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Considering we've been melting up here in the generally temperate Northeast, I expect many of you are braving a similar or worse heat wave.
My professional recommendation to you: sunblock and a cool, poolside drink.
You'll have to forgive me, though, as I ask you to set your umbrella drink down for a moment so I can give a quick update on what we're seeing as we round the corner of Summer and stride towards the Fall.
Like the weather, the market's been unprecedentedly high with nary a dip in sight. There's never a time I don't have a worry nagging at me somewhere, though - let's take a look at the faint clouds on the horizon.
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Timothy C Withers
Firm Principal, CLU, ChFC, MBA
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Hot Temps, Hot Market, Possible Cooling
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Macro Picture
Despite so many shiny things out there, I've got my eyes trained almost exclusively on just two items right now.
The first is a "tell" on which stocks I think may outperform the others: the strength of the dollar.
The second object of my attention (and I've been keeping close watch here for a while now) serves more as an indicator of the economy's potential strength and through that a guide as to how much of our portfolios we should have invested in the market.
Here, I'm looking at productivity.
Let's start with Dollar Strength:
When the dollar is strong, certain stocks thrive while others take a beating. A strong dollar almost always favors companies with more U.S. sales (think small and mid-cap companies, for the most part). On the flip side, firms that rely on a large portion of international revenue or commodity firms (metals, oils) are likely to dip.
Those that can foresee the direction of the dollar can usually make a few bucks.
During 2014 we saw the dollar rallying quite nicely relative to other currencies (Wooden Brothers), but this growth has slowed since 2015 to a sideways crawl. Recently we've seen a real weakness here - I'm willing to bet saying "sideways" is even too optimistic.
The one fly in our soup is - surprise! - what the ever-fascinating Fed will do with the interest rates and how the market will subsequently react.
When the Federal Reserve hints at raising interest rates - as they've done recently - common lore is that our currency will now draw the attention of international investors and give the strength of our dollar an upwards kick.
This response certainly seems predictable, but in my experience conventional wisdom is often a poor indicator of reality in these markets. Consider this: as rates get raised, the predicted initial bump in the dollar is met with a slew of selling as the higher rates signal to some a slowing of our economy long-term. Net effect: the dollar actually gets weaker. Now, most people I listen to and read seem to find this scenario fairly unlikely (meaning it's an outcome that I'm paying close, close attention to).
When the dollar is strong, certain stocks do better and others do worse.
For example, a strong dollar usually favors companies with more U.S. Sales (often small and mid cap companies are in this area). Firms with a large percentage of international sales or commodity firms (metals, oils), however, often do worse.
On the second front, time to talk about productivity.
Lately, our productivity has been on the decline. I don't just mean recently, either - see the chart below for a sinking trend over years.
Why Is Worker Productivity Declining and What HR Can Do
To best understand productivity, we just need a bit of simple math. Our economic production (Gross Domestic Product) is basically the number of people we have currently working multiplied by how productive they are.
Now, wait a second, you say: "If that's true, how can we have such a low unemployment rate -and therefore so many people hard at work - if our GDP growth has stagnated around a measly 1.5% per year for quite some time?"
I have a few theories. First, a portion of our workforce may be simply out of position - the people we have at work aren't working in the sectors of the economy that generate the most wealth and productivity. Or, technology innovation is no longer giving us the leaps in productivity we've grown used to in years past. One more tricky one: new regulations all along the productivity curve may be reducing our productivity overall.
Now, it's obvious that regulation can be a very good thing. If a new law cleans up an area's drinking water, for example, general health should improve. This should result in fewer sick people, ultimately upping our productivity as a whole. However, not all regulation is so beneficial - if no economic upsides are added when regulations are made, they only add more cost to producing the same output. Productivity will, understandably, decline.
When it comes to economic strength, productivity is a hard measure to top. The signals it sends about economic strength ultimately affect business growth rates which ultimately affect company valuations and stock prices. As it's generally the case that my clients like to see their money grow, productivity merits its own set of high-intensity binoculars.
