Last week I mentioned August performance may provide some clues to how investors are going to position themselves for the end of the year. After looking at July returns I raised an eyebrow. The month served-up many large moves, both up and down; some you would not expect. Others make you shake your head. Outside of U.S. stocks there continues to be few good investment opportunities based on current price action.
Readers know when I evaluate the health of the U.S. stock market I place a lot of emphasis on the performance of leading stocks. Leading stocks are those companies with strong sales and earnings growth along with other fundamentals. When investors are willing to bid up the prices of this category of stocks there is an element of risk taking in the market that tends to be healthy for the market overall. Right now leading stocks are one of the few categories of stocks performing well and with many coming from the Nasdaq 100 (QQQ) we understand why the index delivered an amazing 4.5% return in July! Impressive right?
Consider this, 20+ year treasuries (TLT) also had a strong month, up 4.5% too. This on the verge of a rate-hike cycle kick-off! Regarding short-term bonds (SHY), they held firm, essentially flat for the month. The bond market was hardly concerned about rising rates or inflation in July. To have the Nasdaq 100 and Long Treasuries deliver such strong performance during the same period is well, odd especially in light of other factors.
Real estate (IYR), after getting hammered earlier this year also rallied in July, up 5%! Real estate, along with other interest-rate sensitive equities (like utilities), have been under pressure most of this year as result of possible higher borrowing costs in the near future. It is interesting as we approach the actual rate hike event (not!) real estate and utilities rally. Maybe they over corrected earlier this year but all of these moves during the same period as other events are unfolding has caught my attention.
One the downside, we have the following in July:
Oil (USO), down -21.5% and commodities (DBC) in general, down -12.6%. Gold (GLD) fell another -6.6%. Those are very big ONE MONTH moves! Perhaps it will mark the final chapter in the multi-year bear market for commodities and the vibrant demand engine policy makers have so diligently tried to create is ready to roar but we are not seeing it in the economic data that is for sure.
Chinese stocks (FXI) listed on U.S. exchanges declined -12.2%, emerging market stocks (EEM) fell -6.3%.
How do we make sense of a bond rally on the verge of rate hikes when stocks are also in rally mode and commodities continue to get crushed? Some of the bond buying can be attributed to money that has to find its way into that asset class as an investment mandate. There is so much money in the world right now long-bonds appear to be the lucky recipient of money flows by pension managers, insurance companies and the well healed. Outside of asset inflation there is very little concern about broad consumer-price inflation right now. However, this could change quickly and when the Chinese start to liquidate their estimated $1.6 Trillion in U.S. Treasuries we could see a divergence between the primary and secondary markets prices/yields for U.S. treasuries. Let's hope that doesn't actually happen. For more on the drivers in this area check the article on the following: balance of payments, exchange reserves, current account, etc..
Real estate may also be the lucky recipient of money looking for a home or evidence of inflation hedging long-term. While the economy continues to underwhelm and talk of debt restructuring abounds, real estate rallies. In real estate, especially in high demand markets we do have some evidence of inflation where rents and prices have climbed. Cities with strong economic growth versus those stagnating (urban versus suburban, etc.) are seeing the lion's share of gains. We also clearly have evidence of money chasing assets (check out this article on Chinese buyers). Don't get too excited, the asset class (IYR) is still down -6% over the last 6 months. Whether the recent bounce represents a new leg up for the asset class remains to be seen but the technical picture looks pretty good and on the verge of a breakout.
Deflation continues to be an issue as evidenced by the persistent decline in commodity prices. Some of the lower prices are the result of supply (energy markets) but that simply cannot be the case for ALL commodities and there are simply very few, if any, commodities where prices are being bid up. This must be driving central bankers crazy as they desperately try and inflate the global economy.
Taken as a whole, the combination of asset price direction is not very encouraging. Commodities have been in a multi-year bear market yet to find a bottom. Emerging market stocks continue to struggle despite an improved U.S. economy and recovery attempts in Europe and Japan. Bonds are clearly not concerned about rising rates at this point and why should they be. The Rate normalization the Fed is looking to accomplish can't even lift off so the likelihood of a big-move in short-term rates appears low. More troubling is the risk-off trade bonds may be signaling. Long-bond price action could be the result of moving down too far too fast. If anything you would have expected the bond market to stabilize and maybe move up slightly, not deliver a strong rally.
Here's a list of several leading stocks that are performing well (not recommendations) in the current environment Disney (DIS), Under Armor (UA), Ulta Cosmetics and Fragrance (ULTA), Intrexon Corporation (XON), and Manhattan Associates (MANH). These are all stocks I have been tracking since they broke-out earlier this year.
As long as we have decent action with leading stocks I will maintain my exposure to Nasdaq and S&P 500 stocks. Once this part of the market breaks down the likelihood we will enter into a longer-term correction will increase, in my opinion. All of which should represent a buying opportunity as policy makers cook up another batch of QE/stimulus to reflate once again. Then again, there is so much money sloshing around in the global economy every time we get a 5% correction money flows in to take advantage of the lower prices. It has been laugh at by just maybe we will see Dow 30,000 before the next bear market materializes. In a policy driven market investors have to be prepared for just about anything.