June

HUTCHENS INVESTMENT MANAGEMENT WEEKLY COMPASS June 29, 2015

on Tuesday, 30 June 2015. Posted in 2015, June

HUTCHENS INVESTMENT MANAGEMENT WEEKLY COMPASS June 29, 2015

Auf Wiedersehen Greece!

“You shouldn’t commit suicide because you fear death.”
                                                                Jean-Claude Junker

Goodbye to the euro, say hello to the drachma. Greece has sealed its fate and the US stock market will shortly turn the page on this European problem. The call for a referendum vote on July 5th preceded by a non-payment to the IMF of 1.5 billion euros tomorrow will make reinstatement virtually impossible. As we have mentioned on these pages, the lack of bargaining leverage, accompanied by an inflexible position, enabled the European Union (EU) to pull the string. But more likely, it was Germany that ultimately decided Greece’s fate. In fact, it may have been the German plan since Alexis Tsipras’ election in January.

The Maastricht Treaty in 1992 creating the EU, and a few years later the euro, is without a fiscal union, leaving no mechanism for profligacy. Germany, by its size and favored position in the resulting EU bureaucracy, enhanced their trade position by exploiting the southern periphery, including Greece and the other PIIGs. Greece borrowed from European banks to propagate their spending. Today, saddled with debt at 180% of GDP, owed mostly to state lenders, Greece would have to grow in excess of 4% annually to pay the interest on the 141.8 billion euro debt owed to the European Financial Stability Fund (EFSF). This facility refinanced bank debt, reducing the possibility of contagion in the private banking sector. Additionally, the 315.5 billion euros in total Greek debt is mostly held (upwards of 80%) by the EFSF, central banks, and the IMF. Given that GDP is down 25% over the past five years even further lending would not pay down debt. The Syriza Government has vowed not to touch pensions and further reduce the budget.

There is little likelihood of contagion as government bond rates of the other weaker countries (Italy, Portugal and Spain) have been little impacted by the current situation. The withdrawal by Greece from the EU may have a positive longer-term impact on these other marginal countries. The Grexit should serve as a clarion call to the other profligate countries that austerity is alive and well, and there is no blank check from the EFSF. For Greece it is devastation. If the ECB seizes the government deposits used for collateral as stated in the agreement, Greece will not recover for a generation. Younger workers are leaving an already aging population and as unemployment, currently at 26%, rises and GDP will collapses. A member of NATO since 1952 and with one of the best outfitted militaries in the Alliance, Greece may look to Russia or even China to restore solvency. However, the message from Germany is clear, a default by any other name in Greece is a default.

Investment Strategy

As Europe works through the current problems, US equities should be afforded a premium relative to other developed countries. The widespread Greek selloff will not trigger more than an overdone reaction for US stocks, and depending on the magnitude, result in a buying opportunity, as short-term trading adjustments from fast money investments are reallocated and losses taken. Also, one has to question the efficacy of the timing of the Commonwealth of Puerto Rico’s $73 billion in debt classified as non-payable. Aside from being imprudent, it certainly drew a media response tying US debt vulnerability to Greece. But earnings season is around the corner and the economy is tilting to more growth in 2H2015. Housing is rapidly gaining traction and the earnings pressure from the oil breakdown and stronger dollar has reversed. A financially healthy consumer is returning, and given the level of interest rates and low inflation, we expect stronger spending as the rest of the year unfolds. With the prospect for economic growth improving, the possibility of a definable 10% correction is slowly evaporating. While many expect a Fed rate increase to add instability to the financial markets, we anticipate a Y2K type event.

Once the Fed raises rates, stocks should perform well during the rate normalization process. Longer term we believe that moderate economic growth, accompanied by slow rising real interest rates and low inflation, will result in increased earnings and limited multiple expansion with continued upside for equities. Our investment policy remains optimistic on selective Large-Cap domestic corporate equities.


