As we’ve been saying at PFS, this year is going to be about stock picking with the S&P 500 up merely 1% year to date. A lot of that has to do with the incredible run in the U.S. indices last year, which has caused many investors and analysts to question valuations (“S&P 500 is lofty by almost any measure” — David Kostin, Goldman Sachs equity strategist in January). Just when investors might be thinking, “I’ll just buy an index ETF like I should have done last year” to focus investment, we get flat performance in the index. That’s because some of the sectors aren’t performing while others are. More specifically, some of the specific industry groups are working rather than whole sectors. It’s time for the individual investor and professional to do some homework, understand the themes and stories, and trade individual stocks.
If there’s one thing you need to learn about the stock market, it’s “rotation, rotation, rotation”. Rotation is to the stock market what location is to real estate. This is truer in 2014 than it was in 2013. In 2013, you had to get one rotation. Between April and May of 2013, investors shifted into cyclicals (industrial stocks) and growth stocks for the first time in three years from defensive, high-yielding investments. This year, the rotations have been rapid. In January, the cold spell wrecked retail stocks and other cyclicals including stocks associated with rising interest rates. As rates dropped due to the slowing economic numbers, these stocks consolidated. As the economic numbers improve in snap-back fashion, so too have these cyclicals and rate-sensitive stocks. This was clear on Wednesday when investors connected the “dots” from the Federal Open Market Committee statement.
Leadership Market
Let’s backtrack a bit before we delve into the Fed and interest rate expectations. While it’s pretty well known by now that healthcare and utilities have been outperforming the stock market year to date, other smaller industry groups are also outperforming the stock market by a wide margin. You just need to know where to look.
Biotech and Pharmaceuticals have been leading the healthcare sector as well as other defensive areas like utilities and REITS. What you may not realize, is that some of the growth and momentum stocks are still working in this environment. Take a look at the internet stocks, hotel stocks, and solar stocks. Semiconductors, clean energy, and the gold miners are other non-defensive names that are performing. Some of these risk-on and growth-oriented areas like hotel stocks (recovering), have seen their 2013 success transition into 2014; however, things may be changing as I see a rotation back into financials and rate-sensitive areas due to interest rate expectations after the Fed’s recent meeting.
Source: Stock Charts
Dots All I Have to Say About That
Yesterday’s policy statement and Janet Yellen’s Q&A session spooked trigger-happy traders and high frequency traders regarding interest rates and the fed funds rate. Expectations have been for the fed funds rate to begin rising mid-2015. Based on the forecasts of individuals on the FOMC for the federal funds rate, called the “dots”, the median projections for the rate at the end of 2015 and 2016 were 1% and 2.25%, respectively. This marked a quarter point increase for 2015 from the previous statement. And as the FOMC withdrew their 6.5% threshold for the unemployment rate with regard to short-term interest rate policy, investors were scrutinizing any change from a new forecast on the guide path for interest rates. However, I think the market was getting a little too cute for itself here.
The Dots
Source: Federal Reserve
The second cue came from Fed chair Janet Yellen’s Q&A session after the policy statement when she specifically said 6 months after they finish the Fed Taper (tapering the amount spent in Treasury and agency securities). If she would have stuck to Bernanke’s known verbiage, she should have kept it vague with “data dependent”. A rookie mistake; however, one that Bernanke also performed in June last year at the end of a long career as Fed chair - he gave reporters the firm calendar date finish to the taper of mid-2014. It would have been alright if that was the estimates analysts have been projecting, but as I said, this moved the time line on forecasts up three months. The S&P fell 17 points near this period yesterday on her comment, but it was a knee-jerk reaction that didn’t last long.
As a result of the meeting and its effect on interest rates, financials, semiconductors, and healthcare providers flew. United health (UNH), WellPoint (WKP), Charles Schwab (SCHW), Bank of America (BAC), Regional Banks (KRE), Applied Materials (AMAT), Intel (INTC), and more have seen big moves in their stocks this week as a result. Another asset that benefited from the news was the dollar. The dollar should strengthen if interest rates are headed higher and if economic indicators improve like the Philly Fed survey did today, that doesn’t bode well for the gold miners that have rallied recently on falling interest rates and Russia-Crimea news. This will definitely be a true test of gold’s technical bottom as the dollar rallies; however, geopolitical events will probably continue to support gold in some way as the final chapter hasn’t been written regarding eastern European politics. Obama travels to Europe starting on Monday where he will be meeting with EU and NATO leaders (and the press) along the way regarding appropriate responses to Russia. The real kicker will be if NATO decides to begin arming EU allies in the Eastern bloc. It’s not likely, but more sanctions are probable.
Conclusion
It’s been quite the week with the rally in response to Putin calling off further encroachment of Ukraine as well as the Philly Fed survey Thursday. Rotation is happening with a big push in financials and semiconductors. Gold is undergoing a key test of its technical bottom with the specter of more geopolitical tensions on the horizon with Russia. And what of other countries who may begin testing the west’s resolve? Could China begin flexing its muscle on some of the islands near its mainland? Are these inalienable parts of China as Russia refers to the Crimea? More questions are arising than are being answered due to the response by the EU and NATO which should support gold. The next catalyst to move select stocks in industrial and emerging market groups will be Monday morning with the March flash Purchasing Managers’ Index (PMIs) from Markit.
