Year: 2014

On the surface, the performance of the major indexes appeared to show a calm market over the first few days of the week. If we look deeper there is a raging battle between the bulls and bears.  That was very evident today at the major indexes slumped, led by the Nasdaq which was down 1.75 percent.

The Dow Jones Industrial Index came within 16 points of its all-time high during trading on Tuesday, and closed Thursday about 0.5 percent away from that new high.  A new high was not yet meant to be; the DJIA dropped .85 percent on the day.  Earnings results from Ford (F) and Amazon (AMZN) sent the market sliding today.  Bulls are still waiting and watching for a break, but selling throughout the day means no new highs will come for several days.

Nevertheless, the DJIA is still close to a new high. A solid day or two in the market could push it into record territory and force the bears to cover shorts.  This has the potential to start another multi-week rally in share prices after a long sideways consolidation period this year.

The next few days will give us a strong indication of the direction the economy and stock market will be headed over the coming months. The bears believe the markets are topping and chartists see the Nasdaq and Russell 2000 as tracing out head-and-shoulders patterns. This would indeed be a bearish topping pattern if fully formed. Luckily for the bulls, these patterns are not complete and are only speculative guesses.

More worrisome is the economic weakness in China. The yuan weakened below the critical 6.25 level and reports show no sign of a pickup in economic growth. Also of concern is the escalating situation in Ukraine. There is a financial war unfolding and Russia is responding to U.S. financial attacks by threatening retaliation. China and other emerging economies could deliver a major blow to Western markets if they act in concert, and they have grown increasingly wary of U.S. political interference in economic affairs.

If the conflict escalates in this direction, it could prove to be the financially destabilizing shove that finally pushes China into a further slowdown. Investors should not assume that leaders in Moscow and Beijing, who are politically secure, would be unwilling to make economically damaging moves that have big political payoffs.

While a few high profile risks exist, there are still a number of positive indicators. The most important stock for technology funds is Apple (AAPL), which delivered a positive earnings report, raised its dividend, increased its buyback plan and announced a 7 for 1 stock split.

Additionally, the flash manufacturing PMI for April indicates the U.S. manufacturing sector is still expanding at a healthy clip. Manufacturing is a leading sector in the economy and continued strength here will mean solid growth for months to come. Confirming the PMI number were strong results in durable goods orders.  Next week the GDP report for Q1 and the unemployment rate for April will be released.  This will give us even more insight as to the direction of the economy.

Fidelity has won 18 Lipper Awards recently across 15 funds. The awards were given on the basis of “risk-adjusted, consistent return.” There was no sector or asset class concentration in the awards, with everything from treasury bonds to biotechnology and China winning recognition.  In several cases, the institutional (lower fee) version of a fund won the award.

Below are the winners:

Fidelity Advisor Biotechnology (Institutional)
Fidelity Advisor Income Replacement 2042 (Institutional)
Fidelity Advisor International Real Estate (Institutional)
Fidelity Pacific Basin
Fidelity Select Consumer Finance
Fidelity Select Defense and Aerospace
Fidelity Spartan Long-Term Treasury Bond Index
Fidelity Advisor China Region (Institutional)
Fidelity Advisor High Income Advantage (Institutional)
Fidelity Convertible Securities
Fidelity Select IT Services
Fidelity Intermediate Government Income
Fidelity Select Energy
Fidelity Select Software and Computer Services
Fidelity Worldwide

We hold several of these funds in our portfolios, including Fidelity Convertible Securities (FCVSX) and Fidelity Select Energy (FSENX).  In addition, numerous other funds, such as Fidelity Select Biotechnology (FBIOX), which have been highly ranked the newsletter.  In general all of these funds are solid choices in their part of the market. This month we’ll look at how some of these asset classes and sectors are shaping up in 2014.

The biotechnology sector has been outperforming for more than two years now, with the fund’s performance accelerating in early 2014 (a chart of FBIOX starts looking hyperbolic in late 2013). Going back to the start of its outperformance in 2011, when FBIOX was up about 17 percent in a year when the S&P 500 Index was flat, the fund climbed as much as 236 percent from its closing price in 2010. Since hitting its peak, however, shares have tumbled, down 17 percent over the past two months.

There are reasonable explanations for biotech’s slide. One is company specific issues. As mentioned in the Market Perspective, Gilead (GILD) received a letter from Congress asking about the $84,000 price for its hepatitis-C drug, Sovaldi.  However, while the Congressional inquiry may have shaken up the company, the losses in GILD are right in line with the sector. Many analysts see GILD rebounding from the sell-off.  The drug, while expensive, is also highly effective and cheaper than the alternative of treating patients with this chronic illness.

The other reason for the drop in stock prices is overbought conditions. Biotechnology exploded higher in 2014. FBIOX was up more than 25 percent by early March, compared to the S&P 500 Index which was only breaking into positive territory in March. Investors piled into volatile, high growth sectors such as biotechnology and Internet stocks early in 2014 and this resulted in a sell-off over the past few weeks. Given the run-up, further profit taking may be a possibility given the huge advance in biotechnology shares. Over the long-term, the outlook for biotechnology remains positive due to an aging population and a need to find more cost effective treatments.

Fidelity Convertible Securities (FCVSX) remains a solid choice for investors looking for a little more risk than bonds, but less risk than stocks. Convertible bonds can be converted into equity once the stock price reaches a certain threshold. Those bonds a long way from converting to equity will behave in a more traditional manner. As the stock price climbs, the bonds begin behaving more like equities. These funds offer some downside protection when stocks fall (since they trade more like bonds) and they offer upside during bull markets.

