In 1998, the world experienced a strong dollar and a drop in oil prices.  At that time, the only place to invest was in a few large cap stocks.  We are seeing a complete replay of that scenario today.  If you listen to the folks on CNBC, the stock market is in a bull market as measured by the Dow and S&P 500 indices, which are both heavily weighted to a handful of large company stocks.  Underlying fundamentals of a majority of the stocks out there tell a different story – international, small company, micro cap and emerging equity markets are all negative this year.  As of September 15, 47% of the stocks in the Russell 2000, which is over 920 stocks, were down more than 20% in value.  This bifurcation of returns is the widest it has been since 1998.  The good news is that the disparity of returns in 1998 set up a multi-year time period where diversified portfolios significantly outperformed the Dow and the S&P 500 indices.  We think the stage is being set again for US large company stocks to underperform in the near future.

If you look at the earnings of US large companies today, they will be under pressure in the months ahead.  Almost half of the S&P 500 revenues are derived from sales overseas.  Both Europe and Japan are engaging in a currency war by trying to devalue their currencies in order to spark economic growth.  Economist James Grant recently performed a study on the impact of a rising and falling dollar on company earnings.  His study indicated that companies will accept lower profits when translated back to the dollar than to lose market share by raising prices overseas when the dollar is strong.  In other words, earnings for US companies selling overseas will suffer during a period when the dollar is rising.  Intuitively, earnings of smaller companies selling mainly to US markets should hold up much better than their larger brethren.  Emerging market stock earnings should also improve because their goods would now be cheaper for US consumers.  Thus, one would expect larger companies to underperform which is the opposite of what is occurring this year.  In the months ahead, a diversified portfolio that is underweight large US companies should outperform, just like it did in the four years following 1998.

What we are saying today is similar to what we were telling clients at the end of 1998.   Many people incorrectly think that if it is a large cap stock, it is a safe investment.   Click here to view a copy of our quarterly newsletter from March of 2000 that we thought you might find of interest.

High-Yield bond update

We have mentioned in previous market updates that we have reduced THOR’s exposure to high yield bonds to the lowest level in our firm’s history.  We did this because of relative valuation.  We did not know what would cause a drop in high yield bond prices, but we believed that the risk of being in that space did not justify the expected returns.  As you can see from the chart below, this move is starting to pay off. 

What does this mean for investors?

When the market has dislocations like this, it opens up opportunities.  We believe the riskiest part of the market is US large cap stocks.  We added to emerging markets in October and expect to add more to this sector as the market adjusts.  Buying cheaper assets with expensive dollars makes more sense to us than buying expensive assets – US large companies – that will experience problems growing earnings in the future.  Smaller company stocks are also beginning to look more attractive.  We will look to opportunistically add to this area in the months ahead.  Having positions in the Euro short, managed futures and the non-traded REIT continues to pay dividends during this volatile time in the stock market.

Best wishes to all during this Holiday Season and looking forward to a fantastic 2015!

Sincerely,

Your THOR Team

THOR Investment Management, Inc. is a registered Investment Adviser with its principal place of business in the State of Ohio.  The commentary contained in this market update is limited to the dissemination of general information pertaining to THOR’s wealth management services.