Third quarter earnings season will thankfully return investor focus back to market fundamentals.  Corporate revenues and profits can sometimes get lost in the market noise, but they are the ultimate long-term drivers of stock prices and valuations.  This quarter’s earnings results are especially important as they will set the stage for next year’s expectations and the start of a new decade.

 The recent news cycle has hijacked market attention away from the fundamentals to the breaking news of the hour.  The trade wars and tariffs are a great example.  For almost two years, the ebb and flow of investors’ moods seem to rise and fall with each U.S. and China trade headline.  One day this month, stock prices declined sharply on escalated trade tensions as the White House bans 28 Chinese companies from doing business in the U.S.  Later in the same day, the U.S. issues travel bans on selected Chinese officials.  Three days later we are told of a “very substantial phase one deal” with China.  In the following week, China appears to walk back the idea of a trade deal. Stay tuned.

If U.S. and China trade tensions weren’t enough, let’s add concerns of a global recession, impeachment proceedings, and a string of disappointing initial public offerings (IPOs).  The market has also been focused on the Federal Reserve drama, the potential of an inverted yield curve, Brexit, and the political rhetoric building for the 2020 election.  With so many distractions, it’s easy to lose sight of market fundamentals – earnings and valuations. 

There are just two months left in the year and it has proven to be a terrific year for the financial markets so far.  On a year to date basis through October, the S&P 500 is up 23.2%, the NASDAQ Composite is up 26.0%, and international stocks are measured by EAFE are up 16.9%.  The S&P 500 achieved its fourteenth and fifteenth all-time high this year in October.  Even the U.S. Aggregate Bond Index has gained 8.9% so far this year at a time where most were convinced interest rates were poised to move higher, pushing values lower. 

Overall, the news on third quarter corporate earnings has provided a welcome tailwind to the stock market.  Over 70% of the companies which reported earnings to date have exceeded analyst expectations.  Those companies with positive earnings like Apple, Netflix, Morgan Stanley, J&J, JP Morgan, Pfizer, Tesla, and Merck all saw significant jumps in their share prices.  The companies with disappointing results were punished by the market.  Those included Amazon, IBM, Twitter, Grub Hub, and Beyond Meat.  The net effect for October was market gains across the global indices.  In the U.S., the S&P 500 gained 2.2%, the Dow Jones Industrial Average added 0.6% and the NASDAQ rose by 3.7% in October.  International stocks also rallied as the EAFE and Emerging Markets were up 3.6% and 4.2% respectively.

After a period of free falling interest rates, rates reversed course in October sending yields back to mid-September levels.  However, that level was still well below the mid-January peak in yields this year.  The Federal Reserve delivered on market expectations by lowering the fed funds rate by 25 basis points for the third time this year. The fed funds target now stands at 1.5% – 1.75%.  The Fed sighted a slowing global economy, trade concerns and low inflation as the main points for allowing this third rate cut.  The summer fear of an inverted yield curve is clearly in the rear view mirror as the 2-year U.S. Treasury Note is now yielding 1.52%, which is 17 basis points less than the 10-year U.S. Treasury Note.

News on the economy continues to support the markets.  Third quarter GDP growth in the U.S. economy decelerated much less than anticipated coming in at 1.9% versus the 1.6% expected and the 2.0% growth achieved in the second quarter.  The University of Michigan’s Consumer Sentiment Index rose to 95.5 after spending the prior two months in a range of 89.8 to 93.2.  Strong consumer confidence heading into the all-important holiday season is good news for the economy.  The Department of Labor said that employers added 136,000 net new workers in September. Unemployment was at 3.5%, a level last seen in December 1969. The U-6 jobless rate, which counts both the unemployed and underemployed, fell to a 19-year low of 6.9%. October employment numbers released on November 1, 2019 showed continued strength with 128,000 jobs created and a 3.6% unemployment rate.

