FUNDAMENTALS

  

I wanted to wait for the revisions on Q1 GDP to come in before commenting and - drumroll please - the number was revised down from .2% to a negative .7%.  Basically it went from stinky to more stinky.

 

You may think it is the number itself that I wait for but that's not entirely true.  What I wait for is the reaction to the number, and I was not disappointed.

 

Many economists spent a lot of time trying to explain away the number.  "Seasonal adjustments are not accurate", "the weather was worse that first thought", "my pants are too tight". Whatever...

 

Perhaps it's because I spend most of my time working with stocks, but when the price of a stock drops you can spend all sorts of time giving me reasons for it but it doesn't change the outcome.  I suppose this is where I come out here. 

 

And when you measure GDP the same way for years and now say it doesn't capture the nuance it needs to, well, just call me cynical.

 

That said, you can't also assume this number is the end of the world.  What it should cause you to do is look around at other measures to give you more clues.

 

I have talked before about the fallout from a strong dollar and I think that is some of what you are seeing here for right now.  There is nothing, per se, wrong with a strong dollar but when other countries are going through a quantitative easing process to spur demand it makes buying stuff overseas cheaper and makes our stuff more expensive.  To demonstrate, our exports dropped precipitously in Q1 down to an annual rate of -7.6% (IBD 6/1/2015 Vital Signs page A2). 

 

This Quantitative easing will end at some point but we are going to have to face this headwind a bit longer.  The good news is that a European vacation might get cheaper ;-)

 

To follow this issue with exports down the food chain I also told you I would be looking at the Manufacturing index (the ISM) and this indeed has slipped below 50 down to 46.2 indicating contraction.

 

On the other side of the ledger I see M and A deal values at close to an all time high (Thomson Reuters 5/29/15). I personally see this as positive because it means that companies still are willing to put money at risk and these larger entities might be more impervious to economic shocks.  The negative is, of course, that some employees could be eliminated but we will need to see how that develops.

 

I have also been looking at earnings for some of the smaller and newer companies on the listed exchanges and they are, in my opinion, pretty good.  I think some of these companies are going to simply try and find their niche and be comfortable growing themselves even if we only see GDP grow at approximately 2% this year (which is where I see it).

 

In essence, the fundamental picture continues to be murky and you need to look at individual companies who can execute in this environment to find the winners.  Not everyone is going to benefit if we grow at the 2% mentioned.

 

 

TECHNICALS

 

 

Going back to an old song, we can look at the Dow Jones Transports [RL1] as a "tell" for the larger economy and markets at least for the near term.

 

The basic theory goes that is the transports stocks slide a bit it means that people are shipping less product which will eventually be seen in lower sales and earnings at all those companies selling the goods.

 

Well the DJ-20 Index (the Dow Jones 20 Transports Index) rolled over in April/May and is trending lower  (see the chart below).

 

 

 

 

Again, this isn't Armageddon but it does suggest some short-term caution for those of you being tactical in your portfolios

 

On the other end there is the Small Cap Growth Index, which looks pretty good right now.

 

 

 

 

So what do I think?

 

In the short term, as with my last letter, I think its okay to hold some cash here given some of the weaker macroeconomic picture.

 

But, perhaps oddly enough, I am using this time to do research and select those companies that I think will benefit down the road.  I still see inflation showing itself a couple years from now which means I want to take some interest rate risk off the table.  It also means I want to look at some stocks, such as financials, that will benefit from a higher rate environment.

 

Sure we could get more weakness from here but if you are a longer term investor  - and not a trader -looking for good prices then this might be an okay time to shop given a 5 year plus horizon.

 

In the meantime, I hope to get access to all my data much before the end of June for your next note.

 

 

Cheers,

 

Tim