Monthly ADE Commentary

I. SUMMARY
Market Update


II. THE NEXT PHASE OF THE BOOMER
Where is the tailwind?


III. MARKET ACTION
Reflexive Bounce Seems Likely


IV. U.S. DOLLAR UPDATE
Where Next?


V. MONSOON REGION
The 900 LB. Gorilla that is India


VI. SUMMARY OF INVESTMENT THEMES

I. SUMMARY

  • As of March 31st, equity market averages in the U.S. have recovered all of their losses in January and February and are now slightly positive for the year.  They have now equaled their October and November 2015 levels. The recent rally has pushed 93% of stocks in the S&P 500 above their 50-day moving averages, a key indicator of price strength. The rally has been broad based, which is a major positive. The major trend remains lower but this is a powerful bounce. Historically, markets have often traded at least sideways if not corrected after this type of bounce.
  • Foreign stock and bond markets, especially emerging markets advanced in a powerful bounce, but remain in a well-defined long-term downtrend. One of the most unloved areas in the world are emerging market stocks.
  • The U.S. dollar continues to move within its sideways corrective trend. Federal Reserve Chairwoman’s dovish comments toward the end of March seemed to influence currency trading. She downgraded her view of the U.S. economy and recognized the severe slowing of the Chinese economy. She walked back rhetoric about future rate hikes as she noted transitory deflationary effects. This coincided with a pullback in the U.S. dollar
  • Commodities continued a furious rally off oversold levels from late 2015. Precious metals, aluminum, copper, zinc and oil all have rallied as the U.S. dollar weakened. According to Bloomberg, gold had its best quarter of performance since 1986!

II. How to Seek Profits from the Next Phase of the Baby Boomer

Many of you reading this are baby boomers right now. Many others have parents who are baby boomers. It’s no secret that the baby boomer generation has influenced many trends in the United States. Going all the way back to the early 1940s, boomers have influenced American trends in profound ways. In 1941, Gerber Baby foods was meeting a demand for a million cans of baby food each week. Two years later they abandoned adult foods all together to focus on the post-World War II baby boom. I would say that was the beginning of the boomer revolution.

According to the Pew Research Center, approximately 70 million American baby boomers will turn the age of 65 between 2011 and 2029. Roughly 10,000 per day!

  • According to the U.S. Census Beureau, over the last 30 years, the population over the age of 90 has tripled and is expected to quadruple over the next 30 years!

Where are these individuals going to spend an ever increasing amount of their hard earned savings and government assistance in the next decade? I believe the answer is healthcare.

 

Healthcare earnings are driven by demographics, inflation and utilization of products and services to manage and even extend people’s lives. In my opinion, this trend is much more durable, defensive and less exposed to economic cycles than any other industry I can think of. Again, according to the U.S. Census Bureau, annual per capita healthcare spending is almost 4 times higher for individuals over the age of 65 than those 64 and younger. Individuals under 65 spend on average $4,900 in healthcare services annually. Those 65 and over spend $18,000 annually on average.

 

The emergence of the affordable care act has for better or worse provided increased access to insurance for many people who weren’t previously covered. That fact, along with an aging population, an increase in diagnosed diseases, and a focus on a healthy lifestyle may mean increasing overall healthcare needs.

 

Over the past 20 years, the S&P 500 has failed to grow earnings in five of those twenty years. However, the S&P 500 Healthcare index has grown earnings every single one of those twenty years! During recessions, Democratic and Republican presidents, and legislation such as the Affordable Care Act, earnings grew. Earnings growth is often a key factor in long term stock performance. A growing base of people needing more of its services provides a tailwind for the industry.

 

Why am I bringing this up now, when its been a theme of mine for the past five years? Because, the stock market may have presented an opportunity. You see, the current correction in healthcare stocks is the first since October of 2011! According to Bloomberg, healthcare equities expressed as an equally weighted basket were down 30% from their high through the end of 2015. The healthcare market has fallen even further in 2016. The selling has been deep and wide, covering most industries. When this typically happens, often the baby is thrown out with the bath water. Discerning investors could potentially make incredible long-term investments. For example…

  • on average Biotechnology cos. were down 38% from their high through EOY 2015
  • Pharmaceuticals were down 32%
  • Healthcare facilities and services were down 24%
  • Certain small and mid-cap healthcare companies have fallen even worse

I encourage those investors to take a look at an allocation to healthcare during a market sell-off if it fits within your time horizon, risk tolerance and other suitability factors.

