Where does the time go? The days are getting shorter, mid-year is already one month in the rear view mirror and July kicked off another round of quarterly earnings releases. Corporate earnings are the fuel necessary to keep this bull market running. If the earnings estimates are correct, the tank will be full and the markets can cruise into October. High octane earnings can be enhanced with some key additives like low interest rates, a healthy consumer, low inflation, less regulation and a steady Federal Reserve Bank. The near future should resemble the recent past.

July was another good month for investors as all indices in the chart below produced positive returns. We ended the month in new record breaking territory. Such is life in a bull market. Stock returns were positive around the globe with emerging markets leading the way. This sector has been on fire in the past year and produced a 5.96% return in July bringing their trailing 12-month return to an impressive 24.84%. Emerging markets are in a sweet spot supported by positive currency and solid growth in China and India. U.S. stocks continue to ride the strong second quarter earnings wave. International markets are also in the midst of a good run, making up for some recently troubled years. A recent acceleration in overseas economic growth and compelling valuations as compared to the U.S. is being reflected in international stock price outperformance.

The Federal Reserve expectedly took a pass on raising the fed funds rate in July. They have raised the rate 25 basis points in the final month of the calendar quarter for the last three quarters. Consensus thinking is they will skip September and finish the year with one last quarter point rate hike. At the July Federal Reserve meeting, Chairwomen Janet Yellen said the process of unwinding their inflated balance sheet will begin shortly. As you remember, the Fed embarked on multiple quantitative easing programs post 2008 to stabilize the banks and the economy. They purchased trillions of dollars in bonds from the banks, pumping liquidity into the financial system. This unwind process should begin sometime this quarter, and will take years to complete. Stay tuned for the stock and bond market’s reaction.

Right now the news in the financial markets is supportive of continued success over the short-term. Positive economic growth coupled with low interest rates, improved earnings and a better international outlook keeps a safety net under the market.

As an investor it is important to maintain a long-term focus. Take comfort in the fact that the trend is your friend. At some point there will be a 5-10% correction in the stock market, but don’t let that eventual move take you to the sidelines. When the Dow hit 20,000 many experts were encouraging investors to move to cash and wait for a 10% pullback. Hopefully you ignored the urge to time the market and remain committed to your plan. Now the market is 10% higher and the long-term investor continues to be rewarded. Stay the course despite what you may read or hear. Bring on August.

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

As the stock markets reach new all-time highs, publicly traded companies are just beginning to report sales and earnings for the second quarter of 2017. Over the next couple of weeks we will be watching for a number of data points within the earnings reports, along with management commentary around their businesses.

We have been seeing year-over-year earnings growth accelerate over the past several quarters for the broad market index, the S&P 500. In fact, S&P earnings were in decline for four quarters (mid 2015 to mid-2016), with the drop attributed to just one sector, energy. For the first quarter of 2017, we saw earnings growth of 14%; we expect 10% growth in the second quarter. We currently expect earnings growth to accelerate in the second half of this year, providing a strong foundation for the stock market. Looking further out, consensus earnings growth of nearly 12% is expected for 2018, according to FactSet, as seen in the chart below:

A company’s earnings growth is not the only driver of a stock’s price, however. In fact, a study by McKinsey & Co. showed that a 1% beat had virtually no impact of the price of a company stock five days after the earnings announcement.* Often, companies will guide analysts’ expectations down prior to the quarterly report in an effort to create a beat…managing expectations, some might say. More important, we believe, is the quality of earnings and management’s outlook versus current expectations.

We look for sales and earnings growth from core operations, not boosted by one-time events or shifts from one quarter to the next. We want to see expanding operating margins, not an earnings benefit from a one-time item such as a lower tax rate. Investors should be encouraged by management’s discussion of rising orders or new technology that will grow the business over the longer term. Is the sector showing greater growth characteristics than most have expected? Management sentiment around improved operating efficiencies or a more suitable capital structure are other positive factors that can drive stock prices higher.

Yes, a series of disappointments will impact the price of a stock over time. The disappointments would create distrust in management’s ability to accomplish their goals. Similarly a pattern of significantly exceeding expectations will lead to stock price outperformance.

However, a single disappointment, if accompanied by an improved short and/or long term outlook can result in positive stock price performance. We believe we are in a period of rising earnings, which tends to be positive for stock prices. Stay tuned.

* McKinsey & Co. Strategy & Corporate Finance – 2013

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 current bull market in US stocks has been in place since early 2009, which puts us at roughly eight years. That’s not the longest bull market in history, but it’s close. The fundamentals have supported this long bull market, they are:

• A stable and growing economy
• Corporate earnings growth
• A low interest rate environment (which makes stock returns more attractive)

It’s been an ideal environment for stock markets to achieve new highs, but the recent updraft in the first half of 2017 has some folks talking about corrections and crashes again. Most of their basis for a correction is based upon some sort of valuation metric or contrarian indicator. The chart below is a great example of this; it shows the biggest stock markets in the world (G7 countries) combined market capitalization as a percentage of their collective GDP’s:

We can see that it’s approaching the highs of 2001 and 2007 peaks. It’s not up to the 1.5X level but it’s getting closer.

Another chart that’s surfaced recently illustrates the amount of cash institutional investors are holding right now. Yes, it’s currently at eight-year lows. Bears might argue that there’s no more money left on the sidelines to buy stocks and push markets higher. See below:

And finally, Banc of America has a sell-side contrarian indicator that is getting some press lately. The chart below are the results from a survey of Wall Street strategists’ recommendations. The indicator measures the collective bullishness/bearishness of the strategists. An indicator below the green line is bullish for stocks, and above the red line is bearish. Right now, the reading is at 6 year highs, but still in neutral territory. See below:

We’re not going to argue that the market isn’t expensive these days, it is. S&P 500 PE Ratios are above their 5 and 10 year averages, but in our opinion, they deserve to be higher than normal due to the constructive fundamental environment we’re in. In addition, valuation rarely kills a bull market, deteriorating fundamentals do, and right now fundamentals are OK. Our investment team watches the market every day and we constantly survey the fundamental landscape, both here and abroad. Right now, we consider the following critical to moving the market forward:

• Corporate earnings growth. Earnings season begins this week and should solidify forecasts of 10% growth this year
• Economic growth. Global GDPs, labor market metrics and manufacturing statistics are always on our radar screen. Right now, all are still in expansion mode
• Finally, interest rate movements. We understand that rates will most likely move higher over time, but we expect rate normalization to be slow and measured

We understand the anxiety a mature bull market can present, but if valuation and contrarian indicators are the only evidence bears are bringing to the table, that’s not enough to call it a wrap. Disappointing earnings growth, recession and high interest rates can kill a market. Yes, fundamentals can change, we’re watching, but not seeing signs of these metrics deteriorating yet. Remember, markets have been hitting new highs since 1817 when the NYSE was established. It’s never a straight line, we do have corrections, but over the last 200 years markets continue to be resilient.

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