Home On The Trading Range
Stocks continue trading in a concise range. The Dow Jones Industrial Average began the year at 17,823, sagged to 17,164 on January 30 and made a record closing high of 18,828 on March 23. It’s currently around 18,250, almost midway between the year’s highs and lows and up two percent since the beginning of the year. That’s not very exciting after averaging 11% annually over the last six years. The market’s usual summer lull is approaching and there seems to be no immediate catalyst to take it out of its trading range.
The financial media keep us amply supplied with dramatic reports and conflicting predictions. The Federal Reserve and the impact of its actions on interest rates have been a frequent topic for many months. A rise in rates for the first time in nine years will impact both the stock and bond markets. While there is little doubt that the Fed will raise rates at some point, the timing and the extent to which investors have anticipated its actions remain unknown.
Former Chairman Greenspan, referring to the “tapering” of the Fed’s bond-purchasing programs, predicted that markets would react to the Fed’s first steps to raise rates with a “taper tantrum.” Two years ago, the market tumbled for a few weeks when then Chairman Bernanke mildly suggested that the Fed would soon slow its bond-purchasing program. The markets recovered but their reaction then was a dress rehearsal of the nervous running around in circles that will occur when the Fed actually acts.
Fed Chair Yellen has reiterated that it she in no mood to allow rates to head back up until actual data show that the economy has bottomed out on all fronts. When the Fed does act, it will be a solid indicator for the stock market that broader growth is at hand. Logically, that would boost corporate earnings, which should boost stock prices, however, the immediate effects will be emotional as fears break out when the media begin braying about further rate rises.
Ewen Watt, the chief strategist at Blackrock (BLK-$365), the large asset manager (and #5 in my portfolios), said, “Exiting a long period of zero interest rates is tricky and a bit unsettling. Some of us feel like the informed citizens of Pompeii around 79 A.D: we are grateful for the lovely sea views but worry about the volcano in the background.”
Higher interest rates are highly destructive of bond prices. Investors who cling to bonds based on some hazy belief that they are “safe” are in for a surprise, particularly if they have grasped for higher yields by clutching longer-term bonds. Even a ten-year bond will lose about seven percent of its present value on a one percent increase in interest rates. A thirty-year bond loses over 20% on a two percent rate increase.
Although brokers have cheerfully been selling bonds to fearful investors for years, I feel the advertised protections from risks are exaggerated. Inflation will return at some point, further eroding bond values, and bonds do not offer the potential of rising payments available from quality stocks.
Apple (AAPL-$128), for example, yields 1.6% today, more than a five-year government bond, which will never raise its payouts. Apple will bump its dividends, in all probability, and there is a high degree of probability that its stock price will increase. Bonds have enjoyed quite decent returns since the Fed first began lowering interest rates but rate increases will breed negative returns.
Positive returns will continue from quality stocks even if eventual Fed actions cause stocks to break their trading range to the downside. Tech and medical stocks have been strong this year while the industrial sector has lagged as exports weakened as the relative value of the dollar increased. Boeing (BA-$147), Honeywell (HON-$106), Thermo Fisher Scientific (TMO-$131) and United Technologies (UTX-$119) are posting strong earnings despite currency issues and should hit new highs by year-end.
CVS Health (CVS-$101), a new buy, is a leader in the increasingly important sub-sector of prescription benefit management. Past and prospective growth rates are 14%-15% with earnings this year estimated at $5.17, up from $4.51. Yield is 1.4% with increases for 11 straight years.
The stock market trading range persists even though often is heard a discouraging word and with the prospect of cloudy skies from rate increases. Sticking to quality stocks in growing companies will keep investors in the saddle.
Tony Crowell manages stock portfolios for individuals and their trust and retirement accounts with CROWELL•ROBERTS Investment Counsel, a registered investment advisor in Laguna Beach since 1995. [email protected] 949.494.1376/800.697.2622
