Contributed by Doug Walters
Weeks like this I am thankful that at Strategic we take an academically-backed, real-world-tested, long-term approach to investing. Day traders and other short-sighted market watchers are undoubtedly nursing sore necks this weekend following a whiplash-inducing week of trading for U.S. Equities. We never like to see a 5% decline in the S&P 500, but we will sleep well this weekend knowing that a diversified portfolio with a focus on quality and value, will survive the inevitable downturns, and be ready to participate in the next leg of the rally whenever it comes.
Spiking the Punch
On Monday we put out a special note (Market Update – Feb. 5, 2018) to discuss the causes of the recent market volatility. We still see this largely as a “good news is bad news” situation. We are standing on a very strong economic foundation, and corporations are benefiting from the significant stimulus in the form of tax breaks and deregulation. Last year investors were happy to enjoy the party and bid up stocks. After a big run-up in January, the market succumbed to fears that the Federal Reserve might have to accelerate rate increases to contain the celebration.
This week Congress further spiked the corporate punch bowl, passing a two-year budget deal and (mostly) avoiding a government shut down. The bill raises budget caps by $300 Billion over the next two years. Time will tell if investors drink the punch or see it as further evidence that Fed chaperones are needed.
As we discussed in our mid-week note, the financial media will do what they can with scare tactics to drum up viewership. This week’s most misleading headline was, “Worst Two Weeks in the Stock Market Since the 2008 Financial Crisis”. Why is the misleading? 1) the Financial Crisis was an 18-month event which saw the S&P 500 fall over 50% during an economic crisis, 2) the 9% decline we have just experienced is no worse than declines we recently experienced in 2015 and 2016, and 3) it ignores that fact that equities shot up nearly 20% in the six months proceeding this recent decline. Beware of sensational headlines.
Spotlight: Keeping it Simple
When markets are buoyant and everything seems to be going up, it is easy to get complacent. During such periods we often see investors reach for additional return through risky investment vehicles. One such product made headlines this week thanks (literally) to the recent increase in volatility. A class of “inverse volatility” securities, which bet on market volatility remaining low, got a jolt from a sudden increase in equity market gyrations. Some of these funds saw their value decline over 90% this week. We take this as a good opportunity to remind investors the benefits of keeping it simple.
STRATEGIC ASSET ALLOCATION
Taking Small Steps
Risk appetite around the globe took a few steps back while investors digest the idea of higher yields, stronger growth, and inflation. While bears might have been jolted from hibernation, bulls are jumping in on the opportunity to get another chance to buy equities at 2017 valuations. Speaking of opportunity…
- We took “small” steps as we increased our allocation to small capitalization stocks. Last year we identified this as an opportunity due to lower taxes, higher fiscal spending, M&A and a more accommodative environment for small businesses. Our add last year was modest due to valuation. The recent move in equities opened an opportunity to pick up this attractive asset at a more compelling price.
The Technology sector ended the wild week as the one that held up the best. Energy, on the other hand, was the sector that did the worst. In other news…
- Online travel booking agent Expedia Inc. (EXPE) stood out with a notably tough week in an already challenging week for the market in general. The company’s quarterly earnings missed expectations and were stung by big advertising spend. The company tried to assure investors that the advertising spending will translate to earnings growth in the second half of 2018.
STRATEGIC EQUITY INCOME
The Consumer Discretionary sector was the leader this week. Surprisingly it was not the defensive Utilities. The Consumer Staples and Energy sector were laggards. Crude oil retrenching back to $60 per barrel was to blame for Energy’s weakness.
- Boeing Company (BA) found itself in the acquisition rumor mill this week, with whispers surfacing that it is looking to acquire Woodward Corp. (WWD). Woodward is a designer and manufacturer of control system components used in aviation. Woodward’s stock was halted when the rumor hit the tape. Woodward, which has a $5 Billion market capitalization, denied the Wall Street Journal report of a deal in the making.
The Week Ahead
Contributed by Aleksey Marchenko
How to COPE with Volatility
Chinese New Year will commence on Friday, February 16th.
- According to Asian astrology, 2018 will be the year of the Earth Dog. Anyone born throughout the year beginning Friday will be communicative, serious, and responsible in the workplace.
- The celebrations will last for over two weeks, with hundreds of millions of migrant workers traveling home for the festivities.
Olympics have started in Pyeongchang, South Korea.
- The winter games will feature 102 events in fifteen sports disciplines and will run until February 25th.
Pepsi (PEP) and Costco (COST) earnings will be in focus as both are held in Strategic’s Equity Income strategy.
- The secular shift away from soft drinks was not much of an issue for Pepsi in the past as the company is well diversified with healthy drink and snack brands such as Naked, Gatorade, and Quaker Oats to name a few. However, analysts will be watching if higher sugar taxes around the U.S. will be a drag on Pepsi’s revenue.
Economics data will be on the heavier side this week. Investors will have to decide if more economic good news is, in fact, good news, or just further evidence that the Fed needs to tap the brakes.
- The European Union’s preliminary GDP is on deck.
- Inflation readings such as CPI & PPI and retail sales are out Wednesday.
- Housing Starts, Building Permits and the University of Michigan Consumer Sentiment survey round out the week on Friday.
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