2ND QUARTER 2018
Halfway Around the Horn…
"If past history was all that is needed to play the game of money, the richest people would be librarians.”
As we passed the mid-way point in 2018, we’ve seen global markets attempting to navigate a multitude of cross currents, settling essentially flat through the first two quarters of the year. That’s not, however, to suggest that the year has lacked drama, as quite the contrary has been true, given the tariff dust ups and the apparent dismissal of civility in international diplomacy – all of which have given occasional shudders to the world’s capital markets.
After 2017’s magic carpet ride to the upside in the equity markets, where FOMO (fear of missing out) and TINA (there is no alternative) were the continual bids that drove stock prices higher at a rate that far exceeded gains in earnings (thereby stretching valuations), 2018 market volatility is suggesting that current, and future, valuations could in fact matter.
The post-financial crisis’s enamor with passive index-driven funds created a correlated world where everybody was either in the pool, or everybody was out – so the first hints at changes in that dynamic may be in overall market correlations.
“In a risk-on/risk-off market, everything moves with the market. From 2010 through 2016, the 11 sectors of the S&P 500 had an average correlation of 0.82 with the overall index…(A correlation of one means that the two assets move in lockstep.) Since then, correlations have been falling, with the average now around 0.59.”
B Levisohn, Barron’s, 7/16/18
Another potential element in the investor-angst mix has been a sentiment change in the equity fund net inflow/outflow measurements. Prior to this year, the aforementioned FOMO/TINA-led tsunami of dollars cascading into equity funds was a driving force in moving share prices higher, regardless of any relative valuation concerns.
"From a gusher of $103 billion in the first five weeks of 2018, when stocks seemed on an unstoppable ascent, the inflows slowed to $31 billion over the next five months, before reversing to a $50 billion outflow in the most recent five days.”
R Forsyth, Barron’s, 7/2/18
An even more interesting sub-set of this sentiment change has been the slowing of dollars going into index-focused funds and ETFs:
“The flood of money into low-cost index funds is slowing in 2018, testing Americans’ unprecedented embrace of passively managed investments during the nine-year-old bull market for stocks. Net inflows into U.S. mutual funds and exchange-traded funds that mimic indexes dropped to $3.4 billion in June, according to data compiled by Morningstar. That was the lowest amount of new monthly money for these funds since 2014. For the first six months of 2018 passive inflows were down 44% compared to the same period a year earlier.”
Wall Street Journal, 7/14/18
Above and beyond the background noise from the din of geo-political chatter, there are a few basic fundamentals that could give investors pause before throwing their next bucket of cash blindly into the markets. First is that the disparity in valuations between growth stocks and value stocks is extreme, and despite Jack’s experience with his magic beans, stock prices can’t grow to the sky without the broad support of “real” earnings.
“To be sure, growth stocks are relatively pricey. Value stocks are at the cheapest levels since at least 2005, while growth stocks are at the highest relative valuation since 2005.”
Investor’s Business Daily, 7/2/18
The proverbial canary in the mine could be, much like the times where stocks were “partying like it was 1999”, the lack of leadership breadth driving the popular indices higher. According to Goldman Sachs Investment Research, through June of 2018, almost 70% of the S&P 500’s gain is attributable to the shares of three companies, while 99% of the move up was caused by just 6 of the 500 companies in the index…something we wouldn’t consider well rounded.
Recently released profits for the 1st quarter, show S&P 500 profits (which include benefits from tax cuts, share buy backs, one-time event exclusion and overseas operations) up a stunning 26.3%. But a Commerce Department measure for the same time period, which includes all U.S. corporations and not just the big public ones in the S&P 500, showed that profits rose only 0.1%.
“None of these differences have mattered much until now. The S&P and Commerce Department corporate profit figures had been tracking each other fairly well. The split may signal that profit growth is weaker than it seems, something that the stock market, which has essentially gone nowhere this year, seems to agree with. Weaker profits make sense given the backdrop of rising costs for labor and other items, and lack of pricing power in many industries, which combine to squeeze profit margins.”
