Recent market commentary from CSG Capital Partners:

April 2019 Market Commentary

While risks are increasing, the weight of the evidence for stocks going forward remains positive. The first three months of the year were kind to investors as the market reversed most of the losses sustained in the 4th quarter of 2018. This was due to a normal reversion to the mean, a change in investor sentiment from ‘extreme fear’ to ‘neutral’, and the belief that the Federal Reserve would not raise interest rates this year. Still, there are plenty of concerns regarding global growth, a potential US recession, and an inverted yield curve. Our view is that while these concerns are legitimate, the positive indicators for the market still outweigh the negatives.

We wrote last quarter that slowing growth in international economies, particularly Europe, would affect US growth. We have seen that play out so far, as European economic data has been poor and US data has been sluggish. Despite the pace of near term growth slowing from elevated levels, the US economy is still poised to grow. The latest release of the Conference Board’s Leading Economic Indicators showed an increase consistent with about 2% GDP growth this year. Manufacturing surveys and activity are also still consistent with steady, if unspectacular, economic growth. Furthermore, the price of commodities such as copper, which typically decline before recessions, have been resilient. 

After the interest rate on the 10-yr Treasury fell below that of a 3-month Treasury (a phenomenon known as ‘inversion’) towards the end of March, fears of recession intensified. All prior recessions have been preceded by a yield curve inversion, though not all inversions led to recessions. The fear is that with long term rates lower than short term rates, banks have little incentive to lend. The resulting drop in credit freezes the economy and causes a recession. That is generally correct, but we think it is a little myopic. This inversion was not caused by the Fed raising rates (which creates ‘tight’ financial conditions); instead it was caused by market demand for long term bonds. Overall financial conditions remain loose as measured by the Chicago Fed’s National Financial Conditions Index (at its loosest levels since the mid-90s) and the St. Louis Fed’s Financial Stress Index. These big picture indicators lower the significance of the yield curve inversion, in our opinion.

Looking at the supply and demand trends of the market, the data is unequivocally positive.  Most notably, the advance-decline line, a measure of stock advancing vs. those declining, has reached a new all-time high. Based on this, it is extremely likely that the major market indicators follow suit.

It would be foolish to ignore that risks today are higher than they were at the beginning of the year. We are expecting the market to continue to be volatile, and we are diligently monitoring our indicators. Yet evidence suggests it is time to be patient rather than fearful.

The information described herein is taken from sources which we believe to be reliable, but the accuracy and completeness of such information is not guaranteed by us. Past performance is not indicative of future results. The concepts discussed throughout may not consider the effect of fees, expenses, or other costs that will effect investing outcomes. Opinions expressed are subject to change without notice, and should be given only such weight as opinions warrant. The concepts illustrated throughout this document may have tax, legal, and accounting implications. The content herein is not to be construed as legal, accounting, or tax advice, and is provided as general information to assist in understanding the issues discussed. Neither Janney Montgomery Scott LLC, nor its Financial Advisors, give tax, legal, or accounting advice. Please consult with the appropriate professional for advice concerning your particular circumstances.

January 2019 Market Commentary

The weight of the evidence for stocks going forward remains positive, despite the nearly 20% decline in the S&P 500 in the 4th quarter. The biggest reason for the decline was investor concerns over the prospects of a recession in 2019. In short, our indicators suggest these fears are unfounded, and that the US stock markets are likely to enjoy positive returns in 2019.

While data currently indicates that economic growth in 2019 is likely to be slower than in 2018, there is very little sign of a recession in the coming year. The Conference Board’s Leading Economic Index still points to growth of about 2.8% annualized in the first half of the year, moderating slightly in the second half. Jobless claims, retail sales, wage growth, consumer sentiment, and commercial loan growth are among the specific positive signals we see in the economy.

We often write about market ‘technicals’, or objective supply/demand relationships. Our indicators suggest that the technical picture of the market in late September was not consistent with a major market top. Furthermore, supply and demand action since the Christmas Eve stock market low is consistent with previous significant lows. In summation, stock market technicals suggest that it is more likely that the market makes a new high rather than a new low.

The data is less positive on international economies, however. It is likely that a slowdown overseas causes the US economy to weaken. We see this year as analogous to 2015-2016 when fears over a global recession caused the US to slow and stocks to stagnate for a time, but ultimately there was no recession and stocks made new highs. In this environment, we prefer to own US investments over international ones.

The increase in company earnings combined with the decrease in stock prices last year have lowered valuations to levels last seen in 2013, according to data from JP Morgan. A steadily growing economy, compelling valuations, and objective supply/demand trends point to upside in US stocks. To be sure, it will not be straight line up. There will be some negative headlines, especially out of Washington, that spook markets temporarily. But volatility is the emotional price investors pay for higher returns over the long run. Stick to your plan.

The information described herein is taken from sources which we believe to be reliable, but the accuracy and completeness of such information is not guaranteed by us. Past performance is not indicative of future results. The concepts discussed throughout may not consider the effect of fees, expenses, or other costs that will effect investing outcomes. Opinions expressed are subject to change without notice, and should be given only such weight as opinions warrant. The concepts illustrated throughout this document may have tax, legal, and accounting implications. The content herein is not to be construed as legal, accounting, or tax advice, and is provided as general information to assist in understanding the issues discussed. Neither Janney Montgomery Scott LLC, nor its Financial Advisors, give tax, legal, or accounting advice. Please consult with the appropriate professional for advice concerning your particular circumstances.

October 2018 Market Commentary

This year continues to be a tug of war between positive factors, such as a strong US economy and strong corporate earnings, and headwinds such as rising interest rates and tariffs threats. Last quarter we wrote that the positive forces supporting the market would win out by pushing the market to new highs. The major market indexes in the US did reach new all-time highs during the last quarter, but investor concerns remain.

