Guy’s Market Commentary – November 2014
Stocks made sharp gains for the second week in a row as the S&P 500 stock market index made record highs, gaining more than 10% from the lows experienced just two weeks earlier. Small cap stocks saw the sharpest gains, while bonds saw modest losses. However, looking at sector performance, there are a few areas of concern. Energy and materials continue to lag, an indication that investors do not see an end to the weakness in the global economy, while utilities and healthcare lead the way higher, two sectors that are associated with investors playing defense. The rally off the lows has been strong, but I would hesitate to say that we are all clear at this point until we begin to see better performance from more cyclically sensitive sectors.
An interesting trend-
In the previous decade, American corporations have repurchased stock at about the same pace as they’ve issued new shares. That’s a big turnaround from earlier decades, when new-share issuance almost always outpaced buybacks. Good news? Fans of buyback programs think so. They see this as evidence that corporations believe their own shares are undervalued. They like the fact that their claim on a company’s profits isn’t being diluted. They also view buybacks as a more tax-efficient way of returning money to shareholders. If, instead, companies use their spare cash to pay dividends, taxable shareholders are hit with an immediate tax bill
I recently read where IBM has spent more than $140 billion on stock buybacks and dividends over the past decade. While the stock had a nice run through early 2012 coming off of the lows in 2009, the stock has fallen by more than 20% from its highs 18 months ago as the market has become frustrated with the lack of organic growth, instead opting for financial engineering. Buybacks are good when used appropriately, but when management is focused more on the stock price instead of the marketplace, it is the investor that pays the price in the end.
Goodbye QE-
The FED’s cancellation of QE (Quantitative easing) has been a boon for the Liquidity Bears who see QE as a failure, secular stagnation everywhere and warn of great, imminent bear markets in both credit and equities. For the bears the recent bout of volatility was merely a warning shot, in coming months will reveal unambiguous evidence that QE has failed to eradicate deflation and a loss of credibility in central bank policy will send asset prices into a tailspin in early 2015.
Without a doubt there is a lot of concern regarding the direction of the market now that QE has come to a close. Make no mistake about it, QE has certainly helped the market move higher, but to assume that the end of QE is going to drive the market lower is faulty logic. QE has ended, but you are not going to see the Fed shrink its balance sheet. In fact, before shrinking its balance sheet, they will likely begin raising interest rates. That being said, QE was a tailwind for stocks, and now that the tailwind has been taken away, gains will come through a growth of profitability and not the multiple expansion that was seen in 2013.
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