Stock prices, measured by the S&P 500, continued their upward march, gaining 1.93% for the month of July. Year to date, the S&P 500 has generated a total return of 11.6%. These returns are respectable, by most historical measures of stock market behavior. Certainly some investors may be tempted to “step off” the merry-go-round, end the year right here, and wait around until the game starts up again January 1st, 2018.
An old Wall Street adage is “the trend is your friend,” and the recent period has been about as friendly as one could hope. July marked the sixth of seven months this year when prices advanced, an unusually steady winning streak. Over the trailing twelve month period, stocks rose eight of twelve months (stocks typically rise 66% of the time) for a total return of 16.04%.
During the period just prior to the election, earnings (and stock prices to some extent) tracked sideways. There was a long stretch, from 2014 to 2016, when oil prices imploded and the S&P 500 aggregate earnings were stuck at $117 per share. There is no doubt, the election injected a wave of optimism. But unnoticed, and coincident with this wave of populist fantasticism was a true inflection in corporate earnings growth. Beginning with Q1 17, corporate earnings leapt by over 14%. According to FactSet Research, growth for 2Q 17 EPS is expected to be over 10%, and expectations are for $131 per share in 2017 and $145 per share in 2018.
So what’s the fuss? These are terrific numbers. Stock prices measured by the Dow Jones, the S&P 500 and the tech heavy Nasdaq have been hitting record high after record high. In my opinion, investors see the earnings, and they see the stock prices, but there is this nagging sensation something awful is just around the corner. According to sentiment data from the American Association of Individual Investors, bullish sentiment is at 36%, having spent 28 of the last 29 weeks below 38.5%, the historical average. Another old Wall Street adage is stock prices climb a “wall of worry,” and this is largely what we have going on today.
The spectrum of worry is vast. Clearly, one dark cloud shading popular sentiment for owning risky stocks is the torrent of noise coming from Washington DC. Even amidst a period of record earnings, investors cannot take their eyes off the clowns. The void of leadership has left several investment grade “brides” standing at the altar. Up to this point, nothing has been accomplished with respect to regulatory reforms, infrastructure spending or lower tax rates. The pro-growth agenda that was going to accelerate corporate America and pacify Joe-the-plumber is gasping. With no fiscal policy and the Federal Reserve looking to normalize monetary policy, growth hangs in the balance.
Beyond the US, the worries expand. Constant geopolitical tension has become the new normal, whether it’s related to security, trade or the environment. It was clear at the recent G20 meetings in Hamburg Germany that the leaders of the developed world do not view the US in the same light they once did, expressing concern that the US is no longer the reliable partner it was in the past.
Tangible evidence of diminished faith in the US is the constant downward pressure on the US dollar index. While this is a tailwind for US corporate earnings, it also indicates fewer investors want to own US dollars. This is happening in the face of Federal Reserve tightening, generally reflective of higher interest rates and growth, something that would normally attract foreign investors to buy US dollars and assets.
As Mad’s mascot Alfred E. Neuman would ask, “What, Me Worry?” Stock prices are higher. It is widely viewed that stocks are the only game in town. If sentiment ever does take hold, and more investors overweight their allocations to stocks, the table is set for troubled times. I continue to have confidence in corporate America’s ability to leverage improving global growth and a low US dollar, and look forward to seeing the expected earnings realized. I am also well aware we have to tread cautiously here, as a lot of folks have their eye on the exit door, and don’t want to be the last one out. I look forward to catching up with you if we have not been in touch recently. Please enjoy your August.
Bruce Hotaling, CFA