Weekly Investment Newsletter (SITREP) – August 10, 2020

Many U.S. stocks are nearing all-time highs for the first time since February despite the continued divergence between indexes. Quarterly earnings reports dominated the headlines again last week as U.S. companies, once again, proved analysts to be overly pessimistic about the effects of the economic shutdown. July economic data support a sharply recovering global economy pushing stock prices higher as well.

 

U.S. stocks recorded solid gains for the week, pushing the technology-heavy NASDAQ Composite index to new highs and lifting the S&P 500 to within roughly 1.2% of its February record peak.  The small cap Russell 2000 outperformed by a wide margin, helping it to recover some of its lost ground for the year to date.  The Dow Jones Industrial Average added over 1,000 points ending the week at 27,433, a gain of 3.8%.  The NASDAQ Composite rose an additional 2.5% following last week’s strong gain.  By market cap, the large cap S&P 500 added 2.5%, while the mid cap S&P 400 jumped 4% and the small cap Russell 2000 surged 6%.

Source: J.P. Morgan Asset Management, Weekly Market Recap, 8/10/20

 

Small companies closed some of the performance gap last week but remain far behind large companies for the year. The rotation in market performance continued last week as industrials, financial and energy stocks posted strong gains. Those three sectors are down the most for the year despite their recent surge. The S&P 500 Index closed 9.4% above its 200-day moving average after a week of strong gains.1 The current level is nearly 1% from its all-time high recorded on February 19, 2020. The U.S. indexes are showing weaker breadth (read: fewer stocks are participating) over the last few weeks as the S&P 500 cumulative advance/decline line hit a new high in July and has, since, moved sideways.2

Source: J.P. Morgan Asset Management, Weekly Market Recap, 8/10/20

 

Our Global Dynamic Risk Management models continue to show favorable readings for all market indicators. The long-term, quarterly, and short-term indicators remain in positive territory while indicators for bonds and gold reached near-term highs. We have seen increasing strength within the individual indexes such as large growth and large blend. The mid-cap growth category also recently popped up into favor as well. Our qualitative research confirms the moves in the growth categories. Market seasonality continues to urge caution despite the market indicators. As we have written extensively in prior weeks, August and September present challenges for stock returns historically.

 

This is the season for U.S. companies to report their quarterly earnings results. As we discussed during the first few weeks of July, the expectations for corporate earnings were very weak for the second quarter. Two factors have led analysts to mark earnings estimates down more than ever recorded during the second quarter. Obviously the first factor is the economic shutdown that occurred in April and May causing a dramatic decline in consumer demand for products and services. The second factor was the lack of guidance from company leadership sharing anticipated results from the quarter.

 

Financial media headlines over the last three weeks are flush with positive news on corporate earnings. According to John Butters at Factset Insight, 83% of companies in the S&P 500 have reported earnings that are better than analyst expectations.3 Without context, it would be easy to think that the stock market troubles are in the past given most companies are reporting such positive earnings results. However, as with many things in life, the results are relative. U.S. companies are delivering earnings results better than expected because the expectations were so misguided, not because these companies are making money. Analysts were expecting quarterly earnings results for the S&P 500 to fall 44% on an annualized basis (the biggest markdown ever). Instead, results are showing that S&P 500 earnings are down 33.8%, the largest quarterly decline in U.S. history.4 We still have a long way to go for recovery!

Source: Factset Insight, John Butters, S&P 500 Earnings Season Update, 8/7/2020

 

Another common theme you will hear from the financial media is how overvalued stocks have become in recent months. The popular method for determining valuation is P/E ratio (price/earnings) and recent levels have reached record levels. According to Bespoke Investment Group, the P/E ratios for five sectors are now as high as they have been over the last decade.5 However, keep in mind that valuations can rise for two reasons. P/E ratios become elevated when prices rise with constant earnings or when prices stay the same with falling earnings. They become significantly elevated when prices rise with declining earnings!

 

Using P/E ratio as a measure for valuation becomes less effective in times of economic distress. Stock prices will often rise before the economy begins to recover, especially when investors anticipate economic recovery due to government or central bank assistance. Our investment committee recognizes that P/E ratios will normalize as corporate earnings normalize. In the meantime, we look to alternative means of measuring market valuation.

