The summer rally continued through August, once again defying market pundits and conventional wisdom. In the midst of this move higher, however, there has been wide disparity among the various sectors. Year to date, for example, Technology gained 20.0%, and Consumer Discretionary is close behind with an 18.3% rise, however, yield-oriented sectors remain at the bottom of the performance spectrum. Consumer Staples are down 6.1%, Telecommunications off 7.3%, and Utilities have managed only a 0.9% gain. The market continues to favor growth-oriented sectors given accelerating economic growth and consumer spending, as well as robust spending on technology to fuel efficiency gains, while rising interest rates have made yield-oriented sectors less attractive.
The disparity between the United States stock market and the rest of the world continued to widen. Continued worries over tariffs and trade, as well as U.S. Dollar strength and a sharp decline in commodity prices, all contributed to dragging down international equity markets. Overseas markets continue to present good opportunities for investment, at a value price, particularly in the Pacific Rim.
Some of last month’s comments bear repeating, as August markets were but a continuation of July activity:
“Wall Street climbs a wall of worry”. Those of you that have kept up with AWM&T’s market commentaries over the years will remember seeing stock market charts with significant events listed. Over the years, despite a litany of negative occurrences, the market – and the U.S. economy – continue to find ways to improve and move higher. For the past eighteen months, negative talk and investor worry over interest rates, trade and world politics have dominated investment headlines – yet the market has moved higher.
Why? Primarily because corporate earnings have been as strong, or stronger, than expected. For 2018, quarterly earnings are on track for 20 – 23% growth over the previous year. While share prices have begun to rebound, the forward price/earnings ratio is at an average level -16.7x. For 2019, earnings estimates are a more modest 5.3%, albeit from the higher 2018 level. Should those estimates prove correct, it places the S&P 500 index at a greater discount of 15.9x P/E, based on current prices.
Continued low inflation, low interest rates, earnings acceleration and modest valuation is the dream scenario for an equity investor. The fact that so many are not accepting of the current and future conditions probably means the market has much more upside left to go.
|| Month (August)
|| Year to Date
| S&P 500
| Russell 2000
| EAFE (Int’l)
| Barclays Aggregate Bond
Those of you that have listened to our webinars over the years are familiar with the discussions on the bond market and yield curve. As you recall, plotting data points on a graph that shows both maturity from 0 – 30 years and the corresponding interest rate, paints the picture commonly referred to as the yield curve.
Over the past number of months, all interest rates have been increasing, and short term rates are advancing faster than longer term rates. This makes the yield curve look flatter, which can be interpreted two ways: either the curve is getting ready to invert (short rates higher than long rates, meaning recession) or it’s representing a low inflation environment. AWM&T believes the second reason is the more valid interpretation.
While this could be a positive for equity investors, clients invested in the fixed income market have to carefully manage the interest rate risk. This flattening of the yield curve is better observed by looking at the spread (difference) in the 10 year U.S. Treasury Note yield versus the 2 year U.S. Treasury Note yield. A year ago, the spread was 115 basis points (1.15%), but now stands at a paltry 30 basis points (0.30%). This means that a bond investor has to take a large amount of risk for an additional 0.3% yield. It’s simply not worth the risk, so AWM&T made a recent decision to reallocate funds out of intermediate term bonds into short term bonds (< 2 years). We believe this will provide greater protection of principal with little sacrifice in yield.
Connect with your Relationship Manager
Every AWM&T client is assigned a Relationship Manager, an experienced professional that can work with you on your investment positioning. While markets are in this range, take the time to meet with your RM to review your risk profile and any life change impacts that may be occurring. You’ll be glad you scheduled the appointment.