Phil Flynn breaks down the current fundamentals of the energy sector....
Stack on Stocks: Risk and Opportunity
06/02/2020 5:00 am EST
The eventual economic recovery is unlikely to be V-shaped, no matter how much the Federal Reserve turns on the monetary hose. This was not a standard debt/credit recession triggered by tight monetary policy, cautions Jim Stack, money manager and editor of InvesTech Research.
Needless to say, the next few months will be critical for the stock market as the economy gradually reopens — and it won’t be smooth sailing. While the outlook remains unclear, significant amounts of uncertainty always lead to opportunity.
The Fed has implemented the most aggressive monetary easing in its 100+ year history. Ample liquidity is one of the most important conditions for a fully functioning financial system and economy, and this often translates to strong support of financial assets as well.
The sheer size of stimulus is extremely supportive for equity markets in the short-term, but these Fed operations carry their own risks and the long-term consequences are largely unknown.
The Federal Reserve has not only flooded the U.S. financial system with dollars, but its emergency rate cuts this year reduced interest rates to zero, just as they did during the 2008 Financial Crisis.
The benefit of low interest rates as they relate to equity markets is twofold: 1) They enable companies to issue and refinance debt at a very low cost, allowing them to pursue projects (or sustain operations) that might otherwise be unfeasible; 2) The relative attraction to holding bonds instead of equities diminishes significantly when yields all but disappear.
Money that might have been put to work in fixed-income assets is being diverted to the stock market, pushing equity prices higher and investors further out on the risk spectrum as a result.
What separates today from years past is that there is effectively nowhere to attain a reasonable yield without taking risk. The 10-year T-bond is yielding only 0.7% and the Fed’s active participation in the corporate bond market is continuing to drive yields down in that segment of the fixed-income market as well.
Bottomline, the Fed has aggressively used multiple tools in response to the coronavirus crisis and that has undoubtedly helped mitigate the damage from the shutdown.
Moreover, record high money supply growth and record low bond yields have provided monetary fuel to the stock market in the rebound off the March low.
We have added incrementally to our allocation based on the developments in the monetary situation, sentiment surveys, and technical indicators. On April 29, we increased the position in the Health Care Select Sector SPDR ETF (XLV) the Communication Services Select Sector SPDR ETF (XLC).
It should also be noted that our holding in the VanEck Vectors Gold Miners ETF (GDX) has served as a valuable hedge to the portfolio given the massive fiscal and monetary stimulus packages enacted this year, and the position has gradually increased as a result. We continue to view gold as a valuable insurance.
With the recent changes, the overall invested allocation of our model portfolio is 63%; our portfolio continues to carry a hefty cash balance of 37% given the great deal of risk and uncertainty in these uncharted waters.
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