Are the bears ready to surrender?
One month bounce does not make a bull market. Let’s keep it simple. The market has gone nowhere for the past 1.5 years and essentially has been trading in a range from October 2014 until today. Earning season is beginning and it is estimated that earnings will drop for the fourth quarter in a row! Even if we exclude energy, earnings are still expected to drop. It should be noted that both S&P Global Intelligence and JP Morgan have recently stated that excluding a sector just paints a rosier picture and that it does not provide a good vision for the economy. In any case, earnings are expect to drop regardless and without earnings the market can only go so far. See chart below from FactSet.
Below is an interesting excerpt from the WSJ:
“Weakness appears to be broadening,” J.P. Morgan wrote, adding that “there is a plausible case that lower commodity prices may be masking fundamental weakness in low-oil beneficiaries–like parts of consumer discretionary, staples, industrials.” The JPM Chase Institute estimates some 80% of oil savings have been spent by consumers. “It may be wishful thinking to expect a sudden lift in EPS growth from higher consumer spending,” J.P. Morgan equity strategist said.
Looking at Europe and Japan we see these markets have diverged massively. The S&P 500 is the last man standing. With corporate earnings falling, do you want to chase this market? Bulls argue we are in a goldilocks area with the Fed on the sidelines and that investors want to be in the best house (US) in a bad neighborhood (global equities). That’s been an argument for a while now but no market is an island and fear that this market is weak has been expressed by a great deal of investment professionals and money managers.
The March rally saw shorts surge in price as short covering in beaten down names was a major theme. As a result energy and biotech shorts in the portfolio hurt performance. Sitting on around 10-15% cash with a net exposure in the low 40s resulted in missing out on the rally. As a result FatAlpha Active gained 2.3% vs the S&P’s 6.3%. The Market Neutral portfolio was in even worse shape as the long side was stuck in neutral (with the exception of HP Enterprises which gained 34%) while the short side all rose in value. As a result it dropped -3.2% giving up gains it had made in prior months. My plan going forward for the portfolios are: a) On the long side avoid difficult situations with vague outcomes. Looking back this has been an issue for the past year. As a result I recently exited Chicago Board & Iron (CBI) and Jacobs Engineering (JEC). Engineering and construction JEC expects to see major pressure in margins and revenue in Q1 due to energy. CBI took a major write-down of a billion dollars due to its Shaw acquisition. After Buffett’s exited from the position, I decided to follow as backlog has dropped and considering industry weakness the backlog has limited upside. Having said that, as a value investor, most of the positions have problems to begin with (hence the cheap valuation) but some stories are ‘easier’ than others. b) On the short side the concentration has created more volatility than I had desired. As a result I will be looking to reduce this concentration and add more industries. As a first step, I shorted Zillow (Z) which is both overvalued and those business model could face serious tests over 2016 as new agreements with brokers are likely to result in lower revenue.
I remain of the view that the market will correct. As I said above, March was one month. During this month we had the Easter holiday which result in lower volume trading with the market taking the path of least resistance which was to follow oil. Markets do not go from bull to bear. There is a transition phase of sideways action before the switch. This occurred in both 2000 and 2008 with the sideways action lasting for around a year and a half. An event will probably trigger the decline and there is no shortage of such potentials as noted by economist Yra Harris in his blog post here: https://goo.gl/JAjnxp
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