04-16-2014 12:55 PM
By John Jares,
Assistant Vice President of Equity Investments
One of the coldest and snowiest winters in recent memory is thankfully behind most of us. As spring unfolds across the nation, we’re getting the first glimpse of the harsh weather’s actual impact as companies begin to report earnings for the first quarter of 2014.
Results have been mixed for major financial stocks that have posted numbers this week, while some of the key early reporters in the technology and health care sectors have come in better than their forecast. There are a few more weeks of earnings season to come, but so far the preponderance of what we’re seeing has been positive.
As we move further into earnings season, we expect to hear companies say that weather had a negative impact on their operations in the first quarter. We want to hear them go on to say that they anticipate business will pick up in the current quarter and beyond. What we don’t want to hear is that they will have to lower their guidance for the entire year; that will indicate that their problem may be more fundamental weakness than bad weather.
The past few weeks have endured a fair bit of market turmoil, with technology-related stocks being particularly hard-hit due to concerns that they may be overvalued. From where we sit, it appears that some investors have been cashing in their winners ahead of first-quarter earnings reports, and that others are selling to reduce their risk exposure.
We are also concerned about fundamental valuations that are running above historical averages, and as a result, our portfolios hold underweight positions in U.S. stocks. Margin expansion, cost-cutting and share buybacks have been the key drivers of the current bull market, now in its sixth year. We’ve been waiting for revenue growth to pick up in a meaningful way, as pretty much all of the efficiencies have been wrung out of the cost side. We expect that wait will continue at least until the second quarter’s results are reported, given the weather’s impact on top-line growth in the first quarter.
Improving economic conditions may give stocks the lift we’re looking for. Last month’s inflation rose closer to the Federal Reserve’s target rate of 2%, suggesting that consumer demand was picking up. That outlook was supported by retailers’ reports that consumer spending was surprisingly strong in March. There was notably good news for new car sales; on an annualized basis, they were their highest level since mid-2006. Industrial production grew more than expected in March, and the number of jobs created returned to levels seen before winter’s deep cold set in.
That said, there is still fear in the market that the economic gains we’ve been seeing are largely the result of the Fed’s easy-money policies. Some think the ongoing taper of the bond-buying program known as “quantitative easing” will drag the economy back toward recession and undercut stock prices. This could help explain something we’ve noticed in the market of late: a rotation into defensive stocks like utilities and consumer staples that does not typically occur at this stage of a recovery. That rotation also could be due in part to fixed-income refugees chasing yield following the Fed’s reiteration that it’s in no rush to raise short-term interest rates.
We don’t buy into the dire outlook for the post-QE economy. An end to monetary stimulus could certainly put pressure on valuations and sentiment in the market, but we wouldn’t necessarily tie that back to a recession. In our view, the strengthening that we’re seeing across the economy will not collapse once the Fed’s policy support is removed.
USAA Investments Managed Portfolio Outlook
Our view of caution toward U.S. equities remains unchanged — we are underweight U.S. large caps and small caps. We are also tactically underweight fixed income. We remain slightly overweight cash in our diversified managed portfolios.
We also are overweight to assets that are positively correlated to inflation expectations. The USAA Real Return Fund also provides potential protection against the risks of long-term inflation.
Emerging markets represent another opportunity. Though they have been hit especially hard recently, we believe that emerging markets remain attractive. They offer both an interesting long-term prospect for growth and compelling valuations. The USAA Emerging Markets Fund offers exposure to stocks in less-developed countries.
As always, we encourage investors to speak with one of our financial advisors, who can help determine which investment vehicles are best suited for your individual goals, objectives, risk tolerance and time horizon.
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