On the flip side, the Manufacturing Purchasing Manager Index fell to 47.8 in September, its lowest level in ten years. Investors worried that the number reflected weakening business confidence. ISM’s latest Non-Manufacturing PMI also declined, but the 52.6 reading indicated growth in the service sector last month. Shoppers scaled back their purchases in September. The Census Bureau announced a 0.3% dip for retail sales, the first decrease in seven months.
 
As 2019 winds down and we set our sights on 2020, it’s important to bring the right mindset with you on this investment journey.  Challenge yourself to evaluate your personal perspective and dare to incorporate the following into your conscience.

• Separate your political views from your economic views – with the 2020 national election looming, evaluate the economy on economic factors, not political factors
• Expect the market to advance and decline – the markets are never a smooth ride on a day to day basis, but historically the markets do go up over time
• Don’t let volatility alter your financial plan – the latest breaking news will have temporary market implications, but don’t let emotions affect your plan
• View the glass as half full versus half empty – practice long-term trust and optimism and avoid becoming an eternal pessimist
• Take a long term view – don’t let news of the hour turn your financial plan into a market timing scheme.

Stay your financial course as the future is likely brighter than you give it credit.

MARKETS BY THE NUMBERS:

To expand on these Market Commentaries or to discuss any of our investment portfolios, please do not hesitate to reach out to us at 775-674-2222

Last week, Gradient Investments held its annual Elite Advisor Forum.  In this forum, we gather advisors and experts from across the country to discuss hot button topics in markets and trends in the asset management business.  Here are some of the topics discussed.

The Search for Yield

The search for income in a negative rate world was a significant point of discussion.  This is a topic we have also covered in prior market reflections.  Thomas Wood, Director for Blackrock, shared that nearly 25% of global government bond yields are now in negative yield territory.  Paul Blomgren, Portfolio Manager with Nuveen, suggested that slower global growth, controlled inflation, and geopolitical risks are likely to keep a “lid” on interest rates. 

An alternative to bond income is dividend paying stocks, like the holdings in our G50 portfolio, given the negative interest rate environment.  The below chart presented by Sam Stovall, Chief Investment Strategist from CFRA research, reflected that market performance has often been positive when the S&P 500 dividend yield exceeds the 10-year US Treasury rate.

Politics and Portfolios

Another widely discussed topic was the upcoming presidential election and the impact on the markets.  Stu Sweet, President of the Washington DC advisor Capitol Analysts Network, provided some insight into the current situation.  He suggested the “battleground” states to watch in 2020 remain Florida, Wisconsin, Michigan, and Pennsylvania.

Overall, however, recommendations were consistent with Gradient’s position regarding investing based on politics: portfolio decisions and politics are best left separate.  There are always issues and concerns in the markets, including elections, but that doesn’t require a need to deviate from your customized investment plan.  Below is a chart from Yardeni Research that shows stock market performance during Democrat (blue) and Republican (red) presidencies.  As you can see, markets tend to work for either and allocating based upon who may or may not occupy the White House is not a recommended strategy. 

Investment Outlooks

Regarding the stock market, most were positive on the US market but with expectations of continued volatility in the short term.  Brian Belski, Chief Investment Strategist from BMO, believes we are in the middle stages of a long-term secular bull market that has significant future upside even with increased short-term volatility.  Mr. Stovall echoed similar sentiments by stating his case as a “bull with a small b”.  His thought was that while there is an increased threat of recession on the horizon, his base case is US GDP growth above 2% next year and a stock market with upside potential from current levels. 

At Gradient, we remain constructive on stocks but caution investors to temper future expectations given a very strong market in 2019.  We are cautious on bond markets overall and would not be chasing significantly higher bond risk for a very small amount of incremental income.  For clients who are willing to tolerate more risk, we believe dividend stocks like our G50 or our income focused Absolute Yield portfolio are attractive alternatives.  Lastly, for investors looking for some protection from near term volatility, the Gradient Buffered Index Portfolio is designed to participate in market upside but also provides some downside protection. 

To expand on these Market Reflections or to discuss any of our investment portfolios, please do not hesitate to reach out to us at 775-674-2222.

