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Mid-Quarter Outlook as of November 16, 2018
John M. Silvis, CFA | Chief Investment Officer
As we head into the home stretch of 2018 global equity markets remain bifurcated with domestic equities, led by the S&P 500 Index, outpacing international markets year-to-date. The S&P 500 Index currently remains slightly positive with a total return of 4.1%, while the international markets represented by the MSCI All Country World ex-US Index has declined -9.8% this year. Expect more volatility as we head into the final stages of 2018.
Global equity markets have remained volatile for most of the year with equity markets experiencing a positive third quarter with new highs for most of the domestic equity indices. The S&P 500 Index registered its strongest quarter since late 2013 with a total return of 7.7% for the three months ending in September. With the market overbought and likely due for some type of correction, stocks have struggled since hitting an all-time high on September 21 falling over -11% before rebounding after the midterm elections.
With the midterms from early November now behind us, the next few weeks will be dominated by the current trade dispute with China, issues with earnings growth and the path of the Fed going forward. We expect the markets to remain choppy with headlines trumping fundamentals in the near term. Unlike normal corrections, bear markets tend to precede or coincide with recessions. We are unlikely to see a recession in the next few quarters. With the uncertainty of the elections now behind us, it is important to point out that the period between November and January has historically been the best three-month period for equities (going back to 1901). We are staying the course with our overweight to equities at this time and will continue to monitor capital markets with a focus on the long term.
Over the last fifty years, the economy has grown an average of 2.7% and the economy continues to grow above its long-term trend. The most recent third quarter GDP growth clocked in at 3.6%, setting the economy up to grow above 3% in the current year, the highest rate since before the global financial crisis. The jobs picture remains strong with the unemployment rate dropping to 3.7%, the lowest since 1969. Both business and consumer confidence remain elevated and near historic highs reflect an overall positive economic backdrop.
Employment among Millennials (from 25-34 years old) has hit a high as shown on the chart. Household formation among this group also demonstrates that Millennials are becoming a consumer force.
However, there has been rising concern that the economy has started to show signs of a pending slowdown as we head into 2019. There has been some softness in the most recent auto and housing numbers but not enough to confirm a change in trend.
Trade tensions remain in the headlines and have started to show some raised level of concern. A recent survey by Evercore ISI of over 100 corporations has shown an increase in the number of respondents (more than 30%) that indicated the trade tariffs have had a small impact on their business as shown on the chart below. This percentage is likely to go up the longer it takes to find a resolution. The recent survey results still suggest GDP growth consistent with 3.5% GDP growth.
Within the large cap universe, multiples remain in check after the ongoing correction with forward price to earnings multiples trading at 16x, in line with its 16.1x long-term average. There should be room for multiples to expand in the coming months as inflation remains in check with oil, one of its biggest contributors, recently falling to yearly lows.
With the third quarter earnings season coming to an end, earnings growth again topped expectations and came in around 27% higher than the same period last year. With the positive direction of earnings, the overall backdrop for equities remains on firm ground and should provide a tailwind in 2019. Year-to-date, Technology and Healthcare have been the best performing sectors with the S&P 500 Index, areas we have been overweight for most of the year. However, Technology has come under pressure during the recent correction and has been weighed down by the performance of some of its larger constituents such as Apple (ticker symbol: AAPL). Defensive sectors, such as Utilities and Staples, have weathered the recent correction better as investors look for the safe haven of lower volatility stocks. It’s too early to tell if this is a major rotation in leadership out of sectors that benefit from an expanding economy and into areas that can shield portfolios from a pending recession, and is something we continue to monitor.
The rise of the dollar continues to pressure markets outside the U.S. with the current move higher breaking out from a consolidation over the last few months. Europe is still struggling with anemic growth and the ECB’s (European Central Bank) path toward normalizing monetary policy. Valuations look attractive in the region with multiples trading at nearly 75% of their U.S. counterparts, well below the 20-year historical average. While valuations look compelling on overseas equities, a catalyst for money to flow to international markets seems lacking at this point in time. China’s economy growth is slowing with its most recent GDP reading coming in at 6.5% with expectations of further slowing in the quarters ahead. Overall, trade tensions (primarily with China) continue to weigh on emerging markets, with the MSCI Emerging Market Index down -12.8% this year and likely to spill into next year. President Trump is scheduled to meet with China’s leader President Xi later this month with hope that trade negotiations could restart approaching the New Year.
Expect more weakness in the coming weeks and months as the market digests comments from the Fed, earnings guidance and economic data. We remain focused on the next three years and not the next three weeks or months. The economy remains firm, earnings growth is positive and markets will be entering the best period of the four-year presidential cycle in 2019.
Fixed Income Commentary
Rick D’Amico, CFA | Manager of Investments
The recent spike in market volatility seems to be highly correlated with the October breakout in 30-year Treasury yields. Since breaking through the key technical level of 3.25%, 30-year yields have settled into a trading range between 3.30% and 3.45%. 10-year Treasury yields also had a decisive break through a key technical level (3.10%), but have since retreated to their current level of 3.05%. According to Ned Davis Research (NDR) Group, most of the rise in yields can be attributed to “expectations of faster growth and continued withdrawal of monetary policy accommodation.” NDR’s preferred models suggest a modest increase in yields going forward, with 10-year yields settling in between 3.35% and 3.60%.
