Weighing Concerns over the Fed

Weighing Concerns over the Fed (June 15) & Brexit (June 23)

by Louis Navellier

June 14, 2016

*All content in the Marketmail Introduction is the opinion of Louis Navellier of Navellier & Associates, Inc.*

The big news last week was that Fed Chair Janet Yellen was apparently surprised by the disappointing May payroll report and the downward payroll revisions for March and April.  In her speech last Monday before the World Affairs Council of Philadelphia, Yellen said that she expects that the U.S. economy will continue to improve and expects further gradual rate increases will “probably” be appropriate.  Translated from Fedspeak, she seems to be hinting that there will be no interest rate increase at this week’s meeting.

Yellen added, “I continue to believe that it will be appropriate to gradually reduce the degree of monetary policy accommodation, provided that labor market conditions strengthen further and inflation continues to make progress toward our objective.”  In tying the Fed’s action to the labor market, she showed that wage inflation is a key indicator.  As we get closer to the November Presidential election, the “data dependent” Fed may be reluctant to raise rates, since any rate hike could further widen the controversial wealth gap.

In the meantime, since the Fed has apparently reversed its hawkish stance, Treasury yields have fallen and the U.S. dollar has softened considerably.  This has caused commodity prices to rise, which raises the prospect for more inflation.  Ironically, the confluence of weak job creation and inflation will likely put the Fed in a pickle this week.  As a result, their statement will be closely scrutinized to see if inflation fears are mounting and whether inflation fears trump their employment mandate.  In the meantime, “stagflation” – slow economic growth combined with brewing inflation – is a growing possibility.

Britain Exit from the European Union Image

The Fed is also concerned about the “Brexit” vote on June 23.  If Britain votes to leave the European Union, the British pound and the euro are expected to suffer.  The beneficiary of a Brexit could be the U.S. dollar, so be prepared for a possible dollar rally late next week.  Any significant rally in the dollar will help to squelch commodity price inflation and may also cause crude oil prices to peak near-term.

In This Issue

This week, our columnists will weigh in on the Fed’s decision and Brexit, along with other pressing concerns.  In Income Mail, Bryan Perry focuses on lowering interest rates and low inflation expectations. In Growth Mail, Gary Alexander warns against overreacting to fixed-date events like Fed meetings or Brexit votes.  In Global Mail, Ivan Martchev solves the curious case of the overlaid charts of U.S. Treasury rates and Deutsche Bank’s stock price.  In Sector Spotlight, Jason Bodner compares our early-year market quake (through February 11th) to the recovery and aftershocks since then, and I will show how quality stocks (and gold) are re-emerging as market leaders as we approach the mid-year point.

Income Mail:
The Great Divide Between Investor Perception and Reality
by Bryan Perry
Consumer Inflation Survey Results – “I See Nothing!”

Growth Mail:
Don’t Overly Fret the Fed’s Next Move…or Brexit
by Gary Alexander
Fixed-Date Phobias Usually Fizzle

Global Mail:
Deutsche Bank: A Curious Case of Mistaken Identity
by Ivan Martchev
A Brexit Curve Ball

Sector Spotlight:
Quakes, Shakes, and Double-Takes
by Jason Bodner
The Aftershocks of February 11, 2016

A Look Ahead:
Long-term, Quality Stocks Beat “Junk”
by Louis Navellier
Retired Fed Chairmen Favor Gold

Income Mail:

*All content in "Income Mail" is the opinion of Navellier & Associates and Bryan Perry*

The Great Divide Between Investor Perception and Reality

by Bryan Perry

In my experience, markets tend to trade on how investors perceive events of the near future rather than how the market really is in the present. The market is defined as a forward-discounting mechanism, which means that the collective crowd perception takes into account the possible and probable impact of certain future events and decisions that have widespread influence on the current trends. Heading into mid-June, with the major averages nearing new 2016 highs, it appears as if Fed policy, the OPEC summit, the prospect of further easing by the ECB and BOJ, and the Brexit vote have been fully digested and priced in.

Late last week, a sudden shift in sentiment took hold as investors turned decidedly cautious while global bond yields plumbed new lows for the year against a backdrop of fairly neutral headlines. It was as if an alarm went off in the bond pits that triggered a mad rush out of economically-sensitive sectors and into telecoms, utilities, consumer staples, and safe-haven REITs. It had the look and feel of profit-taking – as if those who had ridden the recent rally in oil, base metals, materials, and industrial stocks punched out of that trade, booking short-term gains in lieu of seeing whether the S&P 500 could trade to new highs.

