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Weekly Views – Will rotation lead to volatility?

As shared in our previous Weekly View, the make-up of sector leadership had begun an attempt at rotation to more offensively oriented areas of Technology and the Industrial sector, with increasing interest building in the Consumer Discretionary and Financial sectors.  All this while the long-standing leadership of the defensive/cautious sectors of Utilities and Consumer Staples began to wane – hence rotation from a collective defensive posture to a more aggressive offensive stance.

The near-term concern with rotation is historically it rarely occurs without some turbulence as the baton is handed off from defense to offense if you will.  In addition, rotation beginning is no guarantee that rotation actually manifests into reality whereby we see a stock market that is trending higher and higher led by offensive/risk oriented sectors of the S&P 500.  This is where we are currently – waiting and watching with hyper-vigilance the 9 sectors and their 107 sub-industries of the S&P 500 (SPX9) for any signs rotation is on-going and expected volatility is picking up.  As of the close Friday, neither has occurred.

What we have seen are some attempts at rebuilding strength from said defensive sectors of Utilities and Consumer Staples.  Consumer Staples more so than Utilities to this point.  Furthermore, we have seen some general weakening from said offensive sectors via their sub-industry structures.  Importantly though, the strength of the former and the weakness of the latter is marginal to this point.  So we sit a bit dead in the water waiting for some wind to fill the sails.  Welcome to summer doldrums market style.

US productivity unexpectedly drops for a third-straight quarter

Tuesday, 9 Aug 2016 | 8:30 AM ET

U.S. nonfarm productivity unexpectedly fell in the second quarter, pointing to sustained weakness that could raise concerns about corporate profits and companies’ ability to maintain their recent robust pace of hiring.

The Labor Department said on Tuesday that productivity, which measures hourly output per worker, dropped at a 0.5 percent annual rate in the April-June period. It was the third consecutive quarterly decline.

On the economic analysis front we did have an important structural input for the broad economy and stock market via the U.S. Productivity release.  As offered in our header quote the news was quite weak.  Most concerning is the duration of weakness with this being the 3rd consecutive quarter of negative productivity growth.  This length of negative results is a bit similar to our often stated concerns of the lack of earnings growth for the collective S&P 500 companies which has spanned more than a year now.    The above is not good news for stock market investors because it represents poor structural underpinnings to building greater wealth as a nation.

Prolonged negative productivity growth can place upward pressure on Unit Labor Costs – the cost companies experience per unit of output.  If their per unit costs are moving higher this impacts profit margins negatively.  Weakening profit margins (something else we have been seeing along with said lack of earnings growth) impact companies abilities to increase their bottom line profits for a given level of sales.  Profits are truly the lifeblood of company growth over time if stock prices are to go higher consistently.  This is the economic version of the hip bone is attached to the thigh bone.  It’s all connected and plays an important role in the overall health of the economy and the stock market.

Underneath the lack of productivity is the down trending levels of Capital Investment – a structural underpinning of productivity growth.  As more capital investment is deployed it increases the productivity of the workforce and reduces unit labor costs over time.  For my part the Capital Investment theme has been an on-going concern so it is not a tremendous surprise we are seeing lower productivity.  Capital Investment levels have been declining since the fall season of 2014!  If these trends continue we can expect more concerning news on the U.S. Productivity front over time.

Rising stock prices do not make a country wealthier.  Rising stock prices should reflect growing wealth that is taking place in a country.  Capital Investment and through this rising productivity are basic underpinnings of growing wealth.  For my part, the lack of both has been an on-going concern.  In near-term Weekly Views we will look at Capital Investment more and the lack of growth in this important area.

I wish you well…

Ken Reinhart

Director, Market Research & Portfolio Analysis

If you are new to the Weekly Views and would like more information on our various approaches and products please contact us for direct communication at 877-514-9477 or Stephanie@cornerstoneassetmgmt.com.

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.

This commentary is presented only to provide perspectives on investment strategies and opportunities. The material contains opinions of the author, which are subject to markets change without notice. Statements concerning financial market trends are based on current market conditions which fluctuate. References to specific securities and issuers are for descriptive purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. There is no guarantee that any investment strategy will work under all market conditions. Each investor should evaluate their ability to invest for the long-term, especially during periods of downturn in the market. PERFORMANCE IS NOT GUARANTEED AND LOSSES CAN OCCUR WITH ANY INVESTMENT STRATEGY.

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