We hear a number of clients concerned about a recession occurring in the near future. While the future is always uncertain, the economic data does not indicate that one is likely in the next 12 months. The Conference Board produces a reading of Leading Economic Indicators each month. The August reading indicated a 6.41% increase over last year; since 1980, the earliest a recession has come following a period where the year over year change in the indicators was greater than 5% was 24 months, according to data from the Conference Board. Other ‘recession dashboards’ also indicate that the economy does not appear to be near a turning point.

More importantly, corporate earnings continue to be very strong. Profits, not politics or even the economy, are the real drivers of stock market returns. In the 2nd quarter, profits for S&P 500 companies increased 25% from a year ago. Third quarter earnings are expected to increase 19.2% year over year, with revenue growth of about 7.3% according to data from Factset. Strong earnings growth should continue to be a tailwind for stocks going forward.

It is also important to look at technical factors, such as the breadth of the market, to determine the sustainability of the advance. Oftentimes major market peaks are preceded by deterioration under the surface i.e. fewer stocks participate while a few big companies drag the indexes higher. In short, that is the opposite of what has occurred in the past few months. The recent new highs in the indexes were confirmed by new highs in the market breadth indicators, suggesting that the market advance is healthy and likely to continue. Similarly, analysis using Dow Theory, a form of technical analysis pioneered by Charles Dow, confirms that the recent market highs were indicative of more to come.

As we write this, the market is experiencing a minor pullback. Up to this point, it is a normal pullback in the context of an ongoing bull market. We expect it to be resolved in a matter of days/weeks rather than materialize into something more sinister given the reasoning above. We remind investors to stay focused on objective factors that suggest the market will continue to ‘climb the wall of worry’.

The information described herein is taken from sources which we believe to be reliable, but the accuracy and completeness of such information is not guaranteed by us. Past performance is not indicative of future results. The concepts discussed throughout may not consider the effect of fees, expenses, or other costs that will effect investing outcomes. Opinions expressed are subject to change without notice, and should be given only such weight as opinions warrant. The concepts illustrated throughout this document may have tax, legal, and accounting implications. The content herein is not to be construed as legal, accounting, or tax advice, and is provided as general information to assist in understanding the issues discussed. Neither Janney Montgomery Scott LLC, nor its Financial Advisors, give tax, legal, or accounting advice. Please consult with the appropriate professional for advice concerning your particular circumstances.

 

 July 2018 - The Tug of War between Bulls and Bears

This year has been a battle of opposing forces for investors. An accelerating economy and earnings growth have provided tailwinds to the markets, but investor fears over a trade war have been a strong headwind. We believe, and the technical evidence suggests, that the positive forces supporting the market are ultimately positioned to win out, potentially pushing the market to new highs.

The US economy has continued its strength this year and actually accelerated a bit. Real (inflation-adjusted) GDP is expected to increase from 2.3% in 2017 to 2.9% in 2018 according to Credit Suisse. This is above the post-financial-crisis average of 2.15%, according to data from Thomson Reuters. The Conference Board’s data on leading, or forward-looking, indicators points to further expansion as well.

Company earnings have reflected the underlying economic strength. In the first quarter of 2018, S&P 500 companies grew earnings by 24.8%, surpassing analyst estimates of 17.6%. Some of the earnings growth is attributed to the recent tax cut, however, over 2/3 of the earnings growth was due to better economic conditions, according to data from Credit Suisse. Estimates for the next few quarters are similarly positive, with analysts expecting solid revenue growth and about 20% earnings growth, according to FactSet.

However, investors have not necessarily reaped the benefits of this improved backdrop as news of a potential trade war, and inflation, to a lesser extent, have dominated the headlines. It is worth keeping in mind that the actual cost of any tariffs, likely measured in the tens of billions, is tiny compared to the overall economy. Beyond the real costs that tariffs would impose to the economy, the market hates uncertainty. Uncertainty implies lower valuations, as investors must build in a margin of safety should policy be resolved in an unfavorable fashion. Once the trade talks are finished, this headwind will likely abate.

Besides our belief that earnings will win out in the long run, the market technicals, i.e. the battle between supply and demand, suggest that demand will eventually win out. Namely, the market continues to see broader participation as more companies are performing well and making new highs.

It is normal for markets to move sideways for a few months, especially after a period of excellent gains. This is a time to exercise patience and focus on the positive fundamentals, not the negative headlines.

The information described herein is taken from sources which we believe to be reliable, but the accuracy and completeness of such information is not guaranteed by us. Past performance is not indicative of future results. The concepts discussed throughout may not consider the effect of fees, expenses, or other costs that will effect investing outcomes. Opinions expressed are subject to change without notice, and should be given only such weight as opinions warrant. The concepts illustrated throughout this document may have tax, legal, and accounting implications. The content herein is not to be construed as legal, accounting, or tax advice, and is provided as general information to assist in understanding the issues discussed. Neither Janney Montgomery Scott LLC, nor its Financial Advisors, give tax, legal, or accounting advice. Please consult with the appropriate professional for advice concerning your particular circumstances.

 

April 2018

At the beginning of the year we wrote that the market was likely to see some larger pullbacks this year. Furthermore, we wrote that investors should view pullbacks as buying opportunities in an ongoing uptrend rather than the start of a downturn. In short, our process indicates that this is still the case.

The stock market is enduring its first rough stretch since the fall of 2016. Just as a heart attack patient doesn’t get up and start running immediately after treatment, the stock market needs some time to recover from the sharp correction in February. Political news dominated the trading in February and March, and is likely to continue to do so at least until companies begin to announce earnings in mid-April.

