Week 8 Sitrep

New all-time highs were abundant last week. One commentator we follow noted new highs in the Dow Jones Industrial Average, the S&P 500 Index, the NASDAQ Index, the Wilshire 5000 Index, as well as several advance-decline lines and cumulative volume indexes.1 U.S. stocks continue to ward off fears of global pandemics and election year politics to focus on U.S. economic news and earnings season. The U.S. markets continue to outperform developed international markets while the U.S. dollar continues to rise against most major currencies.


Source: J.P. Morgan Asset Management, Weekly Market Recap, 2/17/20

 

Large growth companies have, once again, opened a wide performance margin against other areas of the market. In fact, all categories of growth are doing better than their value counterparts. We have seen strong earnings propel real estate and utilities companies over the last few weeks while energy and materials continue to lag the market averages. There are five sectors showing stronger performance than the S&P 500 Index in 2020, including technology, consumer discretionary and communication services.

Source: J.P. Morgan Asset Management, Weekly Market Recap, 2/17/20

 

We have written often about the upward trend in the U.S. markets since October 2019. Many analysts attribute the current run in stock prices to a change of sentiment at the Federal Reserve.2 In October, Fed Chair Powell announced that the Fed would continue to be patient with interest rates, even allowing traditional measures of inflation to rise above normally accepted levels to allow more room for the current economic expansion. Clearly, stock investors have interpreted that as good news for stocks as most major U.S. indexes have posted double-digit returns since that announcement.

 

The chart below depicts the performance of major U.S. indexes since the Fed announcement in October. The gold line represents an ETF for the NASDAQ 100 Index, the green line is an ETF for the S&P 500 index, the blue line is an ETF for the Dow Jones Industrial Index while the pink line is an ETF for the Russell 2000 index (typically a proxy for smaller U.S. companies). Each of the indexes is up more than 10% for the rather short time period.

Source: Saut Strategy, Sectors & Stocks, Harry Katica, 2/14/20

 

Recall that stock prices are generally affected over the long-term by changes in earnings growth and projected valuation. Basic finance classes will represent this relationship as an equation [P = E x P/E] where P is stock price, E is earnings growth and the P/E is the price/earnings ratio (a common measure used for valuation). If we expect stocks prices to continue to rise over the long-term, we must be able to justify one (or both) of the variables (earnings growth or P/E multiples) rising during that period.

 

U.S. companies have benefited from stronger earnings growth than was expected by analysts. Analysts were originally forecasting a decline of 1.7% for earnings from the S&P 500 Index. After better-than-expected earnings reports from several sectors, especially utilities and technology companies, the total earnings growth rate has shown a positive 0.7% result. If the current results remain positive then it will be the first year-over-year growth in earnings since the 4th quarter of 2018.3

Source: Factset Insight, John Butters, S&P 500 Reporting Earnings Growth for the First Time, 2/13/20

 

The positive earnings surprises have not been limited to just utilities and technology stocks. Bespoke Investment Group notes that 66% of companies have beat their forecasted earnings expectations. That represents an increase since the 2nd quarter of 2019 that is comparable to earnings reports at the beginning of 2018. Bespoke also notes the impressive rate at which companies are delivering better revenue and sales results for the 4th quarter.4

Source: Bespoke Investment Group, The Bespoke Report, 2/14/20

 

A recent uptick in earnings growth will definitely help our near-term outlook for stocks. However, we also see that stocks have been rising for the last 14 months mostly on an increasing P/E multiple. Current P/E multiples are at the higher end of their range over the prior ten years with several sectors showing P/E ratios in the 99th percentile.5 Keep in mind that elevated valuations do not indicate a future downturn; our investment committee expects to see earnings growth rise to help justify the current valuations. Historically, a higher valuation on stocks does indicate that future returns could be muted until earnings growth catches up.6

Source: Bespoke Investment Group, The Bespoke Report, 2/14/20

 

The U.S. stock market indicators continue to reflect strength in the long-term and intermediate term. However, the short-term indicator remains in a cautious mode due to the market reaction to the Coronavirus news. Our short-term indicator measures the demand characteristics of 36 individual market sectors and subsectors. While most sectors still show demand growth, the trend has slowed since January and tells us to take a measured approach when committing new money to the stock markets. This change does not suggest that we reduce risk in the portfolio altogether, but we will continue to monitor the longer-term indicators for reactions to the current environment.

U.S interest rates remain steady with the 10-year U.S. Treasury hovering near 1.6% while the 30-year Treasury stays just above 2%. It is still hard to remember that one year ago both interest rates were a full 1% higher than they are today. While we would normally associate falling interest rates with weaker economic growth, we also acknowledge the increased demand for U.S. Treasury bonds from global investors who have been faced with much lower yielding options at home. Recent reports continue to show more than $10 trillion of negative-yielding bonds in Europe and Asia.7 That would certainly make a 2% 30-year U.S. Treasury appealing, we suppose!

Source: J.P. Morgan Asset Management, Weekly Market Recap, 2/17/20

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


Footnotes:
1. Saut Strategy, Jeffrey Saut, The Number!?, 2/18/20
2. Saut Strategy, Harry Katica, Sectors & Stocks, 2/14/20
3. Factset Insight, John Butters, S&P 500 Reporting Earnings Growth for the First Time, 2/13/20
4. Bespoke Investment Group, The Bespoke Report, 2/14/20
5. Bespoke Investment Group, The Bespoke Report, 2/14/20
6. Bespoke Investment Group, The Bespoke Report, 2/14/20
7. Armstrong Economics, Martin Armstrong, Euro Crisis, 2/12/20

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