Amidst a torrent of unrest around the globe, the US stock market has essentially reacted with a shrug, racking up returns of 20.55% through the first three quarters of the year. September, often a challenging month for stocks, returned 1.72%. Historically, when stocks have done as well as they have at this point in the year, they tend to finish out the year with positive results. On the other hand, here we are in October, the month of Halloween and also the two worst months in recent stock market history: October 2008 and October 1987.
In my opinion, the backdrop is something akin to a haunted house. The fear people sense is related to the shenanigans in Washington DC. Controlling the narrative, manipulating the average person’s view, is the tool in traditional and social media. The goal is to sway the popular viewpoint. With November 2020 looming, one powerful tenet dating back to 1992 is “it’s the economy, stupid”, meaning one’s election fortunes are closely tied to the economy, and by extension, the stock market. The conviction that everything will be done to buoy the stock market may well be the foundation investors are building their hopes on for the coming 12 months.
While stock prices are up over 20% year to date, it’s more or less a return to baseline. Everyone is avoiding the fact that at the start of the year, stock prices had just fallen nearly 20% from their late summer 2018 highs. Today, if we consider the trailing 12-month returns of the S&P 500 (instead of the year to date) stocks are up 4.25%, less than ½ the long term historical average.
Fundamental concerns for investors at this juncture are related to upended global trade and business activity in disarray, the Federal Reserve’s next move, and the all-important earnings for 4Q2019 and forecasts for 2020.
The trade war the administration has undertaken with China, Mexico, Canada and the Euro-zone is not benefitting US business. To the contrary, it’s a significant factor in the deceleration of global growth. Without constructive policy and a predictable rules-based system, the current backdrop causes businesses to withhold investment. In the coming years, there is a good chance we will experience economic fallout in the form of low growth and negative interest rates due to lack of business investment today.
The Federal Reserve may not be able to jump-start an economy that is principally under pressure from erratic policy from Washington. Since 2008 and the financial crisis, many cite monetary policy has become a far less effective tool. I would argue that the economy in fact needs targeted spending (fiscal stimulus) and public/private partnerships to jump-start largely stalled economic growth. The deficits resulting from the 2017 tax-cut will of course make stimulus more challenging.
Earnings are clearly the elephant in the room. At the moment, according to FactSet Research, estimated earnings for 3Q 2019 are expected to decline 4.1%. This will mark the third successive quarter of year over year earnings declines. Heading into the end of the quarter, more and more companies have been issuing negative guidance. The 12 months forward earnings estimates (through 9/30/2020) for the S&P 500 are 181.66. The S&P is currently in the 2,900 range, implying a 15.9x forward P/E multiple. From here, for stock prices to rise, earnings growth must resume.
October is typically not the time of year to taunt the stock market with anything that might frighten investors. At the same time, U.S. corporations, up to this point, appear to be making their way through the corn maze. This is the foundation on which our guarded optimism rests. Stocks remain the most attractive investment option. We are still finding growth opportunities, though it is clearly a market for stock pickers. Quality U.S. corporate names with solid fundamentals and prospects for steady earnings make up the universe of names we keep on our short list.
As we approach year end, we will be reaching out to you to make sure we have addressed your concerns, capital gains constraints, or any other aspects of your financial life. Please feel free to reach out to us if you have any concerns in the meantime.
Bruce Hotaling, CFA
The views and opinions stated herein are those of Bruce Hotaling, are of this date, and are subject to change without notice. Information contained in this report was received from sources believed to be reliable, but accuracy is not guaranteed. Investments are subject to market risk, including the possibility of loss of principal. Past performance does not guarantee future results. The S & P500 is an unmanaged index of 500 widely held stocks. Investors cannot invest directly in an index. The PE ratio (price/earnings) is a common measure of relative stock valuation.