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Pockets of Strength

Weekly Views from the Corner – Week Ending November 20, 2016

Inter-market activity, along with the S&P 500’s sector rotation offers an expectation of a stronger economy and rising inflation – post-election.  The out-of-the-gate market response has held thus far, and in some cases strengthened further.  As we stand currently, we have solid, if not remarkable U.S. Dollar strength in the currency markets to the point of embarking on multi-year high levels.

Interest rates throughout the bond market landscape have rocketed higher and are holding.  This has left the yield curve (the spread or difference in their interest rates between shorter dated and longer dated treasury maturities) rocketing higher.  In fact, this yield curve expansion is the strongest we have seen since early 2015 and before that early 2013.  Generally, yield curve expansions are viewed as the bond markets way of telling us it expects stronger growth, rising rates, and higher inflation.

The banks in the previous two instances rose in price (as they are in this curve expansion) as profit expectations increase for them with the backdrop of a rising yield curve.  In the prior two instances, the rapid yield curve expansions turned over and proceeded to go considerably lower.  Expectations of a stronger economy/rising interest rates went by the wayside.  This simultaneously placed downward pressure on bank stocks.  This underlines how rapid shifts in expectations can deteriorate, or even turn lower as reality unfolds contrary to expectations.

Within the S&P 500 via our SPX9 system, we have seen the Financials take on a leadership role (on the back of bank strength) on the sector front.  In addition, the Industrials sector within the S&P has also been a rocket in terms of its own strength, clearly giving it a leadership banner.  Technology has held on to said banner but has not displayed the strength, post-election, of the Financials and Industrials.  In addition to this, we now see the Consumer Discretionary sector attempting to add to the leading sector list, although it is too early label it as such.

With this, in two short weeks we have gone from a wilting leaderless structure on the S&P 500 front to an eye-catching attempt at an offensive sector leadership environment.  If Technology and Consumer Discretionary can solidly join in with Financials and Industrials, then our sector leadership backdrop will be overwhelmingly positive.  We are not there yet – we are attempting to be – and yes we’ve seen this development before only to see it fade away.  So we continue to watch closely.

The stock market response also points to amazing strength in the small and even micro sized companies which speaks to an additional message of expected economic strength.  Small companies are more sensitive to the strength or lack thereof of the economic backdrop.

Pockets of Strength

In the stock market we have seen pockets of tremendous strength but this does not hold true for the market as a whole.  As mentioned previously, banks are an example of these pockets of strength.  Simultaneously though, we have also seen weakness in other areas within the stock market – post-election.  This leaves broader indices such as the S&P 500 Index, or the NYSE Composite trailing behind areas that are more focused such as the Dow Jones Industrials, or even the Dow Jones Transport Index – as examples.

As an early indicator of near-future characteristics of stock market investing, this suggests a more focused approach will serve better than owning broad stock market related investments.  Importantly, this is only a couple of weeks into the dramatic market shifts but the lines of separation between more focused areas, compared to broader, more encompassing vehicles has been notable.  We are extremely focused on this dynamic as it can offer important approaches to stock related investing for the coming year.

Here in the Weekly View, we will continue to monitor this among other dynamics as weeks pass by.  One thing is obvious:  There is a plethora of “issues,” both positive and negative that can add to, or seriously curtail the market shifts we have seen thus far.  For my part, I feel the next 60-90 days will be incredibly interesting with all the markets will be facing – both known and unknown.  Stay nimble – be flexible.

I wish you well……

Ken Reinhart

Director, Market Research & Portfolio Analysis

Portfolio Manager, CAMS Spectrum Portfolio

Footnote:

H&UP’s is a quick summation of a rating system for SPX9 (abbreviation encompassing 9 Sectors of the S&P 500 with 107 sub-groups within those 9 sectors) that quickly references the percentage that is deemed healthy and higher (H&UP).  This comes from the proprietary “V-NN” ranking system that is composed of 4 ratings which are “V-H-N-or NN”.  A “V” or an “H” is a positive or constructive rank for said sector or sub-group within the sectors.

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