III. MARKET ACTION

I think it makes sense to continue to update these charts as we move forward because they may help in the efficient deployment of hard earned savings in the coming year. As bear market rallies progress, investors become more excited and convinced that the prior months’ correction is over and that markets are set to soar. It is difficult not to let one’s emotions cloud their judgement. At this point we are eight weeks into this bear market rally. According to Merrill Lynch, corporate stock buybacks have accounted for 93% of net stock buying activity so far this year. According to HSBC, since 2009 more than $2 trillion has been spend by companies to acquire their own shares! Earnings season begins in April and corporations will face black out periods where they cannot buy back stock. The previous four quarterly declines have coincided with corporate buyback blackouts.

 

I believe that markets don’t move in straight lines. Markets like life, are cyclical. Fortunately, one can use market action, sentiment levels and momentum to provide clues where we might be in a given market cycle.  This chart of the S&P 500 shows key support and resistance levels of the stock market.

You will notice that by watching the top and the bottom indicators they may give you signals of the markets being overbought and oversold in the short term. This helps give an idea of where we are in the move. It looks like to me that we may be in the beginning of a larger move lower, but for now, the support level of the 2015 and 2016 sell-offs has held. We seem to be in the latter stages of a bounce that pushed through resistance but has now become overbought. I will be watching to see if in the next correction if we can stay above that 2,000 level on the S&P 500.

chart1

All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.

 

Next is a three year chart of the S&P 500 going back to 2013. 

chart2

All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.

You can see how the chart appears to be rolling over in a topping process. Each time the market reached oversold conditions it bounced back up. Further, each time it sold off it stopped at the 1,880 weekly closing level. At that 1,880 level the market would be 12% below its all-time high. A weekly break of this level would signal to me a more nasty bear market is unfolding and increased risk management may be necessary. Investors would be wise to use the bounce we are getting to make sure they are not too risky for their tolerance to withstand volatility.

 

 

 

And finally lets go back and look over the past twenty years.

chart3

All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.

In the past, this chart has been able to show deterioration in the markets prior to the market sustaining major losses. What has me concerned is the continued deterioration since the middle of 2015 in all the indicators.  This makes me think that whatever is coming might be more than a garden variety correction.  If you are an investor that was able to hold through the previous downturns, didn’t panic and even added to your risk positions then you should be fine.  But, if you are at all concerned I feel as though this bounce may be the last, best chance to position your portfolio.

IV. U.S. DOLLAR UPDATE

The U.S. dollar has been within its sideways action since spring 2015. However, we may be approaching an important juncture. I have stated for over a year that getting the direction of the U.S. dollar correct should be very important to your portfolio over the next 3-5 years, however it is not important to get every little wiggle correct. What is more important is figuring out the trend and how dollar strength or weakness impacts a portfolio. Let the market tell you where to go.

 

Since the beginning of 2016, the US Dollar has been slowly weakening versus a basket of foreign currencies. Not coincidentally, we have seen the largest bounce in gold, emerging market stocks and base metal commodities in four years. The dollar is getting close to its two year support level of $93. By chopping along sideways, the dollar has managed to reduce the massive optimism that existed back in early 2015. The talk of higher interest rates and Fed tightening has subsided and Chairwoman Janet Yellen has publicly walked back the rehetoric. The dollar has now reached an oversold level based on the indicators in the chart below. I would expect a bounce shortly that should carry the U.S. dollar to the upper end of its channel and has the potential to head to a new high. This could coincide with stock market weakness in the next few months as well as host of other concerns. A break to a new high in the dollar should not be considered a good outcome for most investment portfolios.

Conversely, a weaker U.S. dollar could continue and a break of support would be a crucial piece of market information. In that situation, I would expect currencies in the rest of the world to be much, much weaker. That would be an ideal environment for risk assets in general and particularly commodities and precious metals.

chart4

All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.

 

V. MONSOON REGION UPDATE

The majority of the countries around the Indian Ocean have had a good start to 2016. I want to spend a few moments talking further about India, the 500 lb. gorilla of the area. Many investors are well aware of the demographic and educational tailwind the Indian people have at their back, but few know much more than that.

