The market has anticipated several things. First, the entry of the bullish season from October into April / May. History shows that the average market move from the mid-year low (July 2, 2010 – 9686.48) to the pre-election year is 49.2% (source: Stock Trader’s Almanac). That would take us over 14,000 in 2011!
Secondly, the market understood the Fed comments from the August FOMC meeting that the Fed will implement another round of Quantitative Easing, now referred to as QE2. That anticipation of the Fed along with other global central banks has sent investors on a buying spree ahead of these central banks, especially as we have gotten into September. Sometimes this causes unintended consequences and we are seeing the continued “bubblish” move into gold, silver, and metals. Investors are also fleeing the U.S. dollar as the Fed prints money and tries to ignite a tame inflation dragon.
Third, in September, investors came to realize that stocks were undervalued as dividend yields on stocks were exceeding yields on fixed income. So it appears that major institutions have begun implementing some asset allocation back into stocks and away from fixed income. You have the dividend yield on the S&P 500 around 2% and the yield on 10 year Treasuries at 2.5%.
Fourth, the market is looking forward to the change in political balance in Washington with a shift in power in the House and potentially the Senate back to Republicans. Historically, the markets have performed best with split power between the Democrats and the Republicans.
Finally, fifth, on the economic front, we are into the next earnings season and earnings continue to be very good. Corporate America will attempt to reach record profitability. The bad news is that companies will continue to get by with fewer employees. It is our belief that the landscape of employment has changed permanently, such that companies will use more temporary and contract staff that can be quickly adjusted to the business environment. It is too costly to hire the employee, pay the benefits, pay the employee to be sick, go on vacation, pay their ObamaCare health costs, and then be liable for unemployment benefits, COBRA, and a layoff package. With contracted employment, either inside the U.S. or overseas, management will seek to match labor to the business environment.
Companies continue to sit on record amounts of cash. We will continue to see M&A activity, stock buybacks, dividend increases, and increase capital expenditures. Budgets will be better in 2011 for corporate America. Internationally, emerging markets will have higher growth rates and have fewer fiscal problems than the developed countries including the U.S. So, it is not surprising that investors are allocating that way.
We continue to like the High Yield (iShares iBoxx High Yield Corporate Bond ETF (HYG), SPDR Barclays Capital High Yield Bond ETF (JNK), PowerShares Fundamental High Yield Corporate Bond Portfolio ETF (PHB) in the fixed income sectors – we believe that is the sweet spot of the markets right now - especially for fixed income. Income wise, we also like asset backed securities along with preferreds (NPSAX, iShares S&P U.S. Preferred Stock Index ETF (PFF), real estate income (FRIFX, KIFAX), emerging market debt (IShares JP Morgan USD Emerging Market Bond ETF (EMB), PowerShares Emerging Markets Sovereign Debt Portfolio ETF (PCY), PEMDX, PLBDX, PLMDX.
Disclosure: Long KIFAX, Long HAHIX, Long PHIYX, Long MHOIX, Long NPSAX, Long PEMDX, Long FRIFX, Long PLDBX