Tariffs are definitely a negative for the economy and stock market, however the other positive factors supporting the economy should eventually win out. Until February of this year, investors were enthusiastic about the strong US economy, synchronized global growth, corporate revenue growth, and corporate tax reform. All of these factors are still in place.

Technical factors also suggest that this correction is likely to be temporary, and that the long term uptrend will eventually resume. US and International stocks are the top ranked asset classes by our methodology, and they still have a significant lead over commodities, bonds, and cash. Despite the recent sell-off, the majority of US stocks are still in a positive trend. Furthermore, riskier small cap stocks have outperformed large companies, and more aggressive or cyclical sectors, such as technology, financials, and industrials, have led the market while defensive sectors such as real estate, telecom, and utilities have lagged. If investors were preparing themselves for a prolonged bear market, we would observe more ‘risk-off’ behavior.

This is a time for investors to exercise patience. If you find that you are overly uncomfortable with the volatility we have been experiencing, then we need to review your allocation to ensure your risk is appropriate for your needs. Otherwise our indicators suggest staying the course.

The information described herein is taken from sources which we believe to be reliable, but the accuracy and completeness of such information is not guaranteed by us. The concepts discussed throughout may not consider the effect of fees, expenses, or other costs that will effect investing outcomes. Opinions expressed are subject to change without notice, and should be given only such weight as opinions warrant. The concepts illustrated throughout this document may have tax, legal, and accounting implications. The content herein is not to be construed as legal, accounting, or tax advice, and is provided as general information to assist in understanding the issues discussed. Neither Janney Montgomery Scott LLC, nor its Financial Advisors, give tax, legal, or accounting advice. Please consult with the appropriate professional for advice concerning your particular circumstances

 

January 2018

With the US and broad international stock markets up over 20% last year, as well as modest positive returns for bonds, investors had plenty to cheer in 2017. These exceptional returns came with very little volatility, as we have had the longest period in history without a 3% decline in the S&P 500 according to Bespoke. While we do not make predictions, only game plans, our process indicates that 2018 will be another good year for both US and international stock markets.

The US economy remains strong; in fact recent GDP and manufacturing data indicate that it may be on the verge of accelerating. Earnings growth for the S&P 500 is expected to be 11.8% in 2018 according to data from Fact Set, and this does not include the benefit from corporate tax reform. Several companies have already increased their earnings guidance for 2018; expect more upward revisions during the upcoming earnings season. ®

Technical indicators remain positive as well, as the US market remains in a strong uptrend with many ledges of technical support near current prices and broad participation. Sentiment indicators are showing some signs of complacency however. This fact, combined with the expectation of reversion to the mean, suggests that we will see some larger pullbacks in the market this year. However, we do not encourage people to trade around a potential correction; investors should view them as a buying opportunities in an ongoing uptrend.

International markets are often over looked by US investors, however overall they had an even better 2017 than the US. Economic acceleration, valuation, and extremely strong technical factors indicate to us that international markets, emerging markets in particular, have a lot more upside over the coming years.

The indicators for fixed income are more uncertain. Longer term interest rates are determined largely by inflation; however traditional economic models that forecast inflation have broken down in recent years. Our base case is that interest rates stay relatively flat; however we acknowledge there is a risk that faster economic growth and inflation lead to a spike in rates. Bonds remain an important part of a diversified portfolio, though investors should take steps to minimize risk within their fixed income allocation.

In conclusion, we continue to believe that we are in a secular (i.e. long term) bull market that has years left to run. Any short term pullbacks should be viewed in this context. Investors should not get carried away, however, as prudent asset allocation and risk control never go out of style. We will continue to monitor our objective indicators and adjust portfolios as markets evolve.

The information described herein is taken from sources which we believe to be reliable, but the accuracy and completeness of such information is not guaranteed by us. The concepts discussed throughout may not consider the effect of fees, expenses, or other costs that will effect investing outcomes. Opinions expressed are subject to change without notice, and should be given only such weight as opinions warrant. The concepts illustrated throughout this document may have tax, legal, and accounting implications. The content herein is not to be construed as legal, accounting, or tax advice, and is provided as general information to assist in understanding the issues discussed. Neither Janney Montgomery Scott LLC, nor its Financial Advisors, give tax, legal, or accounting advice. Please consult with the appropriate professional for advice concerning your particular circumstances

 

October 2017

As we near the 10 year anniversary of the last market peak (October 9th, 2007), it is instructive to look back at the last 10 years and see what lessons we can glean for the future. Since that time we have seen multiple financial firms fail or be taken over by the government, the deepest recession since the 1930s, a tepid economic recovery, unprecedented intervention by the Federal Reserve, S&P downgrading the US credit rating, a European debt crisis, and myriad of other events that either did or 'should have' torpedoed the stock market. Furthermore, much of the country thinks that at least 1 of the last 2 presidents we have elected is the worst president ever. What if you knew this ahead of time and invested in the S&P 500 on October 9th 2007? Surely gold, bonds, housing, or oil would have been safer, right? Well, over the last 10 years, according to data from Haver Analytics, the S&P 500 has had an annualized return of 7.2%, gold 5.7%, bonds 4.7%, housing 1%, and oil -4.3%. After all of the heartache of the last 10 years, you would have essentially doubled your money by investing in stocks and being patient.

