INSIGHTS

Here is our monthly view of the financial markets and some of the thoughts that go into our investment decisions.

The Market: September 2019

We are back from the summer and the stock market is, despite some big up and down days, pretty much at the level where it began the summer. The bond market is a different story, interest rates in the US and Europe steadily declined throughout July and August. More than $14 trillion of bonds yield negative interest rates. Rates and bond prices move in opposite directions and as rates have fallen, returns on bonds have been stellar. From July 1 to August 30, the US long-bond was up just over 11%. This compares with a 1% decline over the same period for the S&P500. Globally, investors are clamoring for “safe” assets. Government bonds, gold, consumer staples stocks, utilities, and REITS have seen positive inflows and prices that have been bid up. The markets are trying to grapple with several factors and investor appetite for “safe” assets is a reflection of the concerns. The global economy has been slowing, causing many to fear that a recession is inevitable. Whether the escalated trade war is the cause of the slowdown or whether the conflict has just increased the pressure on the brakes, trade is nonetheless an important factor. Any positive resolution would be bullish for stocks and would likely cool off the bond rally. Perhaps an under-rated concern is Brexit. Maybe the markets were desensitized given that Brexit has been in the news for so long. However, as the October 31 deadline is rapidly approaching, the separation of the UK from the EU has become real. It’s understandable how investors have been behaving. Trade and Brexit add great uncertainty for businesses and consumers. Both hold back expenditures which slows the economy and puts a question mark over future corporate earnings. The uncertainties may ultimately lead to recession and the “safe” assets that have been so popular will continue to work well. However, a word of caution. As an asset’s price goes up, so does the risk. What is “safe” today might become “risky” tomorrow. If there is a resolution on trade and Brexit, investors will exit the “safe” assets all at once and the prices of these assets will tumble. With this in mind, the important lesson for investors is that they should stick with their financial plan and asset allocation regardless of emotion and fear or greed. Similarly, investors should maintain a balanced asset allocation that incorporates “safe” assets and “risk” assets, consistent with long-term goals. Rebalancing becomes essential so as to not let certain asset classes or sectors become too great a percentage of total assets. It’s also important to not let fear keep you out of the markets. Missing the big up days can reduce returns dramatically. Fidelity looked at the growth of $10,000 invested in the stock market from 1980 to 2018. If an investor missed the five best days the growth of $10,000 was reduced from $708,143 to $458,476. It is time, not timing that matters. — Ian Green, Pendragon Capital Management

The Market: May 2019

The stock market is gripped once again by the US-China trade negotiations.  The US has upped the ante by increasing tariffs on $200 billion of goods imported from China.  President Trump has threatened to expand the list.  China has retaliated and could consider other measures.  It may well be that the threats and negotiations will go on longer than most have been expecting.  At this point, it is unclear what a win looks like to either side.  While most believe it is in the best interest of both countries to get a deal done as quickly as possible, the two sides may not be able to deliver.  The markets have been down in response to the escalating trade tensions but this is after the market hit fresh highs. It seems that the trade issue will hang over the market, dampening any good news.  Earnings for the 1st quarter came in better than most feared.  According to FactSet, with 90% of S&P500 companies reporting, 76% of S&P500 firms beat their earnings estimates and 59% reported positive revenue surprises.  The markets are a game of expectations. The earnings beats drove stock prices higher but it is important to note that earnings were actually down 0.5% when compared to the same period last year. This is the first decline in earnings since the 2nd quarter of 2016.  Analysts forecasted that earnings would be down 4% from a year ago.  Being less bad than expected is good. The S&P500 trades at 16.5 times earnings which are about the average for the past five years. The market is not cheap but also is not extremely overvalued, especially considering interest rates are so low.  The earnings picture for the second quarter isn’t shaping up to be great.  Sixty-five of the 500 companies have offered lower profit guidance versus just 17 companies guiding higher.  This makes the trade issue more concerning. It’s one thing to introduce some profit uncertainty when earnings are rising.  It’s another when earnings are soft.  While 16.5 times earnings are within the market’s recent average, if the earnings component to the calculation declines, the price-to-earnings ratio will increase, adding to the precariousness of the market.  I would suggest that investors today need to be more cautious than in the past because computer algorithms can take hold and sell programs can be triggered.  As we have seen in today’s market structure, without an uptick rule or market-making specialists, selling can become relentless.  This is what happened in the 4th quarter of 2018.  With computer-driven trading taking up an ever-larger portion of daily volume, it seems like the markets move around in the short-run irrespective of the fundamentals. Despite the fierce ups and downs, the stock market has not really gone anywhere in 15 months.  Investors need a robust portfolio with quality growth, value and cash reserves to withstand the downdrafts, to take advantage of buying opportunities and to participate in the upswings. — Ian Green, Pendragon Capital Management