In June, the Dow Jones Industrial Average gained .68%, the S&P 500 lost .64%, and the NASDAQ Composite index fell 2.62%. At the midway point of 29017, financial markets continue to ride a long, steady rise as the Dow is up 8.03%, the S&P ahead by 8.24%, and the NASDAQ soared 14.07%. For many years now, the macroeconomic outlook for the U.S. economy has remained consistent: 1.5-2.5% GDP growth with low inflation (1-1.5% annualized). With employment levels remaining at or near the official ‘full’ level and wage growth well contained, the Federal Reserve Board recently decided to continue on the path of gradually raising interest rates. Interestingly, some observers believe the broader economy has enough cracks in the recovery, specifically muted job growth and an abundance of retail and mall closures, to temporarily hold back on raising interest rates. Further evidence to support that idea comes from the auto industry, as it faces a near decade long expansion of new car sales and recent evidence of an uptick in non performing loans from the financing arms of the manufacturers and in the banking sector. Still, with low energy prices and housing remaining firm, aerospace and technology generally showing nice growth, many of the major industry groups are in solid shape. If you add to them the strong balance sheets of the major financial institutions (as evidence by the Fed allowing all 34 to raise their dividends and buyback plans at the recent CCOR capital efficiency tests), it is understandable why the Fed remains committed to normalizing interest rates, and even further, beginning the process of shrinking its vastly puffed up balance sheet.
With respect to financial markets, investors are shrugging off the lack of any accomplishment on the legislative front. Long accustomed to the hyperpartisan name calling and divisive rhetoric, capital allocators are focused on the now refreshed growth of corporate profits across all areas of the business landscape. With the S&P 500 index selling at 18X a 2017 earnings per share estimate of $130, finding value in a fully priced market remains the key consideration. With a selective few growth stocks leading the market higher, one wonders for how long? Patience and choosing wisely remain decade long principles for creating wealth, and this time seems no different.
Global Economic & Financial Markets Outlook: World Markets Party On As Asia, Eastern Europe Lead the Way! (All country index data provided by the market data section of the Wall St Journal, June 29, 2017.)
As has been the case in the United States, global markets have seen a strong first half of 2017. The geographic region posting the strongest returns is Asia, followed closely by specific countries in Eastern Europe. For example, the Hang Sang (+16.7%), Taiwan Weighted (Taiwan, +12.3%), Philippines (+11.6%), South Korea (+17.9%), and India (+15.8%) were the front runners for performance in the Far East. In Europe,, Austria (+18.27%), Poland (+18.7%), and Turkey (+21.8%) led with Germany (+10.2%), Spain (+14.4%), and Portugal (+10.9%) also showing strong gains. Looking forward, indications the ECB will start to return to a more historical interest rate level certainly could change how investors look at the continent relative to the rest of the world, Of note is the sudden rise of German bond yields which could possibly foretell the end of negative interest rates across the globe. The long calm in global markets may have to confront the reality of a changing interest rate environment.
Sector Analysis: Health Care, Technology, Travel Outpace Indexes As Energy and Financials Continue to Lag! (All country index data provided by the market data section of the Wall St Journal, June 29, 2017.)
Domestic equity investors have resoundingly decided technology and travel are the most appealing industry areas of the market, followed closely by health care. The Internet (+25.45%), software (+20.45%), computer services (+20.44%), and computer hardware (+23.70%) paved the way in the various subgroupings. In the travel and leisure component, gaming (+26.04%), hotels (+23.06%), travel and tourism (+23.66%), and recreational services (+24.4%) all posted large returns as well. The health care segment was strong with medical equipment (+25.46%), medical supplies (+23.57%), and equipment and services (+21.86%) setting the pace. I should also point out the weak link in this area, historically strong pharmaceuticals (+10.16%). Finally, in what has now turned into a monthly, quarterly, and yearly theme, energy (-15.05%) and financials (+5.91%) have badly lagged. The only components in these areas bucking the trend would be alternative energy (+26%) and renewables +(26%) and specialty finance (+28.66%). Looking ahead to the back half of the year, with growth industries badly whipping value based strategies, any reversion would see dramatic rotations in capital flows.
The Art of Contrarian Thinking- Looking for Bargains In the Market? Think Small, Real, Real Small! (Y H & C Investments may have positions in companies mentioned in this newsletter. It is the responsibility of each investor to research possible investments mentioned so they can decide on the appropriateness and suitability of the investments consistent with their risk tolerance, risk constraints, and return objectives)
With the east majority of investors convinced of the virtual impossibility of achieving better than market returns over the long term, an important question is how to go about achieving this clearly difficult task? One area to consider is smaller companies. Why small companies? First and foremost, it is far easier to find misplaced assets among the small company universe. Many of these companies attract little institutional or retail investor interest, probably for good reason. The businesses are often in a state of flux with lots of moving parts. Second, you can often buy these businesses for discounted prices, and in some cases, wind up with business operations or specific assets included free in the purchase. Third, the management teams often have large ownership stakes so as a fellow shareholder, you can be somewhat comforted by the fact if the business fails, management will lose a lot more capital than you will. Fourth, with small businesses, the evaluations are usually very simple and straightforward with maybe one, or two operating segments. The danger of small caps are vast and often involve corporate governance practices.
Many companies have poor histories of how they treat shareholders and lack of accomplishment. Also, weak balance sheets and related party transactions litter the terrain. On the competitive front, these businesses can often have large or similar sized companies quickly take away their main lines of revenue with a better overall strategy, stronger business model, or a more attractive portfolio of products. As a caveat, it is nearly impossible to distinguish between a small company destined to become five or ten times its current size and one which languishes in the same spot for a decade or more. You probably should look at this area like private equity or venture capital investing, where one winner can make up for ten losers. It takes capital, time, patience, and courage, but the outcomes can more than make up for the trouble.