Editor’s note: The Investment Panel feature appears regularly in the Banking & Wealth Management special reports of The Central New York Business Journal, spotlighting area investment professionals and their views on the financial markets and investments. In this issue, The Business Journal communicated with David Lemire, John Lombardo, and Ted Sarenski separately via email, asking […]
Editor’s note: The Investment Panel feature appears regularly in the Banking & Wealth Management special reports of The Central New York Business Journal, spotlighting area investment professionals and their views on the financial markets and investments. In this issue, The Business Journal communicated with David Lemire, John Lombardo, and Ted Sarenski separately via email, asking them the same questions.
David Lemire, CFA, managing director, and senior market strategist at Strategic Financial Services in Utica
John Lombardo, CFA, chief investment officer and partner at Blue Water Capital Management, LLC in Syracuse
Theodore (Ted) Sarenski, CPA, CFP, president and CEO of Blue Ocean Strategic Capital, LLC in Syracuse
Business Journal: What is your view on where the financial markets are headed in the coming months?
Lemire: After cruising steadily higher for most of this year, stock market investors were reminded that the rally remains in the hands of the Federal Reserve (Fed). The market’s “taper tantrum” resulted in a selloff that also saw bond yields spike. Fed officials have quieted the taper talk and markets have recovered nicely, although bond yields remain above recent lows. However, there is a sense that investors are keeping one eye on the exits and standing ready to sell should the Fed do more than just talk about exit strategies. Thus, this spring’s declines could be a preview of future market reactions should the Fed do more than talk.
Over the shorter term, it is possible that the Fed once again attempts to condition the market for its eventual withdrawal of support, although actual actions appear unlikely. Thus, heightened volatility may be the norm for a while.
Lombardo: As long-term investors focusing on strategic asset allocations, we are not particularly concerned with market performance over the next several months. However, U.S. equity markets may well have put in their highs for the year. Earnings growth has slowed dramatically over the last 18 months while the S&P 500 has risen about 30 percent in the same period. More robust valuation metrics — such as Tobin’s Q (measuring the ratio between the market value and replacement value of the same asset) or CAPE (the cyclically adjusted price-to-earnings ratio) — suggest that U.S. equities are overvalued. Stocks may continue higher in the short-term, but the rapid rise in U.S. equity prices over the last two years has dramatically reduced return potential over the next three to five years.
Recently, treasury yields have risen rapidly due to apprehension about when the Fed will reduce, and ultimately end, its quantitative easing, or bond buying, program. The effects have rippled across global fixed-income markets, which also have sold off dramatically. This has created some attractive opportunities, especially in municipal and emerging fixed-income markets. Fixed-income markets are likely oversold in the near term, but they are likely to remain volatile. While rates are below long-term equilibrium levels, they are likely to remain low longer than many would suspect due to quantitative easing and economic weakness.
Sarenski: Our outlook for the next few months in the financial markets is neutral to positive. Companies around the globe are improving their bottom line but the improvements in the bottom lines are getting smaller since year-over-year growth is running at a pace of two to three percent, not four to five percent. Inflation remains low, near two percent, so the year-over-year increase in bottom line is slightly above the inflation rate. Steady, but less than robust, growth can be expected in equity markets.
Provide specific recommendations for investments that clients should be making right now.
Lemire: With U.S. equity markets hitting new highs on an almost daily basis, it is hard to find any bargains domestically. In addition, international equity markets face the headwind of a stronger dollar, which detracts from the returns that U.S. investors earn. It is similarly difficult to make a strong case for bonds. While yields are slightly more attractive than they have been for a while, investors want to be cautious taking on interest-rate risk ahead of possible Fed policy changes.
These difficulties leave investors with few buying opportunities. However, emerging markets remain below the highs hit earlier this year, and they may present a better relative value and a rebalancing opportunity for investors. Also, commodity markets lagged other markets during the latest moves higher, and they, too, remain below highs hit earlier in the year. To be clear, we are not making new or substantial investments in these asset classes in the current environment, but merely looking to take advantage of recent volatility to “restock the shelves” within a portfolio context.
