What Happened to Volatility?
2014 is shaping up to be a truly extraordinary year. You wouldn’t know it just from looking at the averages in the market. The gains in the first half of the year are actuallyunderwhelming. It’s the behavior of the market that is extraordinary. This year is marked by stability and is a change from what we are accustomed. Usually stocks swing rapidly when extraneous news events are digested by investors. In this manner, the market reacts simultaneously to external events. For example, news of an anticipated Federal Reserve taper, breaking bad news on the economy, and global political unrest like we see in the Middle East, can send stocks on a swift ride south. For years, we investors asked how political unrest in Egypt or Greece or a government budget impasse could cause such stock market unrest. Today is just the opposite. It seems like the market is impregnable to volatility. We see political unrest in Russia, Syria, and Iraq, and the market barely budges. First quarter GDP actually shrunk 2.9%, a surprisingly bad number, but the market took this report in stride. Last year, threats of a taper in the Federal Reserve Quantitative Easing program sent stocks down 10%. This year, the Fed’s bond buying program has been systematically sliced and is targeted to end this October. Unlike last year, the concerns over the Fed removing a lifeline were shrugged off.
How do investors interpret this muted reaction to news events? We cannot jump to the conclusion that the conditions are bullish. The S&P currently trades at 16 times trailing earnings and this is historically high. At best, the market is fairly valued. Even though the major indices are positive for 2014, the gain seems to be slowing after the strong advance over the last two years. It is reasonable to expect only limited advances for the major market indices in the short term.
Last quarter, I wrote about the “Long Dry Road.” In summary, I implied that stocks are most likely to move sideways without much movement in the overall market. The takeaway strategy for investors is to stay invested through this period. The risk in the market is low and it is best to stay invested until the market makes another big surge.
In my 30 year career, I have never seen the stock market and the underlying economy diverge as much as today. Arguably, our economy is weaker today than last year yet the stock market does not reflect this. Herein lies the opportunity for investors. Eventually, when our economy gains traction, the market will put in another strong period like last year.
Beware of Momentum Stocks
The market’s stability did not apply to all stocks. Between March and May this year, the NASDAQ fell over 8%. The NASDAQ index reflects many momentum stocks. These companies would include high flying biotech and technology stocks and they had massive sell-offs this spring. Our most favored names Tesla and Netflix fell almost 100 points during this period. Any group of stocks that enjoy swift advances are likely to be met with corresponding profit taking.
The second quarter was marked by a standout 21% gain from Apple, the world’s largest company by valuation. Apple appears to have evolved from a growth stock to a value stock. Today, even though earnings growth at Apple is the slowest in the past three years, Apple is recognized more as a financial empire than a fast growing company.
Social site stocks endured substantial volatility in the second quarter. The principle group of Facebook, Twitter, and LinkedIn suffered sharp declines during the second quarter.
Utility stocks remained the best performing industry group in 2014 due to their above average dividend payouts. Energy stocks were buoyed by higher oil prices and they staged impressive advances for the quarter. 2014 has been a fabulous time for long term bonds. This index is now up over 15% for 2014 after posting a 5% gain for the quarter. The advance in bonds suggests a very weak economy in the upcoming months.
Peregrine Returns and Strategy
We still favor a strategy of “sell the rips and buy the dips” for managing our client stock portfolios. During the quarter we sold our long term holdings in Facebook. This was done on speculation that advertising revenue growth would slow. We also sold our long term holding in Trimas for underperformance compared to other companies in its industry.
We continue to be bullish on bonds, signified by our holding in the ETF, I Shares 20 year Treasury. A weak economy is bullish for bonds. I’m also bearish on gold since it has storage costs and no dividend. What would the allure be to holding gold in this world economy?
For the second quarter, our Equity Composite gained 2.96% and is up 3.63% year to date. Our balance composite gained 2.79% and is up 4.08% in 2014.
We recently initiated new positions in two standout equity mutual funds, Akrie Focus and FPA Crescent. These two funds have been vetted through a substantial search process. These funds have outstanding investment management qualities and offer an excellent management alternative for our clients.
We make a priority to identify companies that we can hold for large gains in the upcoming months. Our trading results continue to be profitable but we are focused on holding numerous positions for a longer period.
Past performance is no guarantee of future results. Investment management involves the possibility of losses. Significant general stock market moves up and down can influence the performance of client portfolios. Composite returns are based on client portfolios of over $100,000. Not all clients are included in the composites. All returns include the reinvestment of dividends. All returns are net of fees. Composite returns are derived from aggregated, time-weighted returns for clients of Peregrine Asset Advisers. Individual client returns can deviate from the composite returns. While Peregrine uses the S&P 500 as a benchmark, Peregrine does not attempt to mimic the structure of this index. Individual client portfolios vary. The number of securities held also varies per client.
Do you have questions or would you like to know more, contact Dan Botti.