So far in 2013, U.S. investors have enjoyed a steady climb in stocks, with the major market averages surging into record-high territory. There’s been a near absence of any sort of market volatility, with the CBOE Volatility Index (VIX) sliding to multi-year lows. Whatever the reasons behind the rally, it’s been gradually bringing back positive vibes on the part of market participants. In other parts of the world, however, the story is different: There’s been a greater degree of volatility in many international markets, and in general, international stocks have lagged behind the U.S.
For U.S. investors, foreign currency fluctuations can be a critically important – but much overlooked — factor to consider when investing in international stock or bond fund. If a foreign currency is appreciating relative to the U.S. dollar, it can provide a boost to returns, but if the currency is weakening, it can detract from them.
The 2012 election is over and we now know who our president will be for the next four years. We’ve received questions from clients asking what we think the market is likely to do in light of the election. While we don’t pretend to be political pundits, it appears that the balance of power in Washington has not changed: The Republicans hold the majority in the House, the Democrats hold the majority in the Senate, and President Obama will remain for another term. The stock market is likely to refocus on what kinds of policies may actually be implemented going forward. Campaign rhetoric is mostly just that – rhetoric. Now comes the reality of trying to pass specific pieces of legislation. Given a still divided Congress, that will likely entail a fair amount of compromise on both sides. The question is whether compromise is even possible considering that the people who couldn’t cut a deal last year are still in office.
The investment team members at Pinnacle are connoisseurs of investment research. We read a vast variety of analysts and money managers, each having their own opinion about the economic cycle or their particular area of expertise. We have spent a decade finding those analysts who are clear in presenting their point of view, are well-known in the buy-side investment community, and are (hopefully) smarter than we are. However, as we have opined on many occasions, it is simply not possible to be in the business of venturing opinions about the financial markets without being wrong at one time or another. For that reason, most analysts make certain they caveat their thoughts about financial issues and at least make an effort to present the opposing view, if for no other reason that they don’t want to make a devastating mistake that could upset their reputation and their business. Everyone involved knows how to play this game. For Pinnacle, as the consumer who is willing to pay for the privilege of reading an analyst opinion, we subscribe to analysts and research firms that give the clearest possible forecast. We know how to sift through all of these opinions and add them to our own internal research as part of the “weight of the evidence” we use to formulate Pinnacle’s own investment view. If the analyst or research house we follow is too vague they inevitably get dropped from our research. And if they are clear and concise we applaud them, but also require that they are right more than they are wrong.
Over the past couple of weeks, we have executed several portfolio transactions in line with our belief that the second half of the year may be a good one for stock investors. Most of the trades have been relative in nature; for example, we’ve swapped defensive U.S. sector holdings for late cyclical sectors. We also traded “up” within our international holdings, by swapping a fairly conservative actively managed fund for an ETF targeting mainland Europe (the iShares MSCI EMU Index Fund; symbol EZU). In our two most aggressive policies, we purchased the iShares MSCI Italy Index Fund (symbol EWI).
We continue to position portfolios at neutral levels of risk, believing that the substantial downside risks (Europe, the looming fiscal cliff, an economic slowdown, etc.) are balanced by the growing possibility that global central banks may soon inject more stimulus that could propel risk markets higher again — similar to what’s happened the past two years (see our June Market Review for more details on our outlook).
One of the interesting (and frustrating) aspects of the current environment is just how muddled the evidence is right now. While it’s true that there’s always a bullish or bearish case to be made, it’s struck us lately just how far the gulf between the two camps has grown. The independent analysts that we follow, all of whom are seasoned market observers, are all over the map. Some are extremely positive and are looking for big gains for the second half of the year, while others are terrifyingly bearish. As we’ve said now several times in conversations around the office: Someone is going to be really right, and someone is going to be really, really wrong with their market calls.
Since the stock market made its recent high on April 2nd (in the S&P 500), there has been a noticeable shift in sector performance. As they often do during periods of market indigestion, defensive sectors such as Health Care, Consumer Staples, and Utilities have been outperforming. Meanwhile, the cyclical sectors of the market that had previously been leading are now underperforming. The notable exception among cyclicals is the Consumer Discretionary sector, which not only continues to outperform the broad market even during this correction, but is the best performing sector this year by a decent margin.
Second quarter earnings season officially kicks off today, as companies report on their performance during the first quarter of 2012. Dow component Alcoa, an aluminum company, reports shortly after the market close. Earnings have been incredibly strong for the past few years coming out of the last recession, and have been one of the main drivers powering the stock market climb.