Mid-Year Update: Proceed... With Caution

Adam Fischbaum's picture

Tuesday, July 11, 2017 - 2:30pm

by Adam Fischbaum

Here we are again at the halfway point in another trading year. What's happened? What's going to happen? I'm not sure of what will happen going forward. But we can look in the rearview mirror and try to position our investments as prudently as we can based on what we already know.

A lot of variables can affect the outcome: Interest rates, the economy, and geo-political events just to name a few. Let's dive right in...

Stocks Are Still Cruising In The Stratosphere
Midway through 2017, U.S. equity markets seem to be in the optimism business. Year-to-date, the S&P 500 index has climbed 7.6% on a price basis. Annualized, that puts us on track for better than 15% return. But will we get there? Good question! The forward P/E of the S&P 500 currently sits at 18.7 -- not too terribly overvalued. If we can get through the summer doldrums without any surprises (more on that in a bit), we could at least get close.

The real story in stocks, though, is international. The MSCI EAFE index, one of the best measures of developed market performance, has turned in an impressive 12.3% year-to-date, leaving the S&P in the dust. It may be too late to jump on that particular trade, but you can still get exposure to that theme by sticking to mega-cap multinational stocks that derive 30% or more of their revenue from overseas. The likely suspects are names such as Unilever (NYSE: UL), Coca Cola (NYSE: KO), and Procter and Gamble (NYSE: PG). These names own the most recognized brands on the planet, and they're defensive in nature as they fall in the consumer staples bucket. Even better, all three throw off an average dividend yield of 3%.

Another globally-focused choice is a closed-end fund (CEF) I've been gravitating towards lately: Voya Global Equity Dividend & Premium Opportunity Fund (NYSE: IGD). The fund holds big, global brand names such as Apple (Nasdaq: AAPL), Cisco Systems (Nasdaq: CSCO), and General Electric (NYSE: GE). In addition to trading at a 6.8% discount to its net asset value (NAV), the fund throws off a healthy 9.8% income stream. Its financial health is protected by the fund manager's use of a conservative covered call options strategy to manage volatility and juice up the yield.

Interest Rates: Lower For Longer
I've been on a bit of rant lately regarding interest rates. I'll say it again ad nauseam: Lower for longer. Even as the Fed raises rates and slowly unwinds its humongous balance sheet, the market will pay little attention. Here's why.

There is SO much cash out there it has virtually zero velocity (too much supply and not enough demand). 

While the 2008 Financial Crisis unfolded, the Fed and other central banks around the world opened the cash spigot and provided the liquidity markets needed to stay afloat. They accomplished about half of their mission. Financial markets stabilized, preventing Great Depression v2.0. However, the massive liquidity did not translate into rapid business expansion fueled by banks lending mountains of cash to businesses and consumers. Instead, banks have held back, becoming conservative. Consumers have spent less and saved more. The demand for money just isn't there, resulting in a slow-growth, milquetoast economy.

And while savers seem to be more diligent than they were pre-crisis, they aren't being rewarded. If anything, they're being punished by miserly low interest rates. 

Based on the collective opinion of most pundits, the Fed probably has one more rate increase in the bag for 2017, expected in December. Until then (and probably for quite some time after), yield-hungry investors will do best nibbling at bond proxies. 

It's been difficult to find value in individual names in the real estate investment trust (REIT) and utility spaces. Shoppers would be best to stick with tried and true CEFs like CBRE Clarion Global REIT Fund (NYSE: IGR) and the Gabelli Utility Trust (NYSE: GUT). The funds throw off a combined yield of 8.2% and are expertly managed.

Geopolitical Crises All But Guarantee Volatility
Of course, the biggest variable that could potentially affect financial markets is the current geopolitical climate. Due to the steep learning curve faced by the new presidential administration, U.S. defense and foreign policy are murky at best. After missing a handful of opportunities to articulate American intentions on a global stage, it appears as if traditional U.S. allies are considering alternatives when discussing collective defense. This isn't good for global stability, and that lack of visibility will, eventually, show up in financial markets in the form of volatility. 

The good news is that the political trend towards statist populism has ebbed somewhat thanks to election outcomes in France and the Netherlands. Despite obvious buyer's remorse, the U.K. is lumbering towards an orderly "Brexit," meaning that much of that effect has been priced into the market.

While the situation in North Korea is worrisome, the real flashpoint to watch is the mounting diplomatic crisis in Qatar. A longtime U.S. ally in one of the world's most contentious regions, Qatar has found itself isolated from its Gulf State neighbors due to (perhaps unfounded) suspicion of Qatari meddling with the stability of regional governments. The nation is suspected of directly or indirectly providing assistance to opposition groups within Saudi Arabia, Egypt, and the United Arab Emirates.

While this is a complex "page six" story, it has more potential to become front page news. The situation bears watching. We don't want our Persian Gulf allies quarreling.

On the energy front, oil prices are in the same boat as interest rates: Not going way up any time soon. After a strong start to the year, the price of a barrel of West Texas Intermediate (WTI) has tumbled nearly 19% to around $44 from a high of near $55. Although the sector has bounced back nicely after 2014's energy bloodbath, North American shale oil production has become cheaper and more efficient than it's ever been. This keeps the supply of black gold high and has forced prices back to within shooting distance of their 2016 lows. 

Oil prices and energy stocks are more likely to go lower before they go higher. For now, one of the best places for energy exposure is the Alerian MLP ETF (NYSE: AMLP). This exchange traded fund offers investors a basket of energy infrastructure and related master limited partnerships. Shares currently trade at an 11% discount to their 52-week high and yield 5.7%.

Action To Take:  At mid-year, I'd say "so far, so good," yet remain cautious. Low inflation, persistent, negligible interest rates, and lack of government interference have set the stage for a positive year in U.S. stocks. International markets have already delivered handsomely. The question is can they both follow through? 

Because I remain cautiously optimistic, I think the best plan for investors is to focus on high quality and consistent income. Equally weighted, all of the stocks and funds I've mentioned yield nearly 6.7% as a portfolio, outstripping the 10-year U.S. Treasury by 182% and the S&P 500's average dividend yield by 233%. Better safe than sorry.

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Adam Fischbaum owns shares of IGD, GUT.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.