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.”
As we enter the final stretch of the college football season, the quote, “Not so fast, my friend,” from ESPN’s College GameDay analyst Lee Corso, accurately captures the week’s capital markets events. After a weaker-than-expected October jobs report and the U.S. Federal Reserve leaving rates unchanged, investors are confident the Fed is done raising interest rates and have quickly shifted their sights to the first rate cut.
In an otherwise quiet week on Wall Street, the benchmark S&P 500 turned the page on one of its longest-running bear markets. Rebounding by over 20% from its October lows, the blue-chip index has officially surpassed the threshold marking a new bull market. What is notable about the advance from last fall’s lows is how few stocks have participated in the upturn.
As long-term investors, we were pleased to see market news pivot away from last week’s GameStop mania and shift back to a focus on fundamentals. Although we prefer rational markets, we take no pleasure in the knowledge that many retail investors who purchased GameStop at more than $300 per share have seen the share price tumble to around $60.
This week, the conversation around the virtual water cooler centered on the unexpected and meteoric rise of GameStop’s stock price. The movie-worthy combination of hedge funds, internet forums and a 2,700 percent stock price jump culminated in worldwide news headlines and questions from our clients. Most notably, clients are asking: What is going on with GameStop and how is this impacting the rest of the market?
Today’s Bureau of Labor Statistics jobs report spotlighted the difference between Wall Street and Main Street. The net loss of 140,000 jobs in December, driven by the loss of 372,000 restaurants and bar workers, was balanced by the increasing employment in other sectors of the economy, notably the manufacturing sector. These sectors continue to heal from the wrenching effects of the pandemic that took hold in last year’s first quarter.
With stocks, only two things matter: earnings and what investors are willing to pay for a dollar of earnings.
Earlier in this expansion it was all about jobs. Each month, we would wring our collective hands over how many jobs were created, what kind of jobs were created and whether they were even good jobs. Today, while it is still a market moving number, the monthly payroll report doesn’t seem to carry as much mindshare with Wall Street.
The current economic expansion has been punctuated by record profits for large corporations, and slow job and wage growth for U.S. consumers.
This week we experienced something we haven’t in some time: a down week. Stocks struggled to a close, down 3.8 percent with no help from blue-chip names. Alphabet (GOOGL) and Apple reports weren’t favored by Wall Street, driving the stocks down 5.2 and 4.3 percent, respectively.
In a week full of geopolitical news, the market showed a bit of malaise. The S&P 500 posted a small loss of 0.4 percent. Bonds were similarly docile with the 10-year U.S. Treasury ending the week off two basis points at 2.3 percent.
by Ralph Cole, CFA
Executive Vice President of Research
Summertime Blues (and Yoo-hoos)
Earnings season is a whirlwind period of companies reporting their most recent quarterly results. We believe that this tends to be a better indicator of what is going on in the than most aggregate economic statistics. Large U.S. corporations touch virtually every corner of the world, and then report back to Wall Street every three months. This real time data has proven to be more reliable than government economic statistics. What do we mean by that?
Let’s take first quarter GDP, for example. When the Bureau of Economic Analysis first reported U.S. GDP growth for the first quarter it was +.2 percent. While not robust, it was at least positive. The next month they updated their estimate, and decided that the U.S. economy actually contracted .7 percent in the first quarter of the year. Then, last month the BEA updated their numbers again and came back with -.2 percent. U.S. GDP is destined to be revised for years to come. As investors we have to rely on what the companies are telling us in order to anticipate the direction of the global economy.
Thus far, what we have learned from second quarter earnings reporting is that the consumer is in good shape, but they are discerning amongst brands and retailers. The oil and gas slowdown is for real and it is hurting not only energy companies, but industrial companies that sell into that market as well. Banks, technology and healthcare have all seen relatively healthy growth here in the U.S.
Globally companies are citing re-acceleration in Europe despite the headlines in Greece. Weakness is evident in commodity-dependent countries such as Canada, Australia, Brazil and Russia. The materials sector has fallen on weak prices, which is especially troublesome for companies with heavy debt loads.
A number of companies and industries have executed very well in this challenging environment. For example, Amazon is starting to show some profitability along with continued growth. Regional banks are reporting strong loan growth and record low default rates. Biotechnology remains a source of strength for the market with both Gilead and Amgen beating estimates. However, earnings season remains challenging because stocks that miss estimates are punished severely.
Our Takeaways for the Week
by Brad Houle, CFA
Executive Vice President
The bond market is a dealer market with no central exchange. This means that all bond trades are over-the-counter trades whereby market participants trade amongst themselves. By contrast, stocks are traded in a continuous auction market where an investor can get the market price of a stock instantly by seeing where it is trading on the various electronic and physical exchanges. Bond pricing can be more esoteric, particularly for more exotic securities such as some mortgage-backed bonds or high-yield bonds.
