The DJIA hovering around 17,000 upon the close of the second quarter raises many questions regarding stock valuations. We have stated that levels above 17,000 would be considered overbought territory relative to current fundamentals. This is confirmed by our observation of the companies we track, where only 8 out of the 39 positions are currently trading at attractive entry points relative to our price targets. Even though equity markets may be fully valued, a positive sign we are noting is in the area of earnings adjustment trends. At one point, only 5 out of the 30 DJIA components reflected flat to positive trends. We now see approximately 60% of these components reflecting flat to positive trends, which we interpret as an indication of an improving economic outlook. The question remains: How strong is the U.S. economy?
Our economy continues to grow but at a lower rate than anticipated for 2014. Many have attributed the slower growth to weather conditions experienced earlier in the year. The uncertainty in the magnitude of domestic economic growth has caused hesitation in the direction of interest rates. One positive at this time regarding how rates are being determined by capital markets is the absence of an impact caused by further reductions in the Federal Reserve’s commitment to purchasing bonds.
Many are also looking for inflationary signs to support a direction of interest rates. We feel that pricing pressures at this time are attributed to geopolitical issues surrounding the turmoil in Iraq and its impact on oil prices and not on supply & demand factors. We have stated in the past that anytime higher prices are not being driven by demand, these higher prices tend to have an anti-inflationary effect on a sluggish economy due to its negative impact on the purchasing power of consumers. The question we continue to raise is how strong must the economy be to sustain higher prices resulting in demand driven inflation?
We continue to monitor equity markets very closely as we formulate strategies at current market levels. Should a need arise requiring the reduction of equities within portfolios based on macroeconomic variables, our current game plan is to target non-dividend yielding positions as possible sells. This makes sense for trusts and retirees with existing spending rates where interest and dividends are needed to subsidize distributions. What about portfolios without spending rates? While we realize many of the dividend yielding stocks we plan to hold are actually trading at high premiums due to the demand for such companies, we must prioritize the sell candidates utilizing both valuation and dividend yield parameters.
Please note that even at current market levels, opportunities for both buying and selling do exist. Couple this with each client’s unique situation and we see the need for ongoing communication to determine the direction of your portfolio. It is highly recommended that you reach out to your consultant should you have any questions.
Finally, Ellis will be scheduling two more client events for the second half of 2014. If you are interested in additional event details, please contact Leslie Tritschler within our office at: 484-320-6300.