market’s rebound in October
Stocks rebounded in October, returning 8.3% for the month, and lifting the return on the S&P 500 to 2.9% for the year. October has something of a reputation for producing volatile investment returns. This year, August and September were both volatile and down months. It was important that stocks put up a strong showing to avoid sliding into a prolonged decline, or worse. The cautionary evidence in hand was strong, with two consecutive quarters and months with negative returns. Thankfully, October’s stock returns showed some muscle and broke the market’s downtrend.
Several catalysts drove the change in tone. For instance, corporate merger activity (Walgreens and Rite Aid, Ace and Chubb, Heinz and Kraft) leapt to new heights and gave investors an emotional lift. Another catalyst in October was the resurgence of corporate debt issuance. Corporate borrowings increased signaling improved confidence in the economic outlook and the fortunes of corporate America. Finally, and most importantly, earnings reports have been robust and reassured many sitting on the fence.
According to FactSet Research, the blended growth rate for Q3 S&P 500 EPS improved to (2.2%) at the end of last week from (5.2%) at end of last quarter. With the majority of companies reporting, 76% have beat consensus EPS expectations and in the aggregate, companies reporting earnings are 5.9% ahead of expectations. Nine of ten industry sectors have produced positive earnings growth surprises. Earnings have been impressive and the primary driver of the outstanding returns stocks posted in October.
To be clear, the backdrop for stocks is not overly compelling – so I am somewhat wary. At the same time, there is a constructive backdrop often referred to as “climbing the wall of worry.” The macro headwinds are widely discussed in the media. The ones concerning to me are : 1) slower growth across the globe, 2) the strong US $’s impact on US corporate earnings and 3) certain weak economic stats, such as the recent four-straight disappointing monthly non-farm payroll reports.
While stocks do not look cheap at this point, they do look as though they have a reasonable chance of generating their historical rate of return looking ahead 12 months. This cannot be said for some of the other asset classes investors have popularized. I profess “simple is good” and we avoid using asset classes we cannot cash flow forecast, or own directly (without having to use a third party manager or mutual fund). Our decision drivers are based on transparency, quality and liquidity. We utilize a number of different tools to accomplish this including fundamental, technical and quantitative research methods.
In many instances, we had raised cash (sold stocks) taking a more defensive posture as the market became more and more unsettled over the summer. The strength of the market’s rebound in October is reassurance that the market simply needed to blow off some steam, and is not in fact on the precipice of a prolonged downturn. It had not sold off in some time and there is a high likelihood that it needed to “reset” to a certain degree. Now, our focus is to remain well invested, building stock positons at attractive prices. Seasonally, the final two months of the year and first part of the new year tend to be favorable times to own stocks, and we want to take advantage of that tendency.
Difficult as it’s been, stocks remain the prime driver of returns for most investors this year. Growth stocks continue to generate higher returns than value stocks and dividends still do not matter as much as growth. So we will continue down this path. The fears rippling through the REIT market have tempered as have the fears related to the eventual Federal Reserve rate hike. The MLP market, now tied to the price of oil more than ever, will take longer to “normalize”, in my opinion, though the Q32015 reports are making it clear the businesses are maintaining themselves.
If we have not spoken or if you would like to review your portfolio I would be more than happy to get together with you. In the meantime, we are preparing for year end and want to minimize the effects of capital gains in your taxable accounts. Please feel free to call if you would like to discuss further.
Bruce Hotaling, CFA