US stocks churned above and below January 1 st values for most of the month, slumped 3.0% in the last week of January to close 3.0% down on the year. European markets, meanwhile surged 9.1% in Germany, 7.8% in France, 2.9% in the UK. Emerging markets also did well with Shanghai up 3.8%, India up 6.9% and Brazil up 5.9%.
Didn't we say just last month that the US economy was strong, emerging market countries were on slow down, and Europe was a basket case? We did! And not much has changed in the last month. But, as we have said so many times in the past, stock markets are not about current conditions, but expectations about future conditions, usually 1-2 years in the future. The 48.4% gain in US stocks over the last two years was in anticipation of the current benign environment of low inflation, low interest rates, expanding jobs market, gently rising wages, robust consumer spending thanks to cheap gasoline, and GDP growth in the 2.5% range.
Now what? The stock market will take a breather while investors figure out what is next in store. Their attention is on: commodities - does last weeks surge in oil signal a bottom? Interest rate policy - is this the year that the Federal Reserve finally raises the baseline rate from 0%? Can the current anemic growth rates in earnings (+5.5%) and revenues (+1.7%) support current stock market valuations?
Meanwhile, economic statistics for China, India, and Brazil are perking up as the strong dollar draws imports to the US. European stocks jumped on anticipation that bankers and regulators are finally getting serious about boosting those economies. We wondered at year end whether 2015 would be the year that the US economy returned to its traditional role as locomotive for the rest of the world, or whether the world would pull the US back into recession. So far, the locomotive appears to leading.
Some questions from clients:
Should we invest in Shake Shack?
The stock soared 119% in yesterday's IPO. Doesn't that mean this is a good company to invest in? No. Shake Shack operates 63 stores worldwide. The average ticket at $10 is twice McDonald's. However the closing valuation of $1.6 billion values each Shake Shack store at $26 million. The valuation of each of McDonald's 35,000 stores is $2.6 million. Yes, these burgers are good, but not 10X good. Meanwhile, many, many premium fast food chains soared after the IPO but flamed out within a few years including Boston Market and Au Bon Pain. Our rule about IPOs remains the same - wait a few years until the hype dissipates. Once the company and its management are seasoned, we can value and invest if prudent.
What happens if Greece leaves Euro?
Prior to joining the Eurozone, Greece was a backwater country dependent on tourism and agricultural exports. Greece's ability to borrow was limited by the relatively high rates investors demanded to hold Drachma denominated securities, so Greece's balance of payments were relatively even. Once in the Euro, Greeks could borrow at cheap Euro rates, and promptly did so borrowing twice as much money as Greek GDP. The cash was used to more for consumption than investments, and all of a sudden every Greek bought a new (German) car, (German) refrigerator, and added a third story to their house.
Meanwhile, Greece priced itself out of the cheap vacation market and lost agricultural exports markets to other countries. Without economic growth and without a reliable tax base, Greece lurched through the first "Grexit" crisis in 2012, but chose to remain in the Eurp. At this point in time, European banks have prepared themselves for the "haircut" their positions would take (around 50%) if Greece left the Euro now. Germany is the largest lender to Greece and the largest exporter to Greece, so Germany is at most risk. But again, Germany has had three years to prepare for this situation, so the shock will be limited.
If Greece DOES leave the Euro (still a 50/50 proposition) and reaps the benefits of debt write-down and currency devaluation that allows its economy to recover, do Portugal, Spain and Italy follow? These three countries also have low economic productivity relative to Germany, France and the UK and also have suffered competitively from being tied to the Euro.
Our bet right now is that Greece does NOT leave the Eurozone - Germany needs the stability and export markets of the expanded Eurozone and will pay whatever it takes to keep the currency intact.
What about Commodity Prices?
We typically maintain a 4-5% position in commodities in our clients accounts, achieved through a single broadly based PIMCO fund. We sold that position late December across all accounts to harvest tax losses we could use to offset gains elsewhere. Now that the 30 day wash sale period has expired, we are putting clients right back into the same fund. If Friday's 8% jump in the price is an indication that a floor on commodity prices is established after a 6 month slide, we may be in right at the bottom.