Authors:
David Minor
Rebecca Goyette

Editor:
William Hutchens

HUTCHENS INVESTMENT MANAGEMENT WEEKLY COMPASS June 15, 2015

on Monday, 15 June 2015. Posted in 2015, June

HUTCHENS INVESTMENT MANAGEMENT WEEKLY COMPASS June 15, 2015

Bond Market Volatility – It’s Greek to Us.

No discussion of today’s securities markets is complete without prefacing Greece and the volatility in the bond markets.  For Greece’s new government there is little room for an agreement.  In fact on Saturday morning the news from Greece was that Prime Minister Alexis Tsipras stated he is “willing to accept unpalatable compromises to secure a deal with international creditors.”  Sounded like he has finally realized Greece has no further leverage, either accept what is offered or default.  Not so, talks in Brussels on Sunday ended with “large gaps” in the negotiations.  The next attempt will be on Thursday but EU leaders are becoming annoyed at the Greek stonewalling.  By Thursday both sides could possibly reach an agreement keeping Greece in the euro but not solving the longer term problems.  In actuality, Greece should not matter except to traders and a few European banks, most everyone else owning Greek debt and related securities has had three years to insulate themselves.  Even if an agreement is not reached and Greece defaults, so what!  

The volatility in the bond market is no less meaningful to US equities than Grexit.  As Central Banks implement their customized version of QE their purchases limit liquidity in Long-Term bonds.  This attracts traders using leverage seeking to profit from short-term moves based on market internals, rather than on fundamentals.  There is no economic rationale for these almost daily fluctuations.  Incorporating potential negatives of Fed interest rate policy and Greek default into the short-term outlook results in more volatility in a leveraged illiquid market - - a traders Utopia.  The prospect of any clarity on Fed interest rate increases from the meeting will dominate discussion early in the week and without any agreement with Greece, be prepared for continued instability.  All of this with technicians bantering about a ten year chart of the 10-year Treasury showing a “big, inverted head and shoulders bottom pattern,” WOW!

Economic Insights

Since the completion of QE3, the US economy has gradually moved toward self-sustainability.  However, without a viable consumer, growth has been erratic and more influenced by external events, such as weather, falling energy prices, and the strengthening dollar.  Both retail spending and housing are showing clear signs of a consumer returning from hibernation.  Consumer sentiment has improved as employment rises and wages begin to reflect some labor tightening, but also a new segment of non-savers having additional purchasing power are entering the market.  

While one month does not make a trend, the data for May retail sales certainly was welcome.  The comparison with the prior month shows an increase of 1.2%, but comparing month-to-month with year-over-year data gives a clearer picture, as the effect of declining gas prices is included, and the inadequacies of seasonal adjustments is limited in the twelve month data.  

Retail Sales Investing
                                 Source:  US Census Bureau


The Table shows an interesting trend over the past year as the lower-end consumer remains reluctant or unable to spend.  On a 12-month basis, Merchandise Stores, including department stores and discount retailers, remain flat despite a savings reduction of up to 40% from gasoline.  Auto sales are the largest contributor to rising total retail sales as they have been during the past few years.  In May, dealers reported auto sales at an annual rate of 17.7 million, the highest level in nine years.  Hard to fathom the savings at the pump is a determinate of auto sales, but it is in an unconventional way.  Looking at Auto Sales year-to-date through May 2015 shows total new car sales, both domestic and imported, down 3.1% from the same period in 2014.  Total truck sales (which includes SUVs) are up 10% with SUV sales +13.9%, led by luxury SUVs +25.7%, followed by mid-sized SUVs +16.9%.  The all-important pickup category rose 9.9% over the past five months.  Of the top 20 vehicles sold in May, the more reasonably priced cars show a distinctive downtrend, less reflective of cheaper gasoline mileage than the lower-end purchaser, Chevy Cruz (-26.7%), Honda Accord (-18.3%), and Toyota Camry (-11.6%) show the largest declines.  The higher-end consumer remains the bulwark of retail sales.  