The 2008 financial crisis was sparked by speculative mortgage-backed securities which started to fail when homeowners stopped paying their mortgages. Part of the issue was the fact that it was difficult to nearly impossible to value these securities and there was no liquidity for these bonds. The government often regulates in response to the last crisis and this situation is an example of backward looking regulation. As part of the reactive financial market regulation that came out of the financial crisis was that banks are now required to have greater regulatory capital. On the surface this seems like a good idea: banks are required to hold more "safe" assets on their balance sheets like U.S. Treasury bonds to cushion for inevitable bumps in the road. The unintended consequence of this change has made it difficult for large banks to effectively trade fixed income securities. It used to be good business for Wall Street banks to trade bonds with customers. Banks would make a market in bonds and would use their balance sheet to provide liquidity to customers. With onerous capital requirements this business has become difficult and unprofitable for participants. The bond market has gotten much bigger since the financial crisis and much less liquid.
According to the Wall Street Journal, since the 2008 financial crisis the U.S. Corporate bond market has doubled in size to $4.5 trillion dollars. In addition, outstanding U.S. Treasury Bonds trading volumes have fallen 10 percent since 2005 while the size of the market has tripled.
The implication for this change is volatility in the bond market will probably be higher going forward. We have yet to have a real test of bond market liquidity since financial crisis. When interest rates start to climb we will see how resilient the market is when short-term investors in bonds all try to squeeze out the same small door at the same time.
The good news for Ferguson Wellman clients is we largely use individual bonds for clients. This is important because an investor that owns an individual bond can wait out the pricing volatility because at maturity you will get your money back. Participating in panic selling into a volatile or potentially illiquid market is completely voluntary. In the past, we have been able to be opportunistic buyers of bonds sold into illiquid markets. One case in point was the mini-crisis in the municipal bond market when an analyst named Meredith Whitney unwisely used her fifteen minutes of fame on the television program 60 Minutes to incorrectly predict massive defaults in the municipal bond market.
Another silver lining to this potential situation is an advance in technology that could improve liquidity in the fixed income markets. The leading edge of fixed income trading is an electronic bond trading platform that has the potential to revolutionize bond trading. Rather than use a bond dealer intermediary to trade bonds, this platform allows firms like Ferguson Wellman to trade directly with other investment management firms. This concept is in its infancy and Ferguson Wellman is adopting this technology where it can benefit our clients’ portfolios. We are optimistic that wide adoption of this technology can benefit all fixed income investors.
Our Takeaway for the Week
by Jason Norris, CFA
Executive Vice President of Research
Seasons
The more things change, the more they stay the same. Five months ago, we rebuked the old Wall Street adage of “sell in May and go away” which, through the end of August, was a good call. From May 1st to Aug 31st, the S&P 500 was up just over 7 percent. However, just like clockwork, the month of September looks to be producing the same results it historically has. Since 1928, September is the only month out of the twelve that has an average negative return. With only a couple of trading days left, it looks like that trend will not be “bucked” this year. Even though there is still time to pull even, the end of the month is usually the weakest (see below).
Source: Renaissance Macro Research
Send for the Man
While this has been a bad week for stocks, it was also not a good week for healthcare mergers and acquisitions. On Monday afternoon, U.S. Treasury Secretary Jack Lew issued some administrative rules making it harder for U.S. companies to start inversion mergers. This type of merger allows a U.S. company to buy a smaller foreign company and relocate offshore to lower tax jurisdictions (see an earlier post for details). Most of these deals are centered in the healthcare space and while these changes will not stop potential inversions, they are designed to make them more difficult. For example, Medtronic is currently in talks to purchase Covidian (based in Ireland) and would use a meaningful amount of offshore cash to finance the deal. With these new rules, Medtronic would not have access to that cash without paying U.S. taxes. Therefore, they will have to look for other financing means, most likely debt, thus slightly increasing the cost. We still believe the deal will be completed, but it does show that the U.S. Treasury is adamant about changing this part of the U.S. tax code. AbbVie and Shire may also be affected; however, the tax benefits are not as meaningful and the gains from the Shire pipeline are significant enough to proceed.
Lesson Learned
Last week was not a good week for Apple. After announcing a record weekend of sales for the iPhone6 and iPhone6+ with over 10 million handsets sold (and this without shipping any to China), any good financial news was eclipsed by issues with the iPhone6+ bending and a botched iOS update. Investors didn’t have patience for the stock during the last few days. We believe that despite these hiccups, this iPhone launch will net over 60 million units this month, and based on pricing and component costs, should be accretive to gross margins.
What we know
