Having written a number of pieces recently in which I raised ‘yellow flags’ with regard to equity markets (“Yellow Flags Signal Caution Across Markets”, April 1, 2011) - especially in anticipation of the ‘earnings parade’ in which higher input costs would either surface as margin squeezers or as subdued guidance for coming quarters - yesterday, with the global equity markets down 1%+/-, I got quite a few calls/emails from investors effectively expecting, and almost putting, the words “I told you so” in my mouth! But if you know me, you’d know that’s not my style. Frankly, one down day, albeit on the very start of the earnings parade that I cautioned about, is not enough to pound one’s chest in victory of having had a good call.
On a day like yesterday, when companies from various sectors such as oil (XLE, SLB, HAL, WFT), emerging markets (EWZ, BRXX, VWO), industrials (CAT, DE), and materials (AA, NUE) are all under meaningful price pressure, the real question now for investors is whether this sell-off is the beginning of something far more damaging (to longs), or whether this is, in effect, a ‘healthy’ sell-off that takes some of the froth out of asset prices and re-establishes valuations that better reflect a still robust global growth scenario…though somewhat tempered by Japan’s tragic misfortunes and the MENA geopolitical events that have contributed to higher commodity prices.
Goldman Sachs clearly had some thoughts on this as one of their research pieces was highlighted across many media channels yesterday. I was asked by an investor about GS’s research which, as I read in the media, called for taking off the long commodities trade (which has worked very well in recent months +25%), largely due to a rebalancing of risks to the now more symmetric likelihood of commodity price direction. They apparently raised the specter that oil price spikes had already caused some demand-slowing impact which would in turn reduce demand for commodity-related items such as cars, and that Japan’s slowing would have supply-chain impacts furthering the slowdown in production and therefore demand for commodities.
All in all, if I were trading the market with a very short time horizon, I’d consider whether to follow GS’s lead. But for a longer horizon investment portfolio, I believe that the view beyond the immediate horizon might actually call for lowering the “yellow” flags and even raising some “greens”:
- I think the current tempering of all commodity prices is a good thing. It could help offset some of the margin squeeze that most companies are experiencing now and are likely to give ‘guidance’ on as they report earnings in coming days. It still appears that in most sectors, companies have been quite challenged in terms of passing through higher input prices to consumers. That is one reason that the Fed chairman continues to belie the impact of higher commodity prices on overall consumer inflation. So even a modest relief on input costs should bode well for corporate earnings in coming quarters, and give some support to equities to mitigate the current selloff.
- I think the devastating events in Japan in terms of their economic impact are certain to have a slowing effect on economic growth, but only a temporary one. Japan will rebuild robustly, I believe, and that will spur demand for all the commodities that at the time of this writing appear to be under pressure (GLD, USO, JJG, BAL).
- Even when Japan is down and out, there are other countries/companies that are ramping up their car building apparatus to take advantage of the void. Here in the US there is some concern from yesterday’s trade data that suggests that lower demand for imports might be attributed to not only the higher price of imported oil, but also to the slowing in car and related product imports from Japan. If so, that is likely to cause US buyers to shift to US goods, which also shifts pricing power more towards domestic US suppliers of goods. Regardless, the ability of consumers to shift buying patterns is more likely, in my opinion, to impact ‘where’ the business gets done, rather than ‘if’ it gets done at all! In simple but painfully harsh terms, Japan’s economic travails will likely be someone else’s gain.
- How about US jobs? The recent budget cutting exercise in DC didn’t seem to have much to say on that critical front. But that may be self-correcting because companies have been working at very lean levels, and have been benefiting from improved productivity and lower overall labor costs that can only go on for so long. That’s why, I believe, we’ve started to see some pick up in employment numbers. Companies will need bodies to do more work to meet more demand.
- Finally, I do think that emerging earkets stocks could be on the comeback, or will be soon. The number of “free trade agreements” or the like, that I read about every day is staggering…between Brazil and China, Venezuela and Colombia, etc. There is business going on in the emerging countries and their central banks are, in general, being very prudent as to managing the inflation risks…..That’s a good thing!
As you can see, I’m still quite positive on equity markets, despite my near term ‘yellow flag’ syndrome. Caution is always a good thing; especially when markets seem to be too aligned in any one direction…..and that’s the way it’s felt as the markets have continued the upward climb in recent weeks.
Yesterday was sobering, but it should not be a knock-out punch. While I still expect the ‘earnings parade’ to provide quite a few sobering days, ultimately, I still believe that the global growth thesis will prevail. And if it does, as uncharacteristic as it seems, it might actually warrant a little bit of “I told you so”!
(Please note: This article is solely meant to be thought provoking and is not in any way meant to be personal investment advice. Each investor is obligated to opine and decide for themselves as to the appropriateness of anything said in this article to his or her unique financial profile, risk tolerances and portfolio goals).
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