The US markets made headlines last week.
In case you were not aware the US markets seemed to have entered a ‘bull market’ since the start of the year. The US markets (S&P 500) have had their best January month since 1997, with the S&P 500 up already 6%. The Dow Jones Industrial Average has had their best January since 1994.
What on earth is going on? Did we not have a credit crisis from which we are all recovering?
Perhaps we may remind our readers, Lehman Brothers has disappeared, AIG has effectively been nationalized, as has GM, and Citigroup can look to the US government as the single largest shareholder. Why then is the S&P 500 only 3% away from its historic all time high achieved in 2007? We think the answer is based on two parts: Firstly we think the US markets have diverged from the real economy, which has improved only marginally. Rather the US equity markets reflect that ‘its the best option within a group of lousy options’.
Meaning, US equities offer more opportunities than other asset classes. This is probably true. Think of it this way. Would you rather own Johnson & Johnson or Kimberly Clark that yield 3.3% or invest in US money market yielding close to zero? Own 1o yr. US treasury bonds that yield 2% or take part in the profit growth of US multinationals which on average offer a higher yield only one year out?
From this perspective US government bonds do not look that attractive and US equities do not look that bad an option.
The second answer can be found in a stock that should be known to some investors. Apple.
Indeed we think the maker of the IPhone and I pad can yield clues as to what is going on in the US markets. While US stocks have started off to a very strong start to 2013, would you like to guess which is the worst performing stock this year in the S&P 500? It’s Apple. Someone clearly has taken a bite out of the Apple (see image above). The once stock market darling of the past eight years has fallen almost 35% since their peak of $700 in September last year. It is down 14% year to date (see chart below).
So why are we pointing this out? Not because we are interested in Apple as an investment. But rather because of something important called ‘Investor sentiment‘. Investor sentiment is a critical component of investing and looking at Apple shares shows why. Investor’s sentiment has shifted against Apple very quickly despite its strong results posted in January.
And therein lies the problem for US equities. Investor sentiment has favored the US markets now given the problems in Europe. But this can turn very quickly. And we at LME do not want to be on the wrong side when the sentiment does turn negative. Given that the economy is moderate at best and that the jobless rate is still significantly too high at 7.8%, we think the margin for error for equities to disappoint is high.
Concluding thoughts
So while US strategists are pointing towards Dow 17’000 and the S&P 500 to break its previous record high, I see things differently. We think the US markets will not improve from current levels and be lower by the end of 2013. We are thus staying defensive, increasing our cash position and as a hedge to our long positions, have increased our short positions on the S&P 500 using the following ETF’s (SH & SDS).
