wealth management

The Growth Rally Continues: 2nd Half 2019 Outlook

The 2019 stock market rally continued in the second quarter, with the S&P 500 tacking on another 4.3%, giving the S&P a 18.5% return for the year.  With earnings tracking to a modest 2.6%[i] growth rate for 2019, this gain is mostly due to the Price/Earnings multiple expansion.  The market is clearly more expensive today than it was at the beginning of the year.  At the current forward P/E of 16.9, the market is trading slightly ahead of the 10- year average of 14.8.  A major reason for this is the Federal Reserve changing course and pumping liquidity into the market by signaling their openness to lower interest rates.  As the 10-year bond yield has dropped from 2.6% to below 1.9%, the options for investment returns have shrink in the bond market, pushing investors into other areas, including the stock market.

 

Growth has outperformed Value

 

All stock sectors though are not benefiting equally.  We have seen tremendous divergence between value and growth stocks with growth trouncing value.  Over the last 5 years, the Russell 1000® Growth Index beat the Russell 1000® Value Index by almost 6% per year (13.4% vs 7.5%). Much of the market history have favored the exact opposite.  For the prior 19.5 years, value outperformed by over 1.5%/year (10.5% vs 8.9%). [ii]

 

What has caused this notable performance change in Value versus Growth?  In a recent report from Ned Davis Research[iii], they point out how a number of reasons for this. First, the mere fact that value had historically outperformed had market participants overweight in this direction. This may had led to over-valuations in value stocks, in effect, removing the advantage. The second is somewhat counterintuitive.  They have found that value stock outperformance requires a stronger growth economy.  Growth stocks can grow regardless of the underlying economy, while many value stocks need a booming backdrop to succeed. This makes sense for banks, which require a decent spread between short-term rates and long-term rates, typically happening during booms. Another value sector, commodity-based companies earn excess profits when material shortages occur, also typically in a bustling economy. Since the end of the financial crisis, the economy has been slowly and steadily improving, not quite reaching the “escape velocity” that value stocks need.  

 

When will Value be Back in Favor?

The fact that the market has rewarded growth for an extended time may not indicate it is changing any time soon. This is, in part, due to changes in our economic cycles. As the economy has shifted from manufacturing to consumption, the economic cycles have lengthened due to the more stable consumer spending pattern versus shorter manufacturing cycles.  Even with the long period of growth, the Federal Reserve is still pumping the economy with low rates and expectations are for even lower rates in for the next few years.  In their report, Ned Davis points out 12 Indicators which help them to determine which indicators are pointing to Growth or to Value and only 2 are leaning toward Value versus 6 for Growth (4 are neutral).  Furthermore, they argue that the biggest driver of a switch is the economy reaching escape velocity. Therefore, with the Fed still needing to help the economy, they see this trend continuing. 

 

Here at APG Capital, I see reasons to be cautious, namely valuations are elevated and significant political risks. We are favoring a modest underweight to equities, but within our equity allocation we are sticking to a growth theme as these companies continue to disrupt industries. 

 

APG Capital Asset Management recently hit its 2-year anniversary and we are so thankful for the continued trust and confidence of our clients.

 


[i]https://www.factset.com/hubfs/Resources%20Section/Research%20Desk/Earnings%20Insight/EarningsInsight_070319.pdf

[ii]  https://indexcalculator.ftserussell.com/ICStep4DR.aspx

[iii] Clissold, Ed, “US Featured Report: Will Value ever outperform again”, Ned Davis Research, May 30, 2019.

 

 

 

Advisory services offered through APG Capital Asset Management, a Member of Advisory Services Network, LLC.

Phone: 713-446-3233  Website: www.apgcap.com

All views/opinions expressed in this newsletter are solely those of the author and do not reflect the views/opinions held by Advisory Services Network, LLC. Indexes are unmanaged and do not incur management fees, costs, or expenses.  It is not possible to invest directly in an index.  The information and material contained herein is of a general nature and is intended for educational purposes only.  This material does not constitute a recommendation or a solicitation or offer of the purchase or sale of securities.  The future performance of an investment or strategy cannot be deduced from past performance.  As with any investment or investment strategy, the outcome depends upon many factors including investment objectives, income, net worth, tax bracket, risk tolerance, as well as economic and market factors.  All economic and performance data is historical and not indicative of future results.  All information contained herein is derived from sources deemed to be reliable but cannot be guaranteed.

