by Connor Darrell
CFA, Assistant Vice President – Head of Investments Equities
posted healthy gains for the week despite a mixed bag of economic data and
tempering expectations for Q1 2019 earnings growth. Market optimism seemed to
be bolstered by reports from Chinese media outlets of progress in the U.S./China
trade negotiations, as well as an easing of concerns over Brexit negotiations.
On the economic front, the housing and
manufacturing sectors produced results that fell below consensus estimates,
continuing a recent pattern of weakness. New home sales dropped by almost 7% in
January despite the recent decline in mortgage rates easing affordability. Some
of the weakness can likely be attributed to the government shutdown and poor Q4
equity market performance which may have eroded the confidence of potential
buyers. On the positive side, January retail sales bounced back after a poor
December reading and a preliminary gauge of consumer sentiment came in higher
than expected. The mixed signals from economic data are typical of a late cycle
Earnings and Prices Have Diverged Equity investors have had a difficult time over the past 15 months. 2018 was characterized by very strong earnings growth and a healthy economy, yet the stock market performed poorly. This led to P/E multiples (where “P” refers to the price of stocks and “E” refers to corporate earnings) contracting as prices declined and earnings rose. Thus far in 2019, the opposite has been the case. The expectations for corporate earnings growth have deteriorated as global economic growth has subsided, yet stock prices have pushed higher amid a shift in rhetoric from the Federal Reserve and an evaporation of pessimism following December’s market bottom.
Over the long-term, earnings growth is a
key input to determining the trajectory of the stock market, but throughout
2018 and 2019, the two have diverged. In order to justify continued multiple
expansion, markets will likely require the support of some positive
developments on geopolitical issues which have been a major source of
uncertainty not only for investors, but also for business leaders. With last
week’s news that British lawmakers voted against leaving the European Union
without a deal in place, some of that uncertainty was lifted. But the darkest cloud remains the ongoing
trade saga between the United States and China. An eventual agreement that
materially addresses the key concerns of U.S. negotiators and business leaders
(who have had a difficult time making long-term investment decisions as a
result of the uncertainty) could be the catalyst needed to move the ceiling for
by Connor Darrell
CFA, Assistant Vice President – Head of Investments The
major global equity indexes posted their worst week of the year as investor
sentiment was impacted by further evidence of a slowdown in global economic
activity. In the U.S., the monthly jobs number came in far lower than expected,
though there is reason to believe that the report was heavily influenced by
weather-related factors. In Europe, the European Central Bank (ECB) announced
that it intended to inject further liquidity into the European banking system
in an effort to curtail the negative impact that trade tensions and
geopolitical concerns have had on economic growth. Lastly, the Chinese
government seemed to unsettle markets when it announced a new fiscal stimulus
program aimed at increasing activity in its slowing manufacturing sector. Bonds
climbed higher as rates fell amid the flurry of new economic data and policy
The Pendulum Continues to Swing At the beginning of December, the S&P 500 was trading right around the 2,790 level before negative sentiment drove the index to the brink of bear market territory. After a sharp reversal around Christmas and one of the strongest starts to a year in decades, the turmoil from December felt like a faded memory. But last week brought with it five consecutive days of negative returns for equity markets, leaving many investors wondering where we go from here
It’s important to remember that market
performance tends to track earnings over the long-term, and earnings are
largely driven by economic fundamentals. The fact is that economic fundamentals
simply do not reverse course so significantly in such a short period of time.
As such, it makes sense to inquire as to whether the market was too pessimistic
during December or too optimistic during January and February? The answer is
probably yes on both fronts.
Given the heightened uncertainty and
slower growth rates being observed around the globe (as compared to 2017
levels), the current fair value for the market is likely somewhere in between
December’s bottom and March’s peak. The market seems to have attributed much of
the recent slowdown in China to continuing trade tensions with the United States,
while in Europe, the uncertainty of the Brexit situation continues to impact
business investment and economic activity. Clarity on both of these issues is
likely to be provided before the end of 2019, and this may allow economic
growth to reaccelerate by the second half of the year. But until then, the
pendulum may keep swinging back and forth with markets stuck in a bounded
trading range. For investors, this is a period where patience and discipline
will be essential. We continue to favor a disciplined approach to tactical
rebalancing rather than attempting to time entry and exit points.
by Connor Darrell
CFA, Assistant Vice President – Head of Investments Perceived
progress in the ongoing trade negotiations between the U.S. and China seemed to
keep an aura of optimism around equity trading last week, with developed
markets equities (as measured by the S&P 500 and the MSCI EAFE indexes)
inching higher. Bond yields also moved higher, with the 10-Year Treasury yield
reaching its highest level in a month.