Japan’s 10-year bond yield slid to -0.155%, Germany’s 10-year bund touched 0.22%, and the 10-year U.S. Treasury Note saw its yield fall to 1.65%, its lowest close since January 2015. Yields on the Bloomberg Global Developed Sovereign Bond Fund Index dropped to a record low 0.6% Thursday. It has returned 10% so far in 2016, headed for its biggest gain since it started in 2010 (see Bloomberg Markets, June 10).

The optimism that drove U.S. stocks to a 10-month high this week may have peaked before meetings by the Fed and the Bank of Japan, Britain’s vote, and the U.S. political conventions, all of which have the potential to roil markets. While policy makers have done what they can with stimulus to shore up economies, they’ve pushed yields lower, hurting earnings prospects for banks. Though it looked like the upside was being primed, fresh anxiety over these events have resurfaced and markets have recoiled.

The rotation back into the all-weather defensive stocks is, in my view, temporary simply because a lot of big money sitting on their first meaningful profits for 2016 lightened up, not knowing if the market has in fact priced in the upcoming events. Fear far outweighs greed as an emotion dictating investing behavior. As it appeared influential market participants had weighed the potential risks against the rewards, a lot of big fund managers had a change of heart and elected to take a more conservative posture among the funds they oversee until there is a broader sense of certainty – which could emerge by the end of the month.

Even with the recent pullback, commodities still booked a fifth weekly advance in the longest rally in more than two years with crude oil gaining in four of the past five weeks, which argues that what we’re seeing is some plain vanilla profit taking on the back of strong gains and nothing more.

The link between the Dollar And Commodities Chart 

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

Once again the market challenged its old highs and big money took that trade to the bank.

Consumer Inflation Survey Results – “I See Nothing!”

If previous policy-making parameters are any guide, the Fed will delay a rate increase this week. U.S. households’ long-term inflation expectations, a measure tracked closely by policy makers, fell to a record low this month (the data goes back to 1979), according to preliminary results of the University of Michigan’s June survey of consumers released last Friday. Chicago Fed President Charles Evans suggested holding off on a rate hike until actual inflation, excluding food and energy prices, accelerates to 2%. The key thing to watch will be whether the Fed changes its language on inflation expectations and whether they make mention of potential downside risks to their inflation forecasting model.

Record Low for Consumer Inflation Expectations Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

The data is telling because it sends a clear message that consumers do not think the economy is as strong as it was last year nor do they anticipate the economy will enjoy the same financial health in the year ahead as they anticipated a year ago. A sustained reduction in the pace of job creation could prompt consumers to hold down spending to increase their precautionary savings, which is why the Fed ranks this particular data point high on its checklist.

Against this backdrop of record low inflation expectations and sovereign bond yields, commodity and inflation sensitive sectors are highly likely to take a breather after a nice move up whereas rotation into non-cyclical, investment-grade, dividend-paying stocks will retake the leading role for the broad market.

Junk debt has outperformed high quality debt during the past three months, but it now looks as if rotation back into safe-haven, blue chip dividend stocks will outperform over the next month or two as the Fed and investors alike try to understand why all the quantitative easing and unlimited stimulus by central banks can’t generate growth beyond 1% to 2% per year.

This scenario starts to call into question the Fed’s credibility on behalf of the consumers, which are the main driver to the domestic economy. The Friday survey reveals a consumer that is losing faith in the Fed. To quote Viper from Top Gun, investors seem to have “a confidence problem.” Markets have recovered, wage gains are evident, housing prices are back to pre-recession peaks, and yet consumers don’t trust that the recovery is sustainable. The markets seem hunkered down in advance of the FOMC meeting, the BOJ meeting, and the Brexit vote – all of which will be decided in the next week ahead.

From the data that I’ve examined, the current pullback in the major averages is shaping up to be one heck of a buying opportunity for blue chip stocks in companies that aggressively grow their dividends. It’s the best proxy for a bond market in which negative real returns are becoming more widespread and do nothing to grow one’s nest egg. So what can income investors do right now? Buy the dip, confidently.

Growth Mail:

*All content in "Growth Mail" is the opinion of Navellier & Associates and Gary Alexander*

Don’t Overly Fret the Fed’s Next Move…or Brexit

by Gary Alexander

The worry warts are all over the Web, TV, and newspaper accounts, concerned about whether the Federal Reserve will raise rates tomorrow (or in late July).  Next week, we’ll worry about the British vote to exit the EU (“Brexit”) on June 23.  These fixed-date fears have a long heritage in market history.  The fear of a specific event on a known date helps to focus the media on creating scenarios of potential catastrophe.

