Big down days in a flat market

Today’s 350 point drop in the DOW tipped all of the market averages into the red for the year. Concerns about Greece the Greek fiscal condition and the Chinese market have presented the market with a formidable two headed monster to overcome.

Adding to concerns for the stock market is today’s selloff, which penetrated the 200 day moving average for the S&P 500. Conventional signals point to this technical occurrence as a sign of a further decline.

Conventional wisdom on Wall Street is rarely reliable, as we know. In 2014, we had two of these occurrences where the 200 day moving average was breached. In each of these, the S&P 500 rallied 6% over the next month. So, this implies that conventional signals should be disregarded. Our markets are likely to be making an intermediate term low point following today’s selloff.

In this “Long Dry Road”, where a flat market is like “Watching Paint Dry”, a selloff of this nature is a great opportunity to invest and make short term profits when the market recovers.

Wednesday begins a new quarter. Companies engaged in substantial stock repurchase programs often suspend this program until their earnings are reported. These buybacks are reinstated after the earnings report. For investors looking for money making opportunities, it will pay off to wait and invest in these companies sometime between now and the middle of July.  

Assets can still thrive when they can gain in a flat market. 

Watching Paint Dry

The markets continue to plod along on their well-established ways. After a negative start to 2015, the market indices inched to a 3% gain for 2015 only to lose that and retreat to a virtual standstill. According to Bespoke Investments, the S&P 500 has never hovered this close to its beginning of the year starting point this far into the year. There is plenty happening in finance and world economics. None of this can give control to bulls or bears.

On one count, we should be grateful to merely tread water. Stocks have ample reasons to slide. The US economy declined .75% during the first quarter. It only takes two quarters of negative GDP growth to be classified as a recession. Interest rates are rising on vital things like home mortgages. The Fed is expected to hike interest rates soon. Gas prices began to rise in March and consumers’ cost savings from this are dwindling. Looking off shore, the international picture is not rosier as deep concerns exist in Europe and China.

Yet, through all of these factors, stock valuations remain high. The markets are in the vicinity of their all time highs. Furthermore, it is ominous that nearly four years have elapsed since the last 10% market correction.

This fact does not lend anything to forecasting. Bespoke Investments tells us the last time the market rose over three years in uninterrupted fashion was in 1994. If you would have sold at that point, you would have missed out on another 105% gain over the next three years and nine months. Therefore, we can’t predict a correction simply because we haven’t had one for a while.

During this quarter, it became apparent that we needed to overhaul client portfolios by changing the stocks that our clients hold. Stocks that are weak threaten investment portfolios because they dampen potential returns from other superior investments. Our strategy this quarter has been to reduce our holdings. We are rebuilding our portfolios by using companies with the brightest prospects.

As we move toward the midpoint of 2015 and the July earnings reports, the characteristics of Amazon, Accenture, CF Industries, Eaton, and Gilead all look to be rewarded. There can be lots of standout performers regardless of the market’s condition. Carefully selected investments such as these can overcome our flat market; a market that seems pinned to current levels. 

Medicine for a flat market

Despite some big swings both up and down, the market has very little to show for itself for 2015.  The S&P 500 fell 3.6% in January, rose 4% in February and is looking to be slightly negative in March. This market is threatening to post its first quarterly loss since Q4 2012 and this is only the 6^th quarterly loss since the bull market began in 2009.

S&P 500 earnings are now forecast to be down on year over year comparisons.  The decline in earnings from large companies is due to an evaporation of earnings from the energy sector. Despite the woes from energy, other industry groups are showing only muted gains, according to S&P forecasts. Indeed the next three quarters are likely to show negative year over year earnings comparisons from the largest US companies.

Disappointing earnings are likely to limit gains for the market as we move into the second quarter of this year. It appears unlikely that the market is poised to get above its recent highs of 2100 on the S&P 500 index.

In the meantime, trading opportunities continue to brew amongst individual stocks. Many of these could eventually end up being solid long term investments. This would always be a chief hope for anything we invest in. But when the overall market has no traction, we might have to wait too long for these investments to come to fruition. If stocks continue to consolidate in a bandwidth, we want to take advantage of this condition and buy the lows and sell the highs. While we wait for the market to meander, profitable trading is the medicine that we need for assets to grow.

Please expect that our work will yield profitable trading. 

Winning in a trading range

Yesterday’s Federal Reserve announcement ignited a stock market rally that sent the S&P 500 to a narrow gain for this year. The context of this announcement surprised investors because the Federal Reserve and Janet Yellen indicated the economy was actually weaker than the recent data suggested. A weaker economy means the Fed might delay the inevitable day when it must raise interest rates. Investors took heart that this day might occur later rather than sooner.

The stock market has been revealing a very consistent pattern this year. Last year, I wrote about the “Long Dry Road”, and I suggested the stock market would be flat and tethered to the dock for the foreseeable future. Essentially, this has been the case.

This condition is evident by the behavior of the market for 2015. In January, the S&P 500 fell 3.6%. It recovered 5.1% during a banner February. After enduring substantial volatility, the market rests virtually unchanged for this month of March. You can see from these swings that the market is solidly entrenched in a trading range.

A trading range can give an advantage to shrewd investors.  This trading range dictates buy at the low end and sell at the high end.  Each period of gains should be followed by a pullback and each decline should hasten a buying opportunity and the market should subsequently recover.

