Summer is here, and the heat is on. A quick glance at the weather map shows vast portions of the country shaded dark red reflecting temperatures north of 95 degrees. The National Weather Service is expecting temperatures in New York to top 90 degrees for the next seven days, something that apparently happens only once every 30 years.Extreme temperatures in Chicago led to hosing down the Michigan Avenue bridge in order to cool it to the point the expanded steel would once again lift to allow boats to pass. In a replay of last fall, raging wild fires have struck in California, Colorado, Utah and New Mexico.
Communities in the west are mandating water restrictions due to the eerily low snow pack from the past winter and low rain fall. Climate change and the associated heat is compounding the existing water crisis. The High Plains Aquifer in eastern Colorado is drying up. The Denver Post reviewed federal data showing the aquifer shrank twice as fast over the past six years compared with the past 60 (Denver Post, 8/10/17).The problems associated with agricultural over-pumping, farming drought-prone prairie land, increasing development and demand for natural foods is overwhelming the limited water supply. If all pumping stopped immediately, it would still take hundreds of years for rain-fed streams and rivers to recharge the aquifer.
Theatmosphere surrounding the stock market is tense and selling bouts are sharp. While year to date returnsremain positive at 2.65%, measured by the S&P 500, its becomingever more uncomfortable. There has been pronounced selling, particularly by fund and ETF holders. To date, this has been more than offset by companies repurchasing their own shares. There were $433.6 billion in share repurchases during the period, nearly doubling the previous record of $242.1 billion in the first quarter, according to market research firm TrimTabs. The buying has supported returns, but it cannot last.
The stock market continues to favor high growth stocks over dividend or value plays. We pay close attention to these trends and it has been favorable for our style of investing. According to Bloomberg, more than 100% of the S&P 500’s year to date total return is attributable to just 10 stocks, including Amazon, Microsoft, Apple, Facebook, Visa, Adobe and Nvidia. These are all large cap growth stocks we have owned for a number of years and our positioning has provided us with an attractive tail-wind.
The key questionis, how credible is the threat to the current $175 per share in earnings forecast for 2019. As the trade war continues to escalate, expected earnings figures will inevitably begin to be talked down by analysts. We may encounter this as early as the 2Q reporting season beginning later in July. U.S. corporate tax receipts, according the U.S. Bureau of Economic Analysis, have fallen by over 30% since the same time last year. Will our ballooning debt lead to higher interest rates, and a rate induced deceleration?
Another important measure is the yield curve. The economy is heated up, with slackening regulations, reduced taxes and a frothy mindset on Wall Street. The Federal Reserve has been steadily raising rates, and this has flattened the yield curve. The spread between the U.S. 10-year and the 2-year is now a mere 0.28%. An inverted yield curve is a widely accepted (and often self-fulfilling) indicator of a recession. A recession is a period when both economic activity and trade are in decline. This leads to declining corporate earnings, which in turn pulls stock prices down.
So here we are, in the hot-seat. Atsome point the winds will change and we will have to make some tactical adjustments to the portfolios. It’s not at all clear when, but things will change, as they always do. Until then I suggest we try to become more comfortable with the heat, the volatility and the seemingly incessant flow of fiction dressed as news. I may look in the attic for the old Ouija board to see if we can derive any clearer signals (just kidding). In the mean time I hope you have found a cool and comfortable place to enjoy some fireworks, in the true sense. Happy 4th of July. Please feel free to call if we have not been in touch recently.
Bruce Hotaling, CFA