Friday, May 6, 2016

Thoughts on Current market conditions

What an interesting two months we have seen in the market.  Although I wasn't expecting to see one of the biggest rallies the S&P has ever seen in such a short amount of time, my overall mid-term (1-3 years) bearish opinions haven’t changed.  One of the most interesting aspects of the recent rally is that despite companies across the US having terrible earnings calls after the first quarter, investors weren't rattled (so far).  For me, this is the bigger issue.  From a fundamental level, growth continues to slow, profit margins continue to decrease, and international markets continue to struggle (particularly the Bank of Japan, the PBOC, and European Banks).  Although the market could even run higher, I think the upside to downside risk/reward continues to be asymmetrical.

Now, one of the more interesting developments in the market is the FED’s change in forward guidance.  At the start of 2016, the FED was saying they would raise rates four times throughout the new year.  As months progressed, the FED continued to distance itself from being so aggressive.  I believe this is one of the main reasons we have seen the sharp recovery over the past few months.  This “dovish” talk has caused the dollar to lose value (relative to global currencies), which obviously gives US equities the hope for better numbers in the coming quarters (a big if).  Now, where this gets very concerning for me is Japan, Europe, and China.  If the dollar continues to weaken, the Japanese Yen (and other currencies) get stronger.  This has really caused some interesting circumstances for the disastrous monetary policies in Japan in particular.  I think this pressure has the potential to cause major issues in the coming quarters if the Yen continues to get stronger.  This could also cause second and third order effects in the international markets.  One of the benefits of the dollar weakening is that oil is making a very strong comeback (assuming you own oil companies).   I still haven’t taken a position in any oil companies (which might be the wrong decision).  For me, the bigger concern moving forward isn’t the oversupply; it’s the future demand.
Some global risk items and concerns to watch for in the coming quarters:
  1. The impact of negative rates for banks in Europe (Particularly Deutsche Bank)   
  2. A strong Yen pushing Japanese stock prices lower
  3. Chinese Commodity prices returning to reality (because the PBOC pushed commodity prices into outer space during the first quarter)
  4. Potential impacts of the Saudi currency de-pegging from the US dollar due to the speed and impact of their domestic reserves being spent.  Could cause the dollar to strengthen and put more pressure on US Stocks.
  5. Watch the 2nd quarters US earnings trends.  If earnings continue to slip into the second quarter, things could get ugly for US Stocks.
  6. Brexit: This could be a big concern for trade and US stocks.
  7. High yield debt.  The oil industry supposedly has 3 trillion or more in debt with as much as 50% being estimated as junk.  Some really interesting things could happen here if global demand continues to slip in energy and prices start heading lower again.  I think this is a major concern moving forward, but there is no way of knowing if this trend will return for sure.  My expectation is that it will, but who knows at this point.   
Anyway, those are a few big items that got my attention.  I think individuals should be aware of these possibilities to mitigate potential risks in your portfolio. I hope that helps.