Friendly Fed Continues Stock Market Support (11/15/2013)
NOVEMBER 15, 2013
Since our last blog, entitled “Don’t Fight the Fed,” the third- and early fourth-quarters of 2013 brought increased volatility in the markets with minor pullbacks and ensuing higher highs. This volatility was set off by announcements related to the Federal Reserve Chair position, the potential for a government shutdown, a subsequent “11th hour” Congressional agreement to avoid a default on national debt, and the Fed’s decision not to “taper” its Quantitative Easing program. All in all, between September 18, when the market first took notice of the brewing conflict over funding the government, and October 8, when the Republican House leadership acknowledged that it would not permit the nation to default, the S&P 500 lost 4.1%. From October 8 to October 17, when Congress passed the compromise legislation, the S&P gained 4.7% to reach another all-time high. The result is that active investors who purchased equities on the downturn were rewarded. This is because, while events in Washington D.C. have received a bulk of the spotlight during the past few months, it is important for investors to remember to pay more attention to economic and market fundamentals than to political clamoring in our nation’s capital. Likewise, despite temporary market worries to the contrary, Fed Chairman Ben Bernanke and his upcoming successor, Janet Yellen, have emphasized the need for the Fed to continue to support the economy through easing measures until thoroughly convinced of a sustainable upward trajectory of the economy. As such, the Federal Reserve continues to be extremely friendly to the financial markets, supporting prices of both stocks and bonds.
Earnings season brought some positive surprises, including those from Google Inc (up 16% since announcing earnings on October 17), Amazon Inc (up 7.2% since October 24), and Microsoft (up 12.8% since October 24). In general, the commentary coming out of companies has been cautiously upbeat, as most believe 2014 will be modestly better. Looking toward the end of the year and the beginning of 2014, we see that the stage is now set for next round of political confrontation beginning in first quarter of 2014, unless negotiations lead to a more sustainable agreement. While it seems like a long-shot, given recent history, consumer and business confidence would almost certainly be bolstered by some sort of longer-term, credible budget deal between the Administration and Congress. Nevertheless, in light of fiscal policy uncertainty and the lack of a clear economic picture, it appears that the Fed will hold off tapering until at least early 2014. Barring unforeseen events, such as accelerating inflation or exceptional GDP growth, Federal Funds rates will also remain at zero-to-0.25% through 2014. This continued Fed monetary easing implies that valuations are likely to remain high and may expand as appetite for risk taking stays elevated.
Outside of the United States, we have seen vast signs of improvement as Spain’s unemployment rate has fallen for five straight months and the nation emerged from recession in the third quarter, Ireland home prices are rising for the first time in more than five years and they are on track to exit their bailout in December, and Europe as a whole is showing improving manufacturing data. With diminished risk of financial contagion and Eurozone growth likely to return positive in early 2014, we have higher confidence in foreign holdings at this time. Furthermore, while European stocks have historically tended to trade at a discount to US, the valuation disparity is at extreme levels. Concurrently, as profit margins in the US have risen to a 45-year high, margins in the Eurozone have declined since beginning of 2008. If a modest economic recovery continues, as expected, profits could post even higher growth and help narrow the performance gap between the US stocks and European stocks. Japan, China, and the emerging markets have also shown encouraging signs, although we expect these markets to remain more volatile.
Many investors are concerned that a major correction is looming based on the surge that the market has seen this year. We believe that investors should not be surprised to see rounds of profit-taking or short-term correction activity. These present opportunities for our style of active management and are signs of a healthy market. On a real basis, S&P companies are yielding more earnings per dollar invested than at any point over the past 20 years. More importantly, valuations don't appear to be stretched at 15x forward price-to-earnings estimates. Multiples are at a fair price, but historically, when interest rates have been this low, multiples have been higher on average, as the alternatives to stocks are less compelling. Overall, with no impending recession in sight, stable revenue growth, shareholder friendly equity buybacks, and the additional use of debt financing, the fundamental support exists for modest improvements in corporate earnings moving forward. To reflect this view, we will remain invested in a concentrated position of high quality equity holdings and continue our active management strategies of lightening up when we are overbought, adding positions on oversold conditions, and using option trading to boost the overall return on investment.
Lastly, we would like to end by mentioning that in our effort to be the best wealth management company, Tellone Management Group continues to look for ways to enhance management performance, leverage the efficiency of workflows, and provide an unmatched client experience. Therefore, we recently invested in a new state-of-the-art integrated software system. This platform is top in the investment industry and will provide us with web-based solutions designed to 1) streamline portfolio management and trading functions such as rebalancing, monitoring, and trade allocation, 2) enhance performance reporting capabilities, 3) provide an integrated client relationship system, and 4) give clients easier and more secure access to their individual portfolios, retirement projections, financial roadmaps, and all other related documents. Integration of this system will take time and training, however, the outcome will be a huge step towards being the best for you. With Thanksgiving right around the corner, we are thankful to work with such enjoyable clients and wish everyone a wonderful Thanksgiving holiday.