U.S. Largecap Sector Relative Fair Values: Monday, July 11, 2016
Significant Changes Since Last Week:
After the Brexit adjustment of last week, we have returned to a high market DOW of 18,146 which is very close to fair value at 96.8%. There are now 4 sectors above 100% FV. Materials drop from the list when it moved from 105.0% FV to 99.8% FV this month. Even though the overall market did not make a big adjustment, individual sectors made some significant moves. It was no surprise that the generally high yielding Utilities and Telecommunication Services sectors would advance as bond yields came under further downward pressure. Both of these sectors had the largest advances in relative fair value. Utilities is on top at 115.6% FV followed closely by Telecom at 112.8% FV. At this rate we may see Utilities reach a Cautionary valuation if it crosses 120% FV.
Information Technology lost ground retreating from last month’s 95.2% FV to a current level of 92.3% FV. This has been created by some of the polish falling off of earlier rising stars within this sector. Throughout time it has been proven that an investor needs to be cautious when individual stocks rise rapidly relative to their peer groups. Investors can turn away just as quickly as they advance.
Financial stocks did not move either way, up or down, on a relative basis and Energy was also calm. It is interesting how energy related news dominated the first quarter to the point it was predicting the end of market gains only to take a back seat in the news while delivering some of the lowest energy costs to the world.
Economic news was overall encouraging with good news in first time unemployment claims, total employment levels, with workers returning to the labor force due to an encouraged outlook and a near full employment rate. Inflation remains tame due to global competiveness, lower energy costs and near zero costs for debt and logistics. Nearly 20% of the world’s sovereign debt is at negative rates, but global businesses do not feel comfortable taking on borrowed debt. Complicating the debt side of the equation is the condition of government bonds of less than 10 years offer yields lower than inflation creating a negative buying power situation for the investor. Consumers are also spurning debt and remaining deleveraged as borrowing rates remain at historic lows globally. Stocks present a better investment when it comes to potential return.
The DOW advanced 141 points over the previous month and relative fair value increased slightly from 96.3% FV to 96.8% FV. If you are measuring the impact of Brexit using the DOW, it was a non-event. The Midcap reacted in a similar fashion advancing from 106.3% FV to 106.5% FV, a 0.2 point gain. Only the Smallcap market retreated from 102.7% FV to very close to fair value at 100.9% FV.
Within the Midcap sector universe Utilities advanced over 7.0 percentage points into “Cautionary” valuation range at 122.3% FV. If this advance continues the sector could reach a Sell Watch condition if it were to have an equal advance this month. This is most likely a direct result of investors seeking out increased yields from stocks. Several of the midcap sectors experienced a decline in relative fair value. Both Energy and Industrials retreated over 6 percentage points. Energy’s move was directly related to exploration companies that were higher in debt levels.
Most of the Smallcap sectors remained stable, but there was fairly strong movement to the upside in Consumer Staples. This sector advanced over 4.0 percentage points reaching 115.3% FV. Utilities came back from “cautionary” levels to stabilize at 118.1% FV. There was also a significant retreat in Energy fair value moving from 99.2% FV down to 93.1% FV. This leaves a curiosity as to whether the midcap Energy sector will advance later this year and come closer to the Largecap and Smallcap valuations.
U.S. Allcap Industry Relative Fair Values
The same 10 industry groups that were at or above 100% FV last month remain in a similar position this month. Running neck-and-neck are Food Beverage & Tobacco at 111.6% FV and Real Estate at 111.7% FV. Both advanced this month from values last month just above 108% FV. One of the largest advances in fair value came from the Banking industry. This did not come from either the Largecap or Smallcap sectors but originated within the midcap class of bank stocks.
It was nice to see Pharmaceuticals & Biotechnology advance to 96.6% FV along with Consumer & Professional Services advancing to 103.9% FV. Within the industry groupings all are within 10 percentage points of 100% FV which characterizes a balanced market. A balanced market is more supportive of continued growth without the type of surprise that characterizes a tilted market. The only concern from a sector evaluation is Utilities within the midcap market sector. It could very well follow the path of the Smallcap market earlier and return to within the fair value range. We believe this is the most probable but, there is a strong push to gain yield from stocks because it is absent from bonds. Next month could be a clear indicator as to whether this push for yield will continue.