Was The Market's Terrible January A Prelude To A Weak 2015? Does It Matter?

2015 began with one of the worst months for the stock market with the Dow Jones Index (NYSEARCA:DIA) falling 3.7% while the S&P 500 (NYSEARCA:SPY) Index suffered a decline of around 3%. This poor performance was linked to several dark clouds hanging over investors. The main themes are:

1) Global GDP growth is faltering

In January the IMF cut its forecast for global growth by 0.3 percentage points to 3.5% this year and 3.7% next year. Japan has slipped back into recession, Europe is on the brink of recession, the developing world is facing commodity-linked headwinds, Russia's economy is in shambles and China is experiencing its slowest growth in a quarter century. Some point to the United States as a bright spot in the world economy citing its strong GDP growth relative to other countries, yet it should be remembered that Q4 GDP missed expectations dragged down by slowing business investment.

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8 Things Worrying Investors Now

2015 began with one of the worst months for the stock market with the Dow Jones Index falling 3.7% while the S&P 500 Index suffered a decline of around 3%. This poor performance was linked to several dark clouds hanging over investors. The main themes are:

1) Global GDP growth is faltering

In January the IMF cut its forecast for global growth by 0.3 percentage points to 3.5% this year and 3.7% next year. Japan has slipped back into recession, Europe is on the brink of recession, the developing world is facing commodity linked headwinds, Russia’s economy is in shambles and China is experiencing its slowest growth in a quarter century. Some point to the United States as a bright spot in the world economy citing its strong GDP growth relative to other countries yet it should be remembered that Q4 GDP missed expectations dragged down by slowing business investment.

2) Loss of confidence in central banks

Central banks all over the world have brought interest rates down to ultra low levels and have embarked on massive monetary stimulus programs. Yet these unprecedented measures, meant to be short-term solutions to fight a collapse in the financial system and a descent into deflation, have remained in place far longer than central banks had envisioned. Instead, these programs have not caused any meaningful increase in the flow of money that was meant to ignite spending and investment. Inflation has not picked up and amazingly central banks everywhere are stepping up their efforts by further slashing rates and increasing bond buying programs.

3) Global trade is in decline

We live in a highly interconnected world and cross border trade remains a key GDP growth driver. According to the International Monetary Fund, between 1996 to 2007 world trade volumes grew by an average of 7 percent a year but since, 2010 volumes have only grown by 4 percent.

4) Global debt is still at a record high

It would appear that we have not seen the last of excessive debt wreaking havoc on the financial sector. According to last fall’s Geneva Report, commissioned by the International Centre for Monetary and Banking Studies interest rates across the world will have to stay low for a “very, very long” time to enable households, companies and governments to service their debts and avoid another crash. The report finds that total world debt (government, corporate and household) is at a record 212 percent of gross domestic product as of the end of 2013, up from 174 per cent in 2008. Furthermore, some countries like the U.S and the UK have swapped private sector debt for public sector debt and in other countries like Canada and emerging markets, household debt has reached unprecedented levels.

5) The employment situation looks weak

Productivity has been poor, labor force participation rates are low and most alarmingly, wages have not been growing. In fact, for most US workers, real wages have barely budged for decades.

This appears strange in light of strong year over year growth in corporate profits yet labor market slack appears to be the main culprit. The current overcapacity of workers has meant that there is little need for hiring. With automation permeating modern businesses there has been a broad decline in both high and low paying jobs. This has lead to further overcapacity and has reduced the incentives for employers to raise wages reinforcing the cycle of weak consumption and slow growth.

6) US Q4 corporate earnings reports point to a slowdown in 2015

Around 80% of reporting S&P 500 companies have beaten estimates on earnings and 58% on sales which marks the 8th consecutive quarter of year-over-year earnings growth for the index after a year over year decline in Q3 2012 (-1.0%). Nevertheless, this earnings growth is not projected to continue into 2015 as Wall Street has revised estimates down from a 4% increase to an overall earnings growth of around -2%.

7) The price of oil has taken a bone chilling dive

The price of oil has dropped to 6 year lows in only 6 months sparking a fierce debate over whether lower prices are on balance a positive for global growth. Is this drop in oil prices simply an oversupply issue or is it a symptom of something more sinister such as a slowdown in demand caused by a sputtering global economy?

