Last month, we cautioned that despite the market’s normal period of seasonal strength, stocks might find it difficult to mount a sustained rally without at least a modest pullback.
Indeed, stocks had a more difficult time during the latter part of March.
Defensive Posture
Tactically, we assumed a modestly more defensive posture in the Seaview Global Conservative Tactical Macro Investment Portfolio by reducing some cyclical equity exposure and buying bonds while still maintaining a slightly elevated cash level.
The S&P 500 eked out an increase for the first quarter of just 0.4%.
We’ve written often about the likelihood of rising volatility and the last quarter certainly gave testament to it. Investors with a true long-term view could perhaps be forgiven if they didn’t see it.
Rising Volatility
Nonetheless, the rise in daily volatility is causing nervousness among market participants to increase, which in turn reinforces the upward trend in volatility.
Meanwhile, those investors sitting on the sidelines become even more hesitant to jump in.
Earnings
Stocks appear vulnerable near term as weak earnings the consensus estimate is for S&P 500 Index corporate earnings to decline by as much as 4.6% in the first quarter.
All this comes after last month’s extremely poor jobs number (126,000 versus 245,000 estimate) and the downward revisions for the prior two months are likely to dampen investor confidence and pressure volatility higher.
We doubt that management guidance on the earnings conference calls will be helpful for the market. With expectations already low, managements are likely to be conservative and keep the bar low.
Second Half
But if we’re correct in our assessment that the economy will reaccelerate in the second half of the year, we believe the stage will be set for outperformance in subsequent quarters.
Nevertheless, for now there’s little clarity on the economic outlook as economic activity reports repeatedly fail to meet expectations that have been built upon improving positive leading indicators such as consumer confidence that suggest the economy should be doing better.
The Fed
US Federal Reserve Chair Janet Yellen recently commented that she’s worried about the potential risk of “secular stagnation” from demographics and lower productivity gains.
This would warrant monetary policy to keep the real rate of interest low in the absence of expansive fiscal policy.
In my opinion, Congress eschewing its responsibility on fiscal policy while it attempts to make the Federal Reserve its “whipping boy” for the slow-growth economy.
One could apply the same analogy to the Eurozone’s glacial pace of political action while Japan’s lost decades speak for itself.
To many, the concept of secular stagnation lies outside mainstream economic thinking. Perhaps it’s not so far distant as generally believed.
Bonds
We anticipate investor nervousness over earnings to ratchet higher quickly. We take the position that bonds should again be increasingly well bid to drive yields lower.
Oil and gold are likely to both test resistance but we view any movement as short-term technically driven in response to the pullback in the dollar and susceptible to rapid price swings.
In our judgment the dollar will continue rising into 2016, albeit at a slower pace than last quarter.
This might appear contradictory given our view that the Fed will defer raising interest rates and that the U.S. economy and corporate earnings will prove disappointing for the first half of 2015.
ECB
Normally we’d expect the dollar to weaken under such circumstances (and we think it’s likely in the very near term) but the Fed is presently not the prime determinant of the direction in interest rates.
For now, it’s the willingness of the European Central Bank to drive interest rates (and the euro) even lower into negative territory through its bond buying program that’s having the greatest impact in helping depress U.S. interest rates.
The attraction of higher relative U.S. bond yields is compelling for many European investors.
Many institutions (including central banks) don’t want to hold paper with negative yields, which will further drive investment funds into U.S. Treasuries and dollars.
The deteriorating geopolitical environment is likewise boosting demand for safe haven dollar-denominated bonds.
Mighty Dollar
In the absence of increased global demand, the strength of the U.S. dollar continues to maintain pressure on commodity prices.
We continue to avoid commodity exposure unless a compelling fundamental story develops—and these have been rare.
Those that have emerged tend to be short-term highly volatile trades rather than sustainable trends for long-term investment.
China
Beijing will continue down the path of managing the impact of economic reform by selectively implementing additional monetary stimulus.
We expect that the reserve requirement ratio will again be cut during the second quarter along with a further reduction in the benchmark interest rate to expand credit.
Stimulus enacted by The People’s Bank of China will continue pushing investors into riskier assets just as it has for central banks elsewhere.
However, China’s capital controls limit the investment options for the average Chinese investor.
Shadow Banking
In the meantime rising awareness of the risks in some shadow banking products and the recent weakness in home prices has reduced the relative attractiveness of alternative investments for most Chinese.
In our view this will cause a rising proportion of China household savings to be channeled into the stock market, which remains inexpensive on both an absolute and historic basis.
However, those same capital controls limit the positive impact from the spillover of capital into other global markets unlike monetary stimulus by other central banks that have helped to lift the price of financial assets elsewhere.
Banking
Last month in the portfolio, we initiated allocations to the iShares 20-Plus Treasuries ETF (TLT) and the SPDR Doubleline Total Return Tactical ETF (TOTL).
We exited several predominantly equity ETFs to fund these purchases and raised cash modestly to 10% of the portfolio.
Photo Credit: Viridiana via Flickr Creative Commons
The investments discussed are held in client accounts as of April 22, 2015. These investments may or may not be currently held in client accounts. The reader should not assume that any investments identified were or will be profitable or that any investment recommendations or investment decisions we make in the future will be profitable.
