January 8, 2014, Wednesday, 13:28 GMT | 08:28 EST | 17:58 IST | 20:28 SGT
Well, I’m back after roughly a two-week hiatus where I didn’t do very many strategy calls, or strategy reports. I did, however, pen a letter regarding my forecast for 2014 dated 12/30/13. And for those who, like me, kicked back over the past two weeks to spend time with family and rejoice in the holidays, and did not read anything, I urge you to peruse my “2014” report. Probably the most operative paragraph from that missive was this:
In conclusion, in the very short term the equity markets are overbought, but it has been repeatedly demonstrated in 2013 that such readings have been greeted at worst with moderate pullbacks and at best with a sideways consolidation. I would expect the same here. After years of modest growth, the U.S. economy looks poised to gain momentum in 2014. At this stage in the business cycle, uncertainty tends to be on the decline and confidence typically is on the rise. That causes investors to move from safer assets (cash and bonds) to ones with better returns (equities). This eventually leads to excessive optimism. If the markets remain on their current path, excessive optimism should arrive in the February – April timeframe. At that point, the equity market should become vulnerable to a more meaningful decline. Nevertheless, as long as the economy avoids a recession, and we think it will, the odds of a true bear market remain de minimis. My asset allocation is to overweight U.S. equities (Japan remains interesting) and underweight bonds with emphasis on the short end of the fixed income curve. High yield could still have some upside, as could “credit.” I would continue to underweight Emerging Markets (EM) in the near term, although some of them look very cheap. Commodities should also be underweighted in the near/intermediate term, including precious metals, until EM growth accelerates and the U.S. Dollar Index weakens. As for the U.S. dollar, it looks set to strengthen against most currencies as interest rates grind higher. This is yet another reason to underweight EM and commodities. In addition to my often-stated macro themes (the election of smarter policymakers and therefore smarter policy, the American Industrial Renaissance, Energy Independence, the Digitization of Society, Mass Consumerism, Modern Medicine), there are some major disruptive themes that are reshaping industry. They include: 1) 3D printing; 2) LED lighting; 3) Cancer Immunotherapy; 4) Mobil adoption and the convergence of devices; and 5) Big data ... to name but a few. The year ahead for the U.S. economy, and markets, should be dependent on continuing earnings momentum, policy initiatives out of the D.C. Beltway, fiscal and monetary policy, interest rates, and the dollar; all of which causes me to employ a more flexible investment style for 2014 than I used in 2013.
Expanding on the American Industrial Renaissance (AIR), in addition to my recent meetings with Rich Bernstein, portfolio manager (PM) of the AIR-centric Eaton Vance Richard Bernstein Equity Strategy Fund (ERBAX/$14.08), the Eaton Vance Richard Bernstein All Asset Fund (EARAX/$12.36), and First Trust’s Richard Bernstein TS American Industrial Renaissance ETF (FWRVLX/$10.51), I met with another such PM at Fidelity the week before Christmas. His name was Tobias Welo. Tobias is the Fidelity cyclical team’s leader and portfolio manager of the Fidelity Advisor Industrials (FCLIX/$38.73) and Fidelity Advisor Materials (FMFEX/$83.97) funds. For Fidelity Advisor Industrials, he invests primarily in companies engaged in the research, development, manufacture, distribution, supply, or sale of industrial products, services, or equipment. For Fidelity Advisor Materials fund, he invests primarily in companies engaged in the manufacture, mining, processing, or distribution of raw materials and intermediate goods. A few of his themes include: 1) U.S. construction theme – Non-residential real estate construction cycle lags the residential by 12-18 months; 2) Energy efficiency – Growing demand and a limited supply of natural resources are driving energy efficient technologies (efficient lighting and engines); 3) Manufacturing renaissance in the U.S.; 4) Low-cost natural gas – Lower gas prices in the U.S. have created a cost advantage for domestic chemicals companies.
Tobias became more and more animated when he discovered that I love to talk about stocks. One of the names discussed from the Raymond James research universe was Federal Express (FDX/$140.05/Strong Buy). Tobias believes the mindset at the company is changing and given the cost reduction initiative, the share repurchase program, and the reduction in capital expenditures these shares should be able to outperform. Other names Tobias mentioned that are favorably rated by our correspondent research providers include: Danaher (DHR/$76.56); Pall (PLL/$84.01); Precision Castparts (PCP/$267.79); and Honeywell (HON/$90.52). For more information, please see the recent reports from the appropriate analysts. As a sidebar, if you don’t believe in the AIR theme, read the article in last Friday’s Wall Street Journal titled “Factories Begin to Hit Growth Stride” (page A2).
I met another new portfolio manager that same week, namely Warren Koonze, who hangs his hat at Natixis Loomis Sayles. Warren manages the Loomis Sayles Capital Income Fund (LSCYX/$12.24). Currently, Warren is about 85% invested in equities and 15% invested in fixed income. He thinks the interest rate rise is actually bullish for equities, particularly insurance stocks (underwriting cycle with premiums increasing). Moreover, given corporations’ lean posture, combined with a pickup in the capital expenditure cycle (I agree), S&P 500 consensus earnings estimates should be achievable in 2014. Warren also likes the banks. He was particularly keen on the refiners, thinking the pipeline bottleneck has been relieved, allowing shale oil to flow more freely to the refiners along the Gulf of Mexico, thus permitting refining margins to remain robust. Names from Raymond James’ research universe favorably mentioned in our discussions were: Valero Energy (VLO/$49.35/Strong Buy); HollyFrontier (HFC/$49.36/Outperform); and EOG Resources (EOG/$164.56/Outperform).
As for the stock market, in Friday’s Morning Tack I wrote (as paraphrased):
In last Thursday’s CNBC interview I stated that a lot of individual investors had been unwilling to take profits into year-end 2013, preferring to delay the subsequent tax payments from April 2014 until April 2015. Accordingly, I told investors to put on blinders to last week’s late action, preferring to wait and see what the markets would do when the pros return this week. Indeed, selling was not intense in Thursday’s session with Down Volume on the NYSE at just 69% of total Up/Down Volume. Nevertheless, what a difference a year makes because last year the equity markets began the year with a BANG as we experienced back-to-back 90% Upside Days, suggesting the S&P 500 (SPX/1831.37) would be substantially higher one month, three months, six months, and a year later. As for the current downside support levels, last Thursday the SPX closed just slightly above its 10-day moving average (DMA) at 1830.47. Closing below that would bring into view the closest major support level that exists at the former rally highs between 1808 and 1813, which is slightly higher that the SPX’s 30-DMA of 1806.11. My sense remains the equity market will make its true near-term path known this week and I think it will be higher into mid/late-month. From there the markets should become more vulnerable as investors start to contemplate April taxes, which are going to be a lot higher than most are thinking currently. If correct, an up move from here should also bring on excessive optimism. Still, at least at this time, I do not think there should be any material adjustment in portfolio construction.
The call for this week: If I could script this week, I would look for another “treading water” session today (Monday) like we experienced last Friday. Then some kind of downside attempt mid-week to test the resolve of the bulls. If the bears can’t gather much traction on the downside, the rally should resume. In any event, we should not have long to wait to see how the short-term outcome plays. Overnight, China’s PMI slid to the lowest level since August 2011 and Australia’s service sector reading declined, leaving Asian equities down across the board. Today, look for the U.S. ISM non-manufacturing, Factory Orders, and Yellen’s Senate confirmation vote, none of which should be market moving.