Transitions
Friday morning saw the release of these headlines from the Wall Street Journal’s MoneyBeat. “(May is the) Most important payroll release in years…follows the seventh-worst month of returns for fixed income since ’85 and the largest week of bond fund redemptions since Oct ’08.”
As to the first headline, it seems that the financial media has cast every month’s release of the non-farm payroll numbers for the last couple years in some variation of that. In any case, after a couple days of continuous, deeply meaningful pre-release comments by the puffing pundits about the pro or con implications of the outcome, we wound up with Goldilocks at the door.
What the report from the Bureau of Labor Statistics showed was solid job creation – and greater than the gains we got last month. The percentage hiring is the most since October, 2008, and the percentage either firing or laying off is the lowest since March, 2008. It showed too that job creation was strongest in the East and West, with levels moving up to the best since mid-2008. It also had the unemployment rate rising slightly to 7.6%, simply because a bunch more folks have entered the workforce. I say it’s a Goldilocks report because it wasn’t too hot or too cold.
The job creation and hiring numbers demonstrate that, albeit still slowly, the economy is growing. The lack of tightening in the unemployment number suggest that the Fed will probably not be moving too quickly on cutting back its quantitative easing (QE) policy. So, everybody’s happy…well, at least until Monday.
Stock sector transitions
Notwithstanding Friday’s index increases, stocks appear to have hit pause. The market has already given us what we’d be happy as a full-year’s performance– the S&P 500 up 14.4% year-to-date (1) – and we’re only in early June. I think most of us can agree that it’s unrealistic to think the market can continue to go up at the rate we’ve seen so far. There’s bound to be a correction of some sort.
By the way, this, in no way diminishes my positive feelings for the year as a whole. Matter of fact, my close buddies at Credit Suisse gave me additional reinforcement for that view when last Thursday they said,” We increase our year-end target for the S&P 500 to 1,730 (from 1,640) and introduce an end-2014 target of 1,900.” It closed Friday at 1643. So that’s about another 5% and 15% higher respectively from there.
Transitions are a normal part of a market’s evolution. What has worked/performed well “before” stops working as well as it had and something else moves to the fore. I think the market actually started a correction or, perhaps it’s better described as a rotation, in April as we moved to the new highs. It was an under the radar kind of shift initially that’s now moved up onto the high ground and gaining a lot of notice.
At first, the share prices of the utilities and REITS and other what are termed defensive sectors began to trail the market. They went sideways during the broad market rallies and then began a more obvious decline, now being joined by the high yield ETFs and MLPs. It appears that most, if not all, the sectors which have benefited from low interest rates the past few years are now experiencing increasing selling pressure.
Some of those sale proceeds are starting to flow more readily now into the so-called cyclical companies; those that benefit from an improving economy. That thought was echoed by John Manley, chief equity strategist at Wells Fargo Funds Management, when he stated this week that, “I think you want to get more cyclical as the summer progresses [because] the economy is weak and getting better…” Some of the sectors that meet this criteria include the techs, energy, financials, hotels, airlines, restaurants and so on.
Bond market transitions
The reason for the MoneyBeat comment about poor fixed-income results is because from the 2nd of May until Friday, we’ve seen the first real signs of what happens with existing bond values as interest rates rise. For example, according to the Treasury Department, on the 2nd, the 10 year Treasury note was last bid at 1.66%. Friday, it was 2.17%- that’s a 31% increase. The 30 year bond was quoted at 2.82% on the 2nd– it was 3.33% Friday. This is 15% higher. While both are still very low historically, bond math (interest rates up = current prices down) dictates that these movements have consequences.
This is not necessarily a totally bad thing. Higher interest rates are usually indicative of an improving economy. According to economist Dr. Scott Grannis, “These are all healthy developments. Perhaps more importantly, these changes are NOT consistent with the view that the equity market is being pumped up by easy money. If easy money were the driving force, we would be seeing higher gold prices and lower real yields.”(2)
Here’s an example of how bond math works. You may be familiar with PIMCO’s Total Return Fund. Since it’s the largest mutual fund in the entire world, it’s likely you have. According to Morningstar, the portfolio is entirely bonds. A report on Bloomberg.com (3), stated that this month, the fund experienced its biggest monthly loss, down 1.9%, since September, 2008.
The point I’m trying to make with this is simply that this transition from lower to higher rates will have some effect on all types of bonds, even those overseen by outstanding portfolio managers.
Rethinking allocations
Given that most most investors in US retirement plans choose one type of mutual fund or another for their contributions, I thought the following was pretty revealing.
In spite of the increasing potential effect of bond math and extremely low rates of return, so far this year, through May 29, according to Lipper, a unit of Thomson Reuters, taxable bond mutual funds still have had inflows of $116 billion. (Those figures exclude exchange-traded funds.) Overall, more than $2.6 trillion remains stashed in money market funds (4) and another $1.78 trillion is in corporate stockpiles of cash. (5)
There’s been a lot of talk lately that investors are “moving back” into stock mutual funds. Ryan Detrick CMT offers this perspective. From the previous stock market high in 2007, through 2012, there were outflows of $611 billion for US stock funds. So far this year, there have been in flows of $15.3 billion. That means that just 2.5% have re-invested in stock funds.
Summary
That underperforming cash will, ultimately, go somewhere. When individual investors finally get more confident about the future, the money will follow. It’s my contention that a bunch of it will find its way into the shares of the best companies in the US and the world.
In its Beige Book report this week, the Fed said that in the first quarter this year, household net worth rose to a record $70.3 trillion because of rising asset and real estate prices. I believe both of those will continue in a positive trend for some time.
Are you investing in stocks for the next two or three decades, whether in
preparation for, or during, a retirement? Then you’re pretty much for sure going to experience recessions, dozens of pullbacks and maybe even a couple an exciting crash or two. Those who can ride through the ups and downs will likely enjoy very nice returns over time.
As my boy Josh Brown put it so very well…”Count the perma bears on the Forbes 400 list or the amount of pessimists who run companies in the Fortune 500. You will find none.”
Cheers!
Mike
509-747-3323
- CNBC, 7 June 2013
- Calafia Beach Pundit, 28 May 2013
- 3 June 2013
- Investment Company Institute, 5 June 2013
- MarketWatch, 6 June 2013
To get an overview of economic conditions, use this link. It’s updated monthly.
http://www.russell.com/Helping-Advisors/Markets/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.
Michael J. Maehl, CWM®
Senior Vice President
Opus 111 Group LLC
400 S. Jefferson, Suite 400
Spokane. WA 99204-3142
509-747-3323 office
509-944-1790 cell
