George Hosfield, CFA, discusses Ferguson Wellman's quarterly strategy titled, "Inflation's Flame Flickers," which addresses the narrow market leadership, the impact of higher interest rates on inflation and how assets are priced at this stage of the economic cycle.
George Hosfield, CFA, discusses the firm's quarterly strategy titled "Stalemate," which highlights the Fed's ongoing battle to tame inflation along with our views on the health of the banking industry and capital market expectations for the balance of the year.
Director and Chief Investment Officer George Hosfield, CFA, discusses the Fed raising interest rates, peaking inflation and our view on equities and volatility across all asset classes in our Investment Strategy titled, “Balancing Act.”
The U.S. government has endorsed a “strong dollar” policy for much of the last thirty years. Besides sounding much better than the alternative, this messaging has reminded markets that the U.S. dollar remains the world’s reserve currency, despite frequent projections of its demise or threats to its dominance.
Shawn Narancich, CFA, shares our thoughts on the issues of oil supply and demand and our outlook for the energy sector.
Our initial U.S. economic outlook has generally played out as expected this year: continued (albeit slower) economic growth, persistent inflation, interest rate hikes and increased market volatility. However, Russia’s invasion of Ukraine was an unexpected significant development that further elevated market volatility and dampened the global economic outlook.
The second quarter 2022 issue of Market Letter, our quarterly investment publication, titled, Kryptonite.
Chief Investment Officer, George Hosfield, CFA, discusses our second quarter Investment Strategy titled, “Kryptonite.”
With an eventful first quarter now in the history books, we can safely say that the elevated levels of volatility that we predicted for 2022 are now in play.
Our 2022 Investment Outlook features the Superman and Clark Kent theme, a metaphor referencing past extraordinary economic stimulus provided by the Federal Reserve and the U.S. government during the COVID-19 pandemic, as well as the supercharged earnings growth that served as a key tailwind for stocks last year.
While news coverage is understandably focused on the devastation in Ukraine, we remain keenly focused on the fundamentals of the U.S. economy and the companies we follow. We realize that during times of stress markets become disconnected from the underlying fundamentals of the economy, but just like water always finds its equilibrium, markets similarly return to the fundamentals.
The geopolitical situation between Russia and Ukraine remained atop the headlines this week and without a doubt have had a material impact on the capital markets.
by Jason Norris, CFA
Executive Vice President of Research
Recent weakness in the S&P 500 has led to a lot of chatter regarding the inevitable pullback in equities. While the last few weeks have exhibited some weakness, stocks are still up close to 5 percent, year-to-date. While the United States continues to show improving growth, as seen in recent jobless claims and the Purchasing Managers Index (PMI), global political affairs have wound the markets tight. Russia continues to make noise in the Ukraine while the Middle East is demonstrating that nothing has (nor will) changed for decades. This uncertainty coupled with growth concerns in both China and Europe has led to a rally in bonds as well as a minor sell-off in equities.
The 10-year Treasury now yields just above 2.4 percent, which is the lowest in over a year, as global investors flock to the U.S. dollar and park cash in “risk free” assets. This flow of funds has resulted in weakness in equities. U.S. equities are down close to 4 percent from recent highs which have led to some talking heads focusing on an impending sell-off. However, these 2 to 5 percent pullbacks are normal in bull markets. For instance, over the last 30 months, we have seen nine 2+ percent pullbacks, but the S&P 500 is up over 60 percent in that period. What we continue to watch is improvement in the U.S. economy, growing corporate revenues and reasonable valuation. The current environment is favorable for all of those.
Messin’ with a Hurricane
This week brought the first hurricane to the Hawaiian Islands in 22 years, as well as a “storm of headlines” regarding U.S. companies relocating offshore. The equity market was not too happy with Walgreens’ decision earlier this week not to seek a “tax inversion” with its pending acquisition of Alliance Boots in Switzerland. While domiciling in Switzerland would have saved Walgreens billions of dollars in tax expenses, the company decided stay committed to the state of Illinois. There is speculation that the Obama administration’s use of the bully pulpit was a key factor in management’s decision to continue to pay higher taxes. We believe that an inversion would be more difficult for Walgreens to pull off since most of their revenues are generated in the U.S., thus no offshore cash to repatriate. On the other hand, companies like Abbvie and Medtronic have meaningful amounts of international business, thus their “inversion” acquisitions (Shire and Covidian, respectively) would be easier to justify.
