As a former swimmer I have been mesmerized this past week watching the Olympians Free-style, Backstroke and IM finals. What stood out to me is the Underwater Dolphin kick that is utilized so viciously and beautifully by the best swimmers. The power and speed that is generated underwater to get the fastest speeds is truly impressive. Amazing that 30% of a backstroke race can be done underwater! The precision and analysis of that form is a lot of work for swimmers to master, but can be the difference between the glory of winning and the agony of defeat.
The analogy of swimming is so applicable to Investing and our Internal analysis approach. One of the biggest contributing factors to how we feel about a Stock Market making all time highs is what is hiding under the surface. Remember the Indices are just a basket of stocks. To us spending an immense amount of time analyzing those hundreds of stocks (or under the water) is a huge advantage to picking up clues about what the posture of the market is at the time the indices make new highs. Are stocks and sectors running out of steam or are they rested and healthy to continue their run? Are they trading at expensive levels or cheap levels? What do the Charts say about the health and energy of the moves? What would it take for stocks to trade higher fundamentally and in their respective cycles? These are the very questions we try to answer with our detailed under the water Analysis.
Energy & Material stocks are up over 14% and 12% on the year, yet they still remain 48% and 12% below the highs they made in 2015. Biotech stocks a sub-sector inside healthcare remain 36% below where they were trading less than a year ago. Emerging Markets are trading 20% below last years levels and 35% lower than 2014 prices. Financial stocks are trading almost 10% below last summers levels and have not made any progress since entering this range in the beginning of 2014! Under the surface there a many sectors and individual stocks which have not participated with the strong index rallies.
Fundamentally the price that investors are paying for stocks into next year is not crazy at 16.4 times next years earnings estimates. Growth on average is estimated at 13% for the benchmark S&P 500. Many earnings estimates in sectors such as energy, industrials, materials and financials have been taken down a good amount in 2016. Could these earnings estimates actually prove light?
We follow data from ISM manufacturing, to the Purchasers managers index, to Monthly Jobs reports, to what taxes the Treasury actually takes in (real pocket money) to of course individual company earnings and sales. All these have been consolidating in a sideways to slight down bias since the end of 2014 and early 2015. The past 2 months they have begun to show signs of moving back up. Our sense is that the 12 month correction we witnessed from last summer to this year was that pause and rest an economy and companies need before resuming their bull market paths.
Signs of commodity prices firming is giving a potential to emerging markets growing much faster than is priced in right now. If those markets surprise to the upside, we believe that will be a big boost to US growth and more importantly Domestic companies earnings potential. Again not priced in at the moment.
Nothing moves in a straight line, and our markets have had a huge run since the lows off the June Brexit announcement. A pause and healthy pull-back would not be surprising at all. Our “Under the Water” detailed stock and economic analysis continues to leave us looking for a resumption of strong stocks into 2017.
Enjoy your summer weekend and we will be back dark and early on Monday.
Mike Harris