First, let’s take a brief look at the market’s behavior during the Fed’s most recent rate-rising cycles:

  • From February 4, 1994 to February 1, 1995, the Fed raised rates six times, from 3.25% to 6.0%.  Fed Chairman Alan Greenspan was fighting phantom inflation.  His first rate hike shocked the market, causing a 2.3% drop in the S&P 500 that day; but when the final rate increase came a year later, the S&P was a bit higher – and over the next five years, the S&P 500 tripled in value.
  • From June 30, 1999 to May 16, 2000, Greenspan’s Fed raised rates five times, from 4.75% to 6.5%.  During that span, the S&P 500 rose 7%.  In the first half of that rate-raising cycle, the Fed also flooded the nation with liquidity in advance of Y2K, in anticipation of widespread cash hoarding due to the expected collapse of computerized systems on January 1, 2000.  Then, when no crisis happened, the Fed sopped up that liquidity in early 2000, precipitating a popping bubble.
  • From June 30, 2004 to June 29, 2006, the Fed raised rates 17 times, by 0.25% each time, from 1.0% to 5.25%.  In that time, the S&P 500 rose 11.3% from 1140.84 on June 30, 2004 to 1270.09 on June 30, 2006.  Gold grew even faster in those two years, despite the widespread myth that gold falls when rates rise.  Gold rose from under $400 in mid-2004 to over $600 in mid-2006.  (Sources: Yahoo Finance for S&P 500; New York Fed for rate increases; Kitco for gold prices.)

There are no hard and fast conclusions to draw from these three previous rate-rising cycles, but one tentative conclusion is that external events will likely have more of an impact on the market than a few 0.25% rate increases.  Even with two more 2016 rate increases, short-term rates will still be under 1%.

As for Brexit, Europe is undergoing what the Economist (May 21 edition) calls “Referendumania.”  Not counting referendum-crazy Switzerland and Liechtenstein, Europe has staged 210 referenda in the last 24 years, averaging 8+ referenda per year.  There was a recent referendum in Holland on whether to accept the EU’s trade deal with Ukraine.  Most voters know nothing about trade mechanics, and most citizens are easy to manipulate through protectionist rhetoric, so 61% of Dutch voters rejected the Ukraine trade deal.

Referendum Vote Fatigue in Europe Bar Chart 

Upcoming referenda include Italy voting on a new constitution, Hungary voting to relocate migrants, and another two votes on trade deals in Holland.  Last year, Scotland voted on whether or not to leave the UK.

British Prime Minister David Cameron proposed a Brexit vote last year, but “In the campaign to date, the prime minister has informed the British public that the vote he has offered, should it go the ‘wrong’ way, will lead to global recession, a simultaneous rise in mortgage payments and a slump in housing prices, the invasion of Europe by Vladimir Putin, the end of peace on the Continent, and the arrival of at least three out of the four horsemen of the Apocalypse” (National Review, “The Case for Brexit,” June 13, 2016).

Goldman Sachs believes that a vote to leave the EU would push the pound down 15% to 20%.  The British Treasury sees an immediate 12% to 15% drop (source: Wall Street Journal, June 7, “Volatile Pound Underscores Market Jitters as Brexit Vote Looms”).  The pound’s recent decline reflects those fears.

There was a similar brouhaha over whether Britain should adopt the euro in the 1990s, with warnings about the dire events that would happen if Britain stuck with sterling.  That argument went on for years, but Britain was able to maintain a certain level of independence by holding on to its venerable currency.

Others worry that a vote to exit the EU will lead to a wave of similar referenda in euro-zone nations (see Bloomberg, June 7, “Brexit Contagion is Spreading Across the EU).  Anti-EU sentiment is 61% in France:

European Union Favorability in Europe Bar Chart 

Worst case, if Britain votes to leave the EU, that is not necessarily the last word.  There can be (and have been) appeals or re-votes of referenda that did not come out in alignment with the reigning government. In 2005, there were referenda on the EU constitution in France and the Netherlands.  Some ads compared pre-EU conditions to Auschwitz.  “The insinuation was that the sole alternative to ever-closer union was a return to Auschwitz.”  In 2005, the Dutch and French rejected the new EU constitution but EU authorities called for a re-vote until they came up with the ‘correct’ answer, and then stopped having referendums” (National Review, June 13).  Given the closeness of the polls, June 23 may not represent the final verdict.

According to BBC News (June 9, “The UK’s EU referendum: All you need to know”), the result of the June 23 vote is “not legally binding - Parliament still has to pass the laws that will get Britain out of the 28 nation bloc, starting with the repeal of the 1972 European Communities Act.”  Brexit would “have to be ratified by Parliament - the House of Lords and/or the Commons could vote against ratification.”

Fixed-Date Phobias Usually Fizzle

Fixed dates make for wonderful focal points for major debates.  We tend to imagine the worst, which seldom happens.  Here are a few examples from my nearly-50 years’ experience in market-watching.

