What's On Tap...

February 18, 2016

The thawing temperature in the Northeast this week after the frigid weather over the weekend is a welcomed and quick turnaround.  We hope that the action we have seen in the equity markets starting on Friday and continuing this week will warm up investor appetite for equities.  We have seen heavy selling since the start of the year and a lack of buyer’s in the market.  As a result, equity valuations across many different sectors look more reasonable than just at the start of the year.  Investor’s remain very bearish as evidenced by the most recent reading of the American Association of Individual Investor’s Investment Sentiment Readings shown below.

Percent of Investor’s Bullish

Source:  AAII Investor Sentiment Survey

Source:  AAII Investor Sentiment Survey

As the chart shows, investor’s reached similar bearish readings in 2012 and late 2015, but the panic in those time periods was not like the wall of concerns we are witnessing this year.  The ten year bond yield declined to 1.5% last week (as of this writing it has bounced back to 1.8%) and more and more market observers are calling for a full blown recession here in the US.  We here at Braver do not believe the US is headed for a recession and last week there were positive economic readings to help quell recession fears.  Consumer spending was stronger than forecast for January and revised up for December.   At the same time, the Atlanta Fed revised their current projection of first quarter US GDP to 2.5% which seems far from recession conditions to us.  Yet investor’s continue to rotate out of the cyclical areas of the market and into the sectors that are perceived to be safer as they remain concerned about recession fears. 

In our Dividend Income portfolio we remain underweight the defensive sectors, utilities and consumer staples, as valuations look stretched.  This underweight to these sectors differentiates our strategy from many peers that share a focus on dividend stocks but we can’t justify their rich valuation multiples.  This is a very crowded trade as valuations in both sectors are close to their peak historical earnings multiple highs.  With bond yields and equities declining, these sectors do well as investor’s rotate into higher yielding stable equities and perceived ‘safe havens’.  With a whiff of higher interest rates or an equity market recovery, these sectors are likely to see significant outflows as investors rotate for more growth orientation.  The upside in these areas is very limited.

Outside of the defensive sectors, we are finding great opportunities in those sectors that have been beaten up due to perceived recession fears.  Banks are trading like we are in the 2008 financial crisis, when in fact their balance sheets are in great shape compared to the 2008 time period.  The financial sector has been hurt by threats of the Fed moving to negative interest rates and a flattening yield curve.  This could lower their earnings potential in the short term, but in our opinion we do not see a financial crisis, just a growth scare.   We have been adding to our bank exposure with this weakness as the current chart below shows how oversold financials are.

                Source:  Bloomberg and Wells Fargo Securities

                Source:  Bloomberg and Wells Fargo Securities

Financials are only one example of where we are finding great opportunities to add to high quality names that pay an attractive dividend yield.  When analyzing our quantitative screens for opportunities in the industrials, materials and consumer discretionary space there are multitudes of great companies trading below what we believe is their intrinsic value.  Over the coming weeks we will seek to continue to take advantage of this mis-pricing and add exposure in these areas to our Dividend Income Portfolio.

It always tough to call a bottom, but the yield on the 30 year treasury last Thursday was 2.56% and the dividend yield on the S&P was 2.5%.  Longer term investors with the right risk appetite should favor equities over bonds at these levels.

Christopher S Deeley, CFA   Portfolio Manager

Christopher S Deeley, CFA

Portfolio Manager







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