8) Bond markets have been rallying

Around the world investors have been opting to buy bonds with negative yields which on paper imply a guaranteed loss. Why would investors buy such bonds of various maturities in as many as ten countries?

There could be several reasons but fear is the most significant. By accepting a negative yield investors are signaling their uncertainty about global growth and their appetite for safety.

The apparent question is whether the direction of the market in January will determine the coming year’s trajectory. There is no doubt that the dark clouds explained above have made investors nervous about committing new money to the market yet, as I write, a 7% surge in the price of oil is pushing all major US Indexes higher with key commentators calling a bottom. Can January already be safely forgotten? In my view, slight pullbacks like the one experienced in January are symptoms of a healthy bull market and not yet indicative of an impending prolonged downturn.

Nevertheless, we can worry and debate all we want about whether oil has found a bottom or whether the S&P 500 will end positive for the year but the bottom line is that we shouldn’t lose our focus on the long term. The themes above are important yet what the market does from day to day or year to year shouldn’t be your primary concern. Instead, the wise investor should focus on investing in quality businesses and stay calm in order to take advantage of healthy pullbacks like the one that began 2015.

Originally posted on: Seeking Alpha

Five Market Predictions for 2015

In the sixth-century BC, poet and philosopher Lao Tzu observed the following: “Those who have knowledge don’t predict. Those who predict don’t have knowledge.”

I agree with Mr. Tzu and don’t presume to be a seer, yet despite his wise words, I will be providing my top 5 “predictions” for the global markets in 2015. Why? because the notion that the financial future is not in any way predictable is just too unpleasant a thought for the romantic (all true investors are romantics are they not?).

Here are some predictions for the public markets in 2015:

1) Non-energy related South-East Asia and Latin America will help boost global growth estimates

Latin America is going through a very unique demographic environment. On the one hand, Latin America is seeing an increase in its aging population. In 2000, the number of seniors (60 and up) in Latin America was approximately 43 million and by 2020 it is expected to be roughly 83 million. However, there is also incredible growth in young middle class workers. In 1990, there were 170 million workers aged 15-35 and in 2010 that number grew to 280 million. By the year 2020, that number is expected to reach nearly 300 million. Moreover, the largest portion of that growth is expected to be amongst women, who currently comprise over 100 million in the workforce.

In 2014, many Latin American economies had a very good year. The Argentinian stock market rose nearly 54% and Colombia was near full productive capacity. In fact, growth in countries like Peru and Colombia have made it difficult for these nations to curb inflation. Colombia has grown the fastest in 2 years with its GDP growing at 6.4% from a year earlier and Peru has seen an increase in its GDP of 4.9% from a year earlier. A lot of this growth is due to infrastructure as public works spending in Colombia grew 24.8% from a year earlier.

Nations like Vietnam are also seeing incredible growth. Vietnam grew 6.96% in the latest quarter beating all estimates. Exports are surging and retail sales are rising drastically with 10.6% growth from a year earlier, which could rise more due to lower energy costs. Moreover, Thailand is seeing record consumer spending (albeit from increased household debt and the Bank of Thailand’s commitment to low rates) but this has allowed the economy to grow faster than normal. In fact, the entire Southeast Asian region is seeing record levels of consumer debt which I believe will continue to accelerate as interest rates and inflation remain low (inflation in Thailand decreased to 1.26% last quarter), creating more growth than previously estimated.

Overall, expect to see rising consumption in Latin America especially on big purchase items like automobiles. The Latin American consumer is shifting towards more ‘convenience’ so consumer staples with strong brands will play an essential role in the region. Global growth according to the IMF is expected to be 3.8% in 2015 but expect to see growth slightly above 4% due to these region specific catalysts.