Wall Street Journal, 5/30/18
As we referenced at the start of this quarter’s missive, our job is a combination of both retrospective and prospective thinking. Knowing where you came from is easy – knowing where you’re going is more like sailing – having to adjust to changing conditions on the fly to get to your desired destination.
Hind sight is always 20-20, as we talked about after the crash of the tech bubble in 2001 and the housing-led Great Recession in 2008, where we all saw the data but continued to believe we were living in a different paradigm…so our regular focus is to continue to strive to understand the past, lest we repeat it.
At the conclusion of Lin-Manuel Mirada’s award-winning Broadway show Hamilton, Alexander’s protagonists Jefferson and Madison reflect, after his demise at the hands of Burr, on his lasting contributions in the closing number “Who Lives, Who Dies, Who Tells Your Story”:
I’ll give him this: his financial system is a
Work of genius. I couldn’t undo it if I tried
And I tried
He took our country from bankruptcy to prosperity
I hate to admit it, but he doesn’t get enough credit
For all the credit he gave us
Our goal continues to be the proactive review of current data, and future forecasts, so that we can critically evaluate the journeys that work best for our clients – we plan to be there to tell the stories.
Domestic and Global Market Recap...
“The world cannot be understood without numbers. But the world cannot be understood with numbers alone.”
Domestic equity prices rose slightly in the past three months, but the real story of the second quarter was the building disruption in global trade, the sudden uncertainty of held foreign alliances and the possibility of political and economic chaos. The confusion might be felt further down the road, but for now the US economy remains strong enough for the Fed to continue gradually normalization of interest rates in the government bond market, which lent strength to the US dollar.
On May 31, after steep tariffs were announced on steel and aluminum imports from several of the US’s closest allies, industrial stocks dropped 1.5%. The ongoing threat of retaliatory trade tariffs between the US and Canada, Mexico and the EU was reflected most in the stock prices of multinationals, particularly the industrial and manufacturing concerns that will bear the brunt of increased cost for metals.
The industrial heavy Dow Jones 30 Index, home to global exporters 3M, Boeing and Caterpillar, gets around 44% of revenues from overseas. It dropped 4% in the last 3 weeks of June to end the quarter with a 0.7% gain and dropped back into negative territory for the year. In contrast, the S&P 500, which receives around 30% of sales from abroad, gained 2.9%. Technology avoided mention in the trade wars and was responsible for most of the gains in the quarter, with the NASDAQ up 6.3%, as market leadership narrowed.
The market perceives protectionist trade policies as a threat to global economic health. Europe has already started to see fairly sharp declines in growth. Expectations of slowing in economic recovery increased demand for US government bonds, reversing the higher rates seen early in the quarter. The 10-year US Treasury yield wound up below 3% after climbing briefly above that level. Combined with the Fed increasing short term rates, this has led a flatter the yield curve with the spread between 2-year and 10-year yields at its lowest point since August 2007, just before mortgage crisis.
Speaking of the events of 2007-2008, the current expansion is now into its tenth year and this quarter finally saw some small signs of inflation. The Fed relies on the Commerce Department price index for personal consumption (without energy and food) as their target. In May it rose 2% for the first time since April 2012. While unemployment is at an 18-year low, wage increases remain underwhelming, and trail inflation measures. The consumer will be pinched by higher prices and stagnant wages.
Oil prices rose 13%. Industrial metals, used by many as an early economic indicator, were battered by the new tariffs. Copper was typical, losing 10% after the announcement. US steel and aluminum initially rose, then tumbled as worries of a slowdown grew. They were also hurt by the strong dollar.
The geopolitical risk leads to investors feeling uncertain which causes them to favor less risky holdings like the US dollar, which gained 5.5% vs the Euro and 4.2% vs the yen. The stronger dollar and higher Treasury rates hurt emerging equity and fixed income markets.
