There’s right. And there’s dead right.
I was aiming for the former, and fearing the latter.
Tuesday’s price action (down almost 1.5%) may be proof of both…or maybe not.
What’s going on? And what do I mean?
In a nutshell, many of the risk factors that I cited in a piece published earlier this week entitled “Beware Potential Potholes Stemming From Growing Global Currency Wars” continue to overhang the market. In fact, before reading on, please note that this article is best read as a follow up to that work and to related articles cited in that piece. In addition, the points raised in this article, and any citing of specific company names, are meant solely to provide thought-provoking issues for investors to consider as they opine and decide on their own unique investment choices. This is not meant to be personalized investment advice, and each investor has to do his/her own assessment of the appropriateness of anything mentioned in this article to his/her own portfolio, financial profile and risk tolerances.
The backdrop that I painted in last week’s piece contains issues that the markets will likely face for some time, and the key to navigating the market’s choppy waters will be to assess how much the “risk-ometer” is swinging and how much of that risk has been priced into assets. Getting this right could provide considerable value to investors.
With earnings announcements well underway, we’re getting pretty good ‘rearview’ mirror action, but forward views through the windshield are laced with caution and sobriety. Couple that with the banking sector’s foreclosure issue and the ongoing global “currency war”, and investors have reason to be cautious - not cataclysmic - but cautious. The choppiness of big up days and big down days, I’d expect, will likely continue because the issues mentioned above are not easily fixed and forgotten, but rather are more likely to linger and last.
Taking each in turn, corporate earnings so far have given investors lots to feel good about, and should reinforce the notion that companies have continued to respond well to challenging economic times. Even in cases where we’ve gotten modest ‘top line’ improvement or even declines, we’ve seen efficient operating leverage drop more to the ‘bottom line’. That said, in cases where companies have projected more sober outlooks for coming quarters, the markets have been more prone to punish stock prices for the future than to reward them for the past. And that makes sense.
But, it also raises the prospect for investors to acquire assets that they believe have been ‘over reacted to’ on the downside. Companies too will be facing lower hurdles in coming quarters as professional ‘Street’ analysts lower expectations of earnings growth, and in turn, share-price targets. The market’s selloff on Tuesday did provide better entry points for many of the names that I’ve mentioned in previous articles. Wednesday’s up trade puts me back on hold from a buying perspective, but the overall price action appears to be indicative of a sentiment that Tuesday was an ‘over-reaction’ rather than a ‘game changer’. If we see more of the recent choppiness, I’ll be focusing on many of the same names: GE, Cummins (CMI), 3M (MMM), Caterpillar (CAT), Deere (DE), FedEx (FDX), Posco (PKX) and others. (Look for follow up articles on specific companies).
The banks continue to raise new red flags every time old ones come down. The foreclosure dilemma first looked like a fiasco, then sounded like it would be swept under the rug as an issue of “process” over “substance”, and now again looks more serious as the Federal government is considering investigating criminal activity and as the Fed, PIMCO and BlackRock are teaming up against Bank of America (BAC) and their Countrywide subsidiary. It’s clear that the banking industry is undergoing tremendous upheaval in the way it does business and in the way it can make money. Recent earnings showed that the reliance on formally all but certain trading revenues has been called into question as markets have gotten more volatile and thinly traded.
Capital requirements, though many US banks are probably close to or in the comfort zone, continue to hang over their heads from all corners of the Earth, be it US regulators or the BIS. And bottom line earnings appeared to be driven, in many cases, by lower loan loss provisions rather than by very robust top line growth in consumer, corporate and investment banking activities. Again, these are broad brush comments about the industry overall as opposed to any one specific bank. But the issues are likely to be relevant to bank stock valuations for some time to come. As mentioned in previous articles, despite my general caution on this sector overall, Citigroup (C) does stand out as a stock with a unique situation - the US Government as an ever-present seller. Once that’s over, there is a widely held belief that the stock can rally. That point, coupled with the recent earnings that appeared to impress investors, makes C something to watch closely.
Finally, the “devalue-to-deter-deflation conflagration”, better known as the “currency war”, is perhaps, in my mind, one of the biggest uncertainties that the market faces. This weekend’s G20 meeting of finance ministers presents an opportunity for the global financial leaders to ease the market’s concerns about the unilateral actions that keep popping up all over the globe as countries try to keep their currencies from climbing and in turn choking off exports. Brazil has raised rates recently on foreign buyers of their bonds, Thailand made a similar move several days ago, Korea was in the headlines Tuesday night with considerations of capital controls, India has warned that the current global tensions on currencies is damaging issue for world economies, and the list goes on. There are some who think that talk of China lowering exports of rare earth minerals, of which they have a near monopoly, might actually be a part of this retaliatory environment in the face of US Congressional attempts to pass punitive tariffs and the like. The issues are huge, and the likelihood of this weekend solving all of them is remote. But the market needs to see some process or structure put in place that would augur well for the disputant countries with their diverse interests to find common ground in some near term time frame. (I’d recommend reading an article by a former colleague of mine from our Citigroup days, Yiping Huang, entitled “A Currency War the US Cannot Win”).
In sum, these issues collectively, I believe, keep the US equity markets from smoothly trending higher. They may go higher nonetheless, but it is likely to be in a very choppy way, leaving investors, and certainly day-traders, constantly re-examining their investment game-plans, entry points, exit points and overall risk management. To be clear, I remain quite long in equity exposure in the US, Asia, Latin America and Europe, but I also have an unusually large cash position that I’ve been using to ‘buy on dips’. The issues discussed in this article have not derailed my approach, but have made me redefine how far a stock’s price has to fall from current levels before I’d consider it a “dip” worth stepping into.
For all investors who are at the helm of navigating their portfolios, the waters within eyes’ view seem to me to be quite choppy. The waters beyond the horizon, though, could be quite smooth if countries address the economic imbalances in an orderly way, and in turn, allow the global infrastructure growth to continue apace as it has already in so many emerging countries around the world. We should be watching this weekend’s events closely for progress on that front.
Look for follow up articles, both on the G20 meetings, and on specific companies that are on our investment radar screen.
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Disclosure: Long: C, DE, CAT, MMM and ETFs on all regions mentioned. All stocks mentioned, though not necessarily owned by the author, may be owned in separately managed client accounts. All positions could change soon without notice.