2) Sectors to watch: Global Healthcare

This leads me to my next prediction, which is the continued growth in global healthcare. Mexico is seeing a drastic increase in demand for healthcare with a rapidly ageing population but is having difficulty keeping drug administration costs low. This dynamic creates a ripe environment for large generic manufacturers to enter the region. Moreover, companies like Pfizer and AstraZeneca are making sizeable investments into Latin America via acquisitions as they are betting on continued growth in the demand for pharmaceuticals given shifting demographics. Companies like Stericycle and ResMed will also be increasing their exposure in Latin America, particularly in Brazil. Asia is also a significant growth catalyst for pharmaceutical companies as incomes are rising among an expanding middle class. India is also of note as it is experiencing a rise in the demand for healthcare which is evidenced by the recent surge in Indian market focused, Mumbai headquartered Sun Pharma’s earnings. Finally, the USA looks promising as there will be reliable growth in demand for healthcare caused by the ageing baby boomers and the requirements of the Affordable Care Act (think ETFs like VHT and CURE).

3) Europe will see better than expected stock market performance

A bit of a contrarian prediction perhaps, but I remain “carefully” optimistic about Europe’s economic prospects and expect some surprise upside in 2015. Although 2014 was supposed to be the year Europe made it safely out of the fire of the debt crisis, several factors held it back. The first was a slowdown in China and emerging markets, the second was the impact of the Russia-Ukrainian fiasco (think of the big impact on the German economy) and the third and most significant was the inability of Euro governments to remove the structural barriers which make the rebalancing of Euro economies difficult.

These “structural deficiencies” include poor institutions to streamline the restructuring of private sector debt, high corporate and personal taxes, entrenched special interests such as unions and political patronage networks, corruption and stifling bureaucracy. These factors make investors and businesses uncomfortable and thus without their removal the creation of any new cycle of growth will be improbable.

How difficult is it for Euro Governments to address these problems? Reform is proving to be very difficult as such deficiencies cut to the core of European culture itself. Thus, as we are seeing in Greece, European nations will have to ask themselves what kind of vision they have of their societies moving forward and deciding may take more time and more pain.

Nevertheless, I believe these negative catalysts are outweighed by the positive catalysts which are ECB stimulatory measures, lower interest rates for a prolonged period of time, a weaker Euro, a banking sector more flexible with its loan policies and lower commodity prices.

In addition, there is an “elephant in the room” that no one seems to be talking about. After seeing record stock market returns in the S&P 500, many feel that US markets are overvalued and ripe for a major correction. There is no doubt that companies today are more expensive than they were in 2009-2010, but consider the fact that the MSCI Emerging Market Index ETF is currently trading at a paltry 11.2 projected trailing 12 month PE and the MSCI All-World Index (excluding the US) is down 6.2% for the year. Thus, investors will be looking for value outside the US in favour of the developing world and Europe which may cause a surprise rise in European markets (think quality European companies like BUD).

4) Oil will remain weak

With the recent drop in energy over the past few months, and with Saudi Arabia warning that they “may never see $100 barrel oil” again, it seems that there are too many catalysts in play which will prevent oil from getting back to triple digit territory. To be clear, I don’t bet on the price direction of a fixed dollar investment like oil (or gold or silver or any commodity for that matter) since that is a dangerous game, but with current output levels relative to demand, commitment to OPEC market share, technological innovation, a slowing China, Japan in recession-mode and new pipelines in areas like Kazakhstan, I don’t expect oil to be above $100 at year end; for a short position think ETFs like ERY and DWTI. Many funds and traders are betting on the rise of the Canadian energy sector which took a massive beating at the end of the year, and if oil were to rise to $65-$70 that may be a good ‘trade’. However, with oil still in sharp decline and with these new fundamentals intact, I don’t expect to see oil back at what it was at in the beginning of 2014 and thus “playing” the Canadian oil sands could be a particularly painful gamble. Instead, I view oil lower for longer which may amount to a considerable tailwind for many companies with significant operating costs (think airlines, tire manufacturers, chemical companies).

5) Volatility is back

As of the date of this writing the VIX, the most popular measure of volatility which focuses on the stock market (it measures the cost of options which can be conceptualized as the price investors are willing to pay to insure against sudden market moves) is up around 10% for the year. If we consider a chart of the VIX at its peak around 2008 until today there are only two slight spikes (2010, 2011) and from 2011 on it has been relatively smooth as the S&P 500 has marched forward with broad gains for most stocks. This relative calm can largely be attributed to supportive monetary policy (QE and low interest rates) as equities slowly marched back to pre-recession levels. Yet in 2015 the narrative has changed. Equities are widely believed to be fully valued with investors looking at any slip in earnings to justify a selloff and the Federal Reserve has ended QE and is prepared to begin normalizing interest rates. Add to the mix concerns about global growth, an oil shock and a potential geo-political confrontation or two and 2015 looks to be more bumpy indeed.

