The news has been rampant with market pundits attempting to forecast the next direction of the markets. Even though we realize that we will not always be correct and that portfolios should always be “balanced”, we will also attempt to provide you with some thoughtful guidance that we have assembled in our daily reading and to provide you with our assessment of the situation.
Several market indicators, particularly those that follow the volume patterns of the market, have flashed signals that indicate we may have seen the bottom of this particular correction. Jeff Saut, Raymond James’ well-known market strategist, quoted the “sage wisdom of eagle-eyed” Barron’s columnist Jack Ablin in his February 13 letter:
“There are three categories of equity pullbacks in varying degrees of severity: technical, cyclical, and systemic. Technical pullbacks, the most benign of the three, are corrections. When equity valuations get out of line with fundamentals, like earnings and dividends, prices correct accordingly. Technical pullbacks, while disturbing, are generally short-lived with the bottoming process occurring over a period of days or weeks.”
Saut went on to say:
“Jack concludes that the current pullback is merely technical in nature; and, we agree. Does that mean the heart attack patient gets right up off of the gurney and runs the 100-yard-dash? Probably not, but the major downside from here should be over. Buy weakness.”
Having said that, most corrections in recent years have ended up looking like a “W”, not a “V”, meaning we have two dips before a resumption of the advancing market. Therefore, even though we could bounce right back to the market highs, a dip back down to the recent lows would also not be out of character. And that is how we believe this “technical correction” is likely to play out.
TIME FOR A CHECK-UP
We believe market events such as these are opportunities to re-evaluate our holdings, reducing positions that have not met expectations, as well as adding some of the favorites that have been too expensive in the past. We had already raised some cash by selling one or two positions in anticipation of the recent drop, and we were able to add some companies that we believe are best positioned to benefit from a tax-cut inspired bull market. So far, so good.
Now is a great time to sit down and review our portfolios together. We are meeting daily with clients and Kim is making calls to schedule annual reviews, so if you would like to meet sooner rather than later, please give her a call. We can provide much more detail about our thoughts in a sit-down visit.
WHAT ABOUT THE REST OF 2018?
Stephen Auth is the Chief Investment Officer, Equities, overseeing all of Federated Investors’ equity and asset allocation products globally. He is also one of our favorite market experts because he doesn’t seem compelled to parrot the consensus views espoused by most other pundits…in other words, he is an independent thinker.
His February 22nd memo titled “Reiterating Bull Call – Stay Overweight Stocks and Buy Dips” was one of his best. He explains his optimism:
“The reason is simple: we are in the midst of a very positive fundamental economic and earnings backdrop, with still tame inflationary forces and valuations that are too low, not too high. So let the bears growl—we think their case is misguided and based on outdated rules of thumb that simply aren’t applicable in today’s world.”
His response to the cries for higher inflation and interest rates that has some investors spooked:
“I would first point out bond markets have predicted 10 of the last two recessions. That said, while we do expect rising wage inflation in the coming months, particularly once the wage hikes associated with the corporate tax cuts start getting booked, we think markets are mistakenly assuming wage inflation will equal broader price inflation, and take down bonds. We disagree. Deflationary pressures are present throughout the economy: Amazon is disrupting retail and now drug distribution; Uber is disrupting consumer transport services; Facebook is disrupting the advertising industry; and everywhere, CEOs are engaged in using technology to drive down costs, i.e., robots and iPads are replacing workers at a rapid clip. At Federated, our team of 120 analysts and portfolio managers are speaking with companies every day about their businesses. With the exception of companies in cyclical businesses now getting overdue price increases after three to four years of declines, companies everywhere are cutting prices, not raising them. So while some modest uptick in inflation, perhaps close to or a little above the Fed’s long-term 2% target is likely, we simply do not see a dramatic pickup the next two to three years.”
My apologies for the length of these quotes, but they capture the essence of our optimism about these markets since the recent tax reform legislation.
STILL NOT A TIME TO THROW CAUTION TO THE WIND!
“Might there be a rebound in volatility in March? Sure. That’s when wage increases associated with the corporate tax cut (about 25% of tax cut-related announcements have been wage increases) will begin to show up, causing skittish longs to become nervous that the (temporarily) outsized wage increases could lead to more aggressive Fed action. If bond yields gap higher again on these concerns, toward our 3.25% upper target, this could trigger another round of selling from risk-parity funds and/or others. If this were to spark another, probably final correction during this transition phase to higher growth, we almost certainly would add to equities in our stock-bond model and are keeping some powder dry for this possibility. The bottom line: stay the course–this secular bull has more room to run. Stay overweight stocks and buy whatever dips may come.”
Again, we would not be surprised to see another dip in March, most likely triggered by the Employment report on March 2nd. We expect that will be the last of the unfriendly dips for a while. Now even though we believe we are in an economy that is very beneficial to American companies, that doesn’t mean we should throw caution to the wind and abandon our defensive positions. As always, there are risks out there that we may not see, and for that reason, prudent asset allocation should include some un-correlated positions to guard against a surprise.
“Time is the friend of the wonderful company, the enemy of the mediocre.”
Asset allocation does not ensure a profit or protect against a loss.
Any opinions are those of David Crouch and not necessarily those of RJFS or Raymond James. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. There is no assurance any of the trends mentioned will continue or forecasts will occur. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Investing involves risk including the possible loss of capital. Past performance may not be indicative of future results. Please note, changes in tax laws may occur at any time and could have a substantial impact upon each person's situation. While we are familiar with the tax provisions of the issues presented herein, as Financial Advisors of RJFS, we are not qualified to render advice on tax matters. Please consult your tax advisor for your particular situation.