Market Strategy Radar Screen Weekly December 27, 2016

  What Are the Markets Telling Us?

Market Strategy Musings Near Year’s End

• The December non-farm payroll, unemployment and hourly wage numbers due Friday, January 6th
• Q4 earnings results (that could negatively reflect the strength of the dollar over the course of the fourth quarter) as earnings season unofficially gets under way when Alcoa reports on January 9th

As well as an assortment of risks tied to:

• Monetary policy “in times of normalization”
• The direction and momentum of interest rates, currencies, commodity prices
• Political and geopolitical events and trends that could sour the current relatively upbeat sentiment and tone of the market

In other words, sometime after the holidays the stock market likely “gets real again.”

For now and from our vantage point on the market radar screen, it appears likely that stocks will cross the 2300 threshold for the S&P 500 by early January if not before the end of the year.

The mix is in for 2016, and it confirms to us that the fundamentals indeed have improved over the last year both in terms of economic data and corporate earnings results.

Interest rates, though recently on the rise, are still not substantially higher from where they started this year with the 10-year US Treasury yield at 2.55% as of last Friday versus 2.27% on January 1 (see figure below).

When we hear some investors fret about the recent increase in yields, we remind them that yields had fallen to a record low on the 10-year Treasury–dropping to 1.36% on July 8th of this year –before beginning their recent ascent.

In our view, the bond market (as reflected in the yield of the 10-year Treasury) essentially started the year priced about right relative to where inflation was, but then fell dramatically to a record low in July based on what we believe was bond investors’ misperception of the economy’s relative strength, compounded by the effects of foreign investors’ hunger for the higher yields available stateside.

To put it differently, the bond market started out the year fairly valued, then become overpriced just past mid-year on growth fears and greed-foryield, only to get oversold in the fourth quarter on fears of higher inflation projected onto a point somewhere beyond the visible horizon with a potential fiscal stimulus yet to be defined, let alone passed by Congress and implemented.

Last week’s action in the equity market saw stocks stateside edge higher with the S&P 500, the S&P 400 (mid-caps), the S&P 600 (small-caps) and the Russell 2000 (small-caps) adding 0.25%, 0.35%, 0.35% and 0.54%, respectively.

Those respective gains are more impressive when considered from the end of November: up respectively 2.96%, 2.83%, 4.06% and 3.72%.

From Election Day on November 8th the aforementioned indices’ performance was even more impressive as they advanced respectively 5.81%, 10.59%, 16.39% and 14.76% (see figure below). To us these advances provide a clear indication of investors’ enthusiasm and hopes on back of the results of the US presidential and congressional elections resulting in what has been dubbed “the Trump rally” by some investors and commentators.

While last week’s relatively modest gains have some questioning the endurance of the Trump rally much beyond Inauguration Day, we think the rally could persist through the latter part of the first quarter (albeit given normal daily markets’ ups and downs) supported by annual retirement contributions being put to work in qualified accounts that occur each year through April 15th.

Foreign stocks still look attractive

For now from a stateside perspective, we’ll continue to emphasize cyclical exposure over a defensive stance and keep an eye on the relative valuation and performance of market capitalizations, styles and sectors as we go into the New Year.

Foreign markets have not done as well as US markets since the election, pressured by perception of a less friendly attitude held by the President-elect toward the current process of globalization, particularly as it relates to trade.

The strength of the dollar (the trade-weighted DXY index is up 5.26% since the election) adds to that pressure on foreign stocks (see figure below).

Since the election the MSCI EAFE index (consisting of developed market stocks excluding Canada and the US) has gained 1.31% while the MSCI Emerging Markets index has dropped 6.74%. The MSCI Frontier Markets index has slipped in the same period some 1.16% (see figure above).

The same foreign indices’ relative performances from the end of November, however, shed an improved light on the story with those same indices delivering respective performances of up 2.75%, down 2.46% and up 1.3%.

In our view, while foreign markets near term reflect greater uncertainty in the aftermath of the US election, they likely will over the intermediate term reflect their considerable value based on a global cyclical recovery that is currently in progress, as well as on underlying secular trends that should attract significant investment flow in the not too distant future as stateside election year rhetoric loses sway to a more universally practical and beneficial positioning toward the benefits of global advancement and cooperation.

From a global investment perspective we look for the US to move toward trade agreements that acknowledge a more level competitive playing field among developed and emerging nations (due to advancements in technology and globalization trends) rather than toward protectionism.

Thus, we continue to recommend international exposure to equities as well as stateside exposure to equities moving into the New Year.

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