Of Special Interest ...examining a significantly timely topic

S&P 500 profit margins mask the disparate trends taking place on a sectoral level. We dissect those trends with the ten major sectors grouped by five broad themes: Cyclicals, Commodities, Defensives, Interest Sensitives, and Tech/Telecom.

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The current environment will likely persist longer than most expect which will put further downward pressure on profit margins. As margins come under pressure, companies increase leverage to prop up ROE. However, the market wants higher duration, not higher leverage.

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YTD the S&P 500 has fallen 2% while the S&P 500 Banking industry group is down over 12%—a shortfall that has the attention of value investors and contrarians seeking a chance to buy high-quality banking franchises at fire-sale prices.

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We’ve been correctly positioned near our tactical portfolios’ equity minimums, yet we’re oddly compelled to use this month’s “Of Special Interest” section as a very public second-guessing of that move.

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It’s a scary thought but what does 2015 have in common with the infamous years of 2001, 2008, and 2009? An earnings recession for the S&P 500 — and the 2015 vintage certainly has some unique traits.

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For the third consecutive year (thus far), quantitative factors worked best within the Materials sector. Energy also saw success as the decline in oil hurt the same stocks as in 2014. Factors were least effective in Health Care and Telecom.

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The wreckage is beginning to look interesting and—with our cautious stance on the stock market—it would be fun to be bullish about something. Both our GS Scores and intuition suggest it’s still too early.

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Our research shows that the best years to “Play The Bounce” are generally ones in which the stock market is heading down into the fourth quarter. We won’t rule out an allocation to the Bounce strategy in the weeks ahead.

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In view of the last year’s steep decline in oil prices, Energy has been a frequent headline topic.

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Conventional measures of market action, like breadth and industry leadership, point to the formation of a bull market top. Divergences abound.

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Our current view is the lift-off will be December or later. Assuming inflation will pick up and the Fed hikes the rate by the end of 2015, stocks will perform relatively well, with international stocks a better bet than U.S. stocks.

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The “cash on the sidelines” is a Supply/Demand argument that we’ve struggled with even in the most bullish of times; every purchase of a security is matched with a sale. But even taking the argument at face value, current holdings of retail investors and mutual fund managers suggest that the cash left the sidelines long ago.

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How will today’s bull market be viewed through the eventual clarity and objectivity of hindsight? We’ve pulled together several still frames that we think best capture the essence of this historic run.

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A look at profitability trends at the broad sector level; only Utilities and Telecom Services are experiencing levels below their long-term medians.

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Can a deflationary outlook coincide with a bullish stance on equity markets? The short answer: YES. Periods of more commonly experienced mild deflation have actually coincided with above average stock returns, especially when deflation occurs outside of a recession.

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Has the recent collapse in crude oil prices presented us with a good opportunity for an outright commodity investment? No. Energy stocks aren’t on our radar screen either.

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A big question for investors is: have oil prices bottomed? For the past four days, WTI jumped 19% from its low reached on January 28th, giving some the conviction that prices are reverting back to prior high levels.

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We are nothing if not contrarians, but have also highlighted the hazards of “knee-jerk” contrarianism—in which investors are instinctively drawn to the asset, sector, or stock that is down the most in price in the recent past.

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Six of the seven factor categories we track have turned in positive performance so far in 2014; Value is the exception. Lost in the numbers is that most of the value has come from the short quintiles, so it has been hard for managers to take advantage of this trend.

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The recent strength in the dollar coincided with a spike in volatility and weakness in risky assets, but the relationship over the last couple years has been tenuous at best.

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