Insights and Actions – “Overbought and Time for a Correction?”

March 10, 2017

General Comments

While we were quick to see the changes that were appearing before the election and even more enthusiastic about the prospects since then, we must admit we are a bit concerned about the potential for a pullback or mild correction. Trees do not grow to the sky, and markets do not go up every single day. Yet, here we are with the market up substantially since early November, and without even a 3-5% pullback. New presidential administrations have frequently stumbled early in their first year as they make some beginner mistakes before gaining their footing. The Teflon Don has done just that, but markets seem unperturbed. What is most surprising is that there remains a tremendous amount of skepticism, and markets do not show signs of complacency. Despite the strong market move, many investors are waiting for something more sinister to happen, and some have missed an extraordinary investment opportunity. We invest based on the data we see, and the data remains supportive.

Data Points and Global Economic Indicators

Last month we mentioned confidence as an important indicator of the market’s ability to continue upward. While consumer sentiment, as measured by the University of Michigan, did pull back slightly, consumer confidence remains robust, and the strength in small business confidence remains quite strong. This confidence should help to carry the market higher still.

Last week Fed Chair Janet Yellen telegraphed the Fed’s desire to raise interest rates when it meets on the Ides of March. The market was not really anticipating another interest rate quite so quickly, but with inflation creeping up and with the unemployment rate well below 5%, we think it makes sense for the data-dependent Fed to raise interest rates. We view this as a positive since the Fed would not be raising interest rates if they were uncertain about the economy’s ability to handle higher rates. This too adds to our comfort.

Asset Allocation

We continue to remain fully invested and have made no change to our asset allocation.

Sector Allocation

We have made no changes to our sector weights, and we continue to have heavy exposure to financial services, industrial, energy, and material names. We also remain exposed to technology companies where we continue to find above-average growth.

Conclusion

This market has been questioned and unloved since President Trump’s election. The market has displayed a remarkable resilience and ability to shake off surprising and even mouth-dropping political mistakes and biases. This has perplexed investors, encouraged skeptics, and created a huge wall of worry. The market has, however, repeatedly climbed that wall of worry throughout this period.

We have endeavored to utilize portfolio rotation and rebalancing to create a portfolio that seeks to gain from those data points that are now reflecting a business-friendly, stimulus-focused agenda. With monetary policy moving toward interest rate normalization, we remain cautiously optimistic. However, markets do not, and should not go straight up, and some pullback or correction would not be that surprising. Our data points do not suggest the recovery is ending or even stumbling, and any pull-back should be viewed as an opportunity to put idle cash back to work, or to maintain existing positions.