Convertible bonds yield about 2 to 3 percent, and FCVSX paid a yield in the middle of those two figures last year. Fidelity Convertible Securities gained 24 percent last year, lagging the 31.9 percent advance in the S&P 500 Index. The future significantly outperformed straight bond funds, many of which lost ground due to rising interest rates.

FCVSX had outperformed the S&P 500 Index for most of this year, although it how now lost some ground, trading even with the broader index. The fund has about 18 percent of assets in equities and two of those equities are top ten holdings: General Motors (GM) and Citigroup (C). GM has recall problems this year, and Citi failed its stress test last week, sending shares sharply lower. It’s a bit of bad luck for FCVSX, but the fund won its Lipper Award for 5-year performance and investors should keep an eye on the long-term performance. Unlike other more volatile sectors, the benefits from owning FCVSX accrue more slowly across a complete market cycle.

Fidelity Pacific Basin (FPBFX) won three awards for three-, five- and ten-year performance. Manager John Dance was appointed in October of 2013, so he has some big shoes to fill. The fund has hit a new post-2008 high, which is better than the benchmark Pacific/Asia indexes. Strong performance came on the back of technology shares, helping FPBFX to track the Nasdaq as it moved higher in 2013. The top holding in FPBFX is technology giant Softbank, plus both Taiwan Semiconductor and Tencent Holdings are counted among the top ten. Softbank and Tencent both rallied more than 80 percent last year.

FPBFX also benefited from Abenomics last year. The rapid devaluation of the yen unleashed a stock market rally, but with about 37 percent of assets in Japan, FPBFX will need to see this trend continue, something which is an open question in early 2014. Australia is the next largest country exposure in the fund at 13 percent of assets, followed by Hong Kong at 12 percent, China at 9 percent and Korea at 8 percent. These four economies are all closely linked to the Chinese economy and the slowdown in China is worrisome.

Another Lipper Award winner was the institutional class of the China Region (FHKCX) fund. Chinese shares are nearly flat for the past 5 years, having peaked in summer 2010, but FHKCX kept posting gains. It still hasn’t surpassed its 2008 peak, but the performance is very good considering the overall condition of the Chinese stock market. This makes FHKCX an attractive pick for investors looking to buy China. It also shows that Fidelity has strong analysts who have helped keep two emerging market heavy funds outperforming their peers, and that gives us more confidence in the recent appoint of John Dance as manager of the Pacific Basin fund.

Conclusion

At a time when ETFs are providing a formidable challenge to mutual funds, Fidelity’s strong management shows that active managers still have much to offer investors. Those who favored a market capitalization weighted China index ETF, for example, would have seen their money go nowhere over 4 years, while Fidelity’s China Region fund racked up respectable gains. Active managers have some restrictions on how they invest, but they also have more freedom to shift a portfolio towards sectors and countries experiencing bull markets.

Furthermore, awards were won across a spectrum of funds at Fidelity, including convertibles, international REITs, bonds and sector funds. This shows the strength of Fidelity’s managers and the analysts who help them find individual assets that can outperform the market. While the list of winners above is strong, it is not an exclusive list of the many great funds offered by Fidelity.

Stocks seemed to have found their footing, with the major indexes bouncing in a holiday shortened week. The S&P 500 Index gained 2.7 percent on the week and more importantly, the Nasdaq rallied 2.4 percent. Energy also proved to be a big winner as oil prices moved higher, followed by stocks in the sector.

The Dow Jones Industrial Average is also poised for a bullish breakout. We have talked about how the Dow has not made a new high since late 2013, but it has outperformed the other indexes during the recent slump. On Thursday, the Dow closed less than 200 points away from its all-time closing high. A move of a little over 1 percent will push it into new high territory.

This puts both energy and the DJIA on the verge of simultaneous bullish breakouts. Furthermore, the Dow is not an energy intensive index benefiting from energy’s advance. Instead, it appears that economic activity is picking up and energy prices are moving with it. The events in Ukraine are often cited as the cause for rising oil prices, but there’s reason to be cautiously optimistic that the rise is in fact due to economic strength.

We will know in the coming weeks whether this is the case as economic data from Q2 is released.  Janet Yellen and the Fed certainly believe the weather was to blame for weakness in Q1. The Fed’s Beige book, which contains information on the current condition of the economy, mentioned the weather quite often. Areas of the country where economic data remained sluggish did indeed see colder weather. We remain skeptical about the impact of the weather on GDP, but what’s important now is Q2. If there’s a pickup in activity, investor sentiment will turn around in a hurry.

One sign of increased investor optimism appeared as utilities dropped 1 percent on Thursday. Utilities are defensive, but they rallied along with stocks earlier in the week. The slip on Thursday may be a sign that defensive investors are leaving for riskier sectors. At this point, the dip might only represent a normal pullback. Utilities enjoyed a strong run this year and a small retreat does not signal a change in trend. We still favor utilities as a defensive position and we will monitor this sector closely.

Earnings reports and guidance were mixed this week. Hits were delivered by Coca-Cola (KO), Johnson & Johnson (JNJ) and General Electric (GE). Misses were IBM, Google (GOOG) and Unitedhealth Group (UNH). This continues the pattern we have seen previously of investors rewarding good reports or guidance and punishing earnings misses or weak guidance. It’s a positive sign for the market because it means sentiment is not overall bearish. The winners would struggle to rally in a weak market, but they saw considerable bounces this week. Next week it will be important to see these gains are held, but overall this was a very good week for the markets.