 

Third Quarter 2018 Review and Outlook


It was a tale of two markets in the third quarter.  US Equities markets on one hand and, seemingly, the rest of the investable universe, on the other.  US Equities rallied, as evidenced by the 7.7% surge for the S&P 500 for the quarter (+10.6% year to date)[i], while the Developed Markets eked out a 1.1 return in the quarter (-1.3% year to date)[ii] and emerging markets dropped 1.4% (-7.9% year to date)[iii]. Even domestic bonds continued their streak of losing quarters, dropping marginally in the quarter leaving the Barclays’ US Bond Aggregate Index down 1.6% for the year.[iv] 

 

Domestic Backdrop

The effects of lower taxes and regulation have helped sustain the economy’s growth momentum. The 4.2% growth in GDP for the second quarter may have been boosted by a “sugar high” form the tax-cut but expectations are for continued growth as the US Conference Board is forecasting a 3.1% growth rate for 2019.[v] Furthermore, as shown in the Federal Labor Market Conditions Index, the labor market has fully recovered from the Financial Crisis.

 

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Interest Rate changes

Emblematic of this strength, the Fed has removed their “accommodative” stance for interest rates, signaling continued rate hikes.  The effect of these hikes make housing more expensive and hurts profitability for debt-laden companies. The Fed hopes that, while tempering growth, these increases keep inflation under wraps.  While the Fed makes changes to short term rates, longer term rates are set by the market.  Recently, the 10-Year rate broke out of its trading range and moved significantly higher, from about 2.80% to 3.25%.   Back in February, when we saw these rates jump higher, the market corrected sharply, but since has recovered and have shown decent gains for the year.  We may see another similar situation with the markets acting a bit jittery while the economy sorts out these countervailing impacts. 

With the expansion almost a decade old, we are certainly in the later stages of the growth cycle, but when the economy turns downward is still a question.  Positioning portfolios more cautiously is probably warranted, but we are still optimistic for the mid- and long-term for the US markets.

 

 

International Situation

The current trade policies of the US Administration are a heavy-handed approach to fix some of the unfair treatment of US companies when dealing overseas, especially when it comes to intellectual property.  Specifically, escalating tensions with China are proving to be damaging to the worldwide growth story and most markets are feeling those effects.  Hopefully the new tariffs on trade is ultimately posturing, and a more pro-trade resolution is negotiated.  Ahead of that resolution, maintaining some exposure to emerging markets should be a good risk/reward position considering the current weakness, as these markets are trading at significant discounts to US markets and should witness higher growth.

 

Looking forward, the underperformance of international stocks this year make it a good opportunity to bring portfolios back to target allocations by trimming winners like larger cap growth companies and adding (as painful as it may seem) to those international laggards. 

 

 

 

 

 

Advisory services offered through APG Capital Asset Management, a Member of Advisory Services Network, LLC.

Phone: 713-446-3233  Website: www.apgcap.com

All views/opinions expressed in this newsletter are solely those of the author and do not reflect the views/opinions held by Advisory Services Network, LLC. Indexes are unmanaged and do not incur management fees, costs, or expenses.  It is not possible to invest directly in an index.  The information and material contained herein is of a general nature and is intended for educational purposes only.  This material does not constitute a recommendation or a solicitation or offer of the purchase or sale of securities.  The future performance of an investment or strategy cannot be deduced from past performance.  As with any investment or investment strategy, the outcome depends upon many factors including: investment objectives, income, net worth, tax bracket, risk tolerance, as well as economic and market factors.  All economic and performance data is historical and not indicative of future results.  All information contained herein is derived from sources deemed to be reliable but cannot be guaranteed.

 


[i] http://performance.morningstar.com/funds/etf/total-returns.action?t=SPY&region=USA&culture=en_US

[ii] http://performance.morningstar.com/funds/etf/total-returns.action?t=IEFA&region=USA&culture=en_US

[iii] http://performance.morningstar.com/funds/etf/total-returns.action?t=IEMG

[iv] http://performance.morningstar.com/funds/etf/total-returns.action?t=AGG

[v] https://www.conference-board.org/data/usforecast.cfm