Pundits, the financial press, and people who want to sell a story might have you believe the market is bracing for a substantial decline this year. Often, you hear a 20% correction is imminent.  These predictions are based on flimsy supporting data. Furthermore, people advertising a market decline are not the same people that actually control the monolithic pool of money. For example, if you see or read a dire forecast, it is unlikely that the chief investment officer of an organization like CalPERS will be actually selling their equity holdings. CalPERS will remain invested while doomsayers carry on with their forecasts. If the guys in charge of all the stock don't sell, the market can't fall very much.        

Investors win by being cognizant of the investment climate in a trading range. The order of the day is to be discerning about which stocks to hold and which stocks to harvest profits. This quarter, we sold major holdings for our clients in Alibaba, Union Pacific, Apple, Cummins, and Raytheon. In these cases, we took the opportunity to sell, capture recent gains, and redeploy this money to new opportunities.

Tactics like this will be essential for portfolios to gain in this trading range.   

Beware of governments

The bull market may be over. There are lots of reasons that experts are using to support the argument that our six year bull market is coming to an end.  Famous bond investor Bill Gross said at the year’s outset, “Good times are over.”

Chief amongst the concerns are the stresses on foreign governments.   These countries are facing varying degrees of stress. These stresses can be endured temporarily but they can reach a boiling point which can trigger government action.

This month, Switzerland found its balance sheet supported entirely by Euro denominated securities. When your assets are tied to a depreciating currency, this can stress a financial system.  The Swiss National Bank responded in necessary fashion by lifting the pegged exchange rate on the Euro.  This caused all of the Swiss National Bank assets denominated in Euros to decline in value. The markets didn’t like this.

Earlier this month, China lowered its broker loan rate to curb speculation on Chinese stocks. The condition in China is flashing a red warning to investors because this country has decelerating economic growth in the face of a skyrocketing stock market.  It is only a matter of time before this dichotomy is resolved one way or the other.

What will be next? Perhaps the most significant economic trend over the past two months is the decline in energy prices.  How will the petroleum exporting countries that depend on oil to support their entire infrastructure fare?  This is another example of a stress that can build before a government is forced to intervene.  Most of these interventions are not pleasant and don’t help the stock markets.

While the bull market may be over, it won’t clear a path for the bears.  These moves by sovereign governments in response to stress will serve to pin the broad market. This means that stocks are locked in a trading range.

About Face

Just as fears of widespread Ebola virus swarmed the stock market earlier this month, the acceptance that the illness might be contained has returned the market to its previous levels. Put simply, stocks fell 6% in the first two weeks of October and then rallied 6% over the last two weeks.

This type of zig-zag recovery masks a market that is really flat overall. After the volatility, when the smoke clears, we are right back where we started.  It will be difficult for the market to push too much higher after this latest advance. We are still in a “long dry road”, which is a metaphor for a begrudgingly slow advance for stocks. We are also in a very slow economy with considerable economic headwinds throughout the rest of the world.

The brightest opportunities for investment appear in the industrial sector of the stock market. Other areas don’t look nearly as attractive.  Consumer spending is likely to be muted. Job growth and wage increases are barely happening according to most recent data. The principal engine of retailing, Amazon, reported disappointing sales this month. This suggests many consumer related companies will see little progress in their stocks. In addition, financial companies face headwinds from low credit spreads. Social stocks and story-stocks like Tesla have already been played out and investors have been setting expectations too high.

The industrial sector, instead, retains considerable value based on the business outlook for these companies. Companies like Cummins, Chicago Bridge and Iron, Eaton, Parker Hannifin, Paccar, and United Technologies are representative of these companies. We plan to add to our holdings in these stocks.

Overall, we plan for a flat market for the remainder of this year. This will emphasize stock and sector selection in order to make solid gains in the fourth quarter. 

Seeking a Cornerstone

Wanted: Investment manager seeks fun loving stock that can continuously travel to new heights, no matter what. This stock must be able to overcome market corrections from political turmoil.  It also needs to gracefully shrug off any general economic worries. This stock must love to frustrate all of its doubters and maintain an unwavering sunny disposition despite all circumstances. If any possible disappointment should happen, this stock must be able to recover quickly so that no one will remember why it went down in the first place. If you are a candidate for this request, please make yourself known in a clear and concise manner.

The flattish stock market that we are experiencing seems tethered to the dock. After a sell off early in October, the S&P 500 was only up 6% for the year and the DOW was virtually unchanged. The market makes very little progress in either direction.

In order for portfolios to grow, it is imperative that investors dig out and discover standout performers. This might imply singling out small companies that can grow to magnificent proportions from relative obscurity.

Or, as is more often the case, an enterprise that is already a juggernaut simply runs away from the field and catapults itself to new heights by generating more rapid growth than anyone expects.

Such is the case at Netflix which has been the market’s number one stock over the past two years for all stocks at a relevant market capitalization. In spite of this gain, Netflix may be just scratching the surface of its potential.

Netflix is known primarily for streaming movies made by other companies. It has shaken up the TV world by offering original television content  like smash hits “Orange is the New Black” and “House of Cards”.

Most recently, Netflix has announced a foray into making its own original movies. A sequel to “Crouching Tiger, Hidden Dragon” will be a Netflix property. In addition, Netflix has signed Adam Sandler to make four feature films. Netflix’s plans include a suite of pay per view offerings at $5.99 that would be a significant increment to its $7.99 monthly service.

Netflix reached 490 per share in September before succumbing to profit taking. It dropped as low as 437 this month before recovering slightly.

In the months ahead, this company should regain its royal state as investors become more convinced about its bright prospects. Netflix should be a cornerstone for our investment portfolios and we plan to buy these shares this quarter.