Marketline Monthly – January 2018
The stunning surge in stocks during January was called a ‘melt-up’ by some pundits, and it amounted to a little over half what stocks can be expected to return on an annual basis, but you earned it in just one month. The Dow rose 5.8%; the S&P was up 5.6% and the NASDAQ, propelled as usual by technology heavyweights, returned over 7.4%. The long term annual return on stocks in the US is in the neighborhood of 10%. These parabolic returns are at least somewhat justified by solid earnings reports and a benign economic backdrop. However, in the last week, interest rates have finally increased (see below), touching 3% in some maturities, and this has brought stocks to a screeching halt. The Dow shed several hundred points in just a few days. Friday February 2 was particularly brutal: off -660. Higher interest rates offer competition for stocks, as well as making the math that calculates future stock returns look worse.
For the last couple of months, we have noted here: “when everything seems great, it pays to be watching for the negatives, even if those are hard to find.” Risk reduction usually costs performance since the markets are biased upwards, but in the last weeks, it has been beneficial. We most sincerely hope we’ll be able to put cash to work at better values soon. Some hope arrived in the form of a few stocks we were able to add to our watch list, one in particular selling at a price/earnings ratio of just 10 – almost unheard of these days for a major company. In the meantime, the unfolding decline has collected comments from longstanding bears who want to remind us they are finally right. We’ll see. One trend we’ve noticed – which has received exactly zero media attention – is very hefty dividend increases at many companies. High single digits is common; teens is more common, and some companies are instituting hikes in the 20%-30% area. Dividends are as close to a commitment as a stock can get, since Boards of Directors are loathe to cut payouts. Big dividend increases show confidence in the future. So while stocks might need to take a breather for a while, we’re not looking for a serious correction – yet.
The long bond finally forayed up towards 3%, coming just shy by the end of January but breaking through that level as we write this (and dishing out losses on bond portfolios this month, which will show in portfolio returns). In the near past, we’ve said we need to see something around 3.2% on the long bond before we seriously consider this a bear market. However, we chose that level because it was the last high yield point on the long bond – not really for any reason other than that. A better analyst than me recently wrote that choosing old highs or lows isn’t a particularly valid forecasting method, and I’m inclined to agree. Of course, it’s not just where the bond has been in the recent past. We also take clues from markets overseas, capacity, lending activity, debt levels, and so forth.
The bond market is reacting to a potential increase in debt levels in the US, fed rate hikes (finally) and now, suddenly, good jobs reports. Good jobs reports have become ‘bad’. As the job market strengthens against an already ebullient economic backdrop, inflation fears are rising. Inflation itself is still miserably low, but it looks like the trend is upwards, which is what the Fed wanted. We need a little more data before deciding that the bull market is over in bonds, however. Lending isn’t terribly strong, financial regulation has not yet turned benign, and debt levels, particularly on government balance sheets, are looking worse than ever. This big move in long rates could turn out to be a flash in the pan. On the other hand, we’ll remind readers that what the Fed wants in the short end of the curve, the Fed gets. So if the goal is 3% on the five year, we could get there.
Crosscurrents in overseas markets are starting to impose differentiation. While Europe is growing, it’s mostly due to improvement in France. The FT-SE was off -2% last month. Over in Canada, the central bank is raising rates, so the TSE sank -1.6%. Canada is probably going to be a tough market this year, as officials are worried about the overheated housing market. Brazil was a bright spot, surging 11%. Here, rising commodity prices help, but Brazil is also fixing itself, as a more business friendly government has been in place for a couple of years now. The Hang Seng, a proxy for China, surged almost 10% last month alone. China’s mix of statism and market based economics continues to perform well: every time clouds gather, its leadership manages to navigate through. Too, Asian countries are turning to each other for trade agreements, lifting economic barriers and goosing trade.
Marketline Monthly is produced by Cascade Investment Advisors, Inc. We specialize in value investing for individuals. We apply our approach across markets, looking for low-priced securities that offer above-average potential. We use imagination and hard work to bring performance and personal service to our clients. To learn more, contact Michelle Rand at 1.503.417.1950 or 1.888.443.9015; email to Michelle.Rand@cascadeinvestors.com. Our website is www.cascadeinvestors.com. A full list of stocks we invest in is available on request; mention of specific securities is not investment advice; such investments may or may not be profitable.