Global equities made gains in a volatile quarter, as resilient economic and earnings data vied with an unsettling geopolitical backdrop to establish the market’s direction. US equities advanced in Q2, with positive earnings momentum and supportive economic data ultimately outshining escalating US-China trade posturing. Over the quarter, energy, consumer discretionary and technology stocks performed well, while a rotation into more traditionally defensive areas supported real estate and utilities. Industrial stocks were weaker given the discussions surrounding trade sanctions, and financials were weaker due to a flattening of the yield curve.
The Energy sector as a whole rebounded very well in Q2 with a 13.5% move and thus up 6.8% for the year. Oil prices (WTI) have more than doubled since early 2016 largely because of an improving economy. With recent positions on Iran, oil supplies could be significantly constrained, and the combination of additional supply restrictions and a strong economy will likely further increase prices. According to Cornerstone Analytics, a leading independent energy research firm, OPEC does not have enough spare capacity to make up for a full reduction in Iranian exports and non-OPEC production is running near full capacity. If their analysis is correct, then any supply constraints could result in meaningful higher prices. One should not assume that an increase in energy prices might be temporary, although energy prices would likely have to substantially increase before damaging the US economy.
Also current prices of energy sector stocks may be a bargain. At two times trailing price-to-book (P/B) the sector looks cheap relative to its own history. Since 1995 the large cap S&P Energy Sector Index has traded at an average of approximately 2.4 P/B. Energy stocks look even cheaper relative to the broader market. The sector currently trades at just 0.57 times the P/B of the S&P 500. This compares favorably to the long-term average of 0.82 and the post-crisis average of 0.76. This is one reason energy stocks are currently over-represented in value indexes.
Consumer Discretionary was the top performing sector with a QTD and YTD return of 8.2% and 11.5% return respectively. The advance for a number of retailers and department stores has come on the back of upbeat quarterly results and the chatter about whether the “retail apocalypse” may be done. The consumer discretionary sector reported quarterly earnings growth of 15.4 per cent and sales growth of 7.5 per cent, according to FactSet and exceeding the data provider’s estimates in March.
The sector’s growth has been fueled mostly by Amazon, the largest component of the sector. Netflix, another sector heavyweight, has also run to record highs, and the pair have been instrumental in pushing the NYSE FAANG index to a new peak. But in the March to June quarter, shares in Jeff Bezos’ ecommerce juggernaut are up 17 per cent and Tiffany, Mattel, Macy’s, Nike, Under Armour and TJX Cos have all outperformed Amazon over that period.
The sector rally has also come as US consumer spending has regained momentum in the second quarter following a sluggish start to the year and as economists expect the US tax overhaul will boost spending on discretionary items this year. However, it is worth noting that rising home and oil prices and healthcare costs could offset tax benefits. Moreover, it isn’t yet clear how escalating trade frictions could play out for the sector in the months ahead.
Technology was only second best (behind energy) this past quarter, gaining 8.2% vs. the S&P500 3.4%, and second best (behind Consumer Discretionary)on a YTD basis at 10.9% vs. the S&P500 2.6%. Gains in technology should continue as they exploit a growing market, such as social media companies and streaming services, or companies who are revamping traditional industries, such as online retailers that replace brick & mortar companies.
Growth as a whole continued its long run. Growth style outperformance, continued again in the second quarter, although Value started to finally show up! Top-performing sectors, technology and consumer discretionary, are both categorized as “growth” sectors, while the value sector Energy outperformed them both. Significant investment opportunities may still exist in sectors that benefit from nominal growth. The majority of equity managers are underweighting the sectors that might benefit the most from accelerating nominal growth (Energy, Materials, and Industrials).
Concerns For Not Having A Will...
Last quarter we discussed the importance of having a will. A common misperception is “I have no money, why do I need a will?”. As we discussed there are important reasons to draft a will even if you “have no money”. Having a designated Power of Attorney or POA to represent you after you pass away or while incapacitated, and the Advanced Health Care directive which would dictate life support wishes are two reasons. Below are other items that a will can address:
Who Gets the Kids?
