Take a Deep Breath
Halloween came and went this year, and not a single clown came by the house. I have to say, I felt a degree of relief. Something new this year, creepy clowns, have been in the news and haunting us in ways most of us have never imagined. There is a cloak of fear now associated with clowns. I think many of us have been holding our breath in response to the vastly irrational circus we’ve been watching. I suspect and hope there is a collective sigh of relief November 9th when this very odd chapter in our history is in the rear view mirror.
Stock prices, measured by the S&P 500, fell 1.9% in October, the largest monthly drop we’ve seen since the 5.07% plunge in January. October’s lull follows -.12% returns in both August and September. Bespoke Investments pointed out that the three month drop, which tallied less than 2%, was quite unusual and in fact, such a modest three month fade has only happened three other times dating back to 1951. Year to date, stock prices are in the black, having returned a surprising 5.87%, as investors have largely looked through the upcoming election.
On the economic front, GDP figures for 3Q 2016 came in at 2.9%, driven largely by consumer spending and exports. We haven’t seen a GDP number that high since 3Q 2014. Good news is that economic growth in this range is expected to continue through the fourth quarter and into next year. The jobs creation figures have been encouraging for some time, and we’ve recently seen a meaningful pick-up in wage growth. The oil patch continues to stabilize after a near 2-year swoon, and the rebound in prices, contrary to common thinking, is encouraging renewed investment (infrastructure, transportation) in energy related businesses. These factors, in my opinion, will likely allow the Federal Reserve to raise the Fed Funds benchmark next month.
Last year, on December 16, 2015, the Federal Reserve raised rates by 0.25%, for the first time in over 10 years. Stock prices immediately proceeded to correct. From that day until the market’s low on February 11, 2016 stock prices fell 11.5%, echoing the old mantra “don’t fight the Fed.” Some believe when the Fed is raising rates, tightening monetary policy, it indicates a top to the cycle, and is a bad omen for stocks. Whether this thinking played a part in the market drop, or not, we will never know. While I do not agree, be aware there are a lot of people who think this way, and there is a good chance the Fed will raise rates again, for the second time in over 11 years, on December 14, 2016.
According to FactSet Research, impressive earnings reports this quarter have at long last moved the dial. As recently as September 30, Q3 earnings were expected to fall 2.2%. Now, as of October 28, the earnings growth rate for the S&P 500 is a positive 1.6%. That is an important swing and one I have been counting on. After the relentless drag on corporate earnings due to the oil price implosion and the high US$, this quarter may well mark the first year over year earnings growth we’ve seen since the 1Q 2015. The financial stocks have been the largest contributor to the bump in earnings. Assuming the energy sector continues to normalize, we should expect a dramatic lift to the earnings for the S&P 500 in 2017.
I think it’s prudent to reduce asset allocations to fixed income at this point. The credit concerns in the corporate and municipal space that shook the world in 2008 are healed. Today, the primary issue is interest rate risk. Rates appear to have inflected, and individual bonds and bond mutual funds are vulnerable to price degradation. Interest rate surrogates such as REIT’s and MLP’s have also come under some selling pressure as investors consider a shift in the yield curve, but I have confidence that a favorable economic backdrop and their ability to increase their distribution levels will offset worries over higher rates.
Please feel free to check in if you have concerns related to the pending election. Fears of a Brexit-like outcome have compelled some investors to raise cash, and this is likely the source of current pressure on the market. My expectation is that the fundamentally sound backdrop in place today will allow quality growth stocks to continue to work for us. Take a deep breath.
Bruce Hotaling, CFA, Managing Partner
The views and opinions stated herein are those of Bruce Hotaling, are as 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&P 500 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. This note contains forward-looking statements, predictions and forecasts (“forward-looking statements”) concerning our beliefs and opinions in respect of the future. Forward-looking statements necessarily involve risks and uncertainties, and undue reliance should not be placed on them. There can be no assurance that forward-looking statements will prove to be accurate, and actual results and future events could differ materially from those anticipated in such statements.