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Fundamentals
As this earnings season's numbers have turned from projections into historical data, I've been seeing the stronger reports come from the small and mid-cap companies. It's here that I see top line revenue growth in areas like virtual reality, pet care, health care tech, and the like.
Don't get me wrong - the largest companies are doing quite well. Right now, though,
I'm looking not only at revenue growth rates but also company efficiency: are they best utilizing new technologies and logistics? The cost savings found here are very likely to drop down to earnings, often meaning that even small incremental revenue will translate to much higher earnings growth.
As we shift into the third quarter, I'm taking special notice of the energy stocks.
Naturally, they aren't likely to be pretty, but the worst year over year earnings comparisons seem to be dropping away and I expect to see a stabilization going forward (especially considering oil's $47 barrel price).
Technical
The market's done a fine job of moving to higher prices, but you won't find me gasping in surprise if we hit a bit of a lull or even a pullback after such a big move. This won't be a cause for panic, though - simply the short-term rhythms of the market.
To assure myself of a downward blip in a generally upward trend, I find watching certain levels on the charts to be very helpful. Here's a chart of the S and P 500, for example:
Interesting enough, when the market pulls back during an uptrend - as we may very well see here shortly - you're likely to see certain individual stocks break out and begin to race even higher. It pays to watch your stock list closely on these unique occasions.
Right now, I've placed about 50 stocks on our watch list that meet both our fundamental and macro parameters yet still are waiting in the wings for the right technical picture. The next few weeks could be their big scene, though. (
In a healthy market like this one, my big focus trends towards the technical picture of the individual stocks and not the market itself.)
Given everything I see, our models are confidently invested and taking even more opportunities to move more capital to the right stocks. While we're always on guard for any freak storms, right now we're inclined to stay the course.
I hope you continue to enjoy your summer as I plan to - staying outside and spending a bit of time away from the markets!
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Disclosures:
S&P 500 An index of 500 stocks chosen for market size, liquidity, and industry grouping, among other factors. The S&P 500 is designed to be a leading indicator of U.S. equities and it meant to reflect the risk/return characteristics of the large cap universe.
Dollar cost averaging does not assure a profit and does not protect against a loss in declining markets. This strategy involves continuous investing; you should consider your financial ability to continue purchases no matter how prices fluctuate.
"Asset allocation does not protect against loss of principal due to market fluctuations. It is a method used to help manage investment risk."
The Russell 2000 Index measures the performance of the small-cap segment of the U.S. equity universe. The Russell 2000 is a subset of the Russell 3000® Index representing approximately 10% of the total market capitalization of that index. It includes approximately 2000 of the smallest securities based on a combination of their market cap and current index membership.
Dow - The Dow Jones Industrial Average is a popular indicator of the stock market based on the average closing prices of 30 active U.S. stocks representative of the overall economy.
FactSet Earnings Insight February 6, 2016 edition was used for information contained in the Micro Section of this newsletter.
Rebalancing assets can have tax consequences. If you sell assets in a taxable account you may have to pay tax on any gain resulting from the sale. Please consult your tax tax advisor.
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Securities offered through Kestra Investment Services, LLC (Kestra IS), member FINRA/SIPC. Investment advisory services offered through Kestra Advisory Services, LLC (Kestra AS), an affiliate of Kestra IS. MSW Financial Group is a member firm of PartnersFinancial, a platform of NFP Insurance Services, Inc. (NFPISI), which is an affiliate of Kestra IS. MSW Financial Group is not affiliated with Kestra IS, Kestra AS, or NFPISI.
The above links are provided for your information only. As they are provided by third parties, Kestra Investment Services, LLC (Kestra IS) does not endorse, nor accept any responsibility for the content. Kestra IS does not independently verify this information, nor do we guarantee its accuracy or completeness.
The material is for informational purposes only. It represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events or a guarantee of future results. It is not guaranteed by Kestra Investment Services, LLC for accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor. Neither the information presented nor any opinion expressed constitutes a solicitation for the purchase or sale of any security.
The indices mentioned are unmanaged and cannot be directly invested into. Past performance does not guarantee future results. The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the US stock market.
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Copyright © 2016 Timothy C Withers. All rights reserved.
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