Financial Professionals

Market Insights

Clarity High Above

03/13/2014

This past Tuesday, I enjoyed a wonderful journey across the country to Los Angeles, where sandwiched between the outbound and return flights was an enjoyable evening with some gracious folks from Royal Bank of Canada. I find long plane trips often evolve into a much needed market discovery process. When traveling at an altitude of 35,000 feet with limited distractions, clarity tends to permeate.

Now that I am back in the New York area, this is a good time to check in with my latest market insights. Below are some observations regarding the recent price action of select assets within the capital markets. Additionally, as we head toward the second quarter, let’s identify a few conditions that need monitoring.

1. S&P 500® Index (SPX) Directional Correlation

History tends to repeat itself, as people generally seem to panic and react in the same way. That’s why folks like me attempt to find prior correlating years to the current year.

For example, in 2012-2013, the SPX presented incredibly similar to 1975-1976 (Figure 1). Currently, the yearly chart I am focused on is 2010 (Figure 2). Similar to 2013, strong 2009 SPX performance of +23% preceded 2010. The SPX experienced a quick 2010 January sell-off and subsequent strong recovery that lasted into mid-April. Sound familiar?

This would suggest that if the correlation remains high, we could be looking at a 2014 scenario of “Sell in late April and take the summer off.” Keep in mind, 2010 recovered from the summer doldrums, closing out the year very strong. That does seem to highly correlate with my expectation for U.S. growth accelerating during Q3 and Q4.

Figure 1: S&P 500 Index, 2012-2013 versus 1975-1976


Source: Bloomberg. Past performance is no guarantee of future results.

Figure 2: S&P 500 Index, 2014 versus 2010


Source: Bloomberg. Past performance is no guarantee of future results.

2. Stay Focused on Growth and Capital Spending

One of the investment themes we identified heading into 2014 was for capital expenditures to rebound from 2013’s disappointing 3% growth back toward double digits. Clearly, corporations are spending in 2014, and doing so in the form of M&A. An excellent pace is being traced out currently with North American M&A recording at $405 billion, up nearly 92% year on year. To put that in context, in 2013 North American M&A didn’t reach above $400 billion until late May. The evidence is there to suggest a favorable tailwind from 2014 M&A.

3. Japanese Consumption Tax Effective April 15

Investors must keep a close eye on the developments in Japan over the next 30 days. On April 15, the first sales tax increase since 1997 takes effect. It will dramatically slow growth in Japan. What is important for investors to understand is that consensus expectations are for Prime Minister Shinzo Abe and Bank of Japan Governor Haruhiko Kuroda to respond with a new round of monetary and fiscal easing. In fact, therein lies the risk that a strong enough response to offset the tax will not be implemented. Japan needs further stimulus to keep the two-year downtrend intact for the Japanese yen (Figure 3). Keep in mind, the popular “short yen” speculative trade is still carried by many. Over the next 30 days, the developments in Japan take priority on the investor watch list.

Figure 3: Japanese Yen, October 2012 to Present

Source: Bloomberg

4. Focus on the BRIC’s “Vowel,” not the “Consonants”

Year to date, Brazil’s Ibovespa Index is down over 10%. Its currency, the real, is holding steady, nearly unchanged. The Chinese renminbi is down 1.35%, while the Hang Seng struggles, down 6% on the year. As far as Russia, the geopolitical concerns relating to Ukraine will persist. Many cite the Ukrainian situation as an early March three-day event; I expect Ukraine will remain a headwind for the markets much longer than that. Of the countries that make up the leading “BRIC” emerging markets, the investment opportunity is not to be found in the countries whose names begin with consonants, but rather in the country that begins with the lone vowel, India.

India has embarked upon all the needed fiscal measures over the past year to reduce its account deficit. The reward in 2014 is an equity index that has traded to a new all-time high this month (Figure 4), and the value of its rupee currency appreciating nearly 7% year to date. That has encouraged strong capital inflows—a unique condition for an emerging market—and strengthened the purchasing power of the domestic consumer. The potential for 5% GDP growth in 2014 is now a surprisingly positive possibility for India, clearly the standout investment amongst the BRICs.

Figure 4: India Sensex New All-Time High March 10, 2014

Source: Bloomberg

Past performance is not a guarantee of future results.

Virtus Investment Partners provides this communication as a matter of general information. The opinions stated herein are those of the author and not necessarily the opinions of Virtus, its affiliates or its subadvisers. Portfolio managers at Virtus make investment decisions in accordance with specific client guidelines and restrictions. As a result, client accounts may differ in strategy and composition from the information presented herein. Any facts and statistics quoted are from sources believed to be reliable, but they may be incomplete or condensed and we do not guarantee their accuracy. This communication is not an offer or solicitation to purchase or sell any security, and it is not a research report. Individuals should consult with a qualified financial professional before making any investment decisions.