After a long delay related to the
government shutdown, Q4 U.S. GDP was reported last week. The data showed that
the U.S. economy grew 2.6%, which was above expectations but still below the
trend rate that had been in place for the past two quarters. On the whole, the
economy grew at a rate of 2.9% during 2018, up from 2.2% in 2017.
Performance Diverging from Economic Data The
S&P 500 has posted its best two-month start to a year since 1991, even as
economic data and corporate earnings have begun to taper off. While not
necessarily poor in absolute terms, recently released economic data has been
disappointing, with housing starts falling to their lowest level in two years
and consumer spending declining precipitously. In the near-term, it is
difficult to evaluate to what extent the uncertainty stemming from the
government shutdown can be blamed, but thus far the Fed’s reaction (which has
been to suggest that patience may be warranted in determining the path of
future policy) has been celebrated by markets.
It is likely not a coincidence that the
market’s strong start to the year has coincided with a change in tone from the
Fed. The expectation in the market is now for the Fed to hold pat for the
entirety of 2019, which if recent trends are to be believed, would likely bode
well for stocks. But as we observed during the latter half of 2018, sentiment
can change very quickly.
by Connor Darrell
CFA, Assistant Vice President – Head of Investments U.S.
equities moved modestly higher last week, helped along by the release of the
minutes from the most recent Federal Reserve policy meeting, which seemed to
provide further evidence that policy tightening may be put on pause. Market
sentiment has changed dramatically since the end of 2018, and the Dow Jones
Industrial Average has now achieved its longest streak of weekly gains in
nearly 25 years. However, economic data released last week was mixed, and many
of the risks that concerned markets during 2018 still lurk.
International stocks outperformed their U..S
counterparts despite rising uncertainty surrounding the potential fallout from
a “no-deal” Brexit and some disappointing European manufacturing data.
Q4 2018 Earnings Update Roughly 90% of companies in the S&P 500 have now reported Q4 2018 earnings. According to Factset, the blended earnings growth rate for those companies that have reported is 13.1%, a full percentage point higher than the estimates that were in place at the end of 2018. However, the data hasn’t been all rosy. During earnings calls, 68 S&P 500 companies have issued negative EPS guidance and only 25 have issued positive EPS guidance. Additionally, profit margins for U.S. companies are expected to show a year-over-year decline for the first time since 2016.
As the economic cycle continues to mature,
it is reasonable to expect a moderation in corporate earnings and profitability,
especially when considering the uncertain macroeconomic environment (concerns
over escalating trade tensions, Brexit, etc.) that global businesses have faced
over the past several quarters. All in all, the first earnings reporting season
of 2019 has brought no major surprises, and the double-digit earnings growth
rate posted during Q4 is still a healthy one.
by Connor Darrell
CFA, Assistant Vice President – Head of Investments U.S.
stocks posted positive returns for the eighth straight week despite unexpectedly
disappointing retail sales data. Stocks were primarily supported by optimism
that the U.S. and China might make progress on a trade agreement before U.S.-imposed
tariffs are set to more than double on March 1. Bond yields jumped higher to
start the week but reversed course following the weak retail sales data
released on Thursday. Bonds ended the week relatively flat as a result.
