I had the great privilege to interview Phillip Orlando of Federated Investors. As the Chief Equity Strategist, he oversees $361 billion in assets.
I made sure to ask questions that you ask me. For example, the impact of the elections, headwinds, risks, etc. And investors always want to know what the big money is doing. I would say $361 billion constitutes big.
Investors are obviously nervous with so many headwinds at the same time, has the market already priced them in?
With the global economy soft and earnings growth weak, a further rally in stocks off present levels will depend more on a multiple expansion than on fundamental earnings. Presently, we are trading on nearly 18x our forecast for 2016 earnings on the S&P, about the level we have traded on historically for other environments perceived as low risk with low inflation. Certainly, central bankers would like to see investors willing to pay even more for risk assets and are attempting to drive them into such assets through QE purchases, forward guidance and the like. However, under the rubric of “Fool me once, shame on you. Fool me twice, shame on me,” we are not convinced that investors will bite. Unlike the first seven years following the 2008 financial crisis, volatility spikes are now rising in magnitude and frequency, not falling. This is not an environment that supports multiple expansion, particularly with expectations for 1Q16 GDP growth at only 0.4%, according to the Atlanta Fed, and with revenues and EPS expected to decline by 1-2% and 8-9% year-over-year, respectively.
What area represents value for investors now?
With further market upside capped by soft fundamentals and unattractive valuations, we see little reason to move off our cautious stance on markets. In the meantime, we’re watching developments closely, continuing to evaluate the incoming data and looking for signs of real, fundamental improvement or better valuations that would come with a price correction. So for now, we will sit tight at 50% stocks, modestly below neutral, and wait. From a sector standpoint, the more defensive, lower-beta, higher dividend yielding stocks appear to be a good place to tread water, such as REIT’s, utilities, telecoms, consumer staples and health-care companies.
How does the presidential election influence your overweight or underweight decisions?
On the left, the overhang of a potential indictment for Hillary Clinton and the recent resurgence of Bernie Sanders leaves the outcome of the Democratic nomination in question. On the right, the unconventional candidacy of Donald Trump and the staunch opposition from the “establishment” wing of the party make a contested convention a real possibility for the Republicans. Adding more fuel to the fire, the leading candidates of both parties are touting economically populist messages. All of this adds uncertainty as it relates to a shift in fiscal-policy focus next year, which keeps us more cautions on the margin. Of the 11 post-war recessions, seven of them started in the first year of a new president’s term.
Is there a headwind and or tailwind that is not being discussed?
Although we are comforted by the rally in China’s stock markets, we’re less comfortable with the way we’ve gotten there. Real-time indicators on the underlying strength of the Chinese economy, like electricity consumption and movie ticket sales, suggest economic activity there remains soft. The rally to us seems driven more by short-term policy measures designed to encourage stock market speculation, such as lower margin requirements and heightened capital controls, rather than fundamental reforms designed to clear the economic deadwood and excess capacity that plagues China’s economy. Absent a more solid, sustainable fundamental improvement, we see China’s markets posing more risk than reward for global financial markets as we move into spring.
Another important bit of good news recently is the bounce we’ve had in oil off the worrisome $26 double-bottom reached in mid-January and mid-February. The subsequent 60% bounce to $42 was driven partly by news of U.S. production levels peaking, and rumors of an oil deal between the Saudis, the Russians, and other OPEC producers. We’re skeptical of the latter due to Iranian intransigence on production cuts or ceilings, and we’re unsure of how long the former will hold with prices now higher again.
Does this market remind you of another year(s)?
Yes, because two-term presidents in their last year aren’t typically good for stocks, as markets hate uncertainty, and a new president ushers in a change in fiscal-policy thinking. President Obama is only the sixth president in the last 76 years to complete an eighth year in office, and the price-only performance for the S&P 500 has not been kind to his five predecessors in each of their last years:
- Bush, 2008 — 38.5%
- Clinton, 2000 — 10.1%
- Reagan, 1988 — 13.1%
- Eisenhower, 1960 — 3.1%
- FDR, 1940 — 17.3%
So the average annual eighth-year return for the five presidents before President Obama who completed their eighth year in office is (11.2%), with four of the five presidencies posting negative returns.
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