If you missed my June webinar, I’ve posted it below. If you prefer to read what I discussed, keep scrolling. For more of my webinar series, join me every third Tuesday of the month and feel free to reach out to me with questions. I enjoy hearing from you!
This is not your typical market commentary. There are plenty of resources out there with all of your asset class performance and economic and market indicators. This update will normally focus on three segments. My goal is to highlight a couple of significant overarching themes from all that data in more of an educational format. I’ll also hit on some of the challenges that every day investors and advisors are facing from a practical standpoint. And then finally, we’ll wrap up with some things on the horizon to keep an eye on.
Market Highlights: Fed Focus
Many of you may be aware that the Federal Reserve has what’s known as a dual mandate from Congress. What does that actually mean? Since 1977, the FOMC, or Federal Open Market Committee, which is the committee within the Federal Reserve that determines US monetary policy and sets the quarterly fed funds rate, has been tasked with maintaining maximum sustainable employment and stable prices. That committee has lightly indicated that this means a target of 4.5% unemployment rate and 2% rate of inflation.
“In 1977, Congress amended the Federal Reserve Act, directing the Board of Governors of the Federal Reserve System and the Federal Open Market Committee to “maintain long run growth of the monetary and credit aggregates commensurate with the economy’s long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices and moderate long-term interest rates.”
Source: https://www.chicagofed.org/research/dual-mandate/dual-mandate; Inflation is measured by the core PCE price index.
This is a diagram from the Chicago Fed showing that dual mandate. So why am I starting with this exciting topic of the Fed? Well, we’ve had a regime change this year at the Fed in both person and focus. Jay Powell is the first Fed Chair in over a decade to have to focus on the inflation side of the dual mandate. With unemployment near 4%, they can check that one off. But I would say they need to update this diagram slightly, with nearly all inflation measures now firmly in the 2-2.5% range. The market will certainly be watching if Powell and team can normalize interest rates without removing too much oxygen from this economy.
Ok, real quick on what’s been going on in the market this year. Any of you that have worked with my firm, USA Financial, know that we are not big on market predictions. It’s one of those things you can’t control and yet there’s so much focus on it. We prefer to look unemotionally at the data as it comes in. But I will say this – for the last six years price growth has increased faster than earnings growth. In other words, for the last half dozen years P has grown faster than E. So it’s no wonder we entered this year with fairly high valuations. This year has the possibility of snapping that streak. According to Factset, earning projections for the full year are roughly 19%. In fact, first quarter earning with nearly all companies in the S&P 500 reporting, actual earnings growth came in at 24.5%. We are almost half way thru the year with the market up a modest 2 percent. If the second half of the year mirrors the first half in terms of earnings growth and returns – we would finally get some significant valuation compression and I think that would be very healthy for this bull market to continue on.
Earnings Scorecard: For Q1 2018 (with 93% of the companies in the S&P 500 reporting actual results for the quarter), 78% of S&P 500 companies have reported a positive EPS surprise and 77% have reported a positive sales surprise. If 78% is the final number for the quarter, it will mark the highest percentage since FactSet began tracking this metric in Q3 2008
Earnings Growth: For Q1 2018, the blended earnings growth rate for the S&P 500 is 24.5%. If 24.5% is the actual growth rate for the quarter, it will mark the highest earnings growth since Q3 2010 (34.0%).
For this month’s Nitty Gritty, I want to explore some stock market idioms. These are the popular sayings that get tossed around in conversations as quasi-investing advice. You’ve likely heard of them:
- January Effect: Meaning that stocks generally have above average returns in the first month of the year
- Dogs of the Dow: Basically buying highest dividend yields in the Dow, based on the premise that those stocks are near their business cycle bottom and should rebound.
- Santa Claus Rally: Which is self explanatory…
- Super Bowl Indicator: I’m not sure why this one even got started, other than the fact that it’s actually been correct 80% of the time over the last 50 years. In short, it states that if the AFC wins the Superbowl we should expect a down market. If the NFC wins the market should go up. Statisticians call this type of observation spurious correlation – in other words, correlation alone does not indicate causality. This is something that we should be careful with in the financial industry. There can be a tendency to discover some correlation in the past and use that as an investment strategy in the future, when in reality there was never any logical basis for that correlation other than complete random luck.
- Sell in May and go away: Given the time of year, I’m going to take a deeper look at the “sell in May and go away” notion. It’s basically the idea that you’d be better off staying on the sidelines from May through October and invest back into the market the other six months of the year. So what does the data say?
Annualized price returns of S&P 500 (not including reinvestment of dividends), thru April 30, 2018:
I ran the annualized returns of the 2 six-month periods over short, mid, and long term time periods. And you can see, although the 5-year comparison is close, there is a consistent out-performance of the November thru April time-frame compared to May thru October.
So, does this mean that “Sell in May” has validity? Well, I’m willing to concede that the data indicates a performance edge to the winter months. And in fact, I was quite surprised how much of an edge there has been over the last 10 and 30-year periods. But before you go cashing in your chips right now, there are a couple things to consider:
- One, all the summer periods still have positive returns. And so, while going to cash would reduce your volatility, you’d also be giving up gains on average.
- Second, and I think this is the biggest issue with Sell in May, is investor behavior comes into play. Any strategy can go through a long stretch where it doesn’t appear to be working. In fact, for the last 6 years Sell in May hasn’t worked. You’d have to go all the way back to 2011 where it worked to your advantage to be completely out of the market.
Making significant portfolio shifts and trying to time the market every 6-months opens the door to negative behavioral alpha (in other words, making emotional decisions that negatively impact your long-term plan). This line of thinking goes for any strategy that you may be considering. Even if the numbers look good on paper, how does that translate to practical, real world implementation? When in doubt, simplicity trumps complexity in most situations.
On the Horizon
- If you haven’t explored my other posts yet, I’ve been trying to ramp up the content recently. Those posts have a similar feel to these webinar updates, but with a much wider range of financial topics.
- Upcoming things to keep an eye on: employment to continue to stay below 4%? Wage growth key. Summit held with North Korea June 12 in Singapore. Regardless of anyone’s political views, it’s quite a turn of events over the last year considering last summer North Korea was shooting missiles over Japan and just this January the two leaders were comparing the size of their respective nuclear buttons on social media.
Alright, that’s all for this month. Thanks for being here and make it a great day!