Market Commentary – 22nd August 2018
What’s powering the US markets?
The US, as you can imagine is the leading economy based on size and volume and today, the S&P 500 share index, which tracks the 500 biggest public sector companies in America is set to have gone 3,453 days without falling 20% or more, which marks the longest rally ever in US history. Technology firms are driving the growth and these firms represent around 12-13% of market cap (on the S&P index) but have accounted for about 40% of the gains, with big names which we are familiar with, such as Facebook, driving these gains. Whilst some of the share valuations in some of these technology companies may be slightly overvalued, we don’t see parallels with the late 1990s prior to the dotcom crash, as company earnings are still supportive of valuations. Despite this and our theory that the party is due to come to an end within six months, coinciding with the peak in US interest rates in this cycle, US stocks are today being pushed higher and higher thanks to strong corporate earnings results and health economy growth. with the trade talks expected to not go anywhere this week, it is helping stocks edge higher, both in the US and globally.
We are not going fully defensive… yet – why?
As noted above the US data continues to look strong, with expectations that the states will grow by 3% annualised this year. This growth trajectory means that this will lead most of the growth throughout the world for the remainder of 2018. Whilst we remain on this course, we need to continue to watch the core economic fundamentals daily to ensure that we do not miss out on when the data starts to slowdown. The main things to note when looking at the US economy is that the economic data is strong and whilst it is strong and on track record of reaching 3% annualised growth for the year, we will continue to see the rest of the world follow the trajectory. If we have a short-term opportunity that becomes a medium-term threat, if global growth and data continues to remain strong, and the US 10-year yield remains at current levels, we will then remain invested. One of the reasons why we are optimistic that Equities will continue to push upwards in Q3 is that for Q2 2018 (with 91% of the companies in the S&P 500 reporting actual results for the quarter), 79% of S&P 500 companies have reported a positive EPS surprise and 72% have reported a positive sales surprise. For Q2 2018, the blended earnings growth rate for the S&P 500 is 24.6%. If 24.6% is the actual growth rate for the quarter, it will mark the second highest earnings growth since Q3 2010 (34.1%). The forward 12-month P/E ratio for the S&P 500 is 16.6. This P/E ratio is above the 5-year average (16.2) and above the 10-year average (14.4).
Coupled with string US data surprisingly the US 10-year yield which caused mayhem in the markets in February when it went over 3% for the first time in many years is today at 2.82%. We consider 3.3% to be the risk point so we have a long way to go before we get to the pint whereby we would look not take more risk off the table because of this single factor. This bond also tends to signal investors’ confidence when the confidence is high, then the ten-year bonds price drops and yields go higher because investors feel that they can find higher returning investments and don’t feel that they need to play safe. This is therefore a good way of seeing what investors sentiment is like and as long as we remain around the current levels, we remain in a safe place and remain invested. The final barometer is volatility and although price volatility this year is higher than last, we are still seeing volatility that is far lower than historic rates.
By looking at the various barometers we look at, we are constantly watching the economic data to determine where we are in the economic curve. Yes, the million-dollar question always stands as to where should we be invested and why? It is difficult to predict macroeconomic variables like GDP growth; however, economists use models to gauge where we are in the economic cycle. By predicting these key variables, such as growth, interest rates and inflation or, more importantly, the changes in those variables is extremely difficult. This is the reason why our asset allocation process also relies on bottom-up asset class valuations when we do our fund research and how we pick the securities we choose to be invested in within the OBI models. Businesses are not immune to changes in the macro environment and that, in the short term at least, macro does matter. If GDP growth surprises to the downside, company sales are likely to be lower thereby pushing the market price lower. Equally, if inflation is higher than expected, the squeeze on real incomes is likely to have a similar effect by reducing consumer discretionary spending.
For anyone who wants further data to substantiate the position please review the attached Global Economic News Document.
Model Portfolios & Indices
Over the last week we have seen most of the indices that we track deliver mixed messages, with most global indices bar the US still showing YTD returns that are negative. As highlighted above, the S&P 500 has reached record highs and continues to reach new heights. We have seen strong gains on the DOW which is leading growth in the rest of the world. Asia’s main stock markets climbed on when they closed today, which again is mostly due to the boost by Wall Street’s rise. Things seem to have calm down slightly with volatility as the US has said it will take the tariff discussions with China (which is down 17.47% YTD as it keeps getting worse) and its other trading partners a bit more slightly. Asian investors had taken some comfort from hopes that trade negotiations between the US and China this week could help to diffuse trade tensions. Political headlines in the US and Australia and a retreat in Chinese markets dampened the mood. Within Europe, the main stock markets are all in different places in today’s trading hours, and this is mostly due to the instabilities in the US, being pushed higher by strong corporate earnings and economic data but being pushed down by politics and Trump!
Our model portfolios have held up well over the past week, outperforming their respective benchmarks as well as performing in line with the indices. Based on the strong mandate of OBI and the ability to cyclically adjust the portfolios based on the stage of the economic cycle, we can provide constant returns with the capital preservation mandate in mind. As we progress through this year, we will continue to monitor the economic data and will alter the asset allocation when the core fundamentals start to slow down. This further adds to the comment over how important it is to keep watching the economic data and identifying slowdowns, and when they happen.
Upcoming Investment Committee Meeting
We intend to hold the next investment committee meeting in a few weeks and in these meetings, we look at the markets, our positioning as well as market opportunities moving forward, by doing a full top-down analysis on the world and the economic data. We continue to remain invested but with balanced approaches and less exposure to equities than we would do if equities were circa 10% plus lower than they are today even though data and fundamentals suggest that we shouldn’t be worried about an imminent correction. The Investment Committee Meeting will therefore help us determine the current state and where we are in the economic cycle and therefore when we should start thinking about our model portfolios and adjusting our strategies, which will be initially a teak and then a full shift and adopting a more defensive asset allocation as we get toward s the end of 2018.
The data above will not directly correlate to the indices as there is always a delay in pricing because the US markets close significantly later than the European markets and the Asian markets. The data set above reflects the last close and much of the days movements will not yet be reflected in the portfolios due to pricing delays. You cannot therefore directly correlate indices to the portfolios. The value of investments may fluctuate in price or value and you may get back less than the amount originally invested. Past performance is not a guarantee of future performance. Performance figures quoted include the fund manager charges but exclude other fees such as adviser, custodian, switch and/or discretionary investment management fees. Unless otherwise instructed and accrued, income is reinvested into the portfolio.
This Day in History
On this day in 1902, the infamous and ultimate US cool car, Cadillac was founded. Named for the man who founded Detroit in 1801, Antoine Laumet de La Mothe Cadillac, Michigan’s newest car company launches. The Cadillac Automobile Company rises from the ashes of the Henry Ford Company, after Ford leaves his company over a squabble with investors.
As always have a wonderful week and stay safe.