The world continues to anticipate the priorities of the new administration. Investors have been quick to seize upon each executive order as though future economic results are all but guaranteed. To quote Warren Buffet, “Investors should remember that excitement and expenses are their enemies. And if they insist on trying to time their participation in equities, they should try to be fearful when others are greedy and greedy only when others are fearful.” To that end, a quick review of the announcements thus far this earnings season should be somewhat sobering. With the exception of the extractive industries and other commodity-related sectors, we have seen a disconcerting number of earnings and, even worse, revenue misses. Drowned out by the rush to join the parade of domestic job creators are the announcements of store closings and job cuts in the retail space. The recent holiday season was not a tide lifting all boats. As Comerica’s Chief Economist, Robert Dye, points out, we will see unit labor cost rising this year due to minimum wage hikes, implementation of new overtime rules and the spike in health care costs for this year. Even the robust auto sales data masked some early warning signs as its composition reveals that the light truck sector drove unit sales. With fuel prices higher year-over-year, that is a performance that may prove tough to match.
Aside from the economic realities, we should also consider the market mechanics of what has been going on since Election Day. The prospect of interest rates mounting a sustained advance has led to a large scale portfolio rebalancing with investors moving from long duration fixed assets to shorter duration equities. Here it is critical to consider the relative scale. The $3 trillion in bonds sold between November 9th and the end of the year created only a modest ripple in the bond market, but the same cannot be said of what that amount did to stock prices. There was a term coined during the last rotation from large cap to small cap stocks – “buckets-into-thimbles.” Going from bonds to stocks is creating the same distortions. There are some crowded trades lingering, and this is where we need to be proactive. We should be unwinding any stretch for yield, regardless of asset class. With the rebound in commodity prices in the face of global overcapacity, it is important to address the size and composition of the alternative holdings. Perhaps one of the most difficult challenges will be addressing the exposure to emerging markets. There is evidence that many of these economies have begun the migration from export orientation to domestic consumption, with projected GDP growth in some cases double that of the developed economies. These markets are under-owned and have upside surprise potential that warrants consideration.
We are in an enviable position; the long post crisis advance has been stable and fairly uniform. It is early in a new tax year, enabling us to reposition portfolios to reduce downside risk and enhance prospective returns. Accounts with funds to invest domestically should look to small and mid-cap equities with a bias towards value and growth at a reasonable price (GARP). Accounts for which global exposure is appropriate should look first to emerging markets.
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