Capital Market Commentary Third Quarter 2017
October 1, 2017
The Stock Market
The third quarter continued with the first half trends. All of the major indices printed new all-time closing highs. Since the November presidential election, the chart of the S&P 500 is a market technician’s dream – a steady progression of higher lows and higher highs, all the while accompanied by good volume. Pullbacks have been relatively shallow, and the “buy the dip” mantra is in full swing.
S&P 500 October 2016 to Present
The big question on all investor’s minds is, “When are the good times going to end?” There have been no shortages of dire predictions, but markets love to climb walls of worry, and for now there is no market killing recession on the horizon. Q3 earnings are at hand, and we will yield to empirical evidence before passing judgement.
The Scoreboard for 2017
Q3 2017 YTD 2017
S&P 500 3.5% 12.5%
DJIA 4.4% 13.4%
Nasdaq 5.8% 20.7%
Since the end of the recession there have been a total of four FED-induced interest rate hikes, bringing the discount rate from essentially zero to the present target range of 1 to 1 ¼%. Higher rates have been held in check, mainly because inflation has been running below the fed’s 2% target level.
Bureau of Labor Statistics – Annual Inflation
The reasons for low inflation have been ascribed to many different factors including demographics (less spending by boomers), technological advances (higher productivity), and globalization (cheaper labor). Low energy prices contribute to the benign numbers, and the current storm-related gasoline price spike (more on energy later) is expected to fade as refineries come back on line. Subdued inflation is not friendly to fixed income investing, and prospects for higher rates beyond this coming December are murky at best.
Cryptocurrencies; real or imagined?
Threat or technological breakthrough? Hard to believe, but digital money has arrived. Wait a sec, we thought money was tangible, after all there are ATM’s and vending machines all over the place! What about all those money cards for the grandkids at Christmas, birthdays, and graduation? Jamie Dimon, CEO of JP Morgan & Co., one of the nation’s largest banks, has compared bitcoin with the great tulip bulb craze of the 17th century, and cautions eventual implosion. This remains to be seen, but for now we will stay on the sidelines and not be bitcoin miners or designers of ethereum applications.
The recent widening of the spread between WTI (West Texas Intermediate) oil and Brent crude has extended the boom in the export of shale production to foreign refiners. Brent has a low sulphur content and serves as a benchmark for oil traded worldwide. The latest spread of more than $6 per barrel leaves ample room for transportation costs to just about anywhere on the planet.
The ban on oil exports was lifted in 2015, and the rising production from US shale fields has pushed down prices worldwide. Efforts by both OPEC and
US Shale Oil Production(Energy Information Agency)
non-OPEC producers to curb production have been for naught. Shipping companies expanded fleets in recent years, and the glut of tankers has brought shipping rates down significantly. As long as the spread remains above roughly $4 per barrel, exporting pays dividends to domestic producers.
Growth vs Value Investing
2017 has proven, thus far, to be a year in which growth has out distanced value by a wide margin. For the first nine months of the year the S&P Value Index (SVX) gained 6.5% while the S&P Growth Index (SGX) advanced a healthy 17.9%. The S&P 500 (SPX) pretty much split the difference, gaining 12.5%.
Breaking down the constitutents of the two former indices shows the reason why. Over a third of the SGX is comprised of technology stocks compared
to only 7% in the value index. In keeping with the fundamental difference between growth and value, the P/E ratios are lower and the dividend yields higher for value over growth.
To dust off a term we haven’t used in a while, our goal here at Abbot is, and always has been, to favor the value side of investing, while at the same time search out GARP – “growth at a reasonable price”. It is interesting to note that there are many companies that are constituents of both the SVX and SGX, and these companies are fair game for inclusion in client portfolios.
This year noticable laggards in the value camp are energy and telecom, while technology has been the biggest sector winner. As always, diversification is key, and we are committed foremost to value principles when crafting client portfolios.
The Quarter Ahead
Third quarter earnings will, we believe, provide investors with some positive momentum in the fourth quarter. Washington news is always a noisy backdrop, but a solid economy is what ultimately fuels stock markets.
In closing, we would like to repeat, verbatim, the closing paragraph of our July newsletter:
January 2016 was the last time that the stock market had a measurable correction, and that was short lived. We have often said that corrections are a necessary part of investing, and should be viewed as a pause that refreshes. We would opine that we are overdue for a correction that would give non-participants an opportunity to get into the market. As always, if you would like to discuss the financial markets or your portfolio in greater detail, Bill, Andrew and Bob are always available to speak with you.