May Day 1975: Wall Street’s brokerage brotherhood was terrified of the advent of discount brokers on May 1, 1975 – May Day, or “Black Thursday,” as the brokers called it.  James Needham, NYSE chairman then, said cut-rate fees would be a “disaster.”  Critics predicted “the downfall of our free enterprise system.”  But “the exact opposite happened,” according to Donald Weeden, former chairman of Weeden & Co., “Getting rid of those monopolistic restrictions led to the most explosive profitability ever.” Discounter Charles Schwab said, “Deregulation provided the window for people to begin to innovate…It turned the whole industry upside down and led to this great mass flourishing of services and pricing and technology” (source: “Lessons of May Day 1975 Ring True Today” by Jason Zweig, April 30, 2015).

By the way, the S&P rose 4.4% in May, 1975 and +56.7% in the years 1975-76 (source: Yahoo Finance).

Hong Kong’s Transfer to China on July 1, 1997.  Hong Kong was a British colony from 1842 to 1997. Mao called it “a pimple on China’s backside.”  In 1984, British and Chinese officials negotiated a transfer date for mid-1997, but the long negotiations were so terrifying to Hong Kong citizens and global investors that the Hang Seng Index collapsed and thousands of natives made plans to leave the Crown Colony.  Real estate values plummeted and the construction industry collapsed.  The cost of visas soared.

Hong Kong’s Hang Seng stock market index fell below 750 in 1982, 1983, and 1984.  With that index currently around 21,000, investing in Hong Kong stocks returned 28-fold gains in 32 years, but it was a rough ride.  In this logarithmic chart, you can see 50% or greater declines in 1972-74, 1981-82, 1987, and 1996-97, before the handover, but China has treated Hong Kong respectfully – “one nation, two systems.”

Hang Seng Index Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

Y2K (January 1, 2000) is the classic case of the fear of the unknown tied to a specific date.  Planes were supposed to drop out of the sky but didn’t.  Another case was the Mayan calendar calling for the end of the world on December 21, 2012.  So was the date of budget sequestration (March 1, 2013).  Lesser known doomsday dates were November 29, 2003 (by the Japanese cult Aum Shinrikyo), September 12, 2006 (by the House of Yahweh, Texas), or April 29, 2007 (by TV host Pat Robertson) (Source: Wikipedia, “List of dates predicted for apocalyptic events”).  Ironically, September 11, 2011 was not a predicted catastrophe.

As Jason Bodner shows below, Black Swan events are – by definition – unknown and unseen, but they cause the greatest damage.  What we fear most impacts us the least, since we prepare for it (example: selling the pound in advance of Brexit).  It’s the surprise from out of nowhere (like 9-11 or last Sunday morning’s tragedy in Orlando) that does the most damage, but there’s no way to expect the unexpected.

Global Mail:

*All content in "Global Mail" is the opinion of Navellier & Associates and Ivan Martchev*

Deutsche Bank: A Curious Case of Mistaken Identity

by Ivan Martchev

I like to keep an eye on major financials, as they are the backbone of the global economy. If the banks have problems, not much else will be doing all that great from a macro perspective. I know there are serious issues with European financials as collapsing (and in some cases negative) government bond yields, coupled with negative short-term policy rates, have basically shrunk their net interest margins as their loans are priced off those rates. The same is the case in Japan. In the U.S, despite massive flattening of the Treasury yield curve, we have so far been spared from this rather unfortunate banking situation.

So I punched out the ticker “DB” on my screen last Friday and looked at the TV before the chart would load. I looked back at the screen and I thought I had made a mistake as sometimes the web browser will “remember” ticker symbols on the drop-down quote menu and occasionally the wrong chart would load. It had to be a mistake, as I was looking at the 10-year Treasury yield chart that was just shown on the TV screen seconds earlier, with some futures trader making the comment that the U.S. Treasury market was “breaking out.” I looked closer and I was stunned. There was no mistake. To that moment, I had not realized that Deutsche Bank’s stock was tracking the 10-year Treasury note yield almost tit for tat.

If the Treasury market is breaking out, that would mean Deutsche Bank stock is breaking down, I thought.

Deutsche Bank Index Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

It did not take long to figure out why the stock of a major global financial firm – DB, the largest bank in Germany – would follow the 10-year U.S. Treasury yield so closely. As I have explained on numerous occasions in this column, I think we face a global deflationary problem. There are numerous implications for this, but economic growth cycles driven by too much borrowing in the developed world and in many emerging markets – the largest of which is China – are causing that mountain of debt to catch up with faltering economies. Falling long-term U.S. interest rates at a time when the Federal Reserve has not officially given up on a hopelessly-misguided rate-hiking cycle are a symptom of this global deflation.