The other, smaller countries in the monsoon region will most likely move as India moves over the next decade. While global growth may be subpar in 2016, I am very excited about the Indian stock market. After a 25% correction in 2015, India could be set up for a multi-year move higher led by a infrastructure build-out and rising urban and rural consumption.

chart5

All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.

After reducing debt during the past five years, India may already be in the next investment upcycle. Growth in real investment spending moved above real GDP growth in 2Q 2015. For now, this cycle is being led by government infrastructure spending as they continue to build out roads, ports, bridges, airports. It is only a matter of time before the private sector begins to grow. Since Prime Minister Narendra Modi took over in 2014, the focus on government spending has shifted to development and infrastructure. Government reform from the pro-business Modi has already begun to reduce the impediments to private sector growth and improve transparency.

 

India has worked hard to reduce its deficits and keep its currency more stable than its neighbors. In the short time PM Modi has been in office he has been transforming the way India competes for business and seems to be creating the strong foundation needed for growth in the next decade. The Indian stock market is not without volatility. For instance in the 2008 to 2009 period the market lost 64% of its value. But it fully recovered by 2011 and despite its recent setback is still above its 2007 peak. For those whose risk tolerance and time horizon is appropriate, I think it may be time to begin building positions in the monsoon region with a focus on India.

VI. INVESTMENT IDEAS

  • Rather than trying to “beat the market”, focus on beating inflation and the rate on cash. Plan for safety and liquidity while seeking positive returns.
  • Equity valuations are very rich but masked due to the distortion of the Treasury curve. Volatility is returning to the markets and I think long/short managers are best positioned to capture this volatility by owning companies with strong businesses, barriers to entry, and good valuations and selling short weaker companies with high debt loads that have risen sharply with the broad market rally.  I think this strategy of hedged equity may have the potential to produce attractive risk-adjusted returns if and when investors begin to question the valuations of companies.  Stock investing involves risk including loss of principal. No strategy ensures success or protects against a loss.  Long positions may decline as short positions rise, thereby accelerating potential losses to the investor.
  • (NEW) Monsoon country investments. Attempting to take advantage of demographic, educational and investment possibilities in the countries surrounding the old spice routes of the Indian Ocean. International investing involves special risks such as currency fluctuation and political instability and may not be suitable for all investors. These risks are often heightened for investments in emerging markets.
  • In 2013, the Affordable Care Act began implementation. There will be many winners and losers in the healthcare industry as a result of the biggest change in the healthcare industry’s history.  With the largest portion of the U.S. population entering their golden years, healthcare needs will become even more important.  Long/short Healthcare seems to be a very attractive way to invest in a sector with lots of potential and lots of potential pitfalls.  Investing in a specific sector involves additional risk and will be subject to greater volatility than investing more broadly.
  • Supply problems remain high across the energy asset class. While there isn’t a current shortage of energy on the planet, it is taking more and more energy and capital to discover, drill, transport and refine it.  Long term Demand should continue to grow globally, particularly in China, India, and other developing countries.
  • Potential food shortages due to inclement weather and higher demand from the emerging Asian middle class could result in a boon to agricultural land and potash fertilizer companies. International and emerging market investing involves special risks such as currency fluctuation and political instability and may not be suitable for all investors.
  • Tight supply and a depressed single family home market are combining to keep apartment buildings full while driving rents higher. The number of potential renters continues to expand as a large cohort or echo boomers enters the workforce.  Rents have been increasing as the desire to remain mobile and inability to secure home financing keeps renting attractive.  In addition, low supply of new rental units should allow this space to flourish.  Apartment REITS typically offer dividends and potential appreciation opportunities.  Investing in Real Estate Investment Trusts (REITs) involves special risks such as potential illiquidity and may not be suitable for all investors. There is no assurance that the investment objectives of this program will be attained.  The payment of dividends is not guaranteed.  Companies may reduce or eliminate the payment of dividends at any given time.
  • Precious metals mining companies have been extremely beaten down over the past four years. Mining is an industry that spans hundreds of years.  Companies that mine for commodities are often highly cyclical, meaning they have sustained moves both up and down.  When investing in the mining space it is important to be a contrarian.  Ideally, you would want to accumulate miners when sentiment is poor around them and sell them when sentiment is positive.  Historically this has been a good strategy.

No strategy ensures success or protects against a loss.

Regards,

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Colin B. Exelby
President
Celestial Wealth Management

 

 


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