Large Cap Commentary – October 2013
Children in October face the dichotomy between tricks and treats. While investors have received a treat this year – Argent client portfolios are up over 20% year-to-date – we are also faced with a dichotomy. Ours is just a tad more complicated. Recently, we have been monitoring the performance spread between recovery stocks (stocks that are relatively more cyclical) and contraction stocks (stocks less tied to economic activity). The chart below plots representative stocks which fall into each category. Given our belief that the U.S. economy was on a tepid, but positive growth path, the divergence in these two classes of stocks was surprising. Ordinarily, the natural progression of the market cycle is that the economy would continue to slow and eventually tip into a recession. During the transition, contraction stocks would likely perform better than expansion stocks. As the chart points out, this is not currently the case. Given that our recovery began nearly five years ago in March of 2009, it seems reasonable to deduce that the next market move would be a contraction in growth. As such, we have positioned our portfolio closer to contraction than to recovery.
In tandem with our view that the market cycle would move away from more cyclical recovery stocks, was our expectation that the Federal Reserve would engage in tapering at some point. In other words, the Fed would decrease its $85 billion per month asset purchases (Quantitative Easing) and eventually move short-term interests above 0%, where they sit today. We speak to our Main Street Contacts on a regular basis and what we have heard is that business conditions are good, not great. This feedback lent credence to our expectations of gradual tapering, where the Fed would slowly remove the punchbowl because the market had the inherent strength to continue to grow on its own.
As expected, in early May of this year Fed Chairman Ben Bernanke indicated that the Fed may engage in tapering in the near future and this confirmed our views of the economy. However, the bond market reacted both strongly and negatively to Bernanke’s comments. In short order, U.S. 10-Year Treasury rates leapt from 1.9% to 3%. Similarly quick was the reaction by the housing market – refinance activity dried up and home price appreciation slowed. Likely in part to the swift negative reaction from the bond market, Chairman Bernanke retracted his earlier announcement and in September publicized that Quantitative Easing would continue at a constant $85 billion per month.
The Fed’s retraction (or inaction) surprised investors and boosted recovery stocks further. We believe the Fed was re-setting the bar in order to push interest rates down from the overreaction the market witnessed after Bernanke’s initial comments on tapering. Although we anticipated a slightly different market reaction, we continue to believe that current conditions reflect a slow but positive growth environment for the foreseeable future. While not ideal, there are periods when short-term market reactions can push our portfolio out of sync with the current trend of the day. This is why we at Argent remain focused on investing for the long-term, and we tend to not react to transient market volatility. We believe that fundamentals eventually drive stocks prices and it is the researching of investment fundamentals where we spend our time.
As always, we appreciate your interest in Argent Capital Management.
Ken Crawford , Senior Portfolio Manager
Views expressed herein represent the opinion of the portfolio manager as of the date above and are subject to change. Past performance is no guarantee of future results.