Originally posted on: Seeking Alpha

The Consumer Is Not Dead

One who is seeking fantastic medium to long term returns in the global financial markets should remember these five words: the consumer is not dead. This can mean a lot of things to a lot of investors as to what sectors or companies are best to allocate capital, but most importantly, this means that despite the current volatility in the Mideast, the continued tapering discussions and talk of an “overvalued” market, the consumer, which accounts for two-thirds of US GDP and trillions of dollars in global spending, will continue to push global growth.

From 2012 to 2014, the rate of change in the annual growth rate in global annual disposable income per household in real terms rose over 250%. Western Europe seems to be on the right track in terms of reducing unemployment and boosting growth, although it is expected to be the region with the lowest rate of growth in real household disposable income in 2014, at 0.3% year-on-year in real terms. This positive, albeit modest, rate of growth will be a much welcomed turnaround for households in the region who saw their real annual disposable income fall every year since 2007.

Looking at emerging markets, the data is even more incredible. In 2010, the emerging markets accounted for $12 trillion in spending. In 2025, they are expected to account for about $30 trillion of spending, or nearly half of global spending. Obviously, the forecasts of consumer spending, income and demographics of this size can vary, but there’s little debate about the direction. According to the McKinsey Global Institute, the ranks of the global consuming class will swell from about 2.4 billion today to 4.2 billion by 2025, when the world’s population is expected to be about 7.9 billion. In other words, for the first time in history more people will belong to the middle class than living in poverty, according to McKinsey.

Latin America and Asia are obvious players to watch. From 1990 to 2007, the number of middle-class households in Latin America has increased from 56 million to 128 million, according to a 2011 analysis by the United Nations Economic Commission for Latin America and the Caribbean. Moreover, research from McKinsey suggests more than 75 percent of China’s urban consumers will have, in purchasing-power-parity terms, the equivalent average income of Brazil and Italy by 2022. Just 4 percent of urban Chinese households were within that level in 2000—but 68 percent were within it in 2012. In the decade ahead, the middle class’ continued expansion will be powered by labor-market and policy initiatives that push wages up, financial reforms that stimulate employment and income growth, and the rising role of private enterprise, which should encourage productivity and help more income accrue to households. Should all this play out as expected, urban-household income will at least double by 2022.

What does this all mean for the investor considering sectors and individual companies?

There isn’t a universal answer to this question, but there are 4 major sectors that are directly affected by consumer incomes and those are the areas that have my attention. Global consumer finance, healthcare (SRCL), consumer non-cyclicals (BUD) and pharmaceuticals will be best positioned over the next decade given these fundamental drivers. In the international pharmaceutical business, developing countries are not called emerging markets. They’re called “pharmerging” markets. Such countries are expected to significantly increase their spending on medicine over the next four years, accounting for about 70% of the projected increase in sales for the leading pharmaceutical companies through 2017.

One of the most important lessons I have learned in the years I have been investing is as follows: given the status quo, a company’s technical history reflects its business model. Look at a company like General Mills (GIS), Colgate-Palmolive (CL) or Church & Dwight (CHD). These companies are in the fast paced consumer non-cyclical space, heavily tied to global household incomes, rising populations and the growth of emerging markets. Despite wars, recessions and bubbles across the globe, the fundamentals for these companies have been intact for the last 40 years and it seems that they will be +20 PE stocks perpetually. These companies’ stock charts are virtually straight lines averaging 12.6%, 13.3% and 36.9% CAGR excluding dividends respectively over the last 10 years, making the recession of 2008-2011 nothing but a blip. If an investor had held just these 3 stocks in their portfolio over the last 35 years, he would’ve beaten the S&P 500 by more than 4000%. What does this mean for the future? I obviously cannot provide an answer to that but needless to say I don’t see a reason why the next 20 years for these companies will be that much different given their business models and industry fundamentals.

Overall, sometimes the most obvious factors provide for the best investment ideas. Continue to look for global mid-cap companies attacking the global consumer for the best long term results.