WASHINGTON. Today we take a look at the current state of a very indecisive Mr Market in Q1 2019. Right now, he’s very confused. It’s a situation that’s unusually treacherous for individual investors looking to select and time stock purchases and sales to maximize profits.
In our previous article in this series, we discussed the general way the economic and business cycles function in America’s still robust version of capitalism. At that point, we then introduced the concept of business sector rotation. That’s a way to categorize groupings of stocks with similar characteristics. Finally, we put the two together and explained how the usual sector rotation sequence fits into business cycles.
A simple understanding of the way these elements work, at least most of the time, is one way individual investors can time their stock buys and sells to fit in with sector rotation. While no investing technique is perfect, timing your investment activities to coincide with each rising cycle can help maximize your investment returns.
A murky investing crystal ball
Today’s column takes a closer look at how this technique generally works in practice. But we also explore the current investing environment during the first quarter (Q1) of calendar year 2019. This confusing quarter, aided and abetted by the confusion we’re seeing with the indecisive Mr Market, makes it harder to follow the current business cycle and sector rotation patterns since they currently seem askew. In our view, that’s largely attributible to what we regard as the Federal Reserve’s overly eager interest rate hike regime. This fervent desire for a return to interest rate “normalcy” has either caused the current economic pause. Or, worse, it may have served as the catalyst for an incoming recession. Our currently indecisive Mr Market hasn’t been much help recently.
The problem is, we don’t know which scenario we’re dealing with. This is further magnified by the increasing politicization of business reporting. Far too many news and business reporting outlets are transparently eager for an actual recession to occur. Just in time, of course, to derail Donald Trump’s re-election bid in 2020. In their eagerness for this outcome, they may very well be influencing an already jittery market to first weaken and then tank. They have little to no regard to the consequences of a recession for the workers and taxpayers living in flyover country, not to mention the average American investor. We’ll return to this issue near the end of today’s installment.
Business cycles and sectors
Throughout our economic history, we can see that certain sectors act like champs at different points of each business cycle. “Consumer Discretionary” stocks tend to work well during early economic expansion. As things pick up, the “Industrials” and “Materials” can take a turn. Then during late-expansion and recessionary cycles, “Utilities” often take center stage, since they generally offer stable dividend returns during troubled times. Generally, this is the way Mr Market usually works.
“Information Technology” stocks can be a a wild card in any sector rotation scenario. That’s because tech superstars in this sector can take off – or collapse – at a moment’s notice at any time in the business cycle. Today’s otherwise indecisive Mr Market has been boosting IT this quarter. But how long will this fickle fellow’s enthusiasm last?
Given the current state of the indecisive Mr. Market, what sectors are working right now?
Right now, Mr Market is currently back on a bullish path after a disastrous Q4 2018. The big question today is, did the Fed halt its over-eager interest rate-hiking regime in time for the economy to recover and start growing again? Or, alternatively, has the Fed already overreacted, meaning a recession is creeping up on us and nearly ready to pounce?
Unfortunately, it’s hard to say where we’re going at this time. Which means, where we are today in the cyclical rotation is hard to determine. Indicators are contradictory. Investors are confused. So they’re currently holding a lot of utility stocks, and some high-yielding stocks, such as those found in the new “Real Estate” sector, which consists mostly of high dividend-paying REITS. Collectively, it seems that a great many investors and institutions are shoring up their portfolios for an imminent recession.
But at the same time, they’re piling back into that wildcard sector known as Information Technology. That’s is a much more aggressive bet. Or, perhaps,it’s a bet that tech is now largely impervious to business cycles. That’s not true, of course. But if enough investors and analysts think it’s true, it can become a controlling investment philosophy, at least for a time.
But if investors are thoroughly convinced that a recession is nearly upon us, why aren’t they simply hiding right now in Utilities, Real Estate and, of course, cash or cash equivalents?
Similar to the Information Technology sector revival, the “Healthcare” sector remains robust, despite the alleged lateness of the current business cycle. That’s probably due to the obvious fact that hordes of Baby Boomers age, more and more of the US economy will be devoted to healthcare. I.e.,hospitals, insurance companies, drug manufacturers, medical equipment manufacturers, etc. And despite the turmoil in the reluctantly morphing Obamacare scenario and the pressure to cut consumer drug prices substantially, a great many healthcare and pharmaceutical stocks continue to behave bullishly.
Also, “Consumer Durables” still seem to be working out fairly well. These include companies that make things like refrigerators, washers and dryers, etc. They’re products you don’t buy very often because they (should) last a long time and because you only buy them when you need to.
All of this means that, save for stocks in the risky IT sector – which the otherwise indecisive Mr Market currently endorses – investors seem to be heading for more stable sectors, which is generally predictive of a near-term recession. But the same question persists. Are we merely pausing in the economy, or will the current slowdown soon become more pronounced?
If we’re merely pausing, we may find that sector rotation will cycle back to the early growth stage, requiring us to look at a different batch of stocks. If a recession is really nearly upon us, however, the Healthcare, Consumer Durables and Utilities sectors could very well be where investors need to be.
That’s why many investors are hedging their bets today. The normal patterns of sector rotation seem have been disrupted as we move toward Q2 2019. We don’t have a definitive answer as to where in the overall business cycle is heading. When we get a bit more clarity on this, we can gain more confidence when we predict which sectors are the next ones coming up to bat. Right now, however, past history predictors don’t seem to be working as they usually do.
We’ll try to figure this out in enough time to take advantage of the emerging sector rotation pattern. When (and if) we do, we’ll inform you in a future column. As for right now, in a general way, we’re playing the confusion and covering our bases. We’re investing in Utilities, REITs, Healcare, Consumer Durables, and IT. We’ve added some Energy issues as well.
But we’re also hedging our bets by acquiring, little by little, shares in commission free ETFs covering the IT and Consumer Discretionary sectors. ETFs, modeled to reflect entire stock sectors, tend to move more moderately when bad things happen, thus allowing you time to make a dignified exit. At the moment, however, we’re profitable in all the Index ETFs we hold.
Meanwhile, count on the currently indecisive Mr Market to give us a tell. He will ultimately let us know which positions we’ll need to jettison first if we’re headed for the next economic and market downturn.
— Headline image: Confused by the current action on Wall Street? (Image via Pixabay.com, CC 0.0 license, public domain)