Active investment management’s weekly magazine for fee-based advisors

In our note published to clients on June 29, 2015, “Migrating event vs. fundamental risk,” we highlighted our view that event-driven corrections can be used as opportunities in a fundamentally driven bull market.

We believe events create corrections, while fundamental credit issues create sustainable drops.

There have been three significant global events that caused global market weakness and ramping volatility in late June and early July, 2015: Greece’s negotiations on a midterm debt solution, China’s weakness, and Puerto Rico’s debt workout.

We believe all of these issues provided excellent excuses for a pullback but poor reasons to expect sustainable weakness. The fundamental backdrop remains very sound. In fundamentally driven bull markets—those driven by (1) low inflation, (2) accommodative monetary policy, (3) steep/positive yield curve (4) uptrend in economic data and EPS, and (5) valuation expansion—the question isn’t whether you are a buyer, but where to be a more aggressive buyer.

  • Low core inflation. Even on an uptick, the core PCE gives the Fed flexibility to raise rates at a more moderate pace than previous cycles.
  • Accommodative monetary policy as seen through real fed funds rate. This measure could rise 100 basis points and still be at the best level of the past two cycles.
  • Steep/positive yield curve. Every recession since the early 1950s has been preceded by an inversion of the yield curve. We believe a recession is at least three years away because (a) it takes just under two years to invert the curve once the Fed starts raising rates, (b) the mean inversion is 1.25 years, and (c) we are three months away from the first rate hike.
  • Uptrend in economic data and EPS. The keystone to our bullish core thesis is that the market correlates to the direction of EPS, and as long as the economy is trending higher, EPS should follow suit. We continue to expect $123/share for 2015 S&P 500 operating EPS.
  • Valuation expansion. The average market multiple when core inflation is between 1%-3% is 19X S&P 500 operating EPS, and the current trend in valuation is pointing there. This gives us a SPX 2015 target of 2,340.

Corrections only feel “natural, normal, and healthy” until they happen: We highlight the fundamental backdrop so often because on event-driven corrections, there is the fear of fundamental change. Only a dramatic change in the credit/money availability backdrop (driven by the shape of the yield curve) has the power to sustainably change the direction of the economy and EPS.

THE CUMULATIVE ADVANCE-DECLINE LINES FOR THE NYSE AND S&P 500 REMAIN IN WELL-DEFINED UPTRENDS

Our positive core thesis and key tactical indicators around price action, volatility, and correlations suggest a “soft buy.” The exhibit highlights one of our many tactical indicators and shows the continued strength in both the NYSE and S&P 500 cumulative advance-decline lines.

The combination of improving economic data relative to expectations, a solid fundamental backdrop, the millennial demographic trend, and the recent market sell-off (and subsequent rebound) suggests a slight market overweight, with the intention of getting full overweight on a retest of the recent market low, or a breakout to new highs. We would move to a slight overweight in those areas driven by improved credit and household formations—the Financial, Consumer Discretionary, and Info Tech sectors, while moving to a slight underweight in the Energy, Materials, and Industrial sectors.

The opinions expressed in this article are those of the author and do not necessarily represent the views of Proactive Advisor Magazine. These opinions are presented for educational purposes only.

Tony Dwyer is the head of the U.S. Macro Group and chief market strategist at Canaccord Genuity. He also sits on the firm’s U.S. operating committee. Mr. Dwyer joined Canaccord Genuity in 2012 and is known for the practical application of macroeconomic and tactical market indicators. Mr. Dwyer was previously equity strategist and director of research at Collins Stewart and a member of the firm's executive committee. Mr. Dwyer is a frequent guest on many financial news networks. canaccordgenuity.com


Manage investment risk better than ever.
Get started – It’s free

About Us
LinkedIn
Share