Banks tend to perform very poorly in a deflationary environment as weak nominal corporate revenues make servicing debts problematic and lending growth tends to suffer. In a deflationary environment, the real value of debts rises as they stay nominally constant; but the assets those debts are financing tend to fall in price, causing rising NPL ratios. Combine this with the unorthodox global QE monetary policies and negative short-term interest rates and you have collapsing net interest margins for many global banks like Deutsche Bank as many yield curves globally, including the one in Germany, have vanished.

Germany Ten Year Government Bond Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

The German 10-year bund yield – the equivalent of our 10-year U.S. Treasury yield – hit just three basis points (0.03%) last week, an all-time low. The German 2-year Schatz yield, the equivalent of our 2-year Treasury, hit negative 53 basis points (-0.53%). I guess you can call that a positive yield curve, since you must subtract a negative number from the miniscule positive yield (3-(-53) = +56 bps). While this simple mathematical equation may be technically correct, practically it is causing serious issues for Deutsche Bank and all European financials. Since loans are priced off risk-free rates (i.e. the 2-year Schatz and the 10-year bund yields), those loans have tiny interest rates. Also, while corporate lending so far is still being done at positive interest rates, the collapse in the German yield curve is also collapsing DB’s net interest margins and profitability. (When it comes to the German market, Deutsche Bank is global in nature.)

Fed Ten Year Constant Maturity Rate Bond Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

In the U.S., at least we have a positive yield curve. Yes, it is massively flattening as it hit another multi-year low at 91 basis points last week; but at least we are not yet dealing with Germany’s financial system absurdity, deducting negative numbers from a barely positive number to get to a positive yield curve!

I don’t mean to pick on Deutsche Bank, but it does help illustrate the state of affairs in the global financial system. When a major global financial stock is trading at 29 cents per book value dollar (0.29 P/B), then something is wrong.

Deutsche Bank - Monthly OHLC Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

At 29% of book value, Deutsche Bank stock is symptomatic of a problem that has not yet surfaced, in my opinion. The stock is below the 2008/2009 Great Financial Crisis low and it is not the only European or global financial company in such a dire situation.

Markets are not that stupid. There has to be a reason for this dramatic decline in DB stock.

(Please note: Ivan Martchev does not currently own a position in DB. Navellier & Associates, Inc. does not currently own positions in DB for any client portfolios.)

A Brexit Curve Ball

It was prescient to note (see May 23, 2016 Navellier Marketmail article “The Great Pound Mystery”) that the Brexit referendum outcome seemed a bit “too close for comfort” as there has been a dramatic swing in voter sentiment in the past three weeks. The Independent newspaper compiled many sophisticated polls and found that those voting against staying in the EU poll are more likely to vote than those who favor staying in the EU. So if one considers likely voter turnout, Brexit proponents now have a sizeable lead!

Brexit European Union Poll Table 

Another issue that has persistently emerged is that the telephone polls consistently give “Remain” a higher rating than the online surveys. I am not sure if one can read from this that older people are more sensible, but there is a statistically-meaningful difference between telephone and online surveys.

How does that affect the British pound? The answer is rather negatively.

British Pound versus United States Dollar - Daily OHLC Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

The GBPUSD cross rate – dubbed “cable” after the late 18th century exchange rate system when currency quotes travelled over a telegraph cable on the ocean floor starting in 1857 – had a major explosion of volatility on Friday given how the Brexit polls were swinging. Cable broke short-term support and looks likely to challenge the 30-year support of just under $1.40 before the referendum.

United States United Kingdom Foreign Exchange Rate Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

For over 30 years, $1.40 has held. Yes, we were briefly under $1.40 in 2008 and at other times, but cable didn’t stay below that level for long. The singular collapse of cable to $1.05 in February 1985 was when the U.S. Dollar Index soared to 160 (right now it is still under 100) and the U.S. dollar was generally viewed as overvalued leading to the Plaza Accord, which successfully popped the dollar bubble.

I think we will be trading into the $1.30’s on the GBPUSD cross rate before the referendum – if polls indicate a rising Brexit before the referendum – and that there will be a violent reaction lower if Britons vote to leave the EU. This would also be a negative political outcome for the euro, as Great Britain leaving weakens the EU and in that regard it also weakens the Eurozone, as it creates a bad precedent.

Breaking below monthly support at $1.40 right now looks like it has better-than-even odds. A vote for leaving the EU is likely to also boost the headline U.S. Dollar Index past the 100 level as the euro has a 57% weighting in the index.

United States Dollar Index - Monthly OHLC Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

I think that the U.S. dollar rally is far from over, whether Britain leaves the EU or not. A Brexit vote should catalyze it or, if Britain stays in the EU, that should delay the dollar breakout temporarily.

