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Strategic Insights

Volume 4, Edition 38 | October 12–16, 2015

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House of Pain

Mike Leist Michael Leist | Articles

Read Time: 4:45 min

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Equities posted their third straight week of gains, shrugging off both the dysfunction in the House of Representatives, and a rather lackluster earnings season where only Financials have managed to surprise meaningfully to the upside.

 Market Review

Equities posted their third straight week of gains, shrugging off both the dysfunction in the House of Representatives, and a rather lackluster earnings season where only Financials have managed to surprise meaningfully to the upside. M&A and IPOs remained a shiny distraction this week.

Please step forward: The House of Representatives continued its game of “not it” this week.

  • Normally we would expect political uncertainty to spook equities, but apparently investors have grown numb to congressional shenanigans.

Merger madness: While deals prove elusive in congress, they are flowing freely on Wall Street. Dell’s acquisition of EMC and the IPO of First Data dominated the press.

  • Perhaps then it should not be surprising that the orchestrators of these deals are having a good earnings season. Financial stocks are not only posting positive earnings growth, they are beating expectations.
  • Material and Energy stocks on the other hand are reporting dramatic declines in earnings thus far, thanks to weak commodity prices congressional.

Economic Commentary

The Fed has stated that the conditions for rate liftoff are maximum employment and inflation of 2%. With positive news on both fronts this week, why might the Fed still have reservations? Not all inflation is created equal.

Joblessness: Claims for unemployment reached a landmark this week, declining below the Apr. 2000 low.

  • We have to go back four decades to find a lower level. The Fed focuses on the unemployment rate, which at 5.1% is not far off their view of maximum employment.

Inflation game: This week the often quoted measure of inflation, Consumer Price Index (CPI) ticked up to 1.9% – just shy of the Fed’s 2% target. That would appear to be good news for Fed watchers. But…

  • … the Fed’s preferred measure of inflation, Personal Consumption Expenditures (PCE), stands at just 1.3%. What’s the difference? While CPI captures price inflation experienced by an average consumer for a basket of goods, PCE measures inflation for the entire economy.
  • What’s more, the divide between CPI and PCE appears to be expanding (see chart below). Despite this, we see the CPI rise as a positive, and believe it bodes well for a rise in PCE when it is reported at the end of the month.

Looking Ahead to Next Week

I’m loving it? 3rd Quarter earnings announcements for Strategic holdings include McDonalds, Coca-Cola, Verizon, Microsoft and M&T Bank amongst others.

  • Mickey D’s reports the last earnings excluding its new all day breakfast initiative which franchisees have initially called a disaster, impacting service and sales.

Prime ratings: Central banks around the globe will set key interest rates, including Europe, Canada and Brazil.

  • The ECB decision comes in the wake of the V.W. scandal which has shaken confidence across the region.
  • Canada’s rate decision coincides with federal govt. elections, where PM Harper is seeking a 4th term.

Hot seat: Hillary Clinton will testify in front of a Congressional committee regarding the 2012 attack on an American diplomatic compound in Benghazi, Libya.

  • The investigation, focused on Clinton’s private email server content, couldn’t come at a worse time for the leader in the Democratic presidential primary polls.

Investment Strategy Update

Contributed by David Lemire , Max Berkovich

STRATEGIC Asset Allocation

Digging out: While too soon to think about snow (maybe), many asset classes have been recovering from the selloff of the past few months. Coming off of lows hit at the end of September, Emerging markets have posted gains of over 11% while U.S. Large Cap and Developed have climbed in the high single digits.

Called strike: Developed’s recent performance moved the asset class out of our strike zone. So while we may have missed an opportunity to add exposure here, we prefer to remain patient and wait for a fatter pitch (higher margin of safety).

STRATEGIC Growth

Dude, Dell is getting you!: Energy sector lagged and Health Care sector jumped back to the top. In other strategy news…

  • EMC Corp. (EMC) the date storage goliath is being purchased by Dell Corp., a private company since 2013. The deal is extremely complicated. EMC shareholders will receive $24.05 in cash and 0.11 shares of VMware tracking stock. 20% of VMware, Inc. (VMW) is public the rest owned by EMC. The tracking stock’s value is hard to peg and complicates the deal.

STRATEGIC Equity Income

Wal to Wall: Utilities and Health Care sectors were the leaders and Consumer Staples sector was a laggard thanks to…

  • Wal-Mart Stores, Inc. (WMT) caught investors off-guard by offering a steep reduction in guidance. The retailer claims that major investment in technology and significantly higher wages will pressure earnings the next few years. Though, a $20 billion buy back was also announced to cushion the blow.

About Strategic

Founded in 1979, Strategic is a leading investment and wealth management firm managing and advising on client assets over $1 billion.

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