The Brave Report: market Commentary for April 2018

Click here for the PDF version of this report: The Brave Report-April 2018

Earnings to the rescue? There has been a bit of an unsettled feeling in the markets over the past month.  This can often happen in the month preceding earnings results as we aren’t getting much new corporate information so investors are left to react (or overreact) to geopolitical news and other economic data.  This past month has been no different as trade war fears have dominated economic sentiment. It seems that traders and/or the algorithms they employ are reacting to every tweet the President puts out. It has been a trade the headline and figure out the facts later trading environment. This has left us in a situation where the markets have swung wildly and we have seen volume dry up as many larger investors are content sitting on the sideline and waiting for the dust to settle.

While environments like this keep many up at night worrying that one tweet can swing the markets, this environment can also provide opportunities.  Many of the large market moves are simply based on fear, emotion and computers. As with most large moves in the market, there is often an overreaction in both directions. We saw that this past month to the downside. This provides an opportunity for the patient investor to identify quality companies that have been unjustly dragged down.

Market Overview

Volatility hasn’t disappeared yet but the markets did see a bit of a bounce back after two months of losses. The Dow Industrials and S&P both gained 3.5-4%, while in a departure from recent month the NASDAQ lagged, gaining around 2.5%. This leaves both the Dow and S&P hovering just above flat for the year with the NASDAQ up around 2.5%.  These moves seem quite mundane YTD until you look at the ride we have taken to get to this position.  The major indices have fluctuated from up almost 7% near the end of January to down almost 5% in late March and early April.

After being relatively range bound last month, rates dropped to start the month, with the 10-year reaching a low of 2.71% on April 2nd. Since then the climb higher has continued, reaching the highest level since 2014 on Monday.  The 10-year is now flirting with the psychologically important 3% level.  This rise in rates has not just been contained to the 10-year, as the shorter end of the curve has also risen. Fears over inflation and the continued expectations of continued rate hikes the Fed should continue to put upward pressure on these rates.  Reaching the 3% level is no longer an “if” scenario, it is a “when.” How much follow through we see from there and how the stock market reacts to the psychological level are the big unknowns.

Trade War: I touched upon this issue last month but it still seems to be hanging over the markets as we have started to see earnings reports roll in. The rhetoric out of Washington continued earlier this month, only to subside over the last week or so and the market responded positively. However, many investors know that we are a single tweet away from a sharp selloff.

Chinese President Xi also spoke at the National People’s Congress two weeks ago. His speech seemed to add some optimism that a trade war could be avoided but so far we have seen only words or minor policy changes from both sides.  As I mentioned last month, I tend to believe that both sides are in full negotiation mode and the rhetoric will end up being much worse than any actual outcomes.

The market right now seems to grasp onto any fear and uncertainty as it looks for direction and a potential end to the current bull market. In most cases, this increased uncertainty has just caused many to move to the sidelines as they don’t want to be on the wrong side of the next reactionary move. If a trade deal can be negotiated we should see volume return to the markets and solidify the next move higher. Unfortunately, if no new deal is reached, the continued back and forth will continue to weigh on the market

Earnings:  We are only in the beginning stages of earnings season, but so far things have been very positive, with around 80% of companies beating earnings estimates (Keep in mind this is from a very small sample size so far). The expecting is for US companies to report earnings growth of around 19% and these early results seem to be in line with this projection.  However, the market reaction seems to be relatively muted so far, with many of the big banks actually selling off after reporting good numbers. It seems that most traders are not just looking for companies to beat estimates but are also placing a greater emphasis on future projections.  With valuations where they are, this is not unexpected. Even with the current volatility, most stocks have had a pretty good run of it over the past few years.  It seems it will take more than just earnings beats to continue to project this market forward.

A lot of big tech names will be reporting this week and next which typically represent some of the largest earnings movers and headline grabbers during the season. The market reaction to these names will be very telling as to whether this bull market still has another leg higher or if earnings are just justifying the gains we have already seen.

Treasury Yields: I would be doing you all a disservice if I didn’t touch upon this topic briefly.  As I write this, the 10-year treasury is flirting with the 3% level. It may even be above it by the time this goes out.  So what does this mean for the markets? We haven’t touched 3% since the very end of 2013 and haven’t spent any time above it since the first half of 2011. While it has been a long time since we have seen these types of yields, the 3 % level still is more psychological than anything else. Breaching round numbers, whether in the stock market or in yields makes for great TV but does not dramatically change anything from a fundamental standpoint.  The real impact will be if rates continue to rise as that means the risk-free return is getting higher. It also means the rate at which companies can borrow money is growing.  As this rate gets higher it can make certain stocks less attractive by comparison. So while the 3% level is fun to talk about, just because it is a round number doesn’t make it any more impactful from a fundamental standpoint then crossing 2.9%.  There will be an inflection point in yields in terms of when it begins to impact the markets and the economy as a whole (this actual inflection point is still up for debate) but it isn’t 3% just because it is a fun round number.

Strategy Commentary

I trimmed my equity exposure slightly over the last month but am still cautiously optimistic as we head into earnings season.  The trims were not because I think the market is going to see a huge pullback but because I am more comfortable taking a neutral stance until some of the geopolitical risks abate. The underlying fundamentals of the economy are still quite strong and I expect earnings to confirm this. However, these fundamentals are easily discarded if the President continues to add uncertainty to the geopolitical stage.

Domestically I cut my exposure to financials from overweight to neutral. I continue to maintain my overweight to technology. I think we will continue to see strong growth numbers from the sector and this can continue to push prices higher.  As was expected, I sold materials at the beginning of the month and replaced it with consumer discretionary. Consumer discretionary can be another sector the benefits from strong earnings results and I think any trade-war related pullback we saw earlier in the month was overdone.


Internationally, I am maintaining my current exposure. If uncertainty around a potential trade war with China can be muted I will look to increase my emerging markets allocation. I am still staying away from Europe at this point. The economies are not growing at nearly the rate we are seeing domestically.  Earnings growth this quarter in Europe is expected to come in just shy of 2% while expectations in the US are expected to be around 19%. Part of this difference can be attributed to currency but Europe has a host of other issues they are dealing with that are hurting growth.

I still have a negative outlook on the fixed income space. As expected rates have again crept higher and I expect this to continue to put pressure on fixed income prices.  I have increased my cash allocation as a replacement.

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