Market Strategy Radar Screen Weekly May 23, 2016

Old Dawgs Can’t Learn New Tricks

Or so folks say...but not us.

Apple stock advanced 5.2% last week as value investors positioned to mimic the master’s move. The S&P 500’s Information technology sector “felt the love,” rising 1.42% on the week. The sector is the third worst performer among the 10 sectors of the benchmark – off  1.98% from the start of the year but up near 11% from the market’s low on February 11^th. 

Consumer Staples Giant Surprises

Also in the “positive surprise for the markets column.” last week Wal-Mart  (WMT, Not Rated) reported better than expected results with revenue in the latest quarter rising 0.9%. This exceeded analysts’ forecasts and suggesting that its efforts to maneuver around a tough environment for traditional retailers are working.

Recent improvements that range from a boost in employee compensation to a tweaking of store layouts has led to the company seeing a boost in customer engagement in the store.

While 1 percent revenue growth at the retailing giant was not taken as an “all clear” signal by the market against the challenges that Wal-Mart and other stores face in the retail space, it did serve last week as motivation to reward “progress if not perfection” and raised enough investor enthusiasm for the stock to close last Friday some 10.6% above where it had closed just two days prior.

Post Fed Minutes

With last month’s FOMC meeting’s minutes read, digested, pondered and regurgitated, the consensus opinion now seems to have turned around from little expectation of more than one Fed hike this year to concern that the Fed may well be determined to raise at least twice in 2016, and in the process choke off  the current level of modest growth.

This change in sentiment has turned pundits’ focus away from worries about disinflation and deflationary trends instead to focus towards signs of enough inflation to cause the Fed to hike rates more than once and perhaps at a pace too severe for the current economic expansion to live with.

We think the shift in consensus focus and attention is perhaps overdone and reminiscent of what the market has experienced numerous times over the last few years -- going from worries about the potential for a recession to worries about economic growth being strong enough to cause the Fed to make a policy mistake. 

With the first read on Q1 GDP in the U.S. at 0.5% and Q1 earnings season through last week (with nearly 96% or 478 companies in the S&P 500 having reported) signaling negative growth in revenues and earnings of of 1.9% and -8.35% respectively, we think the Fed is likely to stand pat for now and push out further prospects of rate hikes (interest rate normalization via hiking the Fed funds rate).

Add to that thought prospects for the dollar to gain further strength on back of another Fed rate increase (no matter how nominally small) and the potential for a subsequent increase in the disparity between stateside interest rates and interest rates abroad, the Fed would seem to us more than likely to wait until September if it is going to raise more than once in 2016 and not wait until its last meeting of the year in December.

Already some U.S. multinationals have made mention that this year’s earlier decline in the dollar has boosted their competitive stance in doing business abroad and that it increases the likelihood of improved earnings in the quarters ahead----so long as the dollar does not take to moving to higher ground. 

With last week’s jump in expectations for the Fed to raise rates sooner than later, we provide a view via our “Mayan Temple” of the last time the Federal Reserve was in rate hike mode between the end of June 2004 and the end of June 2006.

While stocks did not move higher in a straight line during the process of interest rate normalization, the Fed raised its benchmark rate 17 times in equal increments of 0.25bps between June of 2004 and June, 2006 (taking the benchmark rate from what was then a 45-year low of 1%, to 5.25%), the S&P 500 advanced 11.3% in the period. The S&P 400 (mid-caps) and the Russell 2000 (small caps) rose respectively 25.9% and 22.5% in the same period (see chart on next page).

While we are not suggesting that the stateside major benchmarks will necessarily repeat their performance of the last Fed Funds hike cycle, we are prone to recall the adage attributed to  America’s great author Mark Twain that, “ History may not repeat itself but it often rhymes”.

So far “more of a trim than a haircut”

With stocks ending last week off 2.4% from their recent 2016 high of 2102.4 on April 20^th, we’ve heard concerns that the S&P 500 is stuck below its record high of 2130.82 reached on May 21, 2015. Some investors think this might signal negatively for the market beyond the current weakness seen.

Given the impact of some renewed strength in the dollar; modest economic growth stateside; sluggish to mixed growth abroad;  volatility in currency and commodity prices; geopolitical risks abroad;  and election year uncertainty stateside, our take is rather to focus on the market’s significant resilience since it came off its highs in April.

From our perspective and with the aforementioned headwinds taken into consideration, the resilience seen in the price of the broad market amidst intra-day volatility could likely indicate the market is discounting better things ahead rather than pricing in darker days to come.

Stay tuned.

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