Lombardo: By late 2012, most asset classes were overvalued to one degree or another. Additionally, many asset classes experienced some of the lowest levels of volatility in the last 20 to years over the year ending May 2013. If you believe that the global social, political, and financial environment is among the most stable of the last 25 years, you might expect the low volatility to continue. However, it is nearly impossible to support that thesis, and volatility is among the most mean-reverting data sets we track. As such, investors should expect a significant rise in volatility. We recommend implementing strategies that take advantage of both rising and falling prices. For example, investors can invest both long and short. Two investments that we have implemented are the Orinda SkyView Multi-Manager Hedged Equity Fund and the Goldman Sachs Strategic Income Fund.
Sarenski: Emerging-market equities and bonds have taken quite a fall the first half of this year. The investment growth potential is still larger in this area than in most other areas in financial markets over the longer term. This would be a good time to be adding to your positions in emerging markets through mutual funds or exchange-traded funds (ETFs). One of the bright spots of manufacturing in the first six months of the year was in the automobile sector. Growth in sales in India and China are driving profits at General Motors (NYSE: GM) and Ford (NYSE: F) this year, and that should continue for a while.
What do you see as the greatest risks investors need to be aware of and seek to avoid in the coming months?
Lemire: In a word — complacency. With domestic stock markets providing a year’s worth of returns in just over six months, it is easy to extrapolate these gains for the balance of the year. A disciplined approach to trimming investments is a missing ingredient for many people. At Strategic Financial, we have trimmed our large and mid-cap stock exposure over the past few months. These moves were not done because we possess any particular clairvoyance on the markets, but rather, they were the result our disciplined process for managing the total portfolio. We don’t believe investors can sidestep all risk in financial markets, but employing methodical tactics for selling, as well as buying, can help to mitigate those risks.
Lombardo: Investors appear very complacent about risk, which is evidenced by the exceptionally low volatility over the last 12 months ending in May — although some of the complacency in fixed-income markets was displaced over the last two months. Certainly, the narrative does not match the data. Much has been written about gathering economic momentum in the U.S. despite a lack of statistical evidence. The U.S. economy grew a scant 0.4 percent in the fourth quarter of 2012, 1.8 percent during the first quarter of this year, and likely grew at an annualized 1.5 percent or less in the recently ended second quarter. Each of those figures rank in the bottom half of quarterly GDP growth since the recovery began four years ago. Similarly, investors appear sanguine that the central banks in the U.S., Japan, and Europe can stimulate sustainable organic economic growth through quantitative easing such as printing money through bond purchases. While there is scant evidence that quantitative easing produces economic growth, there is plenty of evidence that it propels equity prices higher. Finally, investors appear convinced that the European debt crisis has ended despite evidence to the contrary. Four of the five so-called PIIGS — Portugal, Ireland, Italy, Greece, and Spain — experienced double-digit increases in their debt/GDP ratios in the year ending in March. Greece managed to lower its debt/GDP by defaulting on its debt, reducing the ratio from 170 percent to 135 percent. Yet just one year later, its debt/GDP is back up to 160 percent. While Portugal and Ireland have been considered successful bailouts, their debt ratios have continued to skyrocket as well. Despite these facts, yields on troubled European sovereign debt are lower today than they were a year ago.
Sarenski: I would urge caution about investments in any heath-care related equities in the next couple of years. The Affordable Care Act’s effect is starting to be recognized with the beginning of the health-insurance exchanges starting Oct. 1 of this year. The law is being implemented in steps. We have already seen delays in enactment, much arguing in the U.S. Senate and House of Representatives and calls for changes. The fallout of all this is uncertainty, which is a signal to avoid this area at this time. I would also caution folks invested in municipal bonds to keep a close eye on the proceedings of the Detroit bankruptcy. The final determinations of who will or who will not get paid will set the precedent for many other municipalities near the brink. California municipalities are the first to come to mind of the next cities in danger.
