Institutional Investors Praying for a Correction

Posted by Dan Wantrobski via Financial Sense

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UnknownFinancial Sense: Dan, there’s a lot of attention these days on the bond market. What’s your outlook and how are you advising clients?

Dan Wantrobski: When we look at the long-term history of the bond market using the 10-year note…yields typically traded over the last 100-plus years or so anywhere from 3-5%. That means anything above or below that tends to be a historical anomaly. So, for example, [in the early ‘80s]… where the yield on the 10-year note traded upwards of 13-14%, that was really more of an anomaly than the mean. And, likewise, when we hit the financial crisis…you saw effectively generational lows as people in huge numbers de-risked and moved to safety… I think the net result of this, and what we’ve been telling clients, is you should continue to underweight the Treasury market relative to equities…

Interview with Dan Wantrobski, Managing Director of Technical Strategy at Janney Capital Markets. Full audio podcast can be found on the Newshour Podcast page here or on iTunes here at the 14:40 mark.

FS: You’ve been arguing that we are entering a reflationary growth environment in the US and, certainly, when we look at the data, the US economy is picking back up after the weakness we saw in the first quarter. If you’re correct in your view and this continues, what sectors or areas of the market should investors pay attention to?

DW: In a reflationary growth scenario… I think you have to look at the banks and financials. They’re extremely interest-rate sensitive in reflationary cycles. In other words, we tend to see a positive correlation between how this sector performs relative to the broader benchmark and the direction of interest rates. In fact, I think it’s almost an 89% correlation between the 10-year note yield and bank relative performance specifically… I think that group will continue to do well so long as we see that upward bias in rates and I think it’s an important point because don’t forget that the banks and financials still make up a decent chunk of the S&P 500. 

FS: What about commodities? If growth picks up and we start to see some signs of inflation, should investors rotate back into this area?

DW: We actually have them as an underperform and an underweight. What we’ve seen looking at the historical data in these reflationary growth cycles is that the pace of commodity price and inflation is actually muted and contained. So we actually expect to see range-bound choppiness and maybe even lower levels in most of the major commodities out there. So to the extent that material stocks, industrial stocks have a correlation to these underlying stock prices, we’re not necessarily going for an overweight in those sectors at this point.

FS: What about the broader stock market? For the past few years, investors have been waiting for a large correction and we haven’t gotten one; or, if we do get one, buyers rush in and stocks quickly turn around. What are your thoughts? Aren’t we overdue for a pullback?

DW: There’s two ways I look at a market correction. You can eventually have a correction in price, which is what everyone talks about [or]…you can have a correction in time. A correction in time is really a way of wrangling out players by just generating these sideways choppy markets… Ultimately, this could lead to a flush out but, I tell you, institutions stand ready to support this market—in fact they are effectively praying for a market correction—so they could put more money to work for what they feel are better prices. So, we don’t see this culminating in a market top, certainly not a secular market top [and]…I think you can continue to slide a little bit sideways—it will be frustrating—but the bias underneath the surface is still up and we believe it’s going to be supportive on any weakness going forward.

FS: So you’re still positive on US equities and also overweight the financial sector. Are there any other areas you’re looking at?

DW: If you have a longer-term time frame, I would just buy US equities in the form of the S&P 500 (SPY) or one of the benchmarks. I mean in terms of sector overweights, yeah, I think I would go back to the banks/financials only because I haven’t seen any deterioration in terms of the correlation or their performance and long rates. Again, our call is for long rates to continue to go higher not only in a couple of months, but in the next several years. That should allow us to see some good performance out of the banks. Outside of that I don’t think biotechnology is in a bubble. So biotechnology and healthcare would be good areas. Within consumer discretionary, I think you have to be very choosey here. I think we’re going to see growth in this economy from areas outside of the consumer. Remember, the consumer is 70% of GDP.  I think that number has dropped down a little bit—it’s like 68% of GDP, but it’s still the eight hundred pound gorilla in the room. I’m not saying there’s no growth there but I think you could see more explosive growth in other areas like alternative energy within the energy complex. Like I said, biotechnology/technology is always there and some of the financials…

Listen to the rest of this interview with esteemed market technician Dan Wantrobski along with our weekly market wrap-up on the Newshour page here or on iTunes here. Subscribe to our weekly premium podcast by clicking here.

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