Why We Are Building a Position In Platinum

I was fortunate enough to have the opportunity to share my thoughts on the virtues of owning platinum as an investment going forward.

Thanks to TraderPlanet for the exposure.  

http://www.traderplanet.com/articles/view/167905-look-to-platinum-and-the-pgm-in-2015/

Joseph S. Kalinowski, CFA
Twitter: @jskalinowski

 

Market Headwinds of 2015

It appears the New Year brings with it increased volatility in the markets. Looking at the market trend, the S&P 500 has been choppy and directionless for 2015 and we are giving the bull trend the benefit of the doubt but remain vigilant in trying to identify and analyze certain red flags that are flashing.

Sector Performance

We are seeing very curious action from sector performance within the S&P 500. Over the past 200 days, economically defensive sectors have been the big winners in the index. Health Care is up over 23%, Utilities are up over 20% and Consumer Staples up over 16%. All three are sectors typically associated as defensive and are bought during economic slowdowns and near market bottoms from a preceding sell-off.  Looking at figure one, this investor would assume a sell-off has occurred and we are nearing the bottom of a downward cycle, but that is clearly not the case. Despite the dramatic negative trading sentiment for energy and materials, the stock market has held up remarkably well. 

Figure two shows an equal weighted price performance measurement between economically cyclical and defensive sectors. This differential between the two is expressed as a Z-score to better show the magnitude of the comparison. Currently the weighting is more than two standard deviations from the mean in favor of economically defensive stocks and is typically associated with a market bottom from a preceding sell-off. The few times this model broke below -2 standard deviations was 3Q to 4Q 2011, 1Q 2009 and 4Q 2000 - all periods of market declines into market bottoms. We understand the magnitude of the commodity bear market but this divergence is very unusual and needs to revert back to the mean. This will only happen with a decline in the market or a change of leadership back to economically cyclical stocks. 

Given where we are with earnings trends and global economics, we are fearful that 2015 will be a challenging year to navigate with the possibility of a significant market decline to come.

Corporate Earnings

Fourth quarter earnings season is off to a rocky start. According to research from Factset, three of the largest banks in America have missed their quarterly numbers. Bank of America, Citigroup and JP Morgan Chase all came up short this quarter.

“The last time all three companies reported actual EPS below the mean EPS estimate in the same quarter was Q4 2011.

What are the implications for earnings growth for the Financials sector with all three of these companies missing expectations? All three companies also reported year-over-year declines in EPS for Q4 2014 as well. As a result, it now appears the Financials sector will likely report a year-over-year decline in earnings for the third time in the past four quarters. The blended (combines actual results for companies that have reported and estimates for companies yet to report) growth rate for the Financials sector is -4.3%.”

We are also concerned about several other earnings misses as well as the guidance we are receiving regarding corporate America’s outlook for 2015. FedEx and Caterpillar missed and provided a less than optimistic forecast for the remainder of the year. This could spell trouble for our economy as both companies can be considered economically sensitive companies that thrive during economic prosperity. Guidance for 2015 has been lackluster with a higher than average number of companies lowering guidance for the year with analysts forecasting a contraction in revenues for the S&P 500 for the first half of this year.

While earnings season is still in its infancy and it is very tough to draw final conclusions, this early trend of fewer companies meeting their revenue targets is unnerving. We consider this important because earnings per share can be somewhat nudged in a certain direction with the help of financial engineering whereas revenues are much more difficult to manipulate. Additional research from Factset concludes fewer companies are reporting actual sales above forecasts and the expected revenue growth for the S&P 500 now stands at 0.63% for 4Q14 versus an estimate of 1.1% heading into the end of last year.

Earnings Trend is Negative

The S&P 500 is now trading 16.6 times 12-month-forward earnings and that sits above its long term averages. This is more a function of declining earnings projections than it is a rising stock market. Looking at the figure below, one will see that the earnings trend has started lower and this offers considerable headwinds for the bull camp.

 

What is equally disturbing are margin expectations looking forward. Should the revenue trends continue its downward trajectory, margins will have to continue to expand greatly for the current EPS forecasts to remain valid. It is unclear to this investor how much additional margin can be squeezed from corporate America given our global economic situation.

 

Our initial thoughts are that EPS estimates are on the cusp of a precipitous decline that will lead to a decline in stock prices sometime in mid-2015.

Strong Dollar

Adding to this somewhat dismal stance is the impact the rising U.S. dollar is having on the bottom line. Several companies such as Monsanto, Red Hat, Accenture , ConAgra, General Mills and Oracle have all provided insight towards the negative impact of earnings due to the mighty buck.

With the expectation of the Federal Reserve raising interest rates later this year and most other developed nations easing monetary policy standards, this dollar rally could be far from over. Some chartists are calling for the U.S. dollar to appreciate another 15% this year against a basket of currencies. The figure below (via Business Insider) tells the whole story for global economic growth this year and thus U.S. dollar direction.

 

Bottom Line

While we are not in the business to attempt to time the market, we are cognizant of the negative trends that appear to be developing.

-          

            Sector leadership from economically defensive sectors

-          Poor forward guidance from corporate America

-          Declining revenue and earnings trends

-          Panglossian profit margin assumptions

-          The strengthening U.S. dollar

-          Tightening monetary policy by the Federal Reserve

Our investment thesis for 2015 is a defensive one. We are on the lookout for companies and sectors in economically defensive sectors with minimal exposure to international currency fluctuations. 

 Companies and sectors that pay dividends and are optionable to institute a covered call writing strategy is preferable. Exposure to the U.S. dollar through liquid ETF’s is also a welcome addition to the portfolio.

Should the fundamental parameters discussed change over the course of time, we would readjust our thesis but remain cautious.

Joseph S. Kalinowski, CFA

Twitter: @jskalinowski