Commentary for the week ending 2-20-15

The beginning of this year has been characterized by very large, volatile moves in the stock market. This week was different in that stocks moved very little until Friday. The news flow was no different than before – some headlines out of Europe and our Fed – so the lack of volatility was unusual, though refreshing.

We’ll start with Europe, where the drama with Greece continued to play out. Like we’ve talked about a lot recently, the country’s bailout is due to end this month. Since conditions have yet to improve and they still have no money, an extension to that bailout is necessary.

This week they did formally request a six-month extension to their bailout. Actually, they cannot acknowledge it as a “bailout,” since the new government campaigned on never extending the “bailout.” Therefore, they sought an extension on their “Euro zone loan agreement.” It looks like they already have the politician-talk down pat! Regardless, stocks were helped by the news.

By formally requesting an extension on the “Euro zone loan agreement,” Greece thought it was in the clear. However, the request was denied by Germany, noting that it changes some of the repayment terms (by making them easier for Greece) they had previously agreed to.

By late Friday, however, a deal appeared to be reached. Greece got a four-month extension – not the six they originally wanted – and stocks rose on the news. Greece may now fall from the headlines, but we are certain they’ll be right back here in four months. Necessary, fundamental changes are never undertaken by these countries, which is why these bailouts have continued for years. At least until they run out of printed money.

Getting back to the U.S., the Fed was in the news with the release of the minutes from their latest meeting. Investors have been watching closely for any clues as for when interest rates will rise. The minutes told us little about those rate increases, though they did talk more about the concept of higher rates. It seems more Fed members preferred to keeps rates lower for longer, so the market interpreted this as positive for stocks.

Questions remain, though. While many investors read the minutes as “lower for longer.” others saw an increased likelihood for earlier rate rises. These different interpretations are likely just what the Fed had in mind – the wording of the minutes was very lengthy and obfuscating and never gave a clear indication on anything. To us it seems the Fed is undecided on what to do, so rather than getting pigeonholed, it’s trying to baffle the market with…

The focus on the timing of an interest rate increase is important because the low rates have helped push stock prices higher. In fact, the Fed even noted concerns that the low rates are pushing stocks up too much and forming bubbles. They called out small cap stocks, biotech, and social media companies as a concern.

We think their concern is very well founded. They have flooded the market with money and there are only a limited number of investment opportunities this money can flow into. Certain sectors, like social media companies, have been tremendous beneficiaries.

Just this week, two social media companies, Snapchat and Pinterest, announced new astronomical valuations for their companies. Snapchat is now valued at $19 billion, which is the same valuation as companies like The Gap, Kroger, Macy’s, or the Discovery Networks.

Pinterest announced a valuation of $11 billion, which puts it at the same size of Under Armour, Nordstrom, or Kohl’s.

Keep in mind, these companies have never earned a penny, yet somehow they have multi-billion dollar valuations. We strongly believe the easy money from the Fed is driving up another bubble, prompting absurd valuations like these. We think the question is when, not if, this will end badly.

Next Week

We’ll see a busier week next week. Corporate earnings are winding down, but there will still be some significant names releasing earnings. As for economic data, we’ll get info on housing, consumer confidence, durable goods, inflation, and a revision to GDP.

The Fed will also be in the news as Fed chief Yellen testifies before Congress on the economy and interest rates. These events are usually quite dull, but will receive more scrutiny as investors watch for any clues on an interest rate increase.

Investment Strategy

No change here. We’re still seeing the investment landscape shifting more to a stock pickers market, where some stocks or sectors rise while others fall. This isn’t like before, where one piece of news – usually from a central bank – would send all stocks up or down in unison. Of course, this could all change when interest rates rise or the European stimulus starts in March.

Still, stocks are on the expensive side and we are seeing fewer buying opportunities. We are not looking to sell at this point, though, but are not looking to put any new money in.

We still have concerns for the longer term. We worry about the distortions created by the central banks and money printing (just look at the recent plunge in oil prices or the high valuations in social media stocks we discussed above). Stimulus continues to send stocks higher, but we worry the longer it continues, the more painful the correction will be.

The bond market traded in a tight range this week. Investors seem to be bracing for higher interest rates soon, which will be bad for bonds. It’s really anyone’s guess what bonds may do in the near-term, but the longer term may see bond prices continue to rise (so yields fall) as the stimulus programs push up bond prices around the globe.

Bonds to protect against inflation, or TIPs, remain a good long term hedge for inflation. They have not fared well recently as the likelihood of inflation has waned with the lower energy prices, but we are keeping a longer term focus with them. Some municipal bonds look attractive for the right client, but not as good as they did several months ago. We like buying individual, insured names for these bonds, avoiding muni index bonds if possible. We keep a longer term focus with these investments, too.

Gold is another good hedge for the portfolio. It is only a hedge at this point – rising on geopolitical worries and falling once they are out of the headlines. It has done well lately, but with the volatility we’ve seen in it over the years, it is better to think of it as a hedge for the portfolio.

Finally, in international stocks, we see weakness around the globe and favor neither the developed or emerging markets.

Please note, these day-to-day and week-to-week fluctuations have little impact on positions we intend to hold for several years or longer. Our short and medium term investments are the only positions affected by these daily and weekly fluctuations.

This commentary is for informational purposes and is not investment advice, an indicator of future performance, a solicitation, an offer to buy or sell, or a recommendation for any security. It should not be used as a primary basis for making investment decisions. Consider your own financial circumstances and goals carefully before investing. Past performance cannot guarantee results.

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Commentary for the week ending 2-20-15

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