Market Memo: Positioning for a potential market melt-up
Readers of this space know that we’ve been waiting for either a 5%-to-10% correction before adding to our equity overweight position, or further confirmation that we’re not going to get one and that instead, we are going to break through the infamous “double top” in the S&P 500. This week, we believe we’ve gotten the latter.
With Cyprus proving yet another the “sky is not falling” event, the Bank of Japan aggressively joining the global reflation party and our secular-bull-market call reconfirmed by this week’s decisive break through the 2000 and 2007 S&P 500 highs, our PRISM asset-allocation committee today voted to boost the equity weight in Federated’s stock-bond model from 55%—a modest 3% overweight, or 30% of maximum—to 57%, or 50% of maximum. We did this by taking further profits on our fixed income and cash positions, and putting the money to work in emerging-market equities, which are down year-to-date. With defensives having outperformed so far this year, we believe the next leg up in stocks will have to be driven by cyclical stocks and emerging markets.
Let’s review these three reasons for the shift in a little more detail.
- The fading Armageddon mindset. As we’ve noted before, the fear that enveloped investors after the 2008 global financial meltdown continues to become more distant, with each ripple—the latest being the Italian elections, then the sequester, then Cyprus—smaller than the one before. In fact, we think Cyprus was a defining moment and catalyst for the market’s latest move as it evaporated from the headlines as quickly as it arose. As investors increasingly conclude the world is not ending, the global economy is not going bust and another Lehman isn’t looming—and as their options for yield and income elsewhere are extremely limited—they are turning to stocks.
- The Bank of Japan’s joins the global stimulus party. After half-hearted efforts to pull its economy out of a two-decade funk, Japan’s central bank—at the prompting of its new Prime Minister Shinzo Abe—unveiled a massive monetary stimulus program that’s roughly 2½ times the size of the Fed’s quantitative easing (relative to each country's respective GDP). While the goal is bolster Japan’s export-centric economy, it is flooding markets all over the world with money as the carry trade rushes out of a declining yen. This stimulus also should boost the rest of Asia. This is why we’re putting our additional equity allocations in the emerging markets, where the equity markets have been down slightly so far this year, and thus offer the potential for stronger gains relative to the U.S., which at current levels would only have to rise 5% to 6% to reach our 1,660 target for the year.
- The market finally cracks through the infamous double top in the S&P. Anyone watching this space over the last few years knows that a part of our bull thesis has been that most of Wall Street has been technically terrified of the double top in the S&P at 1,550, formed over a decade. Technically, most felt there would be heavy selling pressure at this level, which, coinciding with ongoing debt deleveraging and the “new normal,” would lead to a revisit of 2009’s market lows. For this reason, we think the definitive piercing of this level this week is significant. Indeed, looked at from above, the 1,550 level now becomes something of a cement floor on the market, giving asymmetric risk to the upside. And with most investors still positioned on the sidelines, we think the “pain trade” is now up, particularly in economically sensitive stocks.
To be sure, we would expect some bumps along the road. This morning’s reports on consumer sentiment and retail sales suggest consumers are far from giddy—job growth remains relatively subdued, higher payroll taxes appear to be taking somewhat of a bite, and concerns over whether Washington really can get its act together are still very much on their minds. On the other hand, auto sales are robust, home building is accelerating, capital expenditures are on the rise, the Fed remains all-in and corporate earnings, based on early first-quarter returns, continue to surprise to the upside (albeit from beaten-down expectations). These things don’t happen when an economy—or market—is about to stall.