Kent Shaw, a portfolio manager at MONTAG, recently shared his views on the current market. BY KENT SHAW, CFA
Waiting is the hardest part
The correction seems to be taking longer than expected but compared to the corrections in 2010 (14 weeks) and 2012 (9 weeks) the time is very similar. The highly volatile correction that began in September, 2015 and ended in February, 2016 lasted 25 weeks. It has been 11 weeks since the S&P 500 Index made its sharp low in February of this year. It’s impossible to time such events with precision but we find that evaluating similar events in the past is helpful for context.
Market had few winners in the first quarter
The S&P 500 index is broken down into 10 sectors of similar types of companies. Some of these are Technology, Financials (banks and insurance), Consumer Discretionary (apparel, restaurants, etc). Only two of the 10 sectors had positive returns for the first quarter with Technology reporting a return of +2.6% . Technology is one of the most expensive sectors at the moment, and while high valuations are not always a problem in the short-term but they ultimately result in lower returns. We believe the trimming we did in this sector earlier in the year was the right thing to do to manage risk and protect capital for the long-term.
The Consumer Staples sector is a cautionary tale for valuation discipline. It is a sector that includes companies that produce items purchased every day by consumers such as razor blades, diapers, paper goods, etc. These stocks have long been seen as stable investments because the demand for their products doesn’t change dramatically — diapers and razor blades are needed in good and bad economic times. Most companies in the sector pay nice dividends and in an era of lower interest rates the stocks have been in high demand as a source of income. As many investors paid for these dividends, the valuation of the stocks became inflated. Some staples stocks were priced as if they would grow revenues at 2 or 3 times their historical growth rates; a very unlikely outcome. See my blog post here for more information about this valuation method. This sector has fallen 15% since it peaked in February and a number of companies have recently reported earnings that call into question their ability to remain stable growers because new, lower-cost competitors are entering their markets. Higher bond yields allow also offer comparable income with less risk.
Earnings scorecard
As of April 20th, 17% of the companies in the S&P 500 Index have reported earnings for the most recent quarter. Of these, 80% have reported results that were better than expected. Ordinarily, such a large number of positive surprises would lift the market higher but in more than a few cases the response from the stocks has been mild or neutral. As an example, Netflix, an expensive darling of Wall Street, reported results recently and wowed investors with their stellar achievement including the addition of 7.5 million new subscribers, 1 million more than expected. The stock jumped almost 10% the following day but it has given up all of those gains in the last week. Stocks are driven by a number of factors and earnings are primary among them but when expectations begin to exceed those earnings stocks have a hard time performing. Perhaps the behavior of Netflix is simply noise and it will resume its march higher but we take such events seriously. A number of other companies, including many banks, have had similarly positive results with neutral to negative responses. With roughly 80% of the S&P 500 stocks left to report earnings, making a definitive judgement about market health from these instances would be premature.
Outlook
We are focused on finding attractive investments while keeping a close eye on market risk and are finding some interesting ideas in healthcare and consumer-related stocks. There are lots of discussions in the financial press about the risk of a recession in 2019. A number of measures we watch suggest this is possible, but so far, it appears remote. However, stocks tend to peak before a recession officially occurs because when economic growth slows, markets anticipate such a recession. The high valuation of the market as a whole combined with a number of other factors have made us more cautious compared to a year ago. Historically, mid-term election years have had higher volatility in the months ahead of the election. We believe that will likely be the case this year as well.
A light item
With all of these numbers and heavy topics on the page, I wanted to share something a bit lighter. I am a huge fan of coffee. Some years ago, my brother-in-law introduced me to coffee made in a French press. Using a French press allows you to make the coffee much stronger, which I prefer, but it also required a bit more cleanup. For those that like strong coffee, or just want coffee without the use of a large appliance, I’ve found the Clever Coffee Dripper (link). This wonderful low-tech device allows you to make coffee stronger by allowing it to steep for whatever time you choose but it also uses a filter so clean up is very quick. I like it so much that I now own one at work and one at home.
Conclusion
We are watching the market closely for changes in risks and opportunities. Our goal is grow your assets over the long-term and do our best to protect assets during difficult periods. I hope this and other updates are helpful for you and welcome any questions you may have. Please feel free to call or email if I can assist you. Meanwhile, we thank you for entrusting MONTAG with the management of your family’s investments.
