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With the second quarter in the rear view mirror and the kids having made their way back to school, investors are looking ahead and beginning to place their bets for the months ahead. It promises to be eventful with September offering up more bellicose rhetoric from Congress on the debt ceiling and fiscal cliff while taper worries are ever-present in the background. Prices for crude oil are likely to remain elevated as president Obama lobbies Congress for support of a targeted attack on Syria . While the country is a minor oil producer, its sits near major transport and producing facilities and increased conflict is seen by some as heightening tensions in an already volatile region of the world.

Tapering fears have already caused long term yields to rise quite substantially this past quarter with all eyes focusing on the Federal Reserve’s September 17-18 meeting. The concern centers on the very real possibility that the Fed could decide to slow the pace of its monthly asset purchases (currently at $85 billion per month) to something closer to $70 billion per month with more cuts to come. Not only has the tapering talk driven the yield on the US 10-year up more than 120 basis points since May, but it’s sent emerging market currencies running for cover as hot money flows have reversed.

In the last quarter, the best performing sector of the S&P 500 has been the consumer discretionary sector as consumer confidence has strengthened. Helping propel the sector higher has been strong auto sales and purchases of major appliances. And the future looks promising for the consumer discretionary sector as a recent survey of American consumers has indicated that almost half of those surveyed are planning to purchase a major appliance within the next six months. Helping to underpin consumer confidence is an improving payrolls picture that has been averaging 200,000 new hires per month for the past six months, well above the 160,000 rate recorded for the same period of 2012.

Verizon's $130 billion blockbuster deal to buy the remaining 45 percent stake of Verizon Wireless from Vodafone of the United Kingdom underscores the resurgence of the mergers and acquisitions market, but it also highlights the paltry returns for defensive players in the market. Year to date, the S&P Telecom Services Index has posted a mere 6.2% return versus the S&P 500 at 15.9% and the S&P Health Care Index which is up 24.5% so far this year.

For the Fall I am approaching the market with some caution as May and September have historically been the worst two months on record for the S&P 500 in data dating back to 1900. The ongoing shenanigans in Washington will also be hitting their apex in mid-September just in time for the consensus estimate of tapering to the $70 billion of asset purchases a month level by the Fed to kick into high gear. But going forward, I am decidedly more bullish as my expectations are for the U.S. economy to post 3.5 percent GDP growth for 2014. The reason for my bullishness on the U.S. economy centers on the improving housing market and the fact that no new taxes are being contemplated by the administration, which should reduce substantially the fiscal drag that we experienced in 2013. More aggressive capital expenditures by corporations should help spur sustained profit growth, underpinning strong equity performance.

I believe that developed markets will continue to outperform emerging markets for the foreseeable future. Returns in emerging markets have been disappointing for some time, with China’s growth of +2.4% in August being the major anomaly in the group. India’s main bourse slumped -11% in August while Chile slumped -1.8% and Mexico fell -4.5%, over the past month.

The upward adjustment in the U.S. 10-year yields may moderate in the months ahead however, the message is clear—rates are going higher and with it so too are the potential for above-average returns in low-growth dividend paying stocks. Higher interest rates underscore the need for investors to reposition their portfolios away from bonds and toward stocks, particularly those more cyclical securities that can offer investors growth.

Within the portfolios I manage, I am shifting my equity focus away from the consumer discretionary sector and toward cyclical names that have a global footprint in light of the improving economic data from China and Europe . The sectors that have the most promise for the balance of 2013 and into early 2014 are the Energy, Materials, Financials, Industrials and Technology sectors. Investors, who are willing to be strategic and take the long view, should be well rewarded over the next six months by taking advantage of market volatility in the next few months to build positions in some of their favourite names.
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