10-15 Associates

In Search of Value

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September gave not only the financial markets, but the entire world more than one reason to stop and tune into the news to try to make reason of the world we live in today. From one of corporate America’s most vocal and public CEO, Elon Musk, being sued by the Securities and Exchange Commission for fraud, all the way to our Supreme Court nomination hearing turning into a daytime drama that elicited ratings equivalent to a Super Bowl playoff game. That’s in addition to Hurricane Florence pounding the East coast for several days with record rainfall, bringing parts of the South to a standstill, and lastly, news that Facebook has once again been hacked, compromising the data of nearly 50 million accounts. Meanwhile, in the face of yet another rate hike from the Federal Reserve, the markets set new records and September closed out one of the best quarters since 2013.

Even though the Nasdaq did not join the party for the month, losing 0.78%, the Dow and S&P 500 gained 1.9% and 0.43% respectively. It doesn’t seem possible that just six months ago, fears of a trade war and the possible impact on the economy sent stocks tumbling. Investors seem rather content on focusing on the strong economy and corporate earnings growth, meanwhile ignoring some of the looming risks longer term. Some things however, are beginning to show signs that investors are growing a little more cautious. The lack of participation of the Nasdaq and some of the big technology names that have been so powerful for the first part of the year, have been showing some signs of slowing. In addition, according to the Ned Davis Research Crowd Sentiment Poll, investor sentiment is overly optimistic, which is a contrarian indicator of the possibility of a near term pullback. Although sentiment is high, according to Evercore ISI Research, investor actions don’t match sentiment. Their research shows that money flow into equity, mutual funds, and exchange traded funds (ETF’s) is negative, indicating more money coming out of equities than going into equities. One more indication is the type of sectors outperforming. During the month of September, health care and telecom were the top performing sectors which are traditionally more defensive industries.

The move in interest rates was also very notable for the month. Ten-year treasury rates traded as high as 3.11% during the month, closing 7% higher than where they started in the beginning of the month. That brings the total move in long term rate for the year to an increase of 27.26%. Even more telling is the move in two-year treasuries which traded with a yield as high as 2.84% and are now up 49.7% on the year. With another rate hike now in the books for 2018, the Federal Reserve chairman told reporters that policymakers expected inflation to remain at the central bank’s target, “on a sustained basis,” indicating more hikes to come. With the final revision of second quarter GDP confirming 4.2% growth, economists are now forecasting a strong 3rd quarter. The CNBC Rapid Update survey of economists sees a 3.3% third quarter, slightly below the second quarter, but still very robust growth. Several key indicators such as consumer spending, which accounts for roughly two thirds of GDP, rose 0.3% last month following an unrevised 0.4% gain in the prior month. Durable goods orders were up a surprising 4.5% compared to expectations of just 2%. Spending increased across the board, including public and private spending as well as business investment. Also, consumer confidence and business optimism remain at or near record highs. With inflation at target and still behaving, the strong economic backdrop certainly gives Chairman Powell a clear runway for now, to continue to raise rates.

It is likely you could guess the move in oil by the increase in gas prices. The global benchmark for oil is Brent Crude and the price of a barrel is up 23% this year with a 15% increase in just the past five weeks. At $82 per barrel, it’s the highest level since 2014. Increased demand is indicative of growth around the world, and as new supply is difficult to bring on line and inventories decline, the forces of supply and demand push prices higher. Rising oil prices bring both positives and negatives. One concern is that higher prices could push up inflation readings, leading global central bankers to move more aggressively on higher interest rates. Higher than expected rates could have a negative impact on the overall economy sooner than expected. The negative impact is felt most notably on the consumer discretionary sector and industries such as the airlines and autos. On the positive, higher prices will benefit the energy sector, but energy represents a relatively small percentage of the S&P 500. It does however represent over 16% of the MSCI World Index and exceeds the consumer discretionary sector of this index, which could have a net positive impact on the index if prices remain high. Historically, higher oil prices have correlated with better performance in the Canadian market and the emerging markets.

The move in oil and the potential correlation to the emerging markets, along with the underperformance of those markets relative the U.S., may be one reason that investors appear to be looking abroad. According to Fran Kinniry, an investment strategist at Vanguard Group, over the past 10 years, mutual fund and exchange traded fund investors took $34 billion out of U.S. funds and added $1.02 trillion to international funds. Although very contrarian, it may be timely and one more indication that investors are growing more concerned about the level of domestic markets relative to other markets around the world. Over the last decade, U.S. stocks have significantly outperformed international stocks as measured by the MSCI World ex USA Index. However, over the 10-year period ending in 1986, international stocks outperformed the U.S. by an average of 6.2% annually. Due in part to the trillions of dollars of fiscal and monetary stimulus post the financial crisis, U.S. stocks rose so swiftly they left the rest of the world behind. Quoting American journalist, Jason Zweig, “Markets tend to lose their dominance right around the time it seems most irresistible.” Markets feel far from irresistible and there no signs of “irrational exuberance,” yet some caution at these levels may certainly be warranted.

We can look to history for some guidance as we enter the final quarter of the year, await third quarter earnings, and anticipate the impact of the midterm elections. When the S&P rises in the third quarter, it has advanced an average of 3.8% in the fourth quarter every year since 1945, according to Sam Stovall of CFRA Research. In midterm election years, the S&P 500 rallies an average of 7.1% in the fourth quarter, following a third quarter gain. The challenges continue to mount as they have throughout the year. The market is looking for and anticipating more good news from earnings and the labor markets. This data will provide better insight about the resiliency of the economy, which will also help guide any changes we need to consider.

Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product made reference to directly or indirectly in this newsletter, will be profitable, equal any corresponding indicated historical performance level(s), or be suitable for your portfolio. Due to various factors, including changing market conditions, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this newsletter serves as the receipt of, or as a substitute for, personalized investment advice from 10-15 Associates. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing. A copy of our current written disclosure statement discussing our advisory services and fees is available for review upon request.
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