The third quarter seemingly packed a year’s worth of market action into three fast moving months.  Regardless of your stock market, interest rate or economic viewpoint, there was something for everyone in this fluid and volatile quarter. 

Quarter three began in bullish fashion as most of the major stock benchmarks jumped by 1.5% or more in the first week of July.  A key catalyst for this quick start was the Department of Labor’s June jobs report that said the U.S. economy added 224,000 net new jobs – which was 60,000 more jobs than most forecasters predicted.  The momentum to new all-time highs ended in the final trading hours of July as the Federal Reserve announced their first interest rate cut in over ten years.  Normally a 25 basis point rate cut would be positive news, but post decision comments by Chairman Powell disappointed investors and ignited what would eventually become a 6.5% correction in stock prices. From the August lows, the stock market climbed back within reach of new all-time highs the end of September.  A second 25 basis point rate cut in mid-September and a verbal agreement to reopen trade negotiations by representatives from the U.S and China gave the markets renewed hope heading into quarter end.

The quarter produced modest gains in global stock markets with major price fluctuations on a month to month basis.  Fast growing companies have provided much of the leadership in this long running bull market.  Once a year in each of the last four years, cheaper value stocks have unsuccessfully tried to lead the way, but any strength in those cheaper value companies has proven temporary.  This scenario played out again in the third quarter as value stocks outperformed growth stocks.  It appears growth companies will once again reassume their market leadership.  Housing was the strongest sector and the energy sector was once again the laggard.  This is the first quarter since 2009 when dividend yields on the S&P 500 exceeded the yield on the 30-year U.S. Treasury Bond.  This fact, along with bearish investor sentiment gives stocks a potential positive setup for the fourth quarter.

Our stock market thoughts are:

• Corporate earnings grow 5% year over year.
• PE ratios represent fair value at 17x.
• U.S. economy continues to expand while international economies are slowing.
• Focus on U.S. stocks relative to international stocks.

Overall, this was a remarkable quarter in the fixed income market.  The quarter began with interest rates low and thoughts of rates moving significantly lower seemed improbable.  Fear of an inverted yield curve signaling the next recession motivated investors to sell stocks and buy bonds. The rapid move to lower yields caught most investors by surprise. The quarter began with key U.S. Treasury yields for the 2, 10 and 30-year maturities at 1.75%, 2.00%, and 2.52% respectively.  By early September these same benchmark yields resided at 1.47%, 1.47% and 1.95%, marking the first time the 30-year U.S. Treasury bond yielded less than 2.00%.  By quarter end, stocks moved to within 2% of their all-time highs and Treasury yields moved higher. 

Our bond market thoughts are:

• Interest rates will likely remain low for an extended period of time.
• Softness in the global economies combined with low inflation will support bond prices.
• Central banks around the world have accommodative monetary policies.
• The impact of trillions of dollars of negative global interest rates has created a rate ceiling.

The U.S. economy is growing at a moderate pace.  The one-time tailwind from last year’s tax cuts and reduced regulations turned 1% GDP growth into 3% GDP growth.  Now the economy is settling into 2% growth as manufacturing and consumer confidence data are beginning to show signs of slowing.  The growth is still impressive in the face of economic weakness from Europe, China and Japan.  On the positive side:  the U.S. remains at full employment, productivity growth continues to impress and low mortgage rates are supporting the housing market.  Future corporate earnings estimates have been systematically reduced by Wall Street analysts this year, possibly paving the way for positive earnings surprises down the road.  Two percent GDP growth coupled with low inflation can keep long-term expansion fires burning well into 2020.  

Eyes now turn to another round of quarterly corporate earnings and an all-important holiday sales season. These factors, along with the ever evolving headlines, will determine the short-term price action.  The noise from the markets will intensify as we move into year-end and another election year in 2020.  Ignore the noise and remain patiently committed to your long-term personal financial plan.         

MARKETS BY THE NUMBERS:

To expand on these Market Commentaries or to discuss any of our investment portfolios, please do not hesitate to reach out to us at 775-674-2222