Last month I started my newsletter by describing the first quarter of 2015 as lackluster; April did not do much to change that. Year-to-Date the Dow and S&P 500 are up 0.78% and 1.92%, respectively. With Q1 earnings season more than halfway over and only 48% of companies reporting better-than-expected revenues, we can confirm what the weak GDP report already told us: that a cold winter, dramatic declines in energy investment, and a strong dollar combined into a stiff headwind. This will provide good fodder for the "Sell in May and Go Away" crowd. But, pithy anecdotes are no substitute for critical thinking. So let's look past current headlines and consider what may be coming down the road.
First, the dramatic decline in energy prices has bludgeoned the sales and earnings of North American producers, leading to dramatic declines in their investment activity. For example, active North American oil and gas drill rigs are down 50% since April, 2014. Layoffs in the industry are widespread. And the energy industry is the primary reason for the disappointing S&P 500 earnings reportage. But although this has been a hit to recent earnings and economic figures, low energy prices are unambiguously positive for consumers. It just takes time for the benefits to work their way through. Thus, investors should look past the tough Q1 numbers.
Second, interest rates are likely to be the lead story for the second-half of the year. Consensus has the Federal Reserve beginning to raise rates sometime in late 2015. It is being talked about so much that even if it doesn't happen, people will be talking about that. However, all this talk is unlikely to amount to much. As famed economist, David Rosenberg, recently pointed out, "it's not the first rate-hike that's the problem. No cycle ended at first, second, or third rate-hike. The big concern is the last hike." He further points out that, historically, the first rate-hike happens when we are 35% into the bull market. A long-story made short: what matters most is the pace of rate-hikes and not the initiation. Since nobody believes the Fed is in any hurry to ratchet them up, this should not be a reason to avoid stocks.
Third, the bankruptcy of Greece, a perennial favorite of the financial press, is a non-event for several reasons. First, Greece has been bankrupt for five years. They get new loans to pay off old loans, strike deals to lower interest rates and extend maturities, all the while refusing to implement the reforms necessary to improve their lot; this is nothing new. Second, most of the Greek debt is now held by other sovereigns and not by banks, where the rules couldn't be more different, making the impact of a default on the financial system negligible. Finally, European leaders dread the unintended consequences of Greece leaving the European Union, and so does the Greek citizenry. Therefore, like all the other cash crunches we've witnessed over the past five years, this is likely to lead to a new election, not a Greek exit from the EU.
The conclusion is that there is little on the foreseeable horizon that represents a compelling reason to be negative on stocks. Not all stocks are created equal, though. I would argue that one should focus their portfolio sectors like consumer discretionary, industrials, and healthcare, and avoid consumer staples and utilities. Fixed income, however, is another matter. The yields are poor relative to dividends. With the Fed agitating to begin raising rates sooner-rather-than-later, I continue to believe that this traditionally conservative asset class represents a low-return / high-risk investment. Long-term thinking suggests we continue to own stocks and use volatility as an opportunity to build those positions and rebalance away from bonds. Maybe May will give us that opportunity.
Brennan R. Redmond, CFA - Senior Vice President
(This article contains the current opinions of the author but not necessarily those of Brighton Securities Corp. The author's opinions are subject to change without notice. This blog post is for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. References to specific securities and their issuers are for illustrative purposes only and are not intended and should not be interpreted as recommendations to purchase or sell such securities.)