Source: Bespoke Investment Group, The Bespoke Report, 8/7/20

 

Analysts have struggled to ascertain the effects of the economic shutdown on corporate earnings. The second quarter was unpredictable for most companies and corporate management withdrew any guidance that is normally provided before earnings season. We saw a record number of companies offer no comment on earnings expectations for the second quarter forcing analysts to use their “best guess” estimates.

 

Bespoke pointed out that analysts historically set price targets for stocks that are above their current prices.6 The chart below reflects the challenge in the second quarter when analysts were extremely uncertain how long the shutdown would affect stock prices. While most companies are delivering better than expected results for the second quarter, corporate management teams are providing strong guidance for future earnings. As a result, analysts are setting future price targets higher. Factset Insight reports that analysts are predicting modest declines in earnings for the third and fourth quarter of 2020 before returning to earnings growth in 2021.7

Source: Bespoke Investment Group, The Bespoke Report, 8/7/20

 

Inflation remains a highly-debated topic in the investment world. Milton Friedman argued that an increase in the monetary base (increase in money supply by the Fed) has an inflationary affect. The amount of “money printing” by the Fed has stoked a number of headlines about potentially rising inflation in the future. Unfortunately, the amount of money that has been printed by the Fed (and foreign central banks) still does not come close to the amount of money that was depleted in the economic shutdown between February and May.8

 

We should remain diligent looking for signs of future inflation. Indicators for May and June saw limited momentum in rising prices and early economic reports for July show potential for growth in manufacturing and services costs. Bespoke Investment Group also notes the benefit of watching the commodities markets for signs of future inflation:

What is important to note here is that the six-month average of the monthly net number of commodities rising in price has clearly bottomed and is turning higher. Historically, these moves higher have either been accompanied by or led increases in the y/y CPI.9

Source: U.S. Bureau of Labor Statistics, Consumer Price Index for All Urban Consumers: All Items in U.S. City Average [CPIAUCSL], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/CPIAUCSL, August 10, 2020.

 

Interest rates rose nominally last week as the July ISM reports were released indicating that economic activity is rebounding. The 30-year U.S. Treasury Bond remains near historic lows at 1.23% reflecting continued caution on the recovery. Our investment committee watches the spread between inflation and 30-year Treasuries for potential signs of rising rates in the future.

Source: J.P. Morgan Asset Management, Weekly Market Recap, 8/10/20

 

When it comes to streaming television choices, Netflix, Hulu and Amazon Prime probably quickly come to mind.  However, Disney Plus, which had its debut less than a year ago, is quickly gaining ground on those leaders.  This week, Disney announced the achievement of 60 million paid subscribers in less than a year, almost double the number Netflix added over the same period.  Furthermore, once you consider the 35 million+ Hulu subscribers and the 8.5 million ESPN subscribers (both of which are owned by Disney) it is likely Disney has close to, or over, 100 million unique subscribers among its streaming properties.10 The mouse roars!

 

If you would like to schedule time to discuss our process in greater detail, please call our office at (281)616-5935 or send an email to cameron.malott@engravewealth.com. We are continually grateful for the confidence you have placed in our team. We look forward to serving your family in the years to come!

Engrave Wealth Partners Investment Committee

Bill Day, CFP®, CIMA

Taylor Parker, CFP®

Greg Parker


Footnotes:

  1. Bespoke Investment Group, The Bespoke Report, 8/7/20
  2. Bespoke Investment Group, The Bespoke Report, 8/7/20
  3. Factset Insight, John Butters, S&P 500 Earnings Season Update, 8/7/2020
  4. Bespoke Investment Group, The Bespoke Report, 8/7/20
  5. Bespoke Investment Group, The Bespoke Report, 8/7/20
  6. Bespoke Investment Group, The Bespoke Report, 8/7/20
  7. Factset Insight, John Butters, S&P 500 Earnings Season Update, 8/7/2020
  8. Mauldin Economics, Thoughts from the Frontline, 8/8/2020
  9. Bespoke Investment Group, The Bespoke Report, 8/7/20
  10. chartr.co, 8/7/2020
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