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Commodity Investing Shell Shocked
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Talk of a great rotation out of bonds and into stocks, a sense of optimism that the path of economic growth isn’t littered with nasty surprises and plenty of pent-up demands from investors and you have all the makings of a rip-roaring stock market. And so far the S&P 500 Index hasn’t disappointed, surging 6.4 percent this year. Strengthening U.S. housing and employment data, a recovery in China, and a lower yen are all helping to support the energetic start to the year.

Initial public offerings (IPOs) and stock sales have come out of the gate with a vengeance. Overall equity offerings are up 75 percent from the same period last year, while overall debt sales are down 12 percent globally. So far, there have been IPOs worth U.S. $10.6 billion in 2013, more than three times the level of activity in the same period stretch of 2012, according to figures from Thomson Reuters.

The figures so far in fourth quarter earnings parade are supportive of the animal spirits evident in the market this year with 70% of the S&P 500 firms topping expectations this quarter. Even more striking is the average margin beat of five percent by which companies surpassed the consensus estimates. To be sure, the bar had been set pretty low, with analysts adjusting their forecasts down considerably toward the end of the quarter. But now, analysts are positively giddy—with the Street looking for double digit earnings growth in the second half of the year, as the near term drag from the fiscal restraint eases.

A sliding yen and strong equity inflows have helped boost the fortunes of stock investors in the world's third biggest economy. So far this year the Nikkei 225 Index has surged more than 7.2 percent. The ongoing slide in the yen should help raise import prices and spark a modest but necessary bout of inflation in Japan, but the Bank of Japan’s two percent inflation target will remain illusive. Half of Japan’s consumer basket is tied to services and with domestic wages down by 1.4% on a year over year basis, domestic demand is unlikely to provide much of lift to inflationary aspirations.

But with a solid start for investors in North America and Japan, my game plan of favouring developed markets over emerging markets appears intact. The MSCI Emerging Markets (EM) index’s lacklustre January performance is case in point, returning just 1.3 percent. Recent weakness in the emerging markets is concentrated in a few specific countries, namely Korea , Malaysia, Taiwan and South Africa. While emerging markets as a whole are likely to trail the performance in the developed markets, an improving global growth outlook will see leadership from China, India, Mexico and Russia continuing as the year unfolds. With correlations dropping from the 2011 levels, treating the emerging markets as a homogenous group is proving to be costly for investors.

All ten sectors of the S&P 500 moved higher in January with seven sectors showing moves north of four percent. The main laggards in the month were Technology than managed just a 1.3 percent gain and Telecom, up 2.2 percent in the month. The star performers last month were Healthcare, up 7.3 percent and Energy, which was up 7.6%. And with U.S. leading indicators looking supportive for decent growth throughout 2013 and with U.S 10-year yields increasing to 2.25%, the S&P 500 should close out the year at 1575 or above.

I am overweight Financials, Consumer Discretionary and Industrial sectors for the next few months in my portfolios. In Industrials, I look for high quality and relatively low beta plays such as the railroads and some selected conglomerates, while I think investors should avoid companies that rely on emerging markets for their revenues.

Banks in the United States are back from the brink and their stock prices are soaring along with them. The sector as a whole is up about a third since the beginning of 2012. But even after their remarkable run, bank stocks remain priced below their long-term averages—by anywhere from 25 percent to 60 percent. The discount reflects the potent combination of slower economic growth and stubbornly low interest rates, plus increased regulation and capital requirements have clipped banks’ earning power.

But even with these headwinds, banks look attractive. The aggregate profits for publicly traded banks are still only around their 2006 peak levels of $100 billion, but with the American economy beginning to fire on all cylinders and with a steeper yield curve, bank profitability should top $120 billion this year. Not only that, but U.S. banks will undergo a second round of “stress tests” by the Federal Reserve later this year. Those that pass will be allowed to increase their dividends and share buybacks, potentially bringing new yield-hungry investors back into their stocks.

With markets off and running and the leading indicators pointing higher, I continue to favour cyclicals over defensives and developed markets over emerging markets for the months ahead.


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