Riding the market cycles

It’s been a bit of a bumpy ride for the markets lately with fear, uncertainty and doubt having run rampant since mid-August when the current correction began. The talking heads of Wall Street aren’t helping as evidenced by two opposing comments this past week from a couple of those same folks.

Jim Paulsen is chief investment strategist at Wells Capital Management. He said last Tuesday he doesn’t believe the selloff is done yet. Another view was put forward on Wednesday by Ralph Acampora, who is often referred to as the godfather of technical analysis (charts, graphs, tea leaves – all that stuff). He observed that the S&P500 may have completed a double-bottom chart formation which is seen by those kinds of folks as a bullish indicator.

Historically, major upward moves have come when investors were generally pessimistic (the reason for the “climbing the wall of worry” reference in rising markets). A good current example may be that after the end of the “worst quarter since 2011” just a couple weeks ago, the S&P had its best week of all 2015 this past week, with the Dow having its second-best effort of the year.

Well, it can be hard for some to keep to their investing strategy in the face of conflicting news. My suggestion to best deal with that is to (A) ignore the daily headlines and (B) focus on the fundamentals, remembering that markets are cyclical – both as regarding the markets in general, as well as the stocks and sectors that make them up. And, most important, some parts are usually cycling up while others are trending lower at the same time.

Here are a few thoughts to help you determine how you want to ride these cycles in the near-term.

Some effect of the strong dollar and lower oil prices

These two things have wide-ranging effects on the global markets and are each great examples of moving in cycles themselves. Consider the effect of both today on the S&P500, the index that the world looks at as representing the US market.

Regarding the strong dollar, according to a Goldman Sachs article last July, 33% of the earnings of S&P500 companies come from overseas. The Financial Times noted last January that this is really much broader in scope as they reported that 261 of the S&P500 companies receive 15%, or more, of their earnings from outside the US. For now, that’s not good news for those US companies which export a great deal so, in the upcoming earnings season, those folks are likely to see lower comparisons and, perhaps, lower share prices as a result.

The flip side is that strong dollar is good for those foreign companies from which we get our imports. That’s because they can sell their stuff here today for less – relatively speaking.

What about companies doing most of their business within the US – as in most small businesses, in addition to a large number of those really big ones, as well? A company named Cornerstone Macro reports US-based profits for those kinds of firms are fully 2.5 times larger than foreign-based profits…and have grown 16% since 2006. Short version – strong dollar is very good for doing biz within the US.

As to oil…

The strong dollar, in addition to the current over-production relative to global usage growth, also has helped keep commodity prices – chief among them being oil – low. While having a definitely negative effect on the energy sector members for the time being, the other nine S&P sectors – to say nothing of us as consumers – tend to benefit from the ripple effect of the lower commodity prices.

Since about 70% of our national economy is one of consumer-oriented services, this is a good thing. Those companies with low direct exposure either to the energy sector, specifically the upstream segment, i.e., exploration and production (E&P), or to emerging markets and with the majority of their output distributed within the US, should see some generally good results.

Which areas look attractive here?

It used to be that our economy was almost totally driven by our manufacturing sector. Ever hear the phrase from the 50s, “what’s good for General Motors is good for America?” Not so much true today, is it?

One of the continuing challenges is that most economic reporting is still oriented toward manufacturing…instead of on the over 70% of our economy that services represent. Services also represent about that much of the other major developed nations economies – and almost half that of China too. Service-oriented, consumer focused firms should benefit.

It seems that the general category of cyclical stocks look to be coming back to life. These are the kinds of companies that benefit from an improving business cycle, such as steel, cars, rails and housing – typically the last sector to undergo a recovery. Each and all of these sectors are now seeing solid and improving numbers in sales, orders and/or shipments.

On one hand…

This phrase usually leads into a comparison of some sort. However, the majority of financial media, together with their ill-informed readers/listeners, only seem to have one hand. That one hand typically is always holding the lump of coal – not the shiny new gift.

These spreaders of the word according to the school of doom and gloom always seem to focus upon the potential (operative term) negatives and/or liabilities in order to “prove” their conclusions.

When you analyze the financial health of an economy or company, you can’t just look at that side of the books. How about the assets? Are they just so much chopped liver? To get what our economy or a particular company is really worth, you simply subtract the liabilities from those assets. When you do this with the US economy, you’ll likely be amazed at both how our asset side has increased (not just in reference to stock prices, by any means) and how strong we are economically right now.

Summary

Once a cyclical trend is established, up or down, it tends to last a long time. In that regard, the areas of our market that look attractive at this point appear to be those which are consumer-oriented, can benefit from the strong dollar and upswing in the business cycle mentioned above and have low exposure to emerging markets or the E&P component of the energy space.

And remember, if you don’t like what the markets are offering right now, just hang in there. The cycles will turn and what’s now good will, at some point, be the subject of “I can’t believe you own that” commentary from that brother-in-law…

Cheers!

Mike

Securities and Investment Advisory Services offered through KMS Financial Services, Inc.

To get an overview of economic conditions, use this link. It’s updated monthly. http://www.russell.com/helping-advisors/EconomyMarkets/EconomicIndicatorsDashboard/EconomicIndicatorsDashboard.aspx

Past performance is not indicative of future returns.

Investing in securities of any type involves certain risks, including potential loss of principal. Investment return and principal value in a bond and/or securities portfolio will fluctuate so that investments, when sold or redeemed, may be worth more, or less, than the original investment.

Investing in sectors may involve a greater degree of risk than investments with broader diversification. International investments are subject to additional risks such as currency fluctuations, political instability and the potential for illiquid markets. Investing in emerging markets can accentuate these risks.