spring thaw

Should I Stay or Should I Go?

Jason Norris of Ferguson Wellman by Jason Norris, CFA Executive Vice President of Research

Should I Stay or Should I Go

This question seems to more prevalent these days as equity markets muddle along and bonds continue to rally. The yield on the 10-year Treasury fell below 2.5 percent this week as investors attempted to seek safety and income. Economic data hasn’t been great, but it hasn’t been bad and we still believe that the “Spring Thaw” will come to fruition and stocks will outperform bonds in 2014.

Best of Both Worlds

As investors increase their exposure to bonds, driving the yield on the 10-year Treasury below 2.5 percent, it leaves us curious as to what is driving this behavior. One culprit may be that U.S. yields are relatively high on a global basis. Global fixed income investors have a lot of markets to consider, but it seems the U.S. continues to be very attractive. Yields in Germany on 10-year government debt are as low as 1.3 percent, where France isn’t much higher at 1.8 percent. There is relatively no income in Japan, with yields under 0.6 percent. Therefore, the U.S. is competing more with Norway (2.6 percent) and even Spain and Italy (both around 3 percent). It is no wonder with global rates so low, that investors are flocking to the U.S. to boost their coupon.

Gettin’ Better?

We received mixed data on the consumer this week. Retail sales came in with a disappointing 0.1 percent monthly gain, with autos being a drag. Walmart disappointed investors as higher gas prices and lower government assistance programs were a drag on spending. Nordstrom, however, exhibited strong growth in their market segments. Jobless claims hit a seven year low on Thursday with initial applications for benefits dropping 24,000 last week to 297,000 this week. Meanwhile, small business sentiment hit a six year high. We believe the U.S. economy is improving after a poor first quarter, primarily due to weather, and we remain bullish on increasing domestic growth. Cisco Systems reiterated this view on their most recent earnings call citing a “very good month [of April]” with the U.S. leading the way in growth.

A New High in Lows

Global hedge fund data was released and for the first time on record (data inception 2003), hedge funds have lost money for three consecutive months while equity markets rose. It seems that a lot of hedge funds have been long on small cap growth and as we’ve seen that trade unwind (rather quickly), they have been slow to follow. Time will tell if this is a short term phenomenon, or a longer term trend. There have been parts of that market that moved into “bubble” territory. Our small cap exposure tilts toward quality and we still believe this area of the market is attractive due to its exposure to the U.S. economy.

Our Takeaways from the Week:

  • Investors remain skittish and are seeking safety over risk, but this will be a short-term occurrence
  • We believe the U.S. economy will continue to grind higher and will be a stand out for the developed world

 Disclosures

Time of the Season

Jason Norris of Ferguson Wellman by Jason Norris, CFA Executive Vice President of Research

Here Comes the Sun

The polar vortex of 2014 seems to have finally thawed and we believe this change in the weather will bring some warmth to the U.S. economy. Economic growth hit a speed bump in the first quarter as much of the U.S. experienced severe winter conditions. This resulted in lower-than-expected economic activity, which in turn led investors to reduce risk in their portfolios and bid up bonds, leading to a decline in interest rates. We believe the “soft patch” is a short-term phenomenon and we have already started to see a pick-up in retail sales and industrial production, as seen in the Purchasing Managers Index (PMI).

While stock market volatility hasn’t hurt consumer confidence, the price of gas may do so in the near future. We have seen a 10 percent increase in gas prices over the last two months. Commodity prices can be volatile, but if this is a persistent trend higher, it will present an impediment to our bullish view of the U.S. consumer.

Send Me Your Money

April 15 has come and gone, bringing increased revenues to the Treasury. 2013 showed high single digit “revenue” growth for the Treasury. On the expenditure side of the ledger we are seeing lower-than-anticipated spending on healthcare and defense. Both of these instances should lead to lower deficits. While the U.S. is still spending more than it takes in, we are pleased that difference is declining. For those tax payers who have a big heart and want to make a difference, the IRS includes a box on tax forms for filers to check if they want to make a donation to the Treasury. Remember that tax rates are just a minimum requirement – you may always pay more. Over the last 15 years the average annual donation has been around $2 million; however, 2014 has already eclipsed this amount with $2.7 million in donations. Considering the strength in equity markets the last few years, will there be more “giving” to the U.S. government… or will increased capital gains taxes eat into this potential philanthropy?

Back in Business

April kicks off the first quarter earnings season for 2014 and this week we saw two bellwether semiconductor companies report, Intel and Linear Technology. The results were mixed, with Intel citing a pick-up in the P.C. space and Linear seeing strength in automobile and industrial markets. Both companies showed average revenue growth but profit margins continue to remain high.

Overall, expectations for the first quarter are for an earnings growth of three percent (year-over-year). This is down from expectations of 10 percent growth three months ago. We believe this negative revision is a result of the inclement weather in the first quarter. We expect second quarter growth to reaccelerate to nine percent. That may prove to be somewhat optimistic, but we believe we will see greater than five percent growth in the second quarter.

Our Takeaways from the Week:

  • As we move into spring, we would expect U.S. economic growth to continue to pick up
  • We would use the recent strength in the bond market as an indication to reduce exposure and move those funds to U.S. equities

 Disclosures