So what lessons can we take for the future? (1) Do not underestimate the long-term wealth creation ability of stocks; (2) As Warren Buffet wrote in 2003, “our country's dynamism and resiliency have repeatedly made fools of naysayers;” and (3) Paying too much attention to gloomy news stories is an investor's kryptonite. Instead of being scared by headlines or making predictions, our process demands that we take into account what the market is actually doing, not what we fear it might do. Using objective indicators allows us to make game plans rather than predictions. What does our process indicate investors should do going forward?

Over the summer, we wrote that the chances for a correction were elevated, but that investors should not get defensive in anticipation. We reasoned that the intermediate and long term outlook remained strong, and any correction was likely to be shallow and short-lived. In fact, we did not get so much as a 3% pullback in the S&P 500 over the summer.

Today our view remains the same over the intermediate and long term, although we think the chances of a correction in the short term have decreased. Market action has been particularly strong lately, with broad participation and all of the major indexes confirming the recent market highs. While a correction can happen at any time we do not anticipate one in the near term. More importantly, the next one will be a buying opportunity rather than the start of another leg down. We continue to favor stocks over bonds, cash, and commodities, and we advise clients to stay the course.

The information described herein is taken from sources which we believe to be reliable, but the accuracy and completeness of such information is not guaranteed by us. The concepts discussed throughout may not consider the effect of fees, expenses, or other costs that will effect investing outcomes. Opinions expressed are subject to change without notice, and should be given only such weight as opinions warrant. The concepts illustrated throughout this document may have tax, legal, and accounting implications. The content herein is not to be construed as legal, accounting, or tax advice, and is provided as general information to assist in understanding the issues discussed. Neither Janney Montgomery Scott LLC, nor its Financial Advisors, give tax, legal, or accounting advice. Please consult with the appropriate professional for advice concerning your particular circumstances.

July 2017

The first half of the year was an outstanding one for investors as both international and US stocks produced excellent returns. Even bond investors received solid returns as interest rates fell to the surprise of many market watchers. Given the very strong returns since early November, the uncertain future of tax reform, healthcare laws, and trade policy combined with the politically volatile EU and falling commodity prices – where do we go from here?

Our view is that US stock markets will end the year higher than they are today. The driving force behind the market advance of the last 8+ months has been earnings. The first quarter saw earnings grow by 13.9% over the first quarter of 2016. For the 2nd, 3rd, and 4th quarters, earnings are forecasted to grow by 6.6%, 7.4%, and 12.4% respectively according to Factset. Simply put, companies are consistently growing their earnings, and where earnings go stocks soon follow. Note that future profit estimates do not depend on tax reform; if that were to occur it would only add further upside potential.

Recent market action, particularly the volatility in market-leading technology companies during the second half of June, suggests to us that the risk of a correction this summer is higher than it was a few months ago. The evidence does not suggest, however, that investors should try to ‘time' or ‘trade around' a potential correction. Remember that short term pullbacks are a normal part of bull markets. Looking at returns since 1980, the average intra-year decline in the S&P 500 has been 14.1% from peak to trough according to data from JP Morgan. 

Examining today's market, there are several well-defined technical support levels only a few percent below current prices, including one particularly substantial support about 7% below current prices. The probabilities suggest that any market pullback would be relatively shallow and short-lived; investors would likely be better served by simply riding it out. This is not to say we are doing nothing; we have seen signs of a rotation from growth/technology leadership to financials/value leadership and are tilting portfolios accordingly. Our process always aims to identify the strongest areas of the market; it currently indicates that stocks are likely to go higher.

April 2017

Even though we are nearly five months past the Presidential Election, politics are still at the forefront of most people's minds. Perhaps that is understandable given how drawn out, contentious, and unusual our last election cycle was. However, when it comes to investing, getting worked up over politics is counterproductive. Remember that you cannot buy shares of GOP or DNC. Instead you invest in a diversified portfolio that is designed to whether multiple market environments. We suggest listening to data rather than politically motivated hyperbole; our indicators currently point in a positive direction.

This cycle's political rancor has spread to affect Americans' everyday lives. A January poll from the American Psychological Association found that American stress levels were the highest in the 10 year history of the poll, and the leading cause being the political climate. That's right – Americans are more stressed over the election and its aftermath than they were at the depth of the Great Recession. 

Politics lends itself to irrationality and emotion, while good investing requires discipline and prudence. In a 2003 study, Yale Professor Geoffrey Cohen showed that Democratic voters supported Republican proposals when they were attributed to fellow Democrats more than they supported Democratic proposals attributed to Republicans, and vice versa. Clearly this is a not a rational way to evaluate policies. Imagine evaluating investment options the same way; it would be a disaster.

Similarly, the University of Michigan's consumer sentiment survey recently showed that Republicans are expecting the best economy in the 65 year history of the survey, while Democrats are expecting an economy as bad as the worst of the 2008 financial crisis. These outlooks are driven by emotional responses to politics rather than dispassionate analysis. We are comfortable saying that the truth is somewhere in the middle. The most likely scenario, in our view, is that the economy continues on its course of modest growth that has been underway for much of the last 8 years. Many surveys show renewed optimism among consumers and small business, but that has not yet been reflected in the hard data.

It is also useful to look at the technical picture of the market, i.e. the chart. The chart reflects what is, not what we fear might be. The chart of the S&P 500 remains in a positive trend with well-defined support levels only a few percent below current prices. Additionally, analysts expect first quarter earnings growth to be +8.9% compared to last year, according to data from FactSet. Plan accordingly.   

February 2017

With the nearly 10% advance in the S&P 500 since election day, nearly every client we have spoken to is nervous about a potential decline in the market. While we acknowledge the likelihood of a pause or pullback in the very near term, we think any pullback would be shallow, and that the market will make new highs in relatively short order. We have often written that the fundamentals of the US economy and stock market are strong, and the 4.6% growth in S&P 500 earnings so far this quarter vs  estimates of 3.1% shows that they still are. But there are other factors that contribute to the bullish case: technicals and sentiment.
 