The Fed funds futures market is pricing in a 68% probability that the Fed raises the benchmark rate at its December 19 meeting. However, the path for future rate increases appears less clear, as there is a large gap between the FOMC’s and the market’s projected rate paths. According to the FOMC member’s median dot projections from their September meeting, the Fed expects to increase rates three more times in 2019 and once in 2020, before finally pausing in 2021. The market, however, only anticipates one additional rate increase in 2019.
It remains a challenging environment for fixed income investors. As of November 16, 2018, the Barclays U.S. Aggregate Bond Index has returned a negative 1.95% year-to-date. The Index is also negative over the last one-year period, posting a loss of -1.63%. In addition to yields being some 65 basis points higher from where the year began, credit spreads have moved to the upper end of their recent ranges. After falling to their lowest point since 2007, high yield credit spreads have broken higher and are up 90 basis points from the September lows. Healthcare and Communications are the only sectors within high yield with spreads below their 52 week highs. We remain defensively positioned within fixed income relative to duration, and continue to prefer credit relative to government securities. However, the recent spread widening is a concern and warrants close monitoring.
Accolades, awards and appointments
For his strategic thinking and proven record of success in driving operating results, Ken Coleman has been elected to serve on the 2019 Hightower Advisory Council. Ken will be an incredible asset to the committee as they work collaboratively with leadership and the Board of Directors on initiatives to drive the future direction of Hightower.
Ken Coleman joined the AMP (Accelerating Middle Market Progress) – Greater Cleveland Partnership Middle Market Committee. The committee oversees events and programming, content and information and experiences specifically designed with the needs and interests of middle-market companies.
Rick D’Amico has joined the Benjamin Rose Institute on Aging (BRIA) Investment Advisory Committee.
Emily Drake became a member of the highly selective 50 Club of Cleveland. The club is comprised of leaders in business, professional and cultural life of Greater Cleveland who meet monthly to exchange points of view on local, national and international issues. Membership is by invitation only and based on personal qualifications.
David Rubis has been asked to become a member of the Strongsville City School Business Advisory Council and the Southwest Regional Business Advisory Council at Polaris Career Center.
Tom Seifert has been elected to the Beech Brook Board of Directors. He and his wife, Tracy, were co-chairs of the organization’s annual “Beech Ball, Bridges to Hope” Gala and he was a race committee member and participant of the 5k that attracted over 150 runners!
Conferences and continuing education
David Bosak and Joyce Zak attended the 2018 eMoney summit in Orlando in October. The 2018 eMoney Summit had over 1000 Advisors in attendance and focused on how FlexGen advisors are overcoming the generational gap and capturing the next generation of investors. The two also participated in breakout sessions on eMoney best practices.
In September, Andrew Connors participated on a panel of experts at the Crain’s Cleveland Family Business Forum. The panel discussed best practices and biggest pitfalls in succession planning. Click here for the highlights.
Rick D’Amico attended the HighTower Investment Forum in New York City in November. The forum is an intensive 2-day meeting focused on best practices in investment management activities. Speakers include chief strategists, economists, portfolio managers and HighTower Advisors.
Pete DeVito, Chris Isabella and Tom Seifert attended a continuing education program entitled “Executive Compensation/Life Settlements/Divorce Law/Asset Protection Planning” in November.
Heather Ettinger and Chris Isabella presented Raising Financially Responsible Children to parents and alumni at Saint Joseph Academy in October. Interested in tips, tricks and age-appropriate strategies to use with your kids? We are happy to come talk to your PTA organization, school, church. Email us!
David Rubis attended the Excel 401(K) Conference in Las Vegas at the end of October.
Katie Sheehan spoke at the PAX Ellevate Invest in Women Symposium in July. She and the other panelists shared proven strategies to engage clients with impact investing and investing in women. She also attended the Money Management Institute/Morningstar Financial Advisor Forum on Sustainable Investing in early October.
John Silvis kept current on investment trends at the JP Morgan ETF symposium in New York City in September and the 3rd Annual Private Wealth Ohio Forum in Columbus.
Paul Zappala attended Hightower’s Pinnacle Conference in Chicago in September, the CCO Round Table sponsored by Thompson Hine in Cleveland in early October and the Compass Compliance Round Table in Charleston at the end of October.
A Picture is Worth a Thousand Words
At Fairport, we feel strongly that fostering teamwork helps us perform better as stewards of your wealth… and here are some photos to prove it! On a sunny day in August we each grabbed an oar, tip toed into a shell and paddled down the Cuyahoga River in tandem. This internal event (and others like this one) makes us stronger both as individuals and as a unit. We’re wealth management with muscle!
This newsletter represents an assessment of the economic and market environment at a specific moment in time and is not intended to be a forecast of future events or any guarantee of future results. It is for informational purposes only and should not be relied upon as research or investment/financial planning/tax advice. It should not be considered as a solicitation or recommendation by Fairport to buy, sell or continue to hold securities or other investments. Past performance is not a guarantee of future results, and is not indicative of any specific investment. It should not be assumed that the investment process and strategy discussed herein has been or will prove to be profitable.