with higher reporting of 11 percent and nine percent top-line growth, respectively. These are two sectors we favor in our equity strategies. These positive earnings reports have enabled stocks to reclaim their footing in this bull market. From the recent all-time high in September, the S&P 500 fell 10 percent over the subsequent four weeks. However, in the last two weeks we have seen a nice snap back with equities sitting just below the record of 2020 set on September 19, 2014. At current valuations (the market is trading 15.5x forward earnings) and with the strong earnings we are witnessing, we continue to favor stocks over bonds.
Different Stages The quarter’s earnings season has not been friendly to the higher growth, momentum stocks. Last week Amazon “cautioned” investors that they are going to reinvest more money into “growth”. Historically, this wouldn’t have been viewed very negatively but it seems investors may be getting impatient for their return on investment as the stock declined by almost 10 percent. Over the last 10 years, Amazon’s profit margins have fallen from six percent to under one percent, while the stock has been a stellar performer. It looks like investors are shortening the leash. Twitter suffered a similar fate this week. Twitter’s growth metrics (advertising, users, etc.) were disappointing, resulting in a 20 percent decline this week. The overall growth of the company is still strong, but investors may be getting anxious when they are paying over 100x future earnings. While many of us are big users of both of these companies’ services that does not make the underlying stock a great investment. Investors need to make sure that the price they are going to pay for future cash flows allows them to earn a competitive return. We just don’t see that in these two names at this time.
Our Takeaways for the Week:
- U.S. economic growth is improving which will lead to the Fed raising the funds rate earlier rather than later
- Third quarter earnings growth is healthy which supports a reasonably valued equity market
Early Christmas Gifts
by Shawn Narancich, CFA
Executive Vice President of Research
Early Christmas Gifts
In what turned out to be a surprisingly action-packed week before Christmas, the markets finally shook off the shackles of worry concerning what would happen when the Fed began tapering its program of quantitative easing (QE). Bernanke proved that he’s no lame duck chairman and investors learned that stocks can still go up despite a slightly less accommodative Fed. In reducing monthly purchases of Treasury and mortgage-backed bonds by $10 billion per month, our central bank is acknowledging a slowly improving labor market and an expanding economy that is being boosted by several key drivers: a renaissance in U.S. energy production and manufacturing and, increasingly, the wealth effect of rising house and stock prices that is giving a nice lift to consumer spending. Looking ahead, we expect incoming Fed Chair Janet Yellen to continue what Bernanke started. Our view is that further reductions to QE will be commensurate with continued improvement in labor markets, subject as always to the Fed’s other key mandate—keeping inflation low.
Always a Bear Market Somewhere
In stark contrast to stock prices that are once again setting new highs, gold prices have fallen substantially. After attracting increasing amounts of attention as a hedge against monetary dislocation and unchecked growth in the money supply, gold is increasingly being abandoned by investors now more attracted to robust stock market returns and, for those with a lower risk tolerance, bonds that are now offering real rates of return. From its high in August 2011, gold is now down 36 percent. It may be pretty to look at, but with the Fed now in the early stages of unwinding QE, it has lost its shine.
Blue Burner
Sticking to the commodity theme, one key source of energy whose price is going the opposite direction is natural gas. Much maligned by investors because of its seeming ubiquity, the front-month contract is up 31 percent since August. Cold weather has boosted the demand for natural gas, one of the nation’s most common sources of home heating. Weather vicissitudes aside, we like the longer-term demand case for the cleaner burning fuel to take market share of electricity generation from its dirtier cousin coal. Will gas currently priced for $4.40 per-million-BTUs go to $5.50? In the short-term, probably not, because the prolific shale fields in Pennsylvania, Wyoming and Texas will induce considerably more production if prices continue to rise.
Nevertheless, key suppliers can make a lot of money with natural gas prices in the $4.00 to $5.00 range. More importantly, our economy should increasingly benefit from using low cost natural gas and natural gas liquids to generate cheaper power and manufacture plastics. In the latter case, low cost ethane, propane and butane feedstocks are displacing oil-based naptha, incenting major chemical companies like Dow and the petrochemical arm of Shell to locate plastic manufacturing facilities stateside. The beneficial result for America is new jobs, additional exports, and healthier levels of GDP growth.
In this festive season, we wish all our friends and clients a Merry Christmas and a very happy and healthy new year.
Our Takeaways from the Week
- Investors took the start of Fed tapering in stride, as stocks rallied to new highs
- A continued flow of encouraging economic data points to faster GDP growth in 2014