This market slowdown was no surprise as stocks have been long overdue for at least a pause in the Trump-induced rally. Actually, stocks have been remarkably resilient in the face of continually weakening political progress on the Trump pro-growth policy agenda.
This week, we had some progress on the Obamacare front. The new “American Health Care Act” doesn’t solve all of the Obamacare problems but does have a few good features, e.g., no mandates and lower taxes.
However, the “center piece” of President Trump’s agenda is corporate tax reform which investors widely herald as the catalyst for accelerating GNP growth into the 3-4% range vs the current 1-2% growth rate. The administration is targeting to pass tax reform legislation by August although some prominent senators are indicating that tax reform would likely not happen until after the August Congressional recess. In my opinion, a rate hike plus delay of pro-growth legislation until the fall could adversely affect the current market momentum.
Next week, Fed Chair Janet Yellen and company are expected to hike rates at the conclusion of the Federal Open Market Committee (FOMC) meeting on March 15. Wall Street pundits say that a rate hike is already priced into stocks and bonds. Personally, I am a non-believer that the market will take a rate hike in stride given how far the market has gone since the November election. For this reason, we have raised about 25% cash in most portfolios as a hedge against a market correction so we are ready for both “up or down” action.
In the meantime, the likely fate of higher rates has caused bond yields to climb, the dollar to rise… and commodity prices to fall.
Our Current Equity Strategy
Based on the strong market performance since the election, we continue to lock-in profits in overbought sectors that are at or near all time highs. Specifically, we took profits in the three (3) “high flying” indices (Dow, S&P 500 and Nasdaq) and purchased ETF sectors with more realistic upside potential, e.g., retail (XRT), healthcare (XLV), biotech (XBI) energy (XLE) and emerging markets (EEM). Given the potential for a market correction next week if the Fed raises rates and also offers guidance implying more than 3 rate hikes in 2017, we raised about 25% cash in most portfolios.
On a valuation basis, we continue to believe that international stocks are relatively inexpensive compared to U.S. stocks. For example, the price-to-earnings (P/E) ratio on stocks in Europe and Japan is, on average, about 12-13. The P/E ratio on stocks in the S&P 500 is roughly about 19. This means international stocks offer a better value proposition than the major US market indices. We recently took profits in some of our international positions and are looking for a new re-entry point following a pullback.
Finally, we are monitoring price action in commodities, e.g., gold and copper mining companies for possible purchases in our more aggressive accounts. Although these sectors are volatile and require a well-timed entry point, they do offer the potential for significant profits and hedging against a market correction.
Our Current Fixed Income Strategy
Our fixed income portfolio remains unchanged from last month and continues to perform very well on a total return basis. In addition to the average annualized dividend yield of ~8%/yr, the 5 mutual funds in this portfolio have increased in value by ~2.2% YTD for a total annualized projected return of ~10.2%/yr. As discussed in a previous market update, we restructured our fixed income portfolio last November so that its pricing action would be less sensitive to rising interest rates. This was accomplished by screening 30,000 mutual funds using our proprietary methodology in arriving at the selection of the 5 funds in our fixed income portfolio. Assuming the Fed raises rates next week as expected, we will have an opportunity to observe how well these “floating rate” bond/credit funds hold up.
Again, we would like to emphasize that our investment philosophy is to actively manage risk 1st and return 2nd in order to safeguard our clients’ hard earned nest eggs. In addition, we believe that locking-in profits from time to time is better than the “up and down” ride of typical “buy and hold” strategies.
Until next time…relax, give thanks, create happy memories and let us worry about navigating your ride down Wall Street!