The third quarter of 2015 concludes today. You have probably already been made aware that it wasn’t a good one, but there is nothing you can do about it now. One of my favorite scenes takes place in the 1976 movie “The Gumball Rally” when one of the drivers rips off his rear-view mirror and tosses it aside. He then explains to his passenger that whatever is behind him is not important. With that in mind, perhaps it is better for us to focus on what lies ahead.
One event that many observers thought would be behind us by now is the first interest rate hike of the past nine years. However, it is still somewhere out in front of us, and the Federal Reserve has only two more chances to put it behind us this year. Reasons the Fed gave for not raising interest rates earlier this month included concerns about global growth and the lack of inflation. Fed Chair Janet Yellen spent much of her time the following week explaining that the decision to raise rates would be data dependent, and she argued that the required data should be there by the end of the year.
Not everyone sees it that way. The lack of inflation was a point highlighted in this column two weeks ago. Christine Lagarde, the managing director of the IMF, echoes those concerns. She said the IMF was “very pleased to see the fact that the decision will be data dependent.” She believes this is a very good policy because she doesn’t see the needed data on the inflation front and is not convinced global growth concerns have been factored in. In case you couldn’t tell, the IMF does not think it is time for the US to raise interest rates.
The quarterly change of the calendar brings with it a new earnings season. As usual, there will be earnings shortfalls and upside surprises. However, market action will tend to be dictated by the forecasts and outlooks regarding the upcoming quarter and next year. Don’t be surprised if a company points to the strong US dollar as an excuse if it fails to meet its earnings expectations.
Political risk will also be a factor in the months ahead. The government’s fiscal year ends today, and lawmakers are expected to approve a stopgap measure to keep the government running through December 11. While a government shutdown will likely be avoided today, there are no guarantees that a longer-term agreement will be reached over the next two months. This could very well be another data point the Fed needs prior to its interest rate decision at the December 16 FOMC meeting.
I started off saying the third quarter was bad so let’s look to the future. Unfortunately, I wasn’t able to offer a ton of optimism about the fourth quarter, but that doesn’t mean stocks can’t rally from here. In fact, stocks are notorious for ignoring the news and embarking upon their own course. However, don’t worry if the upcoming quarter turns out to be more of the same. In another three months it will also be behind us, and then it will no longer be important either.
Given the recent market turmoil, it is not a surprise to see Utilities ascend to the top of the sector rankings. It had climbed from seventh to third a week ago, and today it sits at the pinnacle. Utilities was the only sector to gain momentum over the past week, but it is still registering a negative value. The defensive nature of the market also pushed Consumer Staples up a notch to third. The third member of the defensive trio, Health Care, went the other way though. Thanks to a rout in Biotechnology stocks, the Health Care sector’s momentum score plunged from -20 to -57, and it fell to ninth in the rankings. Real Estate was sitting at the top in our previous update, but its visit only lasted a week, and today it is in second. Consumer Discretionary fell two places and is now tightly bunched with Telecom, Technology, and Financials. Energy and Materials are still in the basement, but for the first time in 13 weeks, Materials resides lower than Energy.
There are significant changes today. For the past dozen weeks, the dominant characteristic of the style rankings has been the relative strength of Growth over Value. Capitalization had little bearing on the structure during that period. Over the past week, two significant shifts took place. The first was the rise of Value and fall of Growth. The second was the relative strength gains in the Large-Caps and the ranking declines of the Small-Caps. Regarding the Growth to Value shift, a week ago all three Value categories were at the very bottom of the rankings. Today, they have moved up to occupy the fourth-, fifth-, and sixth-place spots. As for the size shift, Mega-Cap climbed from fifth to first, Large-Cap Blend rose three places, and Large-Cap Value jumped from last to sixth. This capitalization shift appears even more pronounced among the smaller capitalization segments. Micro-Cap plunged from second to tenth, and Small-Cap Growth relinquished its fourth-place spot to land on the bottom. Small-Cap Value is the primary anomaly in this new alignment. It climbed six places to fourth and separated itself from the three other small capitalization categories that are now at the bottom.
It’s been a rough week for US stocks. However, the US still has the best momentum score of any of our global categories. The graphic that accompanies this article does a good job of summing up the current situation – the US has been the best of a bad lot. World Equity, which has about a 52% allocation to the US, maintains its second-place position. Japan jumped from seventh to third this week, although it was mostly due to the relatively compressed momentum scores of the categories it surpassed as opposed to a show of strength. The Eurozone, EAFE, and the UK are close behind. Canada had the misfortune of falling the most of any global category this week. In our last update, we noted that Canada’s surge from seventh to third was likely temporary, and today it has fallen back to seventh. Weakness in Energy, Materials, and the Canadian dollar all contributed to the country’s ranking decline. Pacific ex-Japan, which has more than 58% allocated to Australia and is typically highly correlated to Canada, is now just below Canada. The three developing market categories are on the bottom. The more diversified Emerging Markets heads up the trio, with China and Latin America lagging behind. Large negative momentum readings are typically not sustainable, but neither China nor Latin America has been able to get above -50 for seven straight weeks. This is what a bear market looks like. SPDR S&P China (GXC) lost 32% the past five months, and iShares Latin America 40 (ILF) has dropped more than 48% in about thirteen months.
“The simple answer is that there is no simple answer.
Certainly, we are at a difficult and complex juncture.”
– Christine Lagarde, IMF Managing Director in a speech earlier today (9/30/15)
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