Without a will, the court will appoint their guardian. While the court or judge is charged to gather as much information as possible to make a good decision and act in the children’s best interest, without a will they may not pick the person you would ultimately want as guardian for them.
This can be a complex issue and guidelines can vary by state. Without a will, the asset distribution may not occur the way you want
Single with No Children
Without a will, usually your parents would receive the entire estate if they are both living. Otherwise it could be divided with siblings, including half-siblings and surviving parents.
Married with No Children
Without a will, your estate likely will go entirely to surviving spouse, or be split between surviving spouse, siblings and parents.
Married with Children
Without a will, the entire estate will go to surviving spouse (if all children are children of surviving spouse). Otherwise the surviving spouse may receive up to one half the estate, with the remaining portion passing to your surviving children from another spouse or partner.
Passing away without a will can be especially devastating to unmarried couples who are living together. Intestacy laws would only recognize relatives. Unmarried couples would not inherit the property of the other partner; instead, the decedents property would be divided among relatives.
It is important to remember that states differ on their guidelines on disposition of your estate if you die without a will. An estate planning attorney can help go over all the situations that are relevant to you and your family. If you leave it up to someone else to decide, it is probably not going to work out the way you wanted. Please contact your OPA advisor if you need to discuss this topic further.
Mary Ellen Carignan - Mary Ellen joined Old Port Advisors as an Administrative Assistant in this June after working as an Administrative Assistant and then Market Research Analyst for five years at The Signal Group, a consulting firm in the affordable housing industry. Prior to The Signal Group, Mary Ellen stayed at home with her husband Peter and their four children (Joe, Grace and twins Luke & Tom), volunteering in various capacities at their schools and as a board member of the Cape Elizabeth Education Foundation. Mary Ellen has a Bachelor of Science degree in Early Childhood Education from Boston College.
Propel’s 2nd Annual Ignition Awards – The Greater Portland Chamber’s next generation of business leaders held their annual awards event, at which OPA was the sponsor recognizing the first “Young Professional of the Year”. This year’s inaugural winner was Alison Siviski, the Community and Communications Manager at the Olympia Snow Women’s Leadership Institute ( https://www.snoweleadershipinstitute.org/ ), Public Relations Board Chair for The Junior League of Portland, and a varsity sports coach at Deering High.
Save The Dates:
We’re continuing the time of year when a variety of non-profit organizations begin their annual fundraising efforts so they can continue to enhance the fabric of our community. Although by no means complete, the events below are but a sampling of the organizations that our firm, employees, colleagues and clients are involved with, should you want to consider supporting their missions.
Maine Preservation’s 8th Annual Gala – Will be held Friday September 7th, starting at 6:00 PM, in the Armory of The Portland Masonic. OPA will once again be one of the lead sponsors for the event which supports the organization’s mission to promote and preserve historic places, buildings, downtowns and neighborhoods, strengthening the cultural and economic vitality of Maine communities. Tickets and additional information can be found at http://mainepreservation.org/
Center For Grieving Children – Their annual “Swing Fore The Center” golf benefit will be held Tuesday September 11th at The Purpoodock Club in Cape Elizabeth. The Center for Grieving Children, based in Portland, serves more than 4,000 grieving children, teens, families, and young adults annually through peer support, outreach, and education. Since its founding in 1987, the Center for Grieving Children has served more than 66,000 children, teens, and their families. Additional information can be found at http://www.cgcmaine.org/events/golf-tournament/
Also, please feel free to visit our evolving website (www.oldportadvisors.com) as we continue our rebranding efforts and build out more of our online capabilities.
Old Port Advisors was founded more than 20 years ago as Investment Management & Consulting Group (IMCG), with a vision to create a boutique independent investment management firm centered on the best interests of our clients. Our principles were simple and still ground us today: a values-driven, personalized, collaborative, and strategic approach to investing, wealth management, and fiduciary consulting. We changed our name to embark on the next 20 years, but our leadership and our calling remain. We’re excited to build on our past experience and success to deliver on our promise of building a secure future for our clients.