The Bottom Line - - We continue to be optimistic and have advocated not taking any drastic action during this period of heightened volatility and decline. We believe that this environment will persist through the elections in two weeks but that the bias is ultimately to the upside. In our view, the current market environment presents a buying opportunity. Many stocks have been put on sale and we will continue to seek out solid companies with decent prospects for the future. We believe fixed income investing will continue to be difficult but that opportunities still exist in short term securities tied to increasing interest rates, low volatility portfolios, and high yield bonds.
We haven’t changed our views regarding the capital markets. The year-to-date gains posted by the S&P 500, NASDAQ, and Dow have been mostly eliminated over the past couple of weeks. The sell-off began with the rise in Treasury yields a few weeks ago and has continued. The tech heavy NADAQ has corrected (declining more than 10%) and market volatility as measured by the VIX (aka the Fear Gauge) has more than doubled over the last month. Technology and Consumer Discretionary stocks which led the market higher this year have suffered among the worse declines as have a few of the more cyclical sectors – Financials, Industrials, and Materials.
Numerous factors have driven the sell-off including concerns over earnings growth slowing next year, anticipated additional short-term rate hikes by the Federal Reserve, the uncertainty over tariffs and trade talks with China, fears of an economic slowdown globally to name just a few. These issues within the context of an economic expansion which is long in tooth from a historical perspective have investors’ edgy. Selected S&P 500 company comments during earnings conference calls regarding rising costs or projected tariff impacts have fueled concerns further and exacerbated the sell-off.
These concerns largely are not new. As we have mentioned previously earnings are in fact peaking and are projected to grow at about half the current rate next year. That will put next year earnings in the “good” category unlike this year which has been in the “great” category. What is seldom talked about is the drop in the market multiple (price earnings ratio or P/E) because of earnings growth of around 20% this year. The P/E on the S&P 500 has dropped from north of 18X to barely 15X. If one assumes no growth in earnings next year the current market multiple is around 16.8X – hardly excessive. Recent financial press has also pointed out reported revenue disappointments announced during earnings calls, and while there have been some, revenues are running in line with expectations. Revenue growth is predicted to drop next year along with earnings, but this is not new news. The uncertainty about the ultimate outcome of trade talks with China have further fueled the sell-off as downward earnings revisions may be a result. Again, these concerns are nothing new and will continue to hang over the capital markets as a “known unknown” until resolved.
The rise in Treasury yields have also caused concern and in general are portrayed negatively. As mentioned previously we view the increase as an acknowledgement of an economy that is growing and a positive. Many have forgotten that even with the increase in interest rates and projected increases over the next year we continue to be at low levels within a historical context. A month ago, many were concerned over a flattening yield curve. Now that the curve has steepened folks are worried about what they wished for – normalcy.
The current economic expansion has been long but also subdued; we are currently experiencing a pick-up in economic growth towards more normal levels. This has occurred without a meaningful pick-up in inflation which we view as a positive. We believe wage inflation will remain muted.
We believe the expansion has a way to go and our research providers do as well. With the sell-off the gap between performance of growth oriented and value-oriented stocks has narrowed as monies have flowed to some of the more defensive sectors. Both growth and value stocks in the S&P 500 have negative returns over the last two months but value stocks are down less.
The Bottom Line
We continue to be optimistic and have advocated not taking any drastic action during this period of heightened volatility and decline. We believe that this environment will persist through the elections in two weeks but that the bias is ultimately to the upside. In our view, the current market environment presents a buying opportunity. Many stocks have been put on sale and we will continue to seek out solid companies with decent prospects for the future. We believe fixed income investing will continue to be difficult but that opportunities still exist in short term securities tied to increasing interest rates, low volatility portfolios, and high yield bonds.