Sector Spotlight:

*All content in "Sector Spotlight" is the opinion of Navellier & Associates and Jason Bodner*

Quakes, Shakes, and Double-Takes

by Jason Bodner

Tectonic plates, in case you need a refresher course from school days, are the last seven plates of land that compose our planet’s crust. These plates contain all the land, water, mountains, buildings, and everything else we see on land. They move in congruence at a painfully slow pace on an immense sea of magma, which is essentially very hot liquid rock. In fact, the continental plates move only about three inches per year, slow enough to discount the importance of what’s happening – or even forget about it altogether, that is, until nature suddenly reminds us. When it does, it’s usually a sudden, blunt, and forceful reminder.

One plate usually slides quietly under another and slips into the sea of magma to be recycled for future use. But every now and then the plates get stuck and locked. The pressure of plates pushing on each other builds until finally there’s a release and the plates shudder and resume their slow motion. To the earth it’s no more of an event than your car momentarily sputtering as it switches gears. You glance down with an “uh-oh” face but everything returns to normal before you have a chance to overly worry. To earthquake victims, however, a shift in the crust can be catastrophic as evidenced by the earthquake and tsunami of 2004, which was so intense that NASA scientists calculated that it affected the Earth's rotation, decreasing the length of a day, slightly changing the planet’s shape, and shifting the North Pole by centimeters.

Tectonic Plates make up the Continents Image 

The Aftershocks of February 11, 2016

February 11th marked the low in the equity markets for this year. Since then, we have seen a steady march higher in the price of general stocks. Much recent talk has been about how the S&P 500 is flirting with all-time highs again, almost like nothing ever happened. Explanations vary: There is talk of this being a short-covering rally, a rally consistent with election years, a rally based on positive economic data, or a rally based on improving fundamentals of stocks. As usual, everything moves along fine, until it doesn’t.

Last Friday marked a risk-off day, with much of Europe being down over 2%, and much of Asia and the U.S. down over 1%. The question on many minds was: “Is this a natural sell-off after an incredible run up or is this the beginning of something bigger?” It is difficult to answer with authority, but as evidenced by the market’s unusual behavior over the last year, we should always be prepared to expect the unexpected.

For one thing, “Fed speak” is flip-flopping between certain rate increases, possible rate cuts, or maybe no change at all. The “Brexit” vote is weighing heavily on the minds of many investors. Oil is back up and rosy reports of the commodity holding firmly above $50/bbl make it easy to forget that oil was in the $20/bbl neighborhood a few months ago. The nature of human memory, likely honed through eons of evolution, causes us to place much of our mental focus on the immediate-term outcome. This means that most of us have a bias to the most recent events and by default, tend to let past events fade into obscurity. It’s the way our minds work.

The market’s march up from February 11th has been a measured and seemingly systemic process. For some it’s a relief; to others it’s eerie and unnatural. Friday’s price action showed us a clear crack in the market’s crust. Is it an aftershock from February or the start of a new quake? We’ll know more as events unfold.

Friday's sector action was consistent with risk-off with telecom, utilities, and consumer staples finding reactive strength. It is worth noting that bonds have been breaking out to the upside for the past couple of weeks. U.S., U.K., German, and Japanese government bonds have all hit two-month highs in the past two weeks. As you can see in the chart following, TLT (iShares Barclay’s 20+ Year Treasury Bond ETF) has broken out to the upside as bonds rally and yields plummet. This flight-to-quality is a typical response to a slide in equity markets. But what have the sectors been telling us leading up to this?

(Please note: Jason Bodner does not currently own a position in TLT. Navellier & Associates, Inc. does currently own positions in TLT for some client portfolios.)

TLT - iShares 20 - Daily Area Chart 

In recent weeks, we have discussed energy and health care strength as well as bank weakness. This week Telecom was king on Friday as investors sought yield. In fact, Telecom was the best-performing sector Friday, all of last week, and month-to-date as well as our #3 performing sector for the past 12 months. Energy is continuing its uptrend, but it is still the worst-performing sector for the past 12 months.

A low rate (or negative rate) environment is not good for banks. Banks saw some accumulation over recent months as sentiment became stronger for a more probable rate hike. Pressure has resumed on banks as they lead Financials lower. Financials were the second-worst performing sector Friday, the worst performing sector for the week, the worst month-to-date, and the second worst for the past 12 months.

