Take a look at a U.S. stock market chart so far this year, and you’ll see a nice, neat “V”. The S&P 500 index plunged 5.8% in the second half of January, only to recover all of its losses and hit a new high by the end of February. Was it all just a bad dream?
The steady strength of the stock market recovery is all the more remarkable given the relative weakness of the economic data that’s been coming out. Measures of retail sales, job creation, factory output, and housing starts for the U.S. all came in well below expectations and — to add insult to injury — the impressive early GDP growth estimate of 3,2% for Q4 was revised down to 2.4%. Most analysts have been inclined to blame the persistently harsh winter weather for keeping businesses shuttered, construction sites halted, and would-be consumers tucked snugly in their homes. Federal Reserve chief Janet Yellen, in her testimony before Congress last week, was also inclined to blame the weather for what she called “soft” data, but couldn’t be sure. She said she would be watching next month’s numbers for signs of improvement, and so will we.
The big sell-off in January, of course, was sparked less by anything happening in the U.S. economy than by contagious jitters from emerging markets, So in a sense, the recovery in U.S. equities could be seen as investors coming back to their senses, and focusing on the decent (if not always outstanding) fundamentals. This year’s earnings season, after all, has been a good one. Out of the 479 S&P 500 companies that had reported as of February 27, 74% beat earnings expectations (slightly above the 4-year average of 73%) and 62% exceeded revenue forecasts (outpacing a 4-year average of 59). The S&P index currently stands at a comfortable 16.5 P/E multiple of our (significantly lower than consensus) projection for 2014 earnings.
That is not a prescription for complacency. Some analysts seem to have concluded that since January’s concern over emerging markets did not boil over into a spiraling crisis, it was all “much ado about nothing.” Nothing could be farther from the truth. China may have papered over a large trust default it faced at the end of January, but it will continue to see mounting problems from bad debt and asset bubbles as it attempts a wrenching economic adjustment from a credit-fueled investment boom to more balanced, consumption-led growth. Countries with current account deficits, like India and Turkey, will remain vulnerable to volatile “hot money” flows induced by the Fed’s “reluctant farewell” to QE. Brazil, India, South Africa, and others will struggle to overcome the obstacles of corruption and populist politics as they try to get critical reform agendas back on track.
The prospect of unsettling surprises from unexpected directions took shape, this month, in the unfolding crisis in Ukraine. At the time of writing, Russian troops had occupied the Crimea and looked poised to start a shooting war. Oil prices were spiking, while U.S. and European stock prices were suddenly falling again. One could make a strong argument that the market is overreacting: Ukraine’s economy is smaller than Greece, Algeria, or Peru’s. While Ukraine is a main conduit for Russian natural gas exports to Europe, cautious planning plus a mild winter have left Europe with plentiful stockpiles and a variety of alternatives in case of a disruption in supply. But on another level, the events in Ukraine cast a long shadow, raising the prospect of deep geopolitical divisions we thought were history, and contributing to a growing sense of uncertainty and unpredictability all around the globe that has investors understandably anxious about what will happen next.
For the moment, traditional low or no-yield safe harbors like U.S. Treasuries, German Bunds, and — dare we say — gold, are looking attractive again. But that moment will pass. And when it does, we think U.S. equities, along with selective picks in underrated emerging markets like Poland, Mexico, Colombia, and the Philippines, will be the soundest place to be.
This communication contains the personal opinions, as of the date set forth herein, about the securities, investments and/or economic subjects discussed by Mr. Chovanec. No part of Mr. Chovanec’s compensation was, is or will be related to any specific views contained in these materials. This communication is intended for information purposes only and does not recommend or solicit the purchase or sale of specific securities or investment services. Readers should not infer or assume that any securities, sectors or markets described were or will be profitable or are appropriate to meet the objectives, situation or needs of a particular individual or family, as the implementation of any financial strategy should only be made after consultation with your attorney, tax advisor and investment advisor. All material presented is compiled from sources believed to be reliable, but accuracy or completeness cannot be guaranteed.
By Patrick Chovanec, Source: Patrick Chovanec
