Week 6 Sitrep

Stocks took a bigger stumble last week after news that the Coronavirus had spread further shook markets on Friday. The S&P 500 fell more than 2% for the week while smaller companies in the U.S. were lower by more than 2.5%. International and emerging market stocks were the hardest hit as the MSCI Emerging Markets Index was down more than 5%.1 The negative headlines surrounding the virus and the U.S. impeachment trial weighed on stocks despite better than expected corporate earnings in the technology sector.

Source: J.P. Morgan Asset Management, Weekly Market Recap, 2/3/20

 

It was a futile exercise if you were looking for a place to hide in the stock market last week. Nearly every asset class participated in the market fall on Friday with large growth companies offering slightly better performance. The real story we are watching closely, however, is the significant divergence in performance between sectors. Even after last week, the utilities and technology sector have offered strong, positive returns. The energy and materials sectors, on the other hand, have been profoundly affected by negative earnings revisions. The broader energy sector is now down more than 10% for the year.

Source: J.P. Morgan Asset Management, Weekly Market Recap, 2/3/20

 

While the news headlines might make you feel like the world as we know it is coming to an end, the stock market has been very resilient in many areas. Overall, the S&P 500 Index has yet to trade below its 50-day moving average since September 2019. We acknowledged that the index had been “frothy” at the end of the year and many analysts considered stocks to be trading at “overbought” levels.2 The January performance for the market has brought indexes back to healthier ranges in the mind of our Investment Committee.

Source: Bespoke Investment Group, The Bespoke Report, 1/31/20

 

While the S&P 500 Index as a whole is down less than 1% for 2020, many parts of the index have been hit hard by the various headlines. Research for the month of January shows stocks within the S&P 500 that are the largest companies and that have the highest stock price have performed favorably to the rest of the market. Stocks considered to be highly valued using price/earnings (P/E ratio) and price to sales ratios are actually showing substantial gains relative to the overall market. The most significant statistic in our opinion is that stocks with the lowest P/E ratios were down 6.99% as a group.3

Source: Bespoke Investment Group, B.I.G. Tips Decile Analysis, 2/2/20

 

Many of the stocks in the low P/E category fall into the energy sector, which continues to suffer from poor performance. There is an element of the perfect storm for energy stocks that we have spoken of for many months including:

  • A continuing low inflation environment that weakens investment demand for commodities
  • Tremendous productivity and better regulatory environment that has produced excess supplies of oil & gas making the U.S. a likely net-exporter for 2020
  • Continually weaker demand and slower growth in European and Asian markets
  • A stronger U.S. dollar relative to other foreign currencies makes dollar-priced commodities less advantageous

 

2019 saw the price of WTI crude oil rise more than 34% but the price of natural gas fall more than 25%.4

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

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

 

The question we often ask is how much the price of crude oil or natural gas is correlated to the stock prices in the energy sector. Given the rise in price of crude oil for 2019, the Energy Select SPDR Fund (XLE), a broad representation of energy stocks in the industry, was up 11.74% for the year.5 Normally we consider that a solid investment return for a client portfolio. Since 2019 was such a strong year for the rest of the market, the XLE return placed near the bottom of all sector returns for the year. As of last week, the price of WTI crude is down more than 15% for 2020.6 The XLE fund is down more than 12% this year reflecting the difficulty energy companies are having with lower commodity prices.

Source: Stockcharts.com

 

The S&P 500 Index is comprised of multiple market sectors, including energy, with the weightings of individual companies based on their company size. Given the weaker performance of energy companies over the past year, it comes as no surprise that the energy sector has a much lower weighting (only 3.8%) in the index. This represents a significant shift since 2008 when the energy sector represented more than 15% of the index and was virtually tied in size with the technology sector.7

Source: Bespoke Investment Group, Bespoke’s Sector Snapshot, Feb. 3, 2020

 

It does not appear that the investment analyst community has given up on energy companies. In fact, the energy sector has more stocks with “buy” ratings than any other sector while it trades at very reasonable valuations. Bespoke Investment Group notes that the average energy stock now trades 24% below the consensus price target from all analysts.8 There is considerable upside for energy stocks provided a catalyst for investor interest can be discovered. We continue to watch for a reversal in any of the trends mentioned earlier in this letter for a sign that energy stocks would move higher.

Source: Bespoke Investment Group, Bespoke’s Sector Snapshot, Feb. 3, 2020

 

Our short-term market indicator flipped to negative on Friday as we saw several market sectors experience weaker demand. The overall picture for U.S. stocks remains in strong demand for the long- and intermediate-time frames. When the short-term indicator turns negative, we are encouraged to be cautious with new money going into the markets and will usually engage in a strategy to periodically invest over a period of weeks or months depending on an individual’s long-term goals. We will continue to monitor the supply/demand indicators for additional changes in the weeks ahead. At this time, we are not expecting to reduce equity risk in client portfolios.

 

U.S. interest rates fell further last week on fears of a global pandemic from the Coronavirus. Treasury yields will fall as the price of Treasury bonds rise, reflecting the increased demand for safe investments when uncertainty abounds. The decline in interest rates does not appear to have motives other than fear and we would expect those rates to rise nominally when the fear subsides.

Source: J.P. Morgan Asset Management, Weekly Market Recap, 2/3/20

 

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. J.P. Morgan Asset Management, Weekly Market Recap, 2/3/20
2. Bespoke Investment Group, The Bespoke Report, 1/31/20
3. Bespoke Investment Group, B.I.G. Tips Decile Analysis, 2/2/20
4. Bespoke Investment Group, The Bespoke Report, 1/24/20
5. Bespoke Investment Group, The Bespoke Report, 1/24/20
6. Bespoke Investment Group, The Bespoke Report, 1/24/20
7. Bespoke Investment Group, Bespoke’s Sector Snapshot, Feb. 3, 2020
8. Bespoke Investment Group, Bespoke’s Sector Snapshot, Feb. 3, 2020

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