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Looking for trends in this market? I see two--Japan and the U.S.--that are investible over the next few months
03/22/2013 8:30 am EST
That a dysfunctional U.S. Congress will let the government shut down for lack of a budget?
That European leaders will cave in and bailout Cyprus with taxpayer money?
That Japan, having already pushed the yen down almost 16% against the U.S. dollar since December 1, will push it down another 15% before the government of Shinzo Abe says “Arigatou gozaimasu”?
If I were looking for predictions, quite frankly I’d rather consult my Magic 8 Ball. No offense, but my experience suggests that the wisdom of crowds is as unlikely to call the future right as the wisdom of gurus is. There’s a reason cynics in the guru profession advise, “Forecast early and often.”
But if you’re looking for a guide to how the market will move over the next month or two or three, I don’t think you can do much better than by paying close attention to what investors—in the aggregate—expect.
That’s because expectations get embedded in stock prices. Prices anticipate not what is going to happen—because no one actually knows what is going to happen—but what investors think is going to happen.
If the mass of investors thinks that rising inflation will provoke an economic slowdown in China that expectation will be reflected in the price of Chinese stocks. And the stronger that expectation—the more investors share that view--the more prices will take account of that expectation. If everyone thinks the Cyprus crisis will take down the euro, then that view will be embedded in the price of Italian bonds, French stocks, and the euro. If everyone thinks that another debt ceiling battle will hit the U.S. credit rating, then that expectation will send Treasury yields up and stock price down.
What to do with these expectations divides investors into roaring camps. Trend following investors seek to go with expectations as they’re expressed in charts and momentum indicators. Contrarians try to discover mis-guided expectations and get out in front of the turn in opinion.
Me? I’m agnostic. If the trend is strong enough, if the expectation looks likely to be supported, at least for a while, by the flow of news, I say, go with the trend. If expectations look likely to be disappointed, then I say, be contrarian and bet against the expectations of the market.
And always, always remember that in a majority of cases, you probably can’t tell with a useful degree of certainty if the trend will continue or reverse in any time period specific enough to be profitable. Most of the time you’re better off not trying to guess whether expectations will be confirmed or confounded. (Which is, of course, the core belief of another school of investors who say only fundamentals count.)
Most of the time. But not all of the time.
Some markets have clear expectation trends that you can follow. And clear news flows that say the expectations in the market are both correct and likely to last for a while.
Some markets are so volatile that expectations run quickly to extremes. In these markets expectations, good and bad, are likely to out run actual events. That suggests that in these markets there’s money to be made by going against the flow.
Let me look at one current example of each right now and suggest how you might profit from reading market expectations in these two cases: Japan and the United States. And then I’ll finish with a brief argument for why Chinese and European markets aren’t very well suited to this approach right now.
Everybody knows that the government of Shinzo Abe, elected in December, is determined to weaken the yen. The prime minister ran for office on a platform that called for a weak yen as a way to stimulate Japanese exports and the Japanese economy. The yen started to fall against the dollar even before Abe was elected and, despite a few rallies when the euro crisis led to a flight to safety that pushed up the yen, the trend has been down ever since.
Is this a trend worth following? After all everyone expects the yen to drop further so isn’t that drop priced in?
I don’t think expectations yet take into account the degree of the government’s commitment to a really, really weak yen. New Bank of Japan governor Haruhiko Kuroda took the podium Thursday with the yen already at a three and as half year low. With the yen near 96 to the dollar, some analysts before Kuroda’s speech had suggested that he wouldn’t do anything radical in his first outing as the head of Japan’s central bank. But instead Kuroda said, “We will do whatever we can to achieve the 2% price target at the earliest time possible,” and he promised to bring forward the bank’s program for open-ended buying of financial assets from sometime in 2014 to sometime in 2013. Earlier talk that the yen could weaken to 100 to the dollar, which was once the extreme end of expectations, is now at the conservative end. A yen at 105 or even, temporarily at 110 to the dollar is within the current discussion. If the yen gets to 105, I think it would be time to revisit how much longer to ride this expectation. But from 96 yen to the dollar, I think the trend is indeed toward a weaker yen, one weaker than expected. And that suggests that there are still gains to be made from holding onto the shares of Japanese exporters such as Toyota Motor (TM), a stock I added to my Jubak’s Picks portfolio http://jubakpicks.com/ on February 5. If you want to add a little more Japan exposure to your portfolio now, I’d suggest the iShares MSCI Japan Index ETF (EWJ), the New York traded ADRs (American Depositary Receipts) of banking giant Mitsubishi UFJ Financial Group (MTU), or, if you can trade in Tokyo the shares of an exporter such as office-machine maker Ricoh (7752.JP) or carbon-fiber manufacturer Toray Industries (3402.JP.) (Neither of these stocks trades with enough volume in New York for me to recommend buying them on that market.)
That’s my go with the expectations market pick. My contrarian market pick is the United States.