Technical analysis uses past price action to evaluate where prices are likely to go in the future. Using technical analysis, we know that the US market is the asset class with the best relative strength, is in a well-defined positive trend, and has broad participation. There is technical support roughly 3% below current levels, and very strong support near the old highs about 7% below current prices. We would expect a lot of buyers to step in at these levels if the S&P 500 were to test them. However we also know that the current rally is extended when looking at shorter term indicators.
 
It is instructive to look at previous times the market has been similarly overbought on a short term basis and the subsequent price action. What we find is that overbought conditions, rather than leading to an ‘overdue correction' actually lead to better-than-average forward returns. The S&P 500, which is at 2351 as of this writing, was roughly as overbought as it is today in March of 2016 (when it was about 300 points lower) and December of 2016 (when it was about 100 points lower). Clearly forward returns from those points were quite strong, and the longer term track record of such time periods is equally positive. Substantial rallies that occasionally push the index to an overbought or extended condition are a feature of strong stock markets that are poised to go higher, not of weak ones that are about to roll over.
 
Fundamentals are strong and technicals are positive, yet sentiment is hardly optimistic. Remember Sir John Templeton's adage that “bull markets are born in fear, grow in pessimism, and die in euphoria”. The American Association of Individual Investors publishes a weekly survey reporting the percentage of investors who describe themselves as “bullish” or “bearish”. This survey is commonly used as a gauge of investor sentiment. The most recent “bullish” percentage was 33.09%, which marked the 111th week in a row that the bulls have failed to take a majority. That is the longest streak in the history of this survey which dates to 1987. In short, we are nowhere near euphoria. This bull market has more room to run.

December 2016

Much attention has been focused on the political world over the past few weeks, although the financial markets have had their share of commotion as well. While it is tempting to focus on what will change under a Trump administration (and we will touch on that below), we think it is more important to focus on the things that haven't changed. Specifically, the US economy is still growing, and US stocks are still a great place to be invested.

It is likely that the stock market would have rallied regardless of who won the White House. The market stalled for weeks as investors ignored good earnings news; the looming election made an easy excuse for pessimism. The S&P 500 traded down 9 consecutive days leading up to the election – the longest such streak in over 30 years – despite the fact that, thus far, 72% of S&P 500 companies have beaten earnings estimates. In fact, earnings thus this quarter far have grown 2.9% over last year; consensus estimates were for a decline of 0.7%. Now that the election overhang is behind us, investors are free to focus on these positive earnings surprises.

While we expect economy-wide growth, we also expect the financial, energy, and healthcare sectors to benefit disproportionately from a Trump administration. Conversely, bonds could suffer as investors anticipate higher inflation and the potential for higher growth. Higher interest rates in the US and a subsequently stronger dollar could harm international investments relative to domestic ones as well. The weight of the evidence leads us to emphasize US stocks over bonds and international for the foreseeable future.

Although our views on US stocks are more favorable going forward, we will not abandon bonds or international stocks. We still believe that owning a diversified portfolio is important for managing risk and smoothing out returns over time.  It is easy to view bonds and international markets as an anchor in a portfolio when US stocks are going up and a diversified portfolio lags an index like the Dow Jones Industrial Average.  However, this is a trade-off that we accept so that we maintain appropriate downside protection should the rally stall or reverse course. We will continue to look for additional opportunities to add to US stocks while maintaining proper diversification and risk control.

July 2016

“Don't fear market highs”

The stock market recently broke out to all-time highs on the backs of improved earnings expectations, improved economic data, and more optimistic investor sentiment. These moments often produce pessimistic reports that the rally ‘isn't real' or that we are at a long-term market top. We disagree for several reasons. 

First of all, the US economy is still growing. While there are structural issues holding growth below what we experienced in the 80s and 90s, most notably the shrinking of the labor force due to retiring baby boomers, the underlying fundamentals of the economy are still intact. Think of our economy as a ‘healthy tortoise' rather than a ‘sick hare'.

Secondly, earnings still have room to improve. The strong US consumer, improving commodity prices, and weakening US dollar all should continue to help earnings over the coming quarters.

Technical analysis also points to higher stock prices over the intermediate term. Over the past two years, the S&P 500 traded between roughly 2,120 and 1,820. Now that the index has moved above that trading range, the general rule is that the next price target is equal to the size of the range (300 points) plus the previous top (2,120). This implies a price target of 2,420 on the S&P 500. While we do not make specific predictions or price targets, this piece of technical analysis does add to the weight of the positive evidence. 

Lastly, remember that bull markets don't end in pessimism and fear; they end in complacency and euphoria. Individual and professional investors across the country are still positioned conservatively, and the market rally will likely continue as they attempt to catch up. 

We maintain our full allocation to US stocks within the context of the appropriate diversified portfolio. Unless changes in your personal situation warrant a portfolio review, we advise you to stay the course and stay invested. 

April 2016

The stock market got off to a harrowing start in 2016; in fact the first 6 weeks of the year were among the worst starts on record. Since February 11th, however, we have seen a dramatic reversal as stocks have surged back above where they started the year. It is actually not unusual to see such dramatic reversals in the market. The best days in the market often occur very close to the worst days. This pattern underscores the need to stay invested, maintain a long term view, and not overreact in times of market stress.

Over the past few years, more volatile growth oriented companies, such as those in biotechnology or technology, have significantly outperformed the market. This year, however, more stable value-oriented companies, such as utilities and consumer staples, have led the way as investors seek safety and dividends. We are keeping abreast of such changes in the underlying market and positioning portfolios accordingly.