While most analysts have been awaiting the consumer to turn gasoline savings into spending, we have stated that the savings to the average consumer will result only in a marginal increase in spending.  A recent report by the New York Federal Reserve Bank modeling supply and demand oil shocks back through the 1980’s concludes that the “expansionary oil supply shock of late-2014 and early-2015 will have a relatively modest stimulative impact on economic activity, which will peak around mid-2015, and the effect should dissipate significantly by early-2016.”   Aside from looking for increased consumer spending from energy savings, the most recent employment data offer an insight into where consumer spending may begin to make a meaningful impact on economic growth.  In May 2015, labor force participation rate rose to 62.9% but only slightly above its March 2015 all-time low of 62.7% and well-below the 66.4% high in December 2006.  What is interesting is the under-25 age category accounted for 96% of the 392,000 net new entrants into the labor force.  According to the Household Survey, of the 272,000 net employed last month, 76% were in this demographic.  The hiring of these new employees is an indicator of labor market tightening.  With a record 5.38 million available jobs a full employment level in 2H2015 at 5.0% seems attainable.  We anticipate some wage pressure at these levels and with job openings at record highs a further increase in participation rates.  

As retail sales await rising employment and a tighter labor market to ignite purchases by a more financially sound consumer, the housing market in April 2015 is picking up where it left off in 2013.  The transition away from foreign and investment purchasers to the traditional first-time buyer and existing homeowner upgrade is slowly evolving.  

•    Housing Starts – At 31.6% increase in April over March to 103,600 starts is the highest monthly total going back to October 2007.  Also permits were up 15% month-over-month, the best level since June 2008.  Multi-family starts remain about 33% of the total as the rental market for many potential first-time homebuyers is the only alternative.  Also, Millennial’s are moving into cities where they are working, and without family commitments, savor convenience over home ownership.  This trend in multi-family building should remain intact as permits rose 21% month-over-month in April.  

•    Existing Home Sales – Once again, existing home sales came in below expectations.  Although up 6.4% above April 2014, mortgage restrictions, low inventory levels, higher prices and limited equity for existing home owners have all impacted current sales.  This is the category most affected by the withdrawal of investors and foreign purchasers.  

•    New Home Sales - Month-over-month April 2014 new home sales were 8.9% above March and for the first five months 21.4% above 2014.  However, these levels remain 45% lower than the early 2000’s.  Builders have shunned this market moving instead to multi-family or building single family homes above the level of affordability for many first-time homebuyers.  Overall inventory remains low, but the level of housing starts indicates a current level of housing starts that availability will increase.  Also, the proposed easing of mortgage restrictions will draw first-time buyers even as rates rise.  

Markets remain vulnerable as investors and traders assess the effects of lowered earnings amid fluctuating oil prices, a stronger dollar, and rising interest rates.  In the short-term, there is potential for a definable technical correction which will offer a tactical buying opportunity.  Once the Fed raises rates, stocks should perform well during the rate normalization process.  Longer term we believe that moderate economic growth, accompanied by slow rising real interest rates and low inflation, will result in increased earnings and limited multiple expansion with continued upside for equities.  Our investment policy remains optimistic on selective Large-Cap domestic corporate equities.

 


Authors:
David Minor
Rebecca Goyette

Editor:
William Hutchens

HUTCHENS INVESTMENT MANAGEMENT WEEKLY COMPASS June 1, 2015

on Tuesday, 09 June 2015. Posted in 2015, June

HUTCHENS INVESTMENT MANAGEMENT WEEKLY COMPASS June 1, 2015

Dissecting the Sectors

“The future is no more uncertain than the present.”
                                                                          Walt Whitman

Overview

Since 2008, we have followed ETF’s. ETF’s provide money management an asset offering diversification by style and country allocation. The investment research function at both buy-side and sell-side firms is aligned by sector. Performance by most institutional investors and fund managers is reported by sector. For analysis, the major S&P sector ETF’s are unique investment entities, each responds differently to change whether economic, political, or fundamental. These circumstances may be recurring, such as reaction to changes in the complexion of the business cycle or external events such as the strengthening dollar, or changing energy policies. The investment decision on the sector ETF’s is ultimately decided on the fundamentals of the stocks comprising the ETF. The Table below highlights recent data on these ETF’s.

