Week 5 Sitrep

We all should have expected the market to take a break from its winning ways after my comments last week that “everyone is now convinced the market is moving higher”. Frankly, the market held up fairly well last week until Friday when news of the Coronavirus and the impeachment affairs brought about a sour mood for the weekend. Overall, the S&P finished lower by 1.01% for the week while small companies (Russell 2000) and emerging markets (MSCI EM) took the biggest hit; down more than 2% each.

Source: J.P. Morgan Asset Management, Weekly Market Recap, 1/27/20


Traditionally the largest companies with a value orientation are a better place to invest when the market turns down. However, over the past few years we have noticed that growth investments have outperformed in both good and bad markets. Once again, the large growth companies held up better last week than their large value counterparts. The technology and communication services sectors continue to lead the market while energy and materials are laggards. We have been pleased to see utilities and real estate back among top performing sectors recently.

Source: J.P. Morgan Asset Management, Weekly Market Recap, 1/20/20


The most popular questions changed from “…is it too late to buy this rally?” to “…what’s really causing this market to pause?”. Our investment committee has been reviewing a number of key research pieces in the last two weeks and we see a few concerns the market is digesting right now. Before we discuss those concerns, we think it would be wise to frame the conversation relative to how well the market has done over the last twelve months.


It is difficult to show how significant the market increase in the 4th quarter has been. All the major indexes we follow experienced significant gains since September and were trading at very elevated levels. You will often hear commentators express that “the markets are overbought” but not explain what that means. Most stock analysts see the market as “overbought” when the index trades significantly higher than its respective 50-day moving average (DMA – simply an average of the last 50-days prices). The S&P 500 has consistently traded above its 50-DMA since October 2019.1

Source: Bespoke Investment Group, The Bespoke Report, 1/24/19


The index represents a broad array of sectors but not all sectors have participated in the market rally. Most investors would acknowledge the strength in the technology sector, yet the utilities sector actually has the most stocks trading above the 50-DMA. The energy and materials sectors continue to lag the index with less than 40% of their stocks trading above the 50-DMA.2

Source: Bespoke Investment Group, The Bespoke Report, 1/24/19


While everyone feels better if we can identify a culprit for making the market turn down, we also recognize that the market has been in very high territory and does not usually stay that elevated continually. In other words, we were due for a breather. However, it is worthwhile to examine the cause of the market increase and determine whether those conditions will persist. We recognized that U.S. corporate earnings continue to improve, albeit at a slower pace than 2018. Earnings reports for the 4th quarter show a modest decline (-1.9%) over the same period a year earlier.3 The energy sector continues to weigh down the averages while utilities and financials are providing a lift.

Source: Factset Insight, John Butters, S&P 500 Earnings Season Update, 1/24/19


Many analysts were anticipating the lower earnings and provided estimates that were a bit more negative. Thus, the fact that companies are delivering earnings results higher than estimates is providing a boost to the market. Given, only 17% of S&P 500 companies that have reported earnings so far. We will see a large number report this week and the expectation is for companies to continue to deliver earnings better than analysts estimate. Factset Insight reports that 73% of companies have beat estimates and companies are reporting earnings that are 3.2% above estimates.4

Source: Factset Insight, John Butters, S&P 500 Earnings Season Update, 1/24/19


We also recognize the strong demand for U.S. equities in our daily indicators. The strength of our long-term indicator reflects a significant move up from the lows in July 2016. We believe that the U.S. market experienced a “light” recessionary period in 2015 and early 2016. The intermediate and short-term indicators echo the same sentiment and continue to reflect a healthy market for investors in stocks. 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.


U.S. interest rates have reflected the increased risks in global markets over the last week as the 10-yr U.S. Treasury yield fell to 1.70%. We do not believe the lower yields are reflective of significant danger to markets; rather it appears that uncertainty over the Coronavirus and its impact on global GDP has caused investors to seek safety for the time being. We received news last week of central bank meetings in Europe, China and Japan that did not change the status quo of current policy. However, we will be watching for changes in the European Central Bank in coming months under new president Christine Lagarde as they announced a thorough review of all current policies (the assumption is that this includes the negative interest rate policy that has been used by prior leaders).5

Source: J.P. Morgan Asset Management, Weekly Market Recap, 1/27/20


We are paying special attention to the meeting of the U.S. Federal Reserve this week after an interesting comment in Barron’s last week. Our committee has carefully evaluated the Fed’s involvement in the repurchase market since September 2019. During this time, the Fed has increased its balance sheet by more than $300 billion as it sought to provide additional liquidity for ultrashort-term loans. The increase was largely unexpected by analysts and many were quick to say that the Fed would engage in additional “quantitative easing”. However, there is a substantial difference between quantitative easing, which involves the purchase of long-term securities to support lower interest rates, and the current task of providing short-term liquidity for repurchase agreements.

The article referenced how the U.S. stock market had experienced significant gains during the exact same period that the Fed was expanding its balance sheet.6

“Interest rates remain the primary underpinning for stocks, as equity valuations look stretched, except when compared with the paltry returns offered by the debt market. Much of the credit for that is owed to the world’s central banks, notably the Federal Reserve. In addition to last year’s three one-quarter percentage-point short-term rate cuts, the central bank has expanded its balance sheet by over $300 billion since September, when ructions in the repurchase-agreement market led it to inject liquidity. Since then, U.S. stocks’ value has jumped by more than $3 trillion.

As we examine the claims of the article, and have seen historical precedence for similar actions, we also note that the Fed’s balance sheet has stopped expanding since the beginning of this year. In fact, the Fed balance sheet actually contracted by roughly $25 billion over the last ten days, coincidental with the market weakness. While there will not be a direct correlation always, we will continue to monitor the Fed activities for their influence on interest rates, bonds and stocks.

Source: FederalReserve.gov, January 27, 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 cameron.malott@engravewealth.com. 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®

Greg Parker


1. Bespoke Investment Group, The Bespoke Report, 1/24/20
2. Bespoke Investment Group, The Bespoke Report, 1/24/20
3. Factset Insight, Earnings Update, John Butters, January 24, 2020
4. Factset Insight, Earnings Update, John Butters, January 24, 2020
5. Bespoke Investment Group, The Bespoke Report, 1/24/20
6. Barron’s, Stocks Catch A Cold After Fed Stops Expanding Balance Sheet, 1/24/20