Two notable discussion points this year have been oil prices and interest rates. The rebound in oil prices has been a huge boost to the market, and we expect that oil prices will continue to stabilize in the $40 per barrel range. As previously mentioned, the issue in the oil market was oversupply rather than lack of demand; we are seeing signs that the supply side has meaningfully adjusted. Interest rates have surprised many observers by falling significantly this year. Given our high rates relative to the rest of the world, lack of inflation pressure, and investor sentiment, we do not expect interest rates to move higher over the intermediate term.

Going forward, US corporate earnings will drive the market, not presidential politics or noise from China. We expect the market to trade within the same range it has been in for about the last year. However, if the market were to break this range, we expect it would be to the upside rather than to the downside. The driver would be better-than-expected corporate earnings due to a weaker US Dollar and higher oil prices. 

January 2016

“Not the end of the world, it just feels like it”

Global markets have continued their selloff this week.  As we continue to monitor the situation it is important for us to share our perspective on what is happening, but our main message is this:

We entered this cycle of heightened volatility with a thoughtful portfolio, constructed based on your long term goals and the weighty evidence of history.  Thus, the best action may very well be to hold tight and ride the storm out.  We will always consider prudent adjustments given market conditions, but we will make decisions based on a disciplined process and not emotion.

Investors are worried about many things at the moment, but oil prices and the Chinese economy have dominated airwaves and are the main levers leading the markets.  For oil, the global imbalance of far too much supply and demand that cannot keep up will find an equilibrium as producers cut back on what they are bringing to market.  This process is not immediate but we've seen it begin, especially in the US where many regions cannot make money with oil prices below $40 per barrel.  It is important to note that demand does not seem to be the issue. If demand stays intact or continues to grow, balance will come back to the market and we'll see things stabilize.

For China, we'll start with demand.  China's crude oil demand surged to an all-time-high last week.  The pace of growth has slowed, but China is still growing faster than most regions of the world and lower oil prices are a positive for the country.  The transition to an economy led by services and the consumer isn't over and the process has been bumpy at best, but the US investor should not be overly concerned with the problems of China and other emerging markets unless their pain is likely to spill over to us.  The data we monitor does not suggest that China is nearing an imminent economic collapse.

The US economy continues to plow forward, hampered by areas of oversupply that extend beyond the oil markets.  Because consumers are able to efficiently shop for lower prices for everything from clothes to gadgets, companies are having a harder time bringing in more money even when they succeed in moving more product.  Great for the consumer, bad for companies that cannot adapt.  We'll see more retailers close stores to compete with online options and we'll see the market reward those companies that can deliver growth.  Short term, we cannot say when the indiscriminate selling pressure will end, but remember that it is always most painful at the end.  The August 24th lows of last year were highlighted by the Dow Jones Industrial Average opening 1000 points lower.  The end can be gut wrenching but the subsequent rallies can be sharp as well.  When the dust settles and the market again focuses on the fundamental value of earnings, we feel that the market will have a solid foundation to move higher.

November 2015

We have been encouraged by the market progress since the steep drop at the end of August. The market rallied sharply initially, briefly retreated towards, but not below, the August low, and has since rallied methodically to present levels. This was not unexpected, and in fact it follows the pattern of the August 2011 correction. Market corrections are a process that may take several months to sort out. Thus far though, all signs indicate that the correction was not the start of a bear market, and that we have already seen the lows for this cycle. While we are not ready to signal an “all-clear”, we are encouraged by the recent market action.

From a fundamental prospective, we still believe the US economy is on solid albeit unspectacular footing. Consumers have reduced debt to historically low levels, and are buoyed by lower gas prices. The labor market has continued its strength from the past few years, banks have gotten healthier, and credit remains easy. On the negative side, the persistently strong dollar and tepid environment in many international countries will continue to be a drag on earnings. A slow-growing economy will, however, prevent a steeper correction and bear market. Against the backdrop of ultra-low interest rates, we continue to favor stocks over bonds and cash.

We acknowledge that downward moves in the market are unsettling, and that it is natural to want to ‘do something' to combat them. However, occasional corrections are quite normal, considering historically the market has had about 1 per year. We design portfolios using a rigorous process according to a set plan, and recognize that these portfolios will be subject to occasional periods of turmoil. As a consequence, we stay patient and ensure that we are still on course with our plans. As always, never hesitate to reach out to us about your accounts, particularly when the market is choppy and headlines turn negative. If you are ever uncomfortable with your portfolio, we will be happy to review your plan and goals to make sure it is still appropriate for you. 


August 2015

While the recent market volatility has certainly been jarring, our team views it as a potential buying opportunity. To that end, we used Monday's sharp selloff to sell bonds (which were at the high end of their recent trading range) and add 2% more exposure to US stocks. While we may retest recent lows in the very short term, we think this purchase will provide incremental value over the coming weeks or months. We plan on returning to our original stock exposure if and when the stock market rallies back to its level at the beginning of the month. As always, we will continue to monitor the markets and attempt to take advantage of market opportunities as they present themselves. 


July 2015

While Greece continues to dominate the airwaves, we believe that is a distraction from a more salient point for investors; the US economy remains strong. The labor market has continued to improve, and the most recent unemployment reading of 5.3% sits below historical averages. In the stock market, low oil prices have masked solid growth from the rest of the economy; S&P 500 earnings excluding the energy sector rose 8.5% in the first quarter from a year earlier. In our compass portfolios, we took advantage of a brief rebound in oil in May and exited most of our energy positions.

