A shift in sentiment in the second half?

Consider recent comments from Fed governor Stanley Fischer, who made it clear that an interest rate hike simply means the Fed is moving from an “ultra-expansionary” policy to an “extremely expansive” monetary policy. Furthermore, anything beyond the initial hike is far from certain; as Fischer points out, there’s “considerable uncertainty” about the final destination in the Fed’s campaign to raise interest rates.

To that point, the notion that future movements in interest rates are “data-dependent” is Fed-speak designed to telegraph a position that has not been fully vetted – and the most common data points are anything but conclusive.

Take the most recent data points: the income and employment reports for March. Although U.S. wages rose by a modest 0.3%, most of those gains are attributable to increases in management compensation, which accounts for less than 17% of the overall workforce.

The March employment report clearly was a bust. Job creation is running at half the forecasted pace. Worse still, the numbers for February were revised downward by more than 60,000 new jobs, which means the 125,000 number for March actually was closer to 65,000. That’s hardly robust at this point of an economic recovery.

The other challenge facing the Fed is the U.S. dollar (US$). As the world’s reserve currency, a stronger greenback suppresses oil prices, lowers the cost of U.S. imports and keeps a lid on inflation. An interest rate hike could add to the greenback’s strength, which is not what you want when trying to stimulate broad wage growth by reflating the economy.

A strong US$ also reduces earnings for multinationals – although probably not by as much as some would have you believe. I would argue that traders are focused on the income statement and how that affects the price/earnings multiplier. There is little discussion about the positives that could flow to the balance sheet of multinationals that are taking advantage of cheap euro-denominated loans.

For example, Berkshire Hathaway Inc. recently floated an eight billion euro bond issue; when priced in US$, the bond issue means that Berkshire is funding offshore operations at a very low cost. You could argue that a rising US$ means that this new debt is being delivered at a negative interest rate.

I suspect you will see more U.S. multinationals take this same tack, taking steps to strengthen their balance sheet in the longer term at the expense of a short-term impact on their income statements. By the way, any short-term drop in earnings over the next two quarters has been well telegraphed to the financial markets.

If I am right on this – and be forewarned that this is not the consensus opinion in the marketplace – we are likely to see a return to rising profits in the second half of 2015. With a Fed interest rate hike behind us, traders will focus on earnings again. Any shift in sentiment would provide the necessary oomph for the second half.

What we have, then, is a market that probably will not fall into a bear camp, but more likely will churn within a narrow trading range heightened by short-term volatility as liquidity tightens over the summer months. This is an ideal environment for writing covered calls on a broad spectrum of stocks in your portfolio.

Covered-call writing using slightly out-of-the-money strikes with expirations in August or September will provide additional tax-advantaged cash flow during this consolidation phase; assuming the stocks are not called away, this will leave your clients with assets that should grow nicely once earnings pick up.

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