What this recent trend highlights is the need to restructure the U.S. tax code so companies can be more competitive globally. While many of these deals may still be pursued, the tax savings is a key attribute in the overall structure. What can’t get lost in the noise is that although U.S. companies may change their mailing address, they will still bring their offshore cash back to the U.S. and reinvest domestically. With a mid-term election this year, major tax reform may not happen at least until 2015, and possibly not until after the 2016 presidential election.
Too High to Fly
A few weeks ago, the state of Washington started selling recreational marijuana which coincided with the cracking of the high-yield bubble. High-yield bonds have been a strong performer over the last several years; however, like stocks, the month of July hasn’t been friendly to the high-yield market. Spreads have started to increase in the face of lower Treasury yields. This culminated with over $7 billion exiting high-yield funds last week. We don’t believe this is a “canary in the coal mine” with respect to corporate America; however, we are watching it closely. High-yield bonds are trading at historically tight levels, just over 3 percent above Treasury yields, as investors seek income. The long-term average spread has been close to 6 percent higher than Treasuries. Therefore, we would not be surprised if that market continues to show poor performance as we revert back to the mean. While, there are times we may venture into lower rated bonds, we believe that the market as a whole is a bit rich and would wait for spreads to widen further before we allocate additional capital.
Our Takeaways for the Week
by Jason Norris, CFA
Executive Vice President of Research
Take Me to the Top
The most common question we have been getting as of late is when is the market pullback going to occur? Stocks are up over to 200 percent from the March 2009 bottom and 75 percent from the most recent market correction (of 15 percent) in October 2011. While it has been almost three years since a major correction, history has shown this trend can continue for quite a bit longer. To that point, Cornerstone Macro Research gathered some data on previous market pullbacks which are highlighted in the chart below.
History shows that there have been numerous periods of much longer durations when stocks have climbed without a major pullback. If you simply look at the fundamentals of the stock market, an argument can be made that the S&P 500 can continue to move higher without a meaningful pullback. First, U.S. economic growth is improving and global GDP should continue to trend in the mid-single digits, resulting in continued earnings growth. Second, with low inflation and low interest rates, the valuation of the equity market is still attractive and the Price-to-Earnings multiple of the S&P 500 still has room for upside from 15.6x at present. While there will always be unforeseen shocks, the risks in the system are not as predominate as we saw in 2011 (Europe debt crisis, U.S. debt downgrade, Fiscal austerity) or 2000 (stretched valuation, falling consumer sentiment, manufacturing data weakening). However, risks that investors should be cognizant of are a spike in oil prices due to Middle East tensions, China’s economic growth slowing meaningfully, and an adverse reaction to Federal interest rate hikes in 2015.
What Do You Do For Money?
Earnings kicked off this week with mixed results from large cap technology. Specifically, there was divergence within the internet ad space, with Google growing and Yahoo stagnant. One wonders how long the Yahoo board will give CEO Marissa Mayer to achieve the turnaround. Intel delivered a strong quarter due to PC upgrades primarily from businesses as Microsoft sunsets its client support for Windows XP. This strength is allowing the company to return cash to shareholders through an announced $20 billion repurchase plan. While Intel stock reacted very favorably to the announcement, it was disconcerting that their mobile business continues to underachieve. This division lost over $1 billion while grossing a mere $51 million in revenue (down from $292 million a year ago). Intel’s move into this area looks to have been a failure which leads us to speculate where they will have to make an acquisition in order to penetrate the market.
Takeaways for the Week
by Tim Carkin, CAIA, CMT
Senior Vice President
Divergent
This week the market is showing some interesting divergence. The S&P 500 performance is paltry, nearly flat on the year. Technology, biotech and consumer discretionary sectors, which are more heavily weighted in the NASDAQ, started selling off heavily last week leaving the NASDAQ down more than seven percent year to date. This week small cap stocks, which had been performing admirably, sold off more than four percent and are now negative on the year. Citigroup, Morgan Stanley and other large financials also sold off heavily after the Fed’s latest stress test results. On the plus side, emerging market stocks rallied significantly this week in hopes of new Chinese stimulus.