Turning overseas, we continue to favor European stocks. Valuations are no longer at trough levels, but are still reasonable. The economic data, including consumer spending, the Purchasing Manufacturers Index, and credit growth continue to show strong improvement. Furthermore, the European Central Bank's QE program and pledge to do ‘whatever it takes' to support the Eurozone implies easy monetary policy for the foreseeable future. The confluence of these three factors makes us believe that the European bull market has years to run. Since our last commentary, we have since returned to unhedged position vs the Euro, as we believe the market has now fully priced in the expected depreciation from the Eurozone's easy monetary policy. We do not think that fears over Greece should deter one from European stocks as it only represents 2% of Eurozone GDP.

In summation, we continue to favor stocks over fixed income and cash. We will be buyers on weakness in stock prices, and we reiterate our view that the S&P 500's appreciation will be in the mid-to-high single digits in 2015.


March 2015

After nearly six years of a rising US stock market, US stock prices are no longer cheap. However, for comparison's sake, at the end of 2014 the S&P 500 traded at a similar valuation to that as of the end of 1996. That bull market did not end until March 2000 after prices more than doubled from that point. While it would be unwise to count on a repeat of the speculative excess of the late ‘90s, we still believe that the stock market has the drivers to appreciate moderately in 2015. We have touched on several of the reasons in previous commentaries – steady corporate earnings growth, strong labor market improvement, and persistently low interest rates. After the events of the past few months, we can add low oil prices to that list.

Though US stock valuations are no longer compelling, developed international countries do have attractive valuations to go along with structural tailwinds. Valuations outside the US are currently 10-15% lower depending on your metric of choice. Furthermore, we believe international stocks, in particular European ones, have several strong catalysts as opposed to years past. Lower sovereign debt levels and interest rates put less pressure on government budgets. The weakened Euro supports export oriented economies such as Germany. The end of the Asset Quality Review (the European ‘stress test') leads to more lending activity. Eurozone quantitative easing further lowers interest rates and make stocks more appealing on a relative basis. Finally, while the positive effects of lower oil prices are well documented among US consumers, Eurozone countries benefit even more as they import a significantly greater percentage of their oil consumption.

Last year, we positioned portfolios to take advantage of these tailwinds to the European stock market. Unfortunately, we did so too early as Europe continued to underperform the US market, with the declining currency further eroding gains. This year, however, the script has flipped and European markets have easily outpaced their US peers. Furthermore, we have moved to currency hedged position to take advantage of the falling Euro.

While the fear over rising interest rates in the US is well documented, we believe future rate hikes will be moderate and will not have a substantial negative effect on the overall stock market. Going forward, we expect US stocks to have another positive year, with technology and financials as two of our favorite sectors. However, we expect greater returns from European stocks, and will continue to position portfolios accordingly.


November 2014

On September 19th, the S&P 500 Index made a new all-time high as it reached 2019 before closing at 2010. The market subsequently retreated briefly touching 1820 before rallying to close at 1862 on October 15th. The roughly month-long pull back was just a whisker shy of the long-anticipated 10% correction. Market commentators put forth several explanations for the pullback including: uncertainty about the sustainability of the US recovery, weak economic data from Europe, overvaluation of the US stock market, and Ebola fears. Let's tackle these one by one.

In our view, the most logical reason for the decline was sub-par economic data out of Europe and corresponding fears about global growth. We believe there is still reason to be optimistic about European stocks, namely an improving employment situation, reduction in fiscal drag, and loose monetary policy. The recent plunge in oil prices should also benefit the European economy as most EU countries import 70-80% of their oil, and a weaker Euro will increase the attractiveness of European exports. With lower valuations and more room for improvement in the economy as well as corporate earnings, we continue to have a slight overweight to Europe.

We believe the US economy remains strong. The first look at the data showed US GDP expanding by 3.5% in the third quarter following a 4.6% increase in the second quarter. In addition, earnings for the S&P 500 are expected to increase 8.5% this quarter from the prior year. Within the labor market, weekly jobless claims recently reached their lowest point since April of 2000. In short, the vast majority of data point to the US continuing its path of steady though unspectacular growth.

As we wrote in our last commentary, the US stock market is not overvalued. It is fairly valued by historical standards and attractively valued when compared to fixed income and cash. Bond yields began the year at a historically low level and have fallen steadily since. We believe that an improving US economy and a tightening Federal Reserve will provide upward pressure to interest rates, hurting bond prices in turn. Cash still provides a negative return after accounting for inflation. Thus, we continue to overweight stocks against such a backdrop.

While Ebola has grabbed many headlines and sparked much debate, it remains primarily a healthcare issue. It is not an economic threat at this time and should not be a deterrent to equity investors.
In sum, we believe that the recent pullback is not a sign of the end of the bull market; instead it was a normal and overdue correction amidst a longer term uptrend. In fact, we used it as an opportunity to take money out of alternatives and add to stocks. We expect the market to make many new all-time highs before the bull market is over.

 


August 2014

The second quarter saw a large rebound in GDP, and the earnings reported thus far for the S&P 500 are on pace for a record. These figures confirm the positive trends in the underlying data, such as the unemployment rate, manufacturing activity, and consumer confidence to name a few. We expect to see roughly 2% growth in the US and moderate growth in much of the rest of the world. The one threat to all this would be an escalation in geopolitical tensions.

Despite the uninterrupted increase in stock prices over the past few years, we still do not think that the run is over. US stock prices are right in line with their historic average valuations. When compared to other asset classes however, stocks continue to look more attractive. Bond yields are still drastically below historic norms, and cash provides a negative yield after accounting for inflation. Given that it has been almost 3 years since a 10%+ correction, we would not be surprised to see one before the end of the year. Nevertheless, it would likely lead to another leg up in the stock market.

