March Madness is in its full glory with some of the most epic displays of competition, controversy, surprises, and visuals we have ever seen. Oh, and the NCAA basketball tournament is pretty incredible, too, but that’s not what I’m talking about. I’m talking about the U.S. presidential election. And it has produced some crazy headlines, news clips, and sound bites. We have hugely popular candidates ranting about topics ranging from massive walls, to repealing laws, to the size of one’s private parts, to riots if there is a brokered convention, to targeting corporations that seem to be “predatory,” to Denmark as the appropriate model for American political policies.
But in the midst of all this misdirection, corporate America seems to be finding a path to climb out of its rut. So, although earnings might remain weak for the short term, the prognosis is good for the back half of the year, and stocks seem to be reflecting an expectation of improving fundamentals rather than the latest attention-grabbing headline. I told advisors during my travels earlier this year (during the market meltdown) that I believe we will see a flight back to quality this year, a return to valuation-driven investing, including value, GARP, and dividend strategies, along with a stabilization and slight recovery in oil and commodity prices. I also said that we could see new highs in the S&P 500 later this year, and perhaps a double-digit total return for the year. I still think these are in the cards.
In this periodic update, I give my view of the current market environment, offer a technical analysis of the S&P 500 chart, review our weekly fundamentals-based SectorCast rankings of the ten U.S. business sectors, and then offer up some actionable ETF trading ideas.
Market overview:
Yes, the headlines are often borderline crazy, but the good news is that investors seem to be ready to move on from their short-term focus and look toward longer-term fundamentals. From an investor’s standpoint, at least three of the four main headline grabbers (China, oil, Fed, election) of the recent past may have finally moved themselves to page two of the newspaper. China appears to be on a workable path to stabilizing the yuan, although global currency wars continue. Oil prices have rallied substantially, which has not only bolstered some Energy sector balance sheets but also helped lessened the doom-and-gloom in the high yield market. And the Federal Reserve has calmed nerves by demonstrating a willingness to adjust its rate hike intentions.
As for the election, however, it is pretty evident this year just how polarized our society has become, with candidates ranging from Tea Party conservatives to democratic socialists, and populist messages of all sorts gaining plenty of traction. Donald Trump might not like it, but the GOP’s system of electing delegates to a convention where a party representative is then chosen for the general election, has been in place for 160 years. During that time there have been ten instances (roughly 25% of the time) in which no GOP candidate earned a majority of delegates, and in seven of those instances a candidate was chosen who didn’t have a plurality of the delegates (the most recent being 1952 with General Eisenhower) but instead was deemed most likely to win the election.
Meanwhile, improving economic data has been a boon to risk assets over the past several weeks, but the February retail sales report and the January revised number were quite disappointing. However, if we focus solely on core retail sales (i.e., ex-auto and gasoline), the numbers were solid — setting a record in February and gaining more than 4% year-over-year.
Stocks have indeed responded. Surprise! The S&P 500 total return turned positive YTD on Monday, albeit ever so slightly (less than 1%). ETF money flows have pushed over $5 billion into domestic equity ETFs over the past week. Moreover, the S&P 500 is now providing a 2.17% dividend yield, while interest rates remain at historical lows with the 10-year Treasury yield closing Monday at 1.92% and the 2-year yield closed at 0.87%, with the spread between them rising slightly from 99 bps two weeks ago to 105 bps today.
As widely expected, the March FOMC meeting concluded with no change in the fed funds rate and the announcement that it will likely raise rates only twice this year instead of the previously indicated four times. Thus, the Fed has been able to create the illusion that it is easing — at least relative to the prior timetable. Fed funds futures are now pricing the probability of at least one quarter-point hike in April at 7%, June 38%, September 60%, and by December there is a 74% probability of at least one hike and a 34% chance that we will see two rate hikes.
