Investment Insights: The gravy train stops

Wade Balliet
Posted by Wade Balliet
Investment Strategy

This weekly report presents insights from our Global Investment Management team.

Young female broker looking serious on the phone, surrounded by several monitors showing stock market returns.The same stocks which were the darlings for so much of this historic rally have faltered, dragging the S&P 500 off this year’s highs and creating worry that something more nefarious is happening in the market.

After increasing 38.83% in 2017, the S&P 500’s technology sector is now up just 4.08% after hitting a total return peak for the year of 21.61% a little over a month ago. The FAANG stocks (Facebook, Apple, Amazon, Netflix, and Google), which are now spread across the technology sector as well as the newly defined communication services sector have seen some of the larger declines from peak levels. Facebook has fallen 37.31% from its peak, Amazon more than 25% from its, and Apple, Netflix, and Google are all off over 23%, 36%, and 17% from their respective intra-year highs as well.

With these securities starting the year comprising almost 11% of the S&P 500, large moves within these individual names have a significant effect on the broader index, and have resulted in increased volatility for U.S. equity investors. From security breaches to possible tariffs on tech components, the sector has had its fair share of struggles even with the expectation of a big holiday season for retail on the horizon. Additional pressure on the market is posed by the ongoing rout in oil prices, after West Texas Intermediate (WTI) crude hit $76.41 per barrel on October 3rd, it has fallen more than $20 per barrel down to $54.33, putting it in bear market territory currently. With the precipitous slide, energy companies have also contributed to the sell-off with the energy sector down almost 15% from the WTI price high.

As the Global Investment Team reported last week, the fundamental state of the U.S. economy still remains strong although in the later stages of the business cycle. Unemployment remains low, confidence among consumers and business remains high, monetary policy hasn’t tightened financial conditions to extreme levels, and fiscal policy should continue to carry stimulus through 2018 and into 2019. Additionally, earnings still remain strong for U.S. companies. With 484 of the 500 companies reporting earnings for the 3rd quarter, the S&P 500 recorded 26.13% earnings growth and 8.01% sales growth. This was after a 2nd quarter with 25.41% earnings growth and 9.25% sales growth, as reported by Bloomberg.

While these are not the only things to concentrate on when evaluating our equity allocation within portfolios, when the team reviews our entire list of recession indicators, the majority of boxes are not being checked and conditions still look favorable. Reading the tea leaves to understand the volatility the market has experienced over the last couple of months, it seems to come down to a few key risks: First and foremost the actions, as well as the rhetoric, surrounding the Federal Reserve continue to spook investors. The Fed’s path to higher rates and its outlook has equity holders worried that the increase in rates will hamper liquidity resulting in a slowing housing market, tougher interest expense coverage ratios, and an even stronger dollar.

This, combined with aggressive trade policy and the aforementioned strong U.S. dollar, will eventually make its way into corporate income statements which would undermine one of the resiliencies U.S. markets have enjoyed to date – stellar earnings. While the team does not believe it is time to make a significant reduction to equities, cracks that appeared earlier this year have widened and have caught the attention of investors. The next 9-12 months will be volatile, but should continue to produce positive returns for U.S. equity holders. Happy Thanksgiving to you and your families from the Global Investment Management Team.

Chart showing various market returns as of 11/20/18

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Investing involves risk, including the possible loss of principal and fluctuation in value. Economic and market forecasts reflect subjective judgments and assumptions, and unexpected events may occur. Therefore, there can be no assurance that developments will transpire as forecasted. The information in this newsletter is for informational purposes only and is not intended to be investment advice or a recommendation. Nothing in this newsletter should be interpreted to state or imply that past results are an indication of future performance.

Fixed income securities are subject to interest rate, inflation, credit and default risk. The bond market is volatile. As interest rates rise, bond prices usually fall, and vice versa. The return of principal is not guaranteed, and prices may decline if an issuer fails to make timely payments or its credit strength weakens.

International securities involve additional risks such as currency fluctuations, differing financial accounting standards, and possible political and economic instability. These risks are greater in emerging markets.

Diversification and asset allocation do not ensure a profit or guarantee against loss.

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