Standard and Poor's 500 Financials Sector - Daily Area Chart 

Here are the sector tables by day, week, month-to-date, and 12 months:

Standard and Poor's 500 Sector Indices Changes Table Image 

Tectonic plates drift at a literally glacial pace. Unless you are a geologist, they can be uninteresting, until something major happens. The market’s recent rally has seemed like a steady march upward with not much in the way of new or exciting information leading the charge. The question on many minds has been: “When will it crack again?” Nassim Nicholas Taleb wrote about unexpected events in his great book “The Black Swan.” In it, he emphasized that these rare and unforeseen events, in fact, happen quite often. The seismic shifts in the tectonic plates of the market should cause more frequent quakes, by this logic. Is Friday the beginning of the next quake or is it just a normal sputter? Time will tell but keep in mind Taleb’s ironic words: “The world we live in is vastly different from the world we think we live in.”

Black Swan Image

A Look Ahead:

*All content in this "A Look Ahead" section of Market Mail represents the opinion of Louis Navellier of Navellier & Associates, Inc.*

Long-term, Quality Stocks Beat “Junk”

by Louis Navellier

Amidst all the uncertainty regarding “Brexit,” as well as the pace of the global economy, interest rates around the world continue to plunge.  On Friday, 10-year government bonds were yielding -0.155% in Japan, 0.01% in Germany, 1.211% in Britain, and 1.651% in the U.S.  Longer-term, the fact that the 10-year U.S. Treasury bond yields substantially more than other countries means that the dollar will likely remain strong, despite last week’s weakness based on mounting evidence that the Fed may not raise rates.

Corporate bond yields around the world also continue to decline, due largely to quantitative easing by the Bank of Japan and the European Central Bank (ECB).  This has led to a massive corporate bond rally.

As bond yields fall, companies with high interest rate burdens can also rally strongly.  Last week (in “Quality Issues,” June 8), Bespoke Investment Group showed that companies with low credit ratings have done better than companies with high credit ratings since the market low on February 11th.  Specifically, companies with junk bonds have rallied 34.64%, while the companies with AAA credit rating have rallied only 12.47% since the February 11th market lows (through last Tuesday).  This almost 3-to-1 advantage with “junk” companies is also being fueled (near-term) by energy and other commodity-related stocks.

 Average S&P 500 Stock Performance by Credit Rating 
 Source: Bespoke Investment Group, “Quality Issues,” June 8, using stock data through June 7, 2016 
Rating Last 12 Months YTD Since February 11th
AAA 13.22% 7.98% 12.47%
AA 5.32% 4.80% 14.32%
A 3.45% 5.78% 17.83%
BBB 1.90% 6.72% 23.27%
Junk -4.12% 10.73% 34.64%
S&P500 1.82% 3.58% 15.75%

 

However, if you look at the past full year, stocks in high quality companies (i.e., AAA and AA credit ratings) have beaten low quality (i.e., junk) with less volatility.  (Note: Only two companies currently sport a AAA credit rating, so a more inclusive group of “top quality” stocks would include AA stocks.)

Retired Fed Chairmen Favor Gold

The most interesting news last week is that the former heads of the Bank of England and the Fed, namely Mervyn King and Alan Greenspan, are now recommending that investors own some physical gold.

Specifically, Mervyn King wrote in his new book, “The End of Alchemy,” that the current crop of central bankers “have thrown everything at their economies, and yet the results have been disappointing. Whatever can be said about the world recovery since the crisis, it has been neither strong, nor sustainable, nor balanced.”  In this time of what he calls “radical uncertainty,” King is advocating gold ownership.

Gold Bullion Image

King said in the June edition of the World Gold Council’s Gold Investor magazine that investors should own gold as an asset that is “negatively correlated or uncorrelated” to major stock and bond markets, adding that “I am very struck by the fact that over many, many years, central banks, governments and individuals have always, despite the protestations of economists, held some gold in their portfolio. Obviously, there is no high running return, but when unexpected things happen, particularly when governments rise and fall, then gold is a means of payment that everyone is always prepared to accept. And I think that’s why even central banks have always had a role in their portfolios for gold.”

Alan Greenspan, in a May 26 interview with Fox Business News, said, “I think you have a very profound long-term problem of economic growth.”  Greenspan concluded that the western world is headed for “a state of disaster.”  King and Greenspan's comments undermine confidence in the power of governments and central banks, especially those that have embraced negative interest rates and quantitative easing, like the Bank of Japan and ECB.  While King and Greenspan may not be hard-core gold bugs, their comments were timely as gold hit its highest level in three weeks as it appears that global rates are still declining.


It should not be assumed that recommendations made in the future will be profitable or will equal the performance of the securities in this list. Click here to see the preceding 12 month trade report.

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Please note that Navellier & Associates and the Navellier Private Client Group are managed completely independent of the newsletters owned and published by InvestorPlace Media, LLC and written and edited by Louis Navellier, and investment performance of the newsletters should in no way be considered indicative of potential future investment performance for any Navellier & Associates separately managed account portfolio. Potential investors should consult with their financial advisor before investing in any Navellier Investment Product.

