APRIL 2014 INVESTMENT JOURNAL: WEATHER WOES
- Poland plunders pension funds
- Ukraine-Russia conflict escalates
- US GDP flat
- Fed continues tapering
Markets in April produced positive returns across all major sectors. Year to date, bonds and hard assets are slightly ahead of developed market stocks, with emerging markets still struggling:
The month began with Poland confiscating all government bond holdings of private pension funds on April 2nd. They did not offer any compensation, then they cancelled the debt, thereby improving their "borrowing capacity". No one in the mainstream U.S. press seemed to notice. Imagine though, if IBM, Microsoft, Caterpillar etc. were forced to turn over roughly 40% of their pension fund assets to the U.S. Treasury, not receiving anything in return.
This "pension overhaul" will make the system "safer" is how the Polish government spun their outright thievery. The real reason is that they needed to cut the amount of debt on their national balance sheet so they could borrow some more (wouldn't it be great if we could all steal a couple of hundred thou and pay off our outstanding mortgage?) Poland, being a member of the European Union, is setting the new standard for how to destroy an economy from within. (Why worry about Russia on your borders when the kleptocrats in Warsaw are your own worst enemy?)
The situation in the Ukraine continued to spiral downward, with the US and EU imposing more sanctions while pro-Russian activists fomented dissent in much of Eastern Ukraine. A very astute geo-political observer who we follow has said that the Ukraine has always had an East-West split, and that partitioning it would have been the best solution. Since the West/IMF has insisted on Ukrainian sovereignty in return for financial aid, Putin has no way out to "save face". Thus the conflict is likely to escalate. Either way, the gas and oil markets have tightened globally due to threat of constrained supplies. Investors also need to be thinking about agriculture, as Ukraine is the fourth largest exporter of wheat in the world. Commodities have been stronger lately, and this is a big reason why.
In the U.S., much of April saw better than expected earnings news, and more upbeat forward guidance than anticipated. This is a welcome development that should support further gains in equities. The graph below shows this trend over the past several years (notice the last upturn was in early 2009, just prior to a healthy bull run):
On April 28th, Bank of America (BAC) announced it was suspending a share buyback program and a planned dividend increase after it discovered an internal accounting error which cut its equity tier one capital by $4 billion. The stock dropped by over 6%. This is particularly troublesome for BAC because they had already gained approval from the Federal Reserve to proceed with the buyback and dividend increase, so they will now have to submit the same plan again. As one large institutional shareholder was quoted saying: "It's frustrating, unfortunate, it's a stupid mistake, should have never happened. But that combined with all of BofA's legal and regulatory headlines over the past five years, and even this year to date, it's quite unbelievable - it's never-ending."
After JP Morgan's $6 billion "Whale Trading" loss in 2013, this latest banking fiasco is leading some to observe that the "mega-banks" are too big and complex to manage. There is also a growing regulatory burden. As Charles Schwab's Liz Ann Sonders pointed out in a recent research note: "The Dodd-Frank legislation has already imposed numerous new rules on much of the financial industry; but the real rub is that almost half of the rule-making process is still to come. We regularly hear from business leaders that when they don't know the rules of the game, they're less likely to suit up to play. According to law firm Davis Polk, as of April 1, 51.8% of the required rulemakings have been finalized, while 98 (24.6%) have yet to even be proposed, four years after the passage of the bill." There is also an increased concentration of risk in the mega-banks, who are responsible for the overwhelming majority of off-balance sheet derivatives that have levered up the entire global financial system. All in all, it looks like the big banks will need much more time (and expertise apparently) before they can regain a solid footing. The environment now seems ideal for small to medium size banks to shine.
US GDP was released on April 30, and it showed a virtual stall in growth at .1%:
This is a Q1 "advance" report that is backward-looking and frequently revised higher; nonetheless, observers blamed the woes on the continuing and unusually cold weather. Some were keen to point out that the GDP number would have been negative had it not been for the record increase in healthcare expenditures due to Obamacare (up 4.4%). Another notable trend was a sharp increase in the trade deficit, as exports plunged 7.6% versus a fall in imports of just 1.4%. Our friends at briefing.com summed up the report best: "Many analysts over the last couple months have theorized that the softness in the first quarter is the result of extreme winter weather conditions. In our opinion, economic growth has tended to slow during the first half of the year for the past several years. The slowdown in Q1 2014 was not extraordinary but we do not expect a snap back from pent up demand to occur immediately in Q2 2014."
The Fed released their FOMC statement later the same day, and it began on an upbeat note: "Information received since the Federal Open Market Committee met in March indicates that growth in economic activity has picked up recently, after having slowed sharply during the winter in part because of adverse weather conditions." The FOMC "currently judges that there is sufficient underlying strength in the broader economy to support ongoing improvement in labor market conditions." The release stated that the Fed would reduce their bond purchases by another $10 billion per month (more "tapering"), but would reserve the right to adjust things as conditions evolved. On the all-important topic of when they would raise interest rates, "the Committee continues to anticipate...that it likely will be appropriate to maintain the current target range for the federal funds rate for a considerable time after the asset purchase program ends." In other words, it is still going to be quite some time before short term rates rise above zero. That is good news for stocks, but bad for savers who prefer low risk investments.
We think it's notable how widely performance has diverged of late among stock market sectors. The chart below is a simple illustration of the strength that the Utilities sector, and more recently Energy, has shown this year vs. the S&P 500 Index. We also included the worst performing sector this year, Consumer Discretionary stocks, which demonstrates how trends in the market tend to persist for some time before being overtaken by the next trend:
Commodities also appear to be regaining strength, as prices in energy and food have been on the rise. In addition to the tense Ukrainian situation, weather forecasters put the odds at better than even for an El Nino effect for North America during the summer growing season, which could create drought conditions in the Midwest and play havoc with food prices. All major sectors of the DJ UBS Commodity Index have outperformed the U.S. Equity market so far this year, with the exception of Industrial Metals:
Investors are well familiar with the phrase "sell in May and go away", but the averages show that it's really the dog days of summer that are weakest:
Thanks for reading our Journal, and we'll send you the next one in early June.
©2014 Stratford Advisors, Inc. All Rights Reserved.
This publication is intended solely for information purposes and is not to be construed, under any circumstances, by implication or otherwise, as an offer to sell or a solicitation to buy or sell or trade in any securities herein named. Information is obtained from sources believed to be reliable, but is in no way guaranteed. No guarantee of any kind is implied or possible where projections of future conditions are attempted. In no event should the content of this market letter be construed as an express or implied promise, guarantee or implication by or from Stratford Advisors, Inc., or any of its officers, directors, employees, affiliates or other agents that you will profit or that losses can or will be limited in any manner whatsoever. Past results are no indication of future performance. All investments are subject to risk which should be considered prior to making any investment decisions. The firm may hold for its clients, Principals or employees, positions in any securities mentioned herein, and may buy or sell such securities at any time without prior notice.