What geopolitical events? By now, the markets have come to recognize that the risk of an escalating geopolitical event is not a serious threat. Just last Thursday we were wondering how to reduce the risk in portfolios as the U.S. and Iran were headed for confrontation. However, in a manner of days it became clear that both countries would back down and markets resumed their normal uptrend. The S&P 500 posted another positive week up nearly 1%. International stocks did not bode nearly as well finishing slightly lower for the week. The first two weeks of January appear to be a continuation of 2019 thus far.Source: J.P. Morgan Asset Management, Weekly Market Recap, 1/13/20
If we dig inside the S&P 500 Index returns, the sectors leading the way continue to be technology and communication services. The signing of the U.S./China Phase One trade agreement continues to help the industrials rise. We also noticed strong performance continuing from the health care sector. As a result, many of the trends that started in October 2019 are still intact and delivering strong results in the new year. One trend from 2019 that was unique was the dispersion in returns for the various sectors.1 Many investors were unaware of the differences in sector returns – unless you work in the energy industry!
Source: J.P. Morgan Asset Management, Weekly Market Recap, 1/13/20
Source: SPDR ETF’s Chart Pack, State Street Global Advisors, January 2020
The U.S. stock market continues to move higher without many downside concerns. Bespoke Investment Group notes that the rise in stock prices that started in October has been hard to stop. In fact, since October 23rd there has been only one day where the S&P 500 Index did NOT close at an “overbought” (meaning greater than 1 standard deviation above the 50-day moving average). That’s a remarkable rally with very little volatility! Bespoke notes that there have been seven other periods since 1990 that achieved a similar result. While some of those prior periods “were followed by short-term pullbacks, the majority of occurrences came during long-term uptrends.”2
Source; Bespoke Investment Group, The Bespoke Report, January 10, 2020
Our investment committee has been reviewing risk in the U.S. markets over the past two weeks. The more common concerns we hear from analysts relate to higher valuations on U.S. stocks over the past year. In last week’s letter, we shared that forward P/E (price/earnings) ratios have risen to 18.2 as of December 31, 2019. The 25-year average is 16.28 so we are above average on a relative basis. However, J.P. Morgan Asset Management reminds us that historically, positive index returns from our current P/E level are not unrealistic.3 We do not believe that current valuations will be a hindrance for U.S. stocks in 2020.
Source: J.P. Morgan Asset Management, Guide to the Markets, 12/31/19
An additional risk we have considered is how U.S. stock index returns seem to be dependent on a handful of individual stocks. One criticism of the S&P 500 Index as a widely quoted index in financial media is how the index is calculated. The S&P 500 Index is not an index of 500 companies with equal weights. Rather, the index is weighted according to the size of each company (total market capitalization).
That means that a bigger company gets more weighting in the index and can move the index more when it’s stock price changes. In 2019, some of the largest companies had stellar stock returns, such as Apple (up 89%) and Microsoft (up 56%). Other large companies in the index include Amazon, Facebook and Alphabet (parent company of Google). Together, these five companies accounted for just over 7% of the 28.8% return for the S&P 500 Index last year (approximately 1/4th).4 The relative contribution of returns from the largest stocks in the index is not historically out of the ordinary. Bespoke notes that the largest five stocks represent a fair amount of the total index based on prior records.
Source: Bespoke Investment Group, The Bespoke Report, January 10, 2020
Our supply/demand indicators have reached a very high level of demand for U.S. stocks. By way of reminder, we use these measures to determine the overall direction of trends for U.S. stocks, international stocks, bonds and a few smaller sectors. The long-term indicator is built using multiple metrics to gauge the overall demand for stocks while the “indicator value” helps us to visualize daily changes in direction and strength. The current indicator for U.S. equities at 76.56 is up from 44 in December 2018. We confirm the demand trends by looking at multiple time frames, as well as looking at individual asset classes and sectors within the U.S. market. If one of the indicators were to change to a negative position, our investment committee would commence an evaluation of portfolio risk to determine if a reduction in risk were warranted.
Interest rate volatility has fallen dramatically since October when the Federal Reserve Chairman announced that the Fed would be on the sideline for the foreseeable future. The market does not appear to expect higher or lower interest rates in the coming months and the U.S. 10-year Treasury Bond has traded narrowly on both sides of 1.80% consistently since October. Interest rates around the world have risen nominally as fewer negative interest rate bonds are trading now than at the peak in 2017.5 We do not anticipate any significant changes in interest rates over the first half of 2020.
Source: J.P. Morgan Asset Management, Weekly Market Recap, 1/13/20
With stock indexes recording multiple record highs over the past three months, what could be the drivers of higher stock prices in the next month? Our primary focus is currently on earnings season starting this week. Some key questions exist for U.S. companies after we saw actual earnings decline nominally for the first three quarters in 2019. Current analyst estimates are calling for a decline of 1.5% in earnings growth for the fourth quarter.6 However, Factset Insight duly notes that analysts tend to be a gloomy bunch and the actual earnings results tend to be higher than estimates. Therefore, Factset is anticipating a year-over-year increase in earnings growth for the fourth quarter.7 Stock prices tend to rise when actual earnings are reported higher than analyst estimates for the quarter.
Source: Factset Insights, S&P Likely To Report Earnings Growth for Q4, January 3, 2020
If you’d like to schedule a time to discuss your portfolio or the markets in detail, please feel free to call our office at (281) 616-5935 or send an e-mail to firstname.lastname@example.org. We welcome the opportunity to sit down with you and learn more about your situation so we can help you optimize your portfolio to meet your financial goals for years to come.
Engrave Wealth Partners Investment Committee
Bill Day, CFP®, CIMA
Taylor Parker, CFP®
1. State Street Global Research, SPDR ETF’s Chart Pack, January 2020
2. Bespoke Investment Group, The Bespoke Report, 1/10/20
3. J.P. Morgan Asset Management, Guide to the Markets, 12/31/19
4. Bespoke Investment Group, The Bespoke Report, 1/10/20
5. Cumberland Advisors, David Kotok, 2019 Investment Review, 12/31/2019
6. Factset Insight, Earnings Outlook, John Butters, January 3, 2020
7. Factset Insight, Earnings Outlook, John Butters, January 3, 2020