Navellier claims compliance with Global Investment Performance Standards (GIPS). To receive a complete list and descriptions of Navellier's composites and/or a presentation that adheres to the GIPS standards, please contact Navellier or click here. It should not be assumed that any securities recommendations made by Navellier & Associates, Inc. in the future will be profitable or equal the performance of securities made in this report. Request here a list of recommendations made by Navellier & Associates, Inc. for the preceding twelve months, please contact Tim Hope at (775) 785-9416.

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It should not be assumed that recommendations made in the future will be profitable or will equal the performance of the securities in this list. Click here to see the preceding 12 month trade report.

Although information in these reports has been obtained from and is based upon sources that Navellier believes to be reliable, Navellier does not guarantee its accuracy and it may be incomplete or condensed. All opinions and estimates constitute Navellier's judgment as of the date the report was created and are subject to change without notice. These reports are for informational purposes only and are not intended as an offer or solicitation for the purchase or sale of a security. Any decision to purchase securities mentioned in these reports must take into account existing public information on such securities or any registered prospectus.

Past performance is no indication of future results. Investment in securities involves significant risk and has the potential for partial or complete loss of funds invested. It should not be assumed that any securities recommendations made by Navellier. in the future will be profitable or equal the performance of securities made in this report.

Dividend payments are not guaranteed. The amount of a dividend payment, if any, can vary over time and issuers may reduce dividends paid on securities in the event of a recession or adverse event affecting a specific industry or issuer.

None of the stock information, data, and company information presented herein constitutes a recommendation by Navellier or a solicitation of any offer to buy or sell any securities. Any specific securities identified and described do not represent all of the securities purchased, sold, or recommended for advisory clients. The reader should not assume that investments in the securities identified and discussed were or will be profitable.

Information presented is general information that does not take into account your individual circumstances, financial situation, or needs, nor does it present a personalized recommendation to you. Individual stocks presented may not be suitable for you. Investment in securities involves significant risk and has the potential for partial or complete loss of funds invested. Investment in fixed income securities has the potential for the investment return and principal value of an investment to fluctuate so that an investor's holdings, when redeemed, may be worth less than their original cost.

One cannot invest directly in an index. Results presented include the reinvestment of all dividends and other earnings.

Past performance is no indication of future results.

FEDERAL TAX ADVICE DISCLAIMER: As required by U.S. Treasury Regulations, you are informed that, to the extent this presentation includes any federal tax advice, the presentation is not intended or written by Navellier to be used, and cannot be used, for the purpose of avoiding federal tax penalties. Navellier does not advise on any income tax requirements or issues. Use of any information presented by Navellier is for general information only and does not represent tax advice either express or implied. You are encouraged to seek professional tax advice for income tax questions and assistance.

IMPORTANT NEWSLETTER DISCLOSURE: The performance results for investment newsletters that are authored or edited by Louis Navellier, including Louis Navellier's Growth Investor, Louis Navellier's Breakthrough Stocks, Louis Navellier's Accelerated Profits, and Louis Navellier's Platinum Club, are not based on any actual securities trading, portfolio, or accounts, and the newsletters' reported performances should be considered mere "paper" or proforma performance results. Navellier & Associates, Inc. does not have any relation to or affiliation with the owner of these newsletters. There are material differences between Navellier & Associates' Investment Products and the InvestorPlace Media, LLC newsletter portfolios authored by Louis Navellier. The InvestorPlace Media, LLC newsletters and advertising materials authored by Louis Navellier typically contain performance claims that do not include transaction costs, advisory fees, or other fees a client may incur. As a result, newsletter performance should not be used to evaluate Navellier Investment Products. The owner of the newsletters is InvestorPlace Media, LLC and any questions concerning the newsletters, including any newsletter advertising or performance claims, should be referred to InvestorPlace Media, LLC at (800) 718-8289.

Please note that Navellier & Associates and the Navellier Private Client Group are managed completely independent of the newsletters owned and published by InvestorPlace Media, LLC and written and edited by Louis Navellier, and investment performance of the newsletters should in no way be considered indicative of potential future investment performance for any Navellier & Associates separately managed account portfolio. Potential investors should consult with their financial advisor before investing in any Navellier Investment Product.

Navellier claims compliance with Global Investment Performance Standards (GIPS). To receive a complete list and descriptions of Navellier's composites and/or a presentation that adheres to the GIPS standards, please contact Navellier or click here. It should not be assumed that any securities recommendations made by Navellier & Associates, Inc. in the future will be profitable or equal the performance of securities made in this report. Request here a list of recommendations made by Navellier & Associates, Inc. for the preceding twelve months, please contact Tim Hope at (775) 785-9416.

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