While we see value in the US stock market compared to fixed income and cash, we see even more opportunity in international stocks. The Euro zone economy is showing signs of recovery as shown by falling unemployment and increased manufacturing activity in the past few months. Furthermore, the European Central Bank continues to loosen its monetary policy which should provide additional support to stock prices.

The biggest story in the financial markets continues to be the Fed and the threat of rising rates. Barring a major unforeseen event, the Fed will end its bond purchase program in October. As it is currently the biggest buyer of government bonds, rates should rise once that source of demand is eliminated. When the Fed eventually raises rates, we expect they will still be below “normal” for a long time.

Going forward, we continue to favor less-interest-rate sensitive bonds in anticipation of rising rates. On the stock side, we favor financials due to their correlation with rising rates and energy due to the domestic shale boom. In addition we favor business-facing technology companies and dividend paying stocks. While the thin trading that typically accompanies the summer doldrums can lead to increased volatility, we would be enthusiastic buyers of any significant pullback in stocks.

 


April 2014

The Federal Reserve for the past several years has been very accommodative. Meaning they have kept interest rates near zero and have been buying billions of dollars of treasuries and mortgage bonds. This has resulted in both bonds and stocks being artificially overvalued. More recently, the Fed has slowed its pace of bond buying. Eventually they will end altogether and begin to return interest rates to a more normal level. This should result in lower prices and higher yields for bonds and lower P/E ratios for stocks (price/earnings ratio).

In this environment we should concentrate on owning the following:

  1. For bonds, we want to own sectors that are not as affected by rising interest rates. This would include global bonds, high yield bonds, short term bonds, and floating rate bonds. In general, we also want to underweight or maintain a reduced exposure to bonds until interest rates stabilize.
  2. For stocks, we want to overweight low multiple or “value” stocks over high multiple “growth” stocks. We also want to emphasize sectors that can outperform the overall economy. These would include Healthcare, Technology as well as Financials. As P/E multiples decline stocks of companies that can raise dividends faster than the growth rate of the overall economy should do well. We also want to reduce the overweight in stocks we have maintained for the past several years and return to a more normal weighting.
  3. We want to replace the overweight in stocks with a position in alternative investments. This area is much more defensive and can reduce risk in the overall portfolio.

The process of returning to more normal interest rates does not necessarily mean a bad investing environment. It might imply slightly below normal returns. But if managed properly they can still be attractive returns. We just have to be selective in what we own.

 


 

January/ February 2014

2013 will go down as one of the best on record for domestic stocks. International stocks also fared well but had slightly lower returns then domestic. The emerging market stocks were down slightly for the year because of slowing growth in China and lower demand (and prices) for commodities, Bonds actually lost money for the first time in about 15 years because of rising interest rates sparked by the Federal Reserve Tapering their buying of bonds.

Our Compass accounts did quite well as a result of the returns in domestic stocks, our overweight in dividend paying stocks and our significant underweight in bonds. In fact our accounts had a positive return in bonds because we concentrated on areas less sensitive to rising interest rates such as high yield bonds, global bonds, floating rate bonds, and we reduced our exposure to treasuries.

The New Year has started off with the markets pulling back and volatility increasing. We predicted this in our previous months note. After months without a pullback it was not unexpected. Gross Domestic Product GDP growth for the fourth quarter of 2013 was just reported to be 3.2% outpacing analyst's expectations. Some of the improvement may have been a result of inventory accumulation. We would expect GDP growth in 2014 to be between 2.5% and 3% which represents solid but unspectacular growth.

We are about halfway through fourth quarter earnings reports and the number exceeding earnings expectations is about three times higher than those missing estimates.

With all of that said we expect domestic stock markets to have a reasonably good year in 2014 but nowhere near last year's returns. International stock markets should also do reasonably well as the recovery in Europe continues. Emerging markets may well be bifurcated with the countries overly dependent on commodities and those with large deficits doing poorly while others improve. Therefore we switched our EM exposure to a more managed fund to take advantage of this. We also added a Financial ETF because we are confident that rising interest rates will make banks, finance companies and insurance companies more profitable.

We still feel that with low inflation, receding headline risk from policy makers in Washington, passing geopolitical risk, and better economic growth, risk assets should continue to do well in 2014, albeit with higher volatility.


Year End 2013

This year has been good for equities in spite of government shutdowns, fear of Fed tapering, budget debates, looming debt defaults, ACA uncertainty, and continued lackluster growth of the economy and jobs. This is an example of the market “climbing a wall of worry”. Some of the bright spots have been housing improvements and consumer spending.

We anticipate 2014 will continue to be a favorable environment for equities in developed countries. However, we recognize that an overdue, but short-lived correction is likely at some point in the months ahead. The catalyst for growth may well be an increase in capital expenditures since corporations are sitting on record amounts of cash.

“Over the last year, we have reduced our exposure to bonds in all of our Compass Accounts in anticipation of rising rates. Since May 2013 the yield on the ten year treasury has risen from 1.5% to approximately 2.85%. We anticipate it will rise further to 3.0-3.5% in 2014.Therefore, we will continue to maintain an “underweight” position in Bonds.

We increased our exposure to European stocks over a year ago in anticipation of a recovery in the European economy. That has begun to happen over the past few months. We will maintain an overweight position in Europe for the foreseeable future. 

Domestic equities have had a tremendous move up since the recession of 2008, especially the past year. While we still expect equities will outperform bonds and cash for a while we feel it is prudent to begin a process of becoming more defensive in our equity holdings. We will continue this into 2014.”