Starting Point Matters We have consistently warned of the potential perils of attempting to time the market, and the past few months have only served to lend further credence to those warnings. But that doesn’t mean that investors should not consider point-in-time analyses when evaluating their long-term strategy. Following the tumultuous end to 2018, markets have rebounded considerably, and risks now look evenly balanced. We continue to believe that while recent economic data has sent mixed signals to investors, the probability of a U.S. recession in the near-term remains low. However, the reality is that we find ourselves in what is very likely to be the latter stages of the economic cycle, and this fact carries long-term implications for investors. Given the stage of the cycle in which we currently find ourselves, investors need to be aware that the long-term expected returns across asset classes look quite a bit lower than they did in the past. The successful implementation of an investment plan is a dynamic process that responds to the market environment. As such, in an environment where market returns will be lower, investors may need to consider saving more or spending less in order to stay on track.
by Connor Darrell CFA, Assistant Vice President – Head of Investments Global equity markets weakened a bit last week, posting mixed results after news reports suggested that U.S. and Chinese leaders are unlikely to meet before the “trade truce” expires on March 1. Sentiment across markets has remained far more positive than it was at the latter end of 2018, with credit spreads declining to their lowest level since November. Government bonds also fared well as yields continued to decline. The yield on the 10-Year Treasury Note dropped to close the week at 2.63%, down from its high of 3.24% back in November.
How Bond Investing Has Changed Since the Financial Crisis In the world of finance, everything is interconnected, and sometimes it can be incredibly enlightening to take a look at how a change in one area of the economy can have long lasting impacts on global financial markets. The post financial crisis monetary policy environment (marked by artificially low interest rates and high liquidity) has influenced nearly every corner of the economy and the investing world. One major byproduct has been a significant shift in the composition of major bond indices, particularly the Bloomberg Barclays U.S. Aggregate. Over the past 11 years, the yield offered by the average bond in the index has unsurprisingly come down, but the average maturity has also grown longer. Those longer maturities have increased the duration of the index, which is a measure used by bond investors to evaluate how sensitive an investment is to changes in interest rates (see chart provided by JP Morgan Asset Management).
To understand what has transpired, we need to assess the decision making of bond issuers. Low interest rates mean low borrowing costs for corporations, and that provides an incentive for businesses to seek longer term financing (in order to lock in lower rates for a longer period of time). This has changed the mix of securities that make up the index, leading to a higher proportion of longer-term bonds. Passive bond investors should be aware of the changes in the composition of the underlying index being tracked, as the risk/reward outlook for the Bloomberg Barclays Aggregate has become less attractive (lower yields and higher rate sensitivity). In the context of the active vs. passive debate, the proponents of active management may have the strongest argument when it comes to fixed income, where an active manager may be able to manage the tradeoff between yield and duration more effectively.
by Connor Darrell
CFA, Assistant Vice President – Head of Investments Markets
capped off one of the strongest Januarys on record with another positive week,
bolstered by a change in rhetoric from Fed Chairman Jerome Powell (discussed
further below). The bond market reacted positively to the Fed communication as
well, with the 10-year treasury yield dropping to its lowest level in weeks. Internationally,
the focus remains on the uncertainty surrounding the continued Brexit
negotiations. British Prime Minister Theresa May has indicated that she would like
to reopen the discussions which were finalized in November, but EU
representatives have stated that the terms that were reached are legally
binding. Currency markets have been most impacted by the continued back and
forth, but it is likely that equity market gains have been held back as
A Change in Tone Last week, the Federal Reserve held interest rates at current levels and took a significantly more dovish tone in its communications. For markets, words like “patient” and “wait-and-see” represented a refreshing contrast from terms like “auto-pilot,” which was used in recent months when discussing the future path of monetary policy. It also seems apparent from the Fed’s communications that the change in tone had less to do with a shift in its view on the U.S. economy (which remains quite favorable) and more to do with the confluence of risks that have permeated in the global economy. From our perspective, it is also highly likely that the volatility in equity markets was a key influencing factor, even if it were not explicitly communicated during post-meeting comments.
by Connor Darrell CFA, Assistant Vice President – Head of Investments After a strong start to the new year, the major equity market benchmarks ended the holiday-shortened week flat. Stocks struggled to gain momentum throughout the week after Commerce Secretary Wilbur Ross stated during an interview on CNBC that the US and China were “miles and miles” away from a potential trade agreement. Q4 2018 earnings reports continued to indicate healthy corporate profits, though well below the growth rates observed during the earlier parts of the year. Over the long-term, stock market performance tends to closely track corporate earnings, and analysts are still expecting double digit earnings growth for the current reporting period.
