Insights and Actions – “Markets Tend to Confound the Greatest Number of People”

August 9, 2016

General Comments

There is an old adage that the stock market does what it must to confound the greatest number of people. Following an unexpected vote by Britain to leave the EU, the markets recovered all of the losses following the vote and continued to march to new record highs. Stocks seem to be able to shrug off all bad news including another disappointing report that GDP expanded at a meager 1.2% during the second calendar quarter, after expanding at only 0.8% during the first quarter. We now pine for the good old days when economic growth was above 2%.

The combination of slow economic growth and global uncertainty caused the Fed to put any further interest rate hikes on hold, at least for the next few months. The market sees only a 1 in 3 chance of an interest rate hike prior to the end of the year, and that news may have been part of the impetus for the stock market to push higher. As long as interest rates remain near historic lows, investors will be forced to consider owning stocks as the only way to generate any growth in their financial assets. As one strategist suggested, “TINA – There Is No Alternative.”

Data Points and Global Economic Indicators

The recent GDP report confirmed what we have been suggesting that the economy is bipolar, or perhaps schizophrenic. The consumer remains in relatively good shape, while few corporate chieftains have enough confidence to make capital investments that might improve long-term prospects. ISM numbers have improved here in the US, and some of the numbers show improvement in China as well, while France and Italy remain the sick men of Europe.

Many of the credit statistics continue to provide solid evidence of little chance of a systemic credit problem, although we should point out that some of the indices have moved up very modestly. Bank charge off for non-performing loans has moved up slightly, as have the number of banks that reported tightening lending standards. Neither of these has risen to levels that suggest risks are mounting, but we monitor not just the actual level of the indicators but also the direction of change, and we will continue to look for signs that risks are mounting.

Asset Allocation

We continue to remain mostly fully invested and hold a very modest amount of cash. Our focus is on the large cap stocks, and we have very limited exposure to smaller capitalization issues. All of our hedges have been closed, so our equity exposure is fairly straightforward.

Sector Allocation

We remain focused on the healthcare, technology, industrials, and energy sectors, and have recently added exposure to the basic materials sector, with particular emphasis on the steel, iron ore, and industrial commodity names. This is complementary to our exposure in industrials, and is well supported by the increase in the PMI statistics mentioned above. We continue to be underexposed to financial and consumer stocks where we think all of the good news may already be priced in.

Conclusion

We frequently see research reports that remind us that August and September can be cruel months for stock investors. While we acknowledge historic patterns, we know that by following the data and remaining active and tactical we can respond to any situation whether it follows a historic pattern or not. We started August with a positive bias. As we look for attractive opportunities, we remain confident that our freedom and flexibility to invest where we see the best circumstance will continue to benefit investors in the long run.