Need for Speed
A few good economic readings came out this week. Last month’s Q4 GDP number was revised up to an annualized 2.6 percent from 2.4 percent. This came as consumer spending in February rose by the most in three years and jobless claims declined last week to the lowest level in four months. Personal consumption expenditures (PCE), a favorite economic indicator of past Fed Chairman Bernanke ticked up 0.1 percent in February. Lower jobless claims and a low inflation rate give the Fed a little cushion to work with when considering stimulus and rate increases.
Rise of an Empire?
The constant media attention of developments in the standoff between Ukraine and Russian is weighing on the market. We did get good news on that front in an announcement from the IMF of $14-18 billion in aid. In addition, our Senate approved $1 billion in loan guarantees and the EU promised more than 10 billion euros in the next few years. On the other hand, Yulia Tymoshenko, former Prime Minister of Ukraine, announced her candidacy for president. This ensures the standoff will remain in the news through the Ukrainian elections on May 25th.
Takeaways for the Week
Treasuries Hold Losses as Ukraine Tension Eases Before Jobs Data By Kevin Buckland and Mariko Ishikawa
The yield on benchmark 10-year Treasuries maintained the biggest gain since November amid speculation the crisis in Ukraine will ease, and before U.S. data this week forecast to show employers stepped up hiring.
Australian and Japanese government bonds retreated after Russian President Vladimir Putin said yesterday that there’s no immediate need to invade eastern Ukraine, limiting demand for havens. Treasury 10-year yields rebounded from a one-month low, surging back above their 200-day moving average after dipping below the mark this week for the first time since May.
“If the Ukraine situation de-escalates further, we should see higher rates, and that’s what we’re expecting,” said Marc Fovinci, head of fixed income in Portland, Oregon, at Ferguson Wellman Capital Management Inc., which has $3.5 billion in assets. “There’s still a risk-aversion premium in Treasuries.”
The U.S. 10-year yield was little changed at 2.69 percent as of 6:51 a.m. in London from yesterday, when it rose 0.1 percentage point, according to Bloomberg Bond Trader prices. The 2.75 percent note due February 2024 traded at 100 17/32.
Yesterday’s jump in 10-year yields was the biggest on a closing basis since Nov. 8. They touched 2.59 percent on March 3, the lowest since Feb. 4. A break above 2.7 percent would “mark a near-term yield base,” Credit Suisse Group AG analysts David Sneddon and Christopher Hine wrote in research today.
Australia’s 10-year government bond yields rose for a second day, climbing six basis points to 4.06 percent after the nation’s economy expanded faster than estimated. Japan’s 10-year benchmark yield rose one basis point to 0.61 percent.
Crimea Crisis
Russia would use the military only in “an extreme case,” Putin said in a press conference yesterday, signaling the crisis that provoked a standoff with the West and roiled global markets won’t immediately escalate.
Russian intervention in Crimea, which the U.S. condemned as a breach of Ukraine’s sovereignty, sparked demand for bonds of developed countries from the U.S. to Japan for their perceived safety, overshadowing the prospect of higher yields as the U.S. recovery gathers pace.
Treasuries are on track for their best quarter since the three months that ended in June 2012 after turmoil in emerging markets from Argentina to Turkey spurred demand for haven assets. The Bloomberg U.S. Treasury Bond Index (BUSY) has gained 1.8 percent since the end of last year.
U.S. Jobs
U.S. employers hired 150,000 workers in February, after adding 113,000 in January, according to a Bloomberg News survey before the Labor Department releases the figures on March 7. A report from ADP Research Institute today will show companies boosted payrolls by 155,000 last month after an increase of 175,000 in January, a separate Bloomberg poll estimates.
Employment gains for December and January were both less than economists forecast, depressed by winter storms.
“There’ll be some pretty severe weather impact on payrolls, making it another month of hard to interpret numbers,” said Ferguson Wellman’s Fovinci. “There are no roadblocks in the way of economic growth that we’ve seen.”
Federal Reserve Chair Janet Yellen reiterated on Feb. 27 that the central bank is likely to keep curtailing its stimulus. The central bank said on Dec. 18 it would trim its monthly bond purchases to $75 billion from $85 billion, before cutting by another $10 billion in January. The purchases are designed to hold down long-term borrowing costs and spur economic growth.
