Market outlook: gyrations

Economist Paul Samuelson quipped: “The stock market has forecast nine of the last five recessions.” So, advises Toronto-based portfolio manager John Stephenson, dial down the noise about continuing market gyrations and focus on dividend stocks of companies that Warren Buffet describes as having an economic moat around them that gives them a wide and sustainable competitive advantage. He names three large U.S. consumer stocks that fill the bill.

A tumultuous start to the year followed by an equally sharp recovery in markets to near record highs – combined with lingering memories of last summer’s volatility – have spooked investors, leaving many on the sidelines. Even though the market has added nearly $3 trillion to U.S. share values in the last ten weeks, mutual funds have responded by hoarding cash, short sellers have tightened their grip on bearish bets, and individuals have bailed out of the market.

U.S. stocks fell 11 per cent in the first six weeks of the year only to bounce back by that same amount in the six weeks following the February 11 trough.  But in the five weeks since then stocks have risen just 1.4 per cent.   Both the Dow Jones Industrial Average and the S&P 500 were recently trading off about 3 per cent from their highs set in May of last year.

But just when the coast was beginning to clear, the recent volatility in the foreign exchange market started to spill over into the equity markets.  The spike in foreign exchange volatility owes its origins to a surging yen and weaker U.S. dollar, which highlights investors’ views that central banks have lost the ability to influence currencies.  Traders have been fretting that renewed declines for commodity prices would exacerbate deflationary pressures, when coupled with the backdrop of a lackluster corporate earnings season, notably for European banks.

Negatively impacting investor sentiment are renewed concerns about a slumping global economy.  Recently, we’ve witnessed disappointing manufacturing survey results from China and the UK, slower activity in the Euro zone service sector, and an unexpected decline in European retail sales.

Sell in May and Go Away?

Also weighing on investor sentiment and helping to drive markets lower is the old adage ‘Sell in May and Go Away’.  But is there any truth to it?  Certainly last year would have been a good year to have sold your stock portfolio in May.  By selling in late May last year and buying back in after Labour Day, U.S. investors would have avoided a 7.4% decline.

According to research by Credit Suisse, since 1970 the S&P 500 has gained about 1 per cent on average between late May and Labour Day. However, in 30 of those years stocks rose on average 5.6 per cent of the time. But the declines, when they happened, were far more painful, falling on average 8 per cent in the remaining 15 years.

One reason why many investors think this investment strategy makes some intuitive sense is that volumes should be lower during the summer months, as traders and investors go on holiday.  In fact, data going back to 1996 indicate that trading volumes tend to fall about 3.1 per cent below yearly averages.  Fewer shares changing hands means that the swings in the market, when they happen, will likely be sharper.

A potential rate hike by the Fed at its upcoming June meeting is a potential catalyst that could sink stock prices, kicking off another round of summer volatility.  But despite this possibility, most traders’ market expectations for a rate rise at the start of the summer remain very low.  In late June, the UK will vote, in a referendum, on whether to remain in the European Union.  As well, Greece has once again run into trouble with its international creditors, setting the stage for another summer showdown.

But despite a wide range of anecdotal evidence that suggests that selling in May and going away makes sense, the actual data do not support this investment strategy. In fact, the data suggests just the opposite, that selling in May be a poor investment decision.

Market Miscues

Today’s markets are teetering in large part because the rally we witnessed was so weird.  The rally reversed the beginning-of-the-year sell-off and wiped away worries about China, tighter financial conditions, weak economic growth and collapsing commodity prices.

Yet the recent rally was full of contradictions and confusion.  How often do stocks, government bonds and gold rally together? Why did the yen rise even as the Japanese economy weakened?  How come oil rose 67 per cent while producers struggled to find a home for places to store excess supply?

Perhaps it’s because markets are so schizophrenic after years of weak economic growth and distortions caused by central-bank stimulus.  But whatever the reason, the normal rules of investing have been upended, causing bond markets to predict slowdowns while stocks expect recoveries, and currencies move on their own, increasingly untethered from economic fundamentals or central-bank direction.  That makes it especially difficult to predict what’s next.

What I Recommend

Investors should expect pullbacks over the coming year, as equity valuations remain slightly elevated and the market appears to be teetering.  Despite the current uncertainty in the market, it remains very difficult for most investors to try and time the market and as such, many investors missed out on a massive rebound in stocks earlier in the year.

Cash held in funds around the world rose to an average of 5.4 per cent of assets as of mid-April, according to a Bank of America survey of money managers overseeing $493 billion.  That’s above the three-year average of 4.8 per cent and an increase from the prior month.

But by trying to be too tactical, you set yourself up for even more potential problems as an investor than if you just adopted a buy-and-hold approach.  What happens if the market rallies rather than tumbles over the next few months?  How do you then go about planning your re-entry into stocks?

I believe that most investors are best served by buying shares in large well-capitalized dividend-paying companies with solid defensible business models that will allow investors to ride out whatever the market throws at them.

Constellation Brands

One company that I recently added to my portfolios is Constellation Brands, Inc. (NYSE─STZ).   Constellation Brands produces and markets alcoholic beverages in North America, Europe, Australia and New Zealand.  The company has a portfolio of brands across the wine, imported beer, and distilled spirits categories.  The company owns well-known brands such as the Wine Rack, Robert Mondavi, Corona Extra and Modelo Especial.  After years of underperforming on the wine side of the business, Constellation is finally making solid strategic changes that should lead the shares higher.

In addition, the company should experience share gains in the U.S. beer category by capitalizing on the large Hispanic population and by further penetrating into convenience stores, cans and on-premises markets.  The company is planning to sell the Wine Rack retail outlets, which should unlock some substantial value and position the company more squarely in its home market.  I have a Buy rating and a twelve-month price target of USD $182.50 per share on Constellation Brands.

Whirlpool Corporation

Another stock that I really like is Whirlpool Corporation (NYSE─WHR). Whirlpool manufactures and markets major home appliances such as laundry machines, refrigerators, air conditioners and cooking appliances. The company benefits from favorable consumption trends, particularly those in the United States. Lower unemployment and modest wage inflation should lead to a sustained increase in consumer spending, which will likely translate into appliance demand in the mid-single-digit levels in each of the next few years.  Underpenetrated international markets could also serve as a potential catalyst for sales and the stock price. I have a Buy rating and a twelve-month price target of $215 per share on Whirlpool Corporation.

Comcast Corporation

Another solid name that I like is Comcast Corporation (NASDAQ─CMCSA), a U.S. multinational mass media company and the largest broadcasting and cable company in the world as measured by revenue.  The company should outperform its cable and telco peers based on superior revenue growth.  The company has strong bargaining power with programmers given its size, and proportionately less exposure to programming cost increases due to its NBC Universal division. As well, Comcast has been consistent in enhancing value to shareholders through its dividend and share repurchase program. I have a Buy rating and a twelve-month price target of $72.50 per share on Comcast Corporation.

Investors should dial down the noise from the market strategists and focus on a long-term investment plan focused on dividend-paying companies with large moats around their businesses.


The MoneyLetter, MPL Communications Inc.
133 Richmond St. W., Toronto, On, M5H 3M8, 1-800-804-8846

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