The week ended on a positive note when it was announced on Friday afternoon that policymakers had reached an agreement to temporarily reopen the government for a minimum of three weeks. The key focus of markets continued to be directed elsewhere, and there was very little reaction to the news in terms of price movement in the major indices. This is likely due in part to the temporary nature of the “deal.”
Did You Know? ESG: A Different Approach to Investing As issues like climate change, corporate governance, and consumer privacy have become increasingly important to consumers, this has led to significant growth in what is known as ESG Investing. ESG stands for Environmental, Social, and Governance, and refers to three of the key areas of focus for evaluating and measuring the sustainability and ethical standards of an investment in a corporation.
Today, more and more investors are striving to enact changes to the role that large corporations play in society and are seeking to exert their influence via the capital markets. An ESG approach to investing uses a combination of exclusionary screens (avoiding companies that do not meet the minimum standards of sustainability and corporate governance practices of the investor) and active shareholder engagement to address key areas of concern. These include things like environmental sustainability, community engagement/impact, equal pay, and ethical business practices among others. Capital markets play a vital role in our economic system and are one of the most powerful means of influencing the behavior of large corporations because share prices and shareholder engagements directly impact the decisions of company leadership.
In response to the growing interest in ESG investing, our team has invested a considerable amount of time and resources into constructing portfolios that meet these standards. If this is something you would be interested in learning more about, please reach out to your financial advisor to begin a conversation.
by Connor Darrell
CFA, Assistant Vice President – Head of Investments Global
equity markets extended their winning streak to four weeks and built on their
strong start to 2019, bolstered by reports of further progress in the trade
negotiations between the U.S. and China. Markets have climbed higher despite
rising uncertainty surrounding the Brexit negotiations and the government
shutdown, and there has been a meaningful positive shift in market sentiment
over the past few weeks. The market reacted positively to earnings reports from
several major S&P 500 constituents even despite results that were otherwise
less-than-stellar; a sign that market prices were reflecting overly pessimistic
expectations following December’s selloff.
Earnings Season Underway The quarterly earnings season kicked off last week with approximately 10% of S&P 500 constituents reporting Q4 2018 results. According to FactSet Research, the blended earnings growth rate for those companies that have reported is 10.6%, the fifth straight quarter of double-digit earnings growth. Analysts have been steadily reducing their estimates for earnings growth throughout the rest of the year, but the expectation is still for growth to remain positive. The earnings growth rate experienced during 2018 was fueled in large part by the year-over-year effects of corporate tax reform, which will no longer have an impact during 2019, so a decline from the mid-20 percent range experienced last year is to be expected.
by Connor Darrell
CFA, Assistant Vice President – Head of Investments Market’s
climbed higher for the third consecutive week as investors shrugged off the
lingering uncertainty related to the government shutdown, which has now
stretched to the longest in U.S. history. Many economists agree that the
shutdown will have an increasing impact on the economy over time, but the
impact so far has been negligible (though the hundreds of thousands of federal
workers who are no longer receiving paychecks would argue to the contrary). For
now, the gridlock in Washington remains more of a distraction than a material
concern for financial markets.
Bond yields ticked up slightly as the rotation to fixed income tapered off a bit due to the stabilization in equity markets. Minutes released from the Fed’s December meeting highlighted that recent modest inflation numbers and rising concern over downside risks in financial markets has given policymakers more flexibility to evaluate the current path of monetary tightening, suggesting that a pause in rate hikes may be upon us.
2017 & 2018: Unique in their Own Right Towards the end of 2018, Deutsche Bank released a very interesting chart (see below) which showed the percentage of asset classes posting negative returns in each year since 1901. It will immediately jump out to readers that 2018 had the highest percentage of asset classes producing negative returns in more than 117 years. But perhaps less obvious in the chart is that 2017 had the lowest percentage. For many investors, the volatility in 2018 felt particularly jarring, and perhaps that is due at least in part to the fact that it represented such an extreme reversal from the 12 months prior. In any case, it is simply astounding that in a 118-year sample of returns history, the two most “extreme” years (as measured by the percentage of asset classes posting negative returns) happened back-to-back. Our takeaway is that the merits of diversification (of which there are many) have been less evident over the past two years because assets have tended to move in the same direction. We view this as somewhat of an anomaly, and caution investors from making significant portfolio adjustments based on experiences during two “outlier” years.