Buy the Dip or Back to the Bunker?
Buy the Dip has been a rallying cry for talking heads for most of 2013. It always sounds smart and exactly what the Doctor ordered until it actually happens. Suddenly the talking heads turn bearish and the buyable dip feels like the beginning of a correction forcing us back to the bunker. I succumb to the same emotions. The large sell-off last week had me talking cautiously on Fox News Host Charles Payne’s special just a week ago.
August was a challenging month for investors with the S&P down over 3%. Several storms seem to be converging simultaneously. Economic data that continues to show a feeble recovery, rising interest rates, an impending congressional showdown and the potential for an expanding conflict in the Middle East have weighed on market sentiment, forcing many to the sidelines.
Recent economic releases show little momentum and earnings have been at best a mixed bag. While there were some notable positive surprises, retail was a big disappointment. Consumers appear to be willing to spend on home improvement but clothes and other discretionary items failed to show up at the checkout line.
10 Year Yields
Interest rates and a likely Fed exit from quantitative easing continue to put pressure on the market. Rising rates are normal in an economic recovery. However, the impending Fed taper makes it difficult to know if rates are rising because of their exit, or a signal the economy is ready to function on its own.
As you can see in the chart on the left, 10 year yields have risen dramatically since the Fed first hinted of an exit back in May. The debate and the question being asked inside the Fed is the following; without training wheels, will the bike fall over when Dad lets go?
Perhaps the biggest potential storm is the one developing over Washington. Budget negotiations, a continuing resolution and the debt limit all converge in October. Congress isn’t slated to come back from recess until September 9th, giving them very little time.
President Obama spoke to the nation Saturday asking Congress to vote on his decision to attack Syria in response to the use of chemical weapons on its own civilians. If this is our course of action, then the House and Senate should be called back for an emergency session. Military conflict is always a concern for markets. However, I don’t believe the economic effects here will be long lasting.
Bullish Percent Index
The New York Stock Exchange Bullish Percent Index measures the percent of stocks that are on a technical buy signal and that recently has turned negative. It signals the number of stocks breaking down technically on their charts is starting to increase. This is just another data point but needs to be watched.
It’s been very unprofitable to be a bear for most of the last 5 years. Mindful of the fact that this is a medicated market with the Fed pulling the puppet strings along with the concerns I’ve laid out above, I am not ready to head for the bunker. The chart of the S&P 500 shows we are still in the center of a strong positive channel established during the market correction of 2011. A sustained break below 1558 would take us out of the channel.
We are currently about 10% cash in Alpha Select Portfolios. The chart below shows our current sector weighting relative to the S&P 500. I have positioned the portfolio leaning towards growth rather than value. Value stocks tend to provide a total return strategy with growth of earnings plus the dividend adding to performance. The dividend side of this strategy is under pressure and will continue to be as long as interest rates keep rising. We currently don’t own any utilities as there is little growth in earnings and I think current yields remain unattractive.
Industrials and technology still show signs of growth and hence we are overweight both. Healthcare has been the best performing sector this year but is fairly valued.
We are underweight consumer staples and believe most of the sector is trading too rich given only modest growth prospects.
The weakness in financials is a surprise in the face of rising interest rates. Some of the banks that would benefit most from a steeper curve and higher rates have been hit the hardest. For now, the benefit to net interest margins isn’t helping the stocks.
Questions to Be Answered
- Will the U.S. take action in Syria?
- Will the Fed begin to exit Quantitative Easing in September and if they do, by how much?
- Will Larry Summers or Janet Yellen be the next Fed Chairman?
- Will employment figures finally break out to the upside to confirm the recovery?
- Will Congress flirt with a government Shutdown? (Mohammed El-Erian asked this question in a recent op-ed) I can answer it right now. Yes!
- How will markets respond as we approach the debt ceiling?
Some of the above will lead to a confrontation. To get an early read, just look to see who blinks first. – David Nelson, CFA
Disclosure – Funds managed by David Nelson are long Apple stock at the time of the release of this post. however, reserve the right to sell at any time. Belpointe Asset Management, LLC (“Belpointe AM”) is an investment adviser registered with the Securities and Exchange Commission (SEC). Registration with the SEC as an investment adviser should not be construed to imply that the SEC has approved or endorsed qualiﬁcations or the services it offers or that or its personnel possess a particular level of skill, expertise or training. For disclosures visit: http://belpointe.com/disclosures/