How can the U.S. markets, trading at an all time high be a contrarian play? Because within the six-month time span that I’m looking at in this post, the expectations for the U.S. economy are actually relatively negative. That’s a major reason that the rally that has taken the major indexes to these heights has stalled recently. I think the U.S economy could indeed run into problems later in the year and I do worry about the current rally running out of gas later in the year, especially if Congress ties itself into knots instead of putting together a budget for the fiscal year that begins on October 1. But right now, I think expectations are actually too negative.
Use my own expectations expressed in earlier posts here as a good example. I looked at the end of the year fiscal cliff, the beginning of the year budget sequester, the March 27 expiration of the continuing resolution that funded the federal government, and a replay of the debt ceiling fight and I felt the situation was rather grim.
Not only were our politicians in Washington likely to raise taxes (and they did when they let the 2 percentage point Social Security withholding tax break expire in January) and to cut spending with an ax (and they did in letting the sequester go into effect) but they were also likely to shut down the government and threaten the credit of the United States again.
That would certainly be enough to endanger an economic recovery that was still extremely weak and to end any hope that the unemployment rate would fall significantly in 2013.
I can’t say that all danger has passed or that suddenly Washington has become a fount of economic sanity, but things now don’t look as bad as they did even a month or two ago. Granted that’s a very low bar, but that’s how the expectations game is played. Evidence that Washington won’t do all the stupid things that I was expecting a month or two ago is enough.
What has changed my expectations?
On March 20 the Senate voted 73 to 26 on legislation that would fund the government through September 30. (The current funding expires on March 27.) The bill then went to the House and—surprise—the House passed this continuing resolution and sent it to the President.
Let’s be clear. What the Senate passed isn’t a good piece of legislation. It basically continues the meat-ax approach of the sequester to budget cuts while making a few changes around the edges to save some funding for programs such as nutrition for low income infants and children and federal inspection of meat processing plants. And it really only passed because Republicans and Democrats are saving up their energy for the big battles over the debt ceiling and the full fiscal 2014 budget.
But the fact that the Senate and House passed anything at all and that House is way beyond what I expected.
In some other financial market this kind of jump-the-low-bar wouldn’t count for much. But look around at the competition. The United Kingdom is back in recession. The EuroZone looks like it will show almost no growth in 2013. Japan may be weakening the yen to help exporters but the country’s economy isn’t exactly booming. Among the economies of the developed world I think the United States with its slightly less dysfunctional than expected Congress, the continued recovery in its housing sector, its domestic energy boom, and its amazingly resilient consumer spending looks pretty good.
I’m not going to swing from the relative caution of recent posts to giddy optimism. I still think I’d step gingerly given the highs in the major indexes and the uncertainty about whether we’re in a bull market or in a bull market rally inside a secular bear market. My earlier recommendation was to look for U.S. stocks that pay solid dividends so that even if we go into a sideways market for a while you’ll get paid. That’s still my advice—I just think I might buy a few more of these stocks than I would have before this turn for the better than expected. Representative stocks to look at from among those in my Jubak’s Picks and Dividend Income portfolios http://jubakpicks.com/ include McDonald’s (MCD), Intel (INTC), and General Electric (GE).
I’d like to tell you that my go with/go against expectations approach fits every piece of the global stock market right now, but it doesn’t.
In the case of China (and the emerging markets dependent on China) expectations may be sliding too far toward pessimism after the recent spike in inflation in January and February. Inflation moved up to 3.2%, close enough to the government’s target of 3.5% to raise fears that Beijing would move to slow the economy to fight inflation. I think those expectations are wrong, but I won’t know that with any certainty until I see inflation numbers for March and April, at the least. If I were to go against expectations now, I’d just be guessing. So, no thanks, and I’ll just stick with trying to find good stocks on these markets on the fundamentals.
The EuroZone is even worse. Expectations seem to be that the crisis in Cyprus won’t lead to a deeper crisis. But in my mind Cyprus was never going to be the major crisis in the next stage of the euro debt crisis. That is more likely to involve Italy, Spain and France and it is, therefore still out there. In that sense I think expectations are far too optimistic and the market remains far too complacent about events in the EuroZone in the rest of 2013. I think I have to sit out Europe for a while.
How long is this guidance good for? Expectations don’t change overnight, but they aren’t cast in concrete either. I’d be looking at a time span of something more than a month and less than four months for the expectations that I’ve described for Japan and the United States. The U.S. Congress stands a good chance of living up to everyone’s worst expectations when the U.S. runs up against the debt ceiling again sometime around May 19.
That may not seem like very long. But considering the volatility that we’ve seen in the market in 2011 and 2012, one to four months seems like a geologic age.
Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. When in 2010 I started the mutual fund I manage, Jubak Global Equity Fund http://jubakfund.com/ , I liquidated all my individual stock holdings and put the money into the fund. The fund may or may not now own positions in any stock mentioned in this post. The fund did own shares of Toray Industries as of the end of December. For a full list of the stocks in the fund as of the end of December see the fund’s portfolio at http://jubakfund.com/about-the-fund/holdings/
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