Global Stock Indexes Trade to Bottom of Range - Sector Rotation in Full Force

It’s been a rough six weeks for stock investors both here in the US and overseas. As of today’s decline, stock indexes are trading near the lows that they reached a few weeks ago. As we have mentioned recently, some stocks within certain sectors are declining much more than others. Looking at broad indexes alone, we are still within the range of a normal correction. However, some sectors have fallen beyond normal correction territory, which supports our view that the bull market may still be very much intact, but will be led by a whole different group of stocks and sectors as we eventually move beyond this downside. It is this time of year that market prognosticators often suggest that investors will experience what they call the “Santa Claus” rally – a final advance, if you will, bringing investors a reason to smile during the holiday season. Though recent market action might suggest that The Grinch may be up to his usual tricks, we would suggest that it is quite possible that we will see a big rally in stocks before the year is over.

You have probably noticed that over the last few weeks we have reduced your exposure to stocks – particularly stocks in the financial, technology, consumer discretionary and industrial sectors. These sectors have fared far worse than normal for a few reasons, most importantly the possibility that the economy may not grow any faster than its current rate of speed and may in fact grow a bit slower in 2019. These sectors are very economically sensitive which is why we were able to ride their growing fortunes over the past two years. Though these sectors should do “ok” going forward, their future profits and stock prices may not be quite as bright. The sectors that shine brightest in a consistent growth economy or moderate economy are companies in sectors such as healthcare and consumer staples – where we are now most invested in your portfolio. These sectors and the companies within them tend to be able to maintain attractive profit growth regardless of general economic conditions – think of hospital supply companies as a good example. As economies moderate in growth, investors can make great profits in these sectors and we look forward to doing so should the bull market stay intact. But will it do so?

Many investors are convinced that the recent decline foreshadows the beginning of a bear market. If that is so, we are prepared as we are less invested and are exposed to companies that would be less affected by such a decline.  However, it would be odd for a significant bear market to begin here for a few reasons:  too many investors believe it’s possible and the market usually does the opposite of the crowd; bear markets coincide with recessions and economies are growing at a stellar rate; markets are not overpriced with price earnings ratios at 16 times earnings. That said, we do understand that anything is possible and we are dealing with the unknown. Therefore, we have changed your portfolio to be more defensive over the past few weeks should a further significant decline come along. We also continue to use stop loss orders on those positions that have business risk or may be subject to a further decline in the market.  As you know stop losses are meant to prevent catastrophic losses, not short term or normal downside volatility.

We do think a very good argument could be made at this point – or a bit lower in the indexes – that investors may in fact get the famed "Santa Claus" rally this year. Why? Stock markets around the world are very oversold, economies are growing and companies are profitable. Moreover, investor psychology is at very bearish levels which is usually a precursor to a big rally in stocks. Will it look like the advances of the past couple of years? Sort of. As we mentioned above the new leadership of the market will most likely be in sectors like healthcare and consumer staples, so don’t be surprised to see that leadership continue. However, select technology and industrial companies should also fare well with an upcoming advance – should we be fortunate enough to see one unfold.

As always our team is prepared for a number of different scenarios over the next few days, weeks and months to protect your portfolio further if necessary, and be more growth oriented if markets begin to act better - and we hear reindeer on the roof.

We hope this update is helpful during these volatile days and weeks and all of us wish you a Happy Holiday Season.

Your Team at Main Street Research