It is ironic that on the day when the S&P 500 made a new high, the story is buried way back on page B7 of the NY Times. Instead, the lead story on the cover page focuses on PokemonGo-the latest cultural fad (which has captured my daughter and my wife). Despite the market’s strong performance and somewhat miraculous recovery since the Brexit vote, investors’ enthusiasm remains muted. In fact, fixed income ETFs are on pace for a record year, gathering about $44.4 billion as of June 15, compared with inflows of only $2.6 billion for equity ETFs. This is at a time when the 10 year Treasury hit a record low recently of 1.36%.
Several months ago I looked at what could go right for the markets as the year progressed. Certain recent developments have occurred that once again make the case for stocks. First, as my colleague, Chris Deeley, wrote about last week, the economic news has been improving. The Citigroup U.S. Economic Surprise Index reached the highest level since January 2015 on Friday’s payrolls report.
In addition, information from the Daily Treasury Statement indicates that employment and withholding tax deposits are starting to accelerate. They are currently running $62 billion above last year ($1.78T total). Signs of labor market tightness are appearing and could drive up wages.
Because of fears of Brexit, the impending election in the U.S., and general gloom and doom in the media, investors have been pouring money into bonds and defensive sectors such as utilities and staples. As interest rates have declined, all equity yield sectors have outperformed, stretching valuations in the defensive equity sectors, especially in the utilities and staples sectors. Price to earnings valuations in these sectors are in the high teens or even low 20’s and far above their long term average levels.
As Mike Santoli pointed out this week in his CNBC column, the earnings recession is ending. The prolonged contraction in corporate profits appears set to end soon, a function of time as we move beyond the effects of the oil decline and the sharp rise in the dollar.
In our dividend income portfolio, we continue to see value in the beaten down areas such as healthcare, financials, retail and technology. We continue to underweight the expensive sectors such as utilities and staples. We continue to believe that investors who ignore the mainstream and position for growth will be rewarded. The utility/staples yield trade is getting long in the tooth in our opinion.
Stephen E. Johnson, JD, CFP®, CPWA®
Portfolio Manager, Fundamental Analyst
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