As many parts of the country bask in the welcome glow of spring sunshine, my headline now seems a bit counter-intuitive given that we Denverites just topped off the tanks of our snow blowers to clear yet another blast of winter.
But rather than referring to the weather outside, my headline was more specifically meant to address the investment climate. Things are looking pretty good out there with no immediate storm clouds in sight.
This statement may come as a surprise to many of you, particularly if you’ve been enjoying the antics of our current presidential candidates. The message from all sounds pretty similar: “The economy, indeed the world, is a complete mess and the only way to fix it is to vote for me.” It’s very easy to get caught up in the campaign rhetoric and sometimes tempting to believe it. Combine what we hear from candidates with what we read in the press, and opinions can become inflamed pretty quickly while our outlook deteriorates based on all the negative commentary we see.
It’s easy to get frustrated with our political process, and I often start to wonder when our political process went so far off track. As I mentioned a few letters back… that was from the very beginning. Apparently we’ve followed in the footsteps of our founding fathers, many of whom resorted to buying their own newspapers for the specific purpose of slandering their opponent. The ads below are excellent examples:
Of course, Burr killing Hamilton in a duel takes the ultimate cake. However, if dueling again becomes part of the campaign process, I daresay voter interest would likely be piqued and television ratings would skyrocket… and the number of candidates would dwindle rapidly.
While all the campaign insults are being flung, behind the scenes our investment markets have demonstrated a considerable turn for the better. Since a rather unsettling double-digit drop culminating this February, the last 8 weeks have led to a double-digit recovery, bringing the S&P returns positive to about +2% for the year.
For those that have followed these newsletters for some time, you’ve seen the following chart from Dorsey-Wright and associates before:
While I generally don’t consider myself to be a technical analyst, I have made it a point to keep an eye on this chart since early in my career. I like to refer to it as the “Mood of the Market” chart. In short, this chart marks the percentage of stocks on a technical “buy” signal. A column of “O’s” indicates the percent is decreasing, while a column of “X’s” indicates that percentage is increasing. As you can see by the most recent column of “O’s”, we made a 5-year low in February, with only 20% of the NYSE being on “buy” signals. Thus, the “Mood of the Market” was decidedly negative. Given the fact that we saw a -12% decline in the market in September, a rally back to even then another 11% drop in February, I think we all can concur that the ride was a bit tough on the stomach lining. Since then, a quiet but substantial rally has taken place, and the mood has turned decidedly bullish. (You can learn more about Dorsey-Wright’s methodology on their website, www.dorseywright.com).
Interestingly, dividend paying stocks have been leading this recovery. While last year, the strong performance of a very narrow group of “FANG” stocks (Facebook, Amazon, Netflix, and Google) kept the S&P positive, this year value-oriented dividend payers are leading the way. Indeed, the dividend-focused core equity strategy we employ in the Cascade model portfolios is up better than 6% year to date, a full 4% ahead of the S&P. After watching dividend stocks underperform for the last 18 months or so, it is pleasant to see them back in the driver’s seat.
With the turnaround in the equity markets, commentary seems to have shifted immediately from doom and gloom to talk of “bubbles” in the economy. When we look at the market in historical terms, as the chart below from J.P. Morgan’s Guide to the Markets shows:
Most economic sectors appear to be at or below their historical averages in terms of price/earnings ratios. The clear exception to this is the energy sector, whose severe decline in the “earnings” portion of that equation has driven valuations (as measured by P/E ratios) to relative highs. Recently, our colleagues at JP Morgan have developed an interesting new chart, essentially designed to highlight bubbles in various economic sectors:
In this chart, sectors in dark green indicate potential bubbles (see tech in ’99 or financials in ’06), with those in dark red in contraction. Looking at the chart today, we see the possibility of a slight bubble in healthcare and no real indicator of concern elsewhere. I will note the contractions indicated in the energy, industrial, and telecom sectors – all of which are areas we watch with interest for value opportunities.
One potential bubble not shown on this chart is in the area of housing, at least in some markets. The recent population growth in the Denver market has led to rapidly rising housing prices, particularly at the lower end of the market. Nationally, rapid increases in apartment valuations have all but eliminated attractive investment opportunities there. However, for every sector in commercial real estate which might be considered to be in a bubble, there are other sectors which are clearly just entering the expansion phase as indicated below:
Thus, it is our opinion that even if there may be some “bubbles” in the market, there is no dearth of investment opportunity for those with an eye to value.
The Changing Investment Landscape: New Regulation
Last week, a significant change in the regulations regarding investment advice to IRA and qualified retirement accounts was released by the Department of Labor. Since originally proposed in 2010, Cascade has been actively involved in working with the industry and the DOL to have input on the final proposal. In short, the rule looks to apply a “Fiduciary Standard”, meaning that advisors must give conflict-free advice that is in the best interest of the client at all times. According to the proponents of the rule, this was necessary to deal with a “few bad apples” in the industry. We question, however, the need for a new 1,017-page rule to deal with those few bad apples. Cascade applauds the spirit of the law and has worked extensively to ensure we eliminate potential conflicts of interest and improve our offering and skill sets to allow us to provide valuable advice and guidance to our clients and their families. Over the course of the coming year, look for an expanded service offering from Cascade, with a series of education events in coordination with our offices around the country, access to a deep network of professional services, and our continued commitment to helping you Plan Wisely, Invest Confidently, and Enjoy Life!
Political Ads: OppenheimerFunds. Presidential Elections May Not Matter to Markets as Much as You Think.
Bullish PCT for NYSE: Dorsey Wright as of 4/14/16
S&P 500 sectors P/Es relative to history: Compustat, Standard & Poor’s, via J.P. Morgan Guide to the Markets – U.S. Data as of March 31, 2016
Sector weights over time: Standard & Poor’s, via J.P. Morgan Guide to the Markets – U.S. Data as of March 31, 2016. Forward price to earnings ratio is a bottom-up calculation based on the most recent index price, divided by consensus estimates for earnings in the next 12 months (NTM), and is provided by FactSet Market Aggregates. Standard deviation above/below average is calculated using the average standard deviation over the previous 20 years for each sector or index. 2016 sector weights are based on the latest available data.
National Property Type Cycle Forecast: Mueller, 2016, via Baceline Investments