6 1 15

In the Table are the Relative Strength Indicator (RSI), the 6-Month Correlation of Returns, and the performance of the major sector S&P ETF’s. Correlation is the measure of strength and direction of the relationship between two price series, in this case each S&P Sector ETF and the S&P 500 (SPY). Prior to the financial crisis, from 1994-2008, half of the sector funds had a correlation to the S&P of 0.7 or less. Since then and up to today this number has been greatly reduced. This is due, in part, to a recovery phase in the overall markets. As shown in the Table, only the Energy ETF (XLE), Materials ETF (XLB) and the perennially-low correlated Utility (XLU), are below the 0.7 level. Missing are Consumer Staples (XLP) and Healthcare (XLV), both of which were considered defensive sectors and having lower correlations to the S&P 500. Over the past three years, the average return of 15.3% for the XLP and the post-Obamacare XLV at 26.2% outperformed the SPY (11.5%). Healthcare has dominated sector ETF performance since the passage of the Affordable Care Act in 2010, and has benefited more recently from the upsurge in biotechnology, where gains of over 100% in selected biotech stocks are commonplace. In fact, the S&P Biotech ETF (XBI) is up 80.1% over the past year. It will be some time, if ever, that Healthcare is considered once again a defensive play.

Despite average Real GDP growth of about 2% over the past five years, the economy-sensitive Consumer Discretionary (XLY), Industrials (XLI) and Technology (XLK), have consistently outperformed the SPY. Corporate profits continued to rise into 2014, but the trend began slowing in the XLY and XLI by mid-year. Financials were hurt by write-offs, legal expenses and government fines. By late summer, the drop in oil prices were being taken seriously as was the rise in the value of the US dollar. Forward earnings estimates were revised down, but equity markets after a brief but sharp selloff in early October continued into record territory by May 2015. By mid-February oil prices fell by 50% as the value of the dollar rose by 30% against the euro into mid-March. Since then, oil has risen modestly and the dollar has fallen from its high. Falling crude oil prices decimated 2015 earnings for the Energy sector and the rising dollar was felt by not only multi-national corporations but also domestic importers. Earnings growth was projected to be negative in 1Q2015 and 2Q2015 with FY2015 flat or up slightly from 2014. However, once again earnings surprised to the upside and were positive in the first quarter.

The Utility sector was a leading gainer into year-end 2014 reflecting the widely unexpected drop in interest rates from late-spring. With prospects of a rate rise almost certain during this year, Utilities have fallen nearly 6% in the past three months - - back to playing defense. Healthcare continues to outperform and seems to be gaining momentum from expanding employment, new conventional immunology therapy for cancer treatment, and cost cutting on medical equipment through technological advances. The upcoming Supreme Court decision on Obamacare could temporarily derail this upside momentum. Continued strength in Consumer Discretionary, up 5.8% in the last three months is based more on expectations than reality. Retail sales remain weak, housing is marginally gaining strength, and the gas savings are proven more fiction than fact. There is too much dependence on the prospect of wage increases buoyed by rising consumer confidence. Healthcare and Technology, both outperformers in 2014 and thus far in 2015 are capable of sustainable earnings growth in a choppy environment. Looking forward to 2H2015 overall earnings should begin to recover.

Markets remain vulnerable as investors and traders assess the effects of declining earnings amid fluctuating oil prices, a strong dollar, and below consensus economic data. In the short-term, there is potential for a definable correction which will offer a tactical buying opportunity. Once the Fed raises rates, stocks should perform well during a rate normalization process. Longer term we believe that moderate economic growth, accompanied by slow rising real interest rates and low inflation, will result in increased earnings and limited multiple expansion with continued upside for equities. Our investment policy remains optimistic on selective Large-Cap domestic corporate equities.


Authors:
David Minor
Rebecca Goyette

Editor:
William Hutchens