August, 2017

BBT-perspectives-market-monthly-august-2017-feature

“Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves.”

Peter Lynch

The bull market just turned 100 months old. For history buffs, that makes it the second longest running bull market in history trailing only the dot com era of the 90s. In this month’s Market Monthly, we discuss one of the more fatal emotionally-driven investment decisions investors make. Market timing! Robust global economic and earnings growth, accommodative central banks and likely fiscal stimulus all argue for continued expansion. Geopolitical tensions, Washington turmoil and the extended duration of this recovery can all test the resolve of investors. History shows that time IN the market beats timing OF the market handily over time.

Summary:

North Korea: Tensions with North Korea are not new but they have undoubtedly escalated. This could continue to cause spurts of elevated volatility but in the long run is likely to be overrun by positive economic and earnings news. Newspapers think war will break out while we think that ultimately, negotiations will break out.

Time in the Market Beats Timing the Market: Any of us can make an occasional timely market move but none of us can correctly and consistently time the market and expect to succeed. In the nine years since the Day that Lehman Died (high emotion) in September 2008, we conclude that buy and hold looks pretty good over time.

Equity Update: YTD trends continue to show strength in international markets with tailwind returns from a weaker dollar. Fundamentals support further equity advances into 2018 but not without occasional bouts of renewed volatility. Another positive earnings season is behind us and active managers continue to enjoy success. Don’t count out tax reform yet.

Bond Update: “Keep your coupon” is still the mantra for best return expectations from the bond market. Unexpected wage inflation could prompt the Fed to tighten more aggressively but is more likely to be a 2018 event.

North Korea:                        

There is clearly cause for concern around escalated geopolitical tensions surrounding North Korea. The rhetoric from North Korean leader Kim Jung Un is disturbing. The United Nations vote to impose tougher sanctions on North Korea to publicly punish their nuclear ambitions reportedly will strip North Korea of a third of its exports. This could test the North Korean people’s resolve toward their leader over time but regime change might be a stretch. Markets have a history of geopolitical conflict but often don’t respond absent a corresponding economic crisis or shock to the financial system at large. Headlines suggest that war is on the brink of breaking out but it is more likely that negotiations are on the brink of breaking out behind the scenes. Chinese President Xi Jinping will be a key player to cool tensions in any negotiations between China and the U.S.

Markets last week responded modestly to escalating tensions yet South Korea’s KOSPI Stock Index has still gained over 14 percent YTD. While markets have not experienced knee jerk reactions to recent geopolitical conflict, the spike in volatility we saw last week was unsurprising and could signal growing concern beneath the surface of recent record highs. Consider the table below that offers a history of other significant geopolitical events and market reactions. We don’t suggest that each event was the only catalyst behind subsequent market behavior but only proof that markets survive and advance.

Event Date Day of + 60 Days + 125 Days + 250 Days
Pearl Harbor 12/7/1941 -3.8% -10.5% -5.6% 3.7%
JFK Assassination 11/22/1963 -2.8% 11.8% 15.7% 23.9%
Nixon Resigns 8/9/1974 -0.9% -7.1% -2.8% 6.7%
Iraq Invades Kuwait 8/2/1990 -1.1% -11.3% -3.0% 10.0%
World Trade Center Bombing 2/26/1993 0.2% 2.4% 3.8% 6.3%
911 Terror Attacks 9/11/2001 -4.9% 10.0% 12.2% -14.3%
Iraq War 3/20/2003 0.2% 12.1% 17.2% 28.3%

We can’t dismiss the seriousness of this escalation but often the bully who starts a fight either backs down or ends up flat on his back. Don’t be reactive and stay the course.

Time in the Market Beats Timing the Market:

Successful investing is very difficult to achieve without consistency and discipline. Market timing is an emotional decision often made with limited data that usually leads to inconsistent and disappointing results. Anyone can time the market and get it right occasionally but not consistently. It is like shooting a good round of golf at your annual outing and thinking you’re ready for the Masters. Consistency and discipline matter.

Sometimes when emotions run high, people make poor decisions that are motivated by fear. At the markets bottom in 2009 some folks said, “I can’t take it anymore.” Last year, people were fearful of the election. At record highs some delay investing while waiting for a correction while others go “all in” for fear of missing out. We suggest an alternative path when those emotions surface at times of high valuations or turbulence.

Disciplined dollar cost averaging is one way to put new cash to work by investing incrementally over regular time intervals during periods of concern. For fully invested portfolios, periodically rebalancing your portfolio back to the asset allocation consistent with your risk comfort zone never goes out of style and may be appropriate now.

The chart below is revealing about the results of market timing. The time frame is from the day that Lehman went belly up on September 15, 2008 to August 10, 2017.

It asks: If you had $100 on the day that Lehman failed (a very emotional day), how would you have performed under the following scenarios? (Annualized returns)

  1. Buy and hold the S&P 500 +10.74%
  2. Buy the S&P 500 and exclude the 20 best days -2.21%
  3. Buy the S&P 500 and exclude the 20 worst days +27.08%
  4. Buy the S&P 500 and exclude the best and worst 20 days +12.22%

The results are startling.

September 15, 2008 – the day that Lehman died.

BBT-perspectives-market-monthly-august-2017-S&P-500

The chart above is a bit busy but makes our point well. The best (B) and worst (W) days clustered in the fall of 2008 immediately after Lehman and the summer of 2011 when S&P downgraded U.S. debt.

Bottom Line: This is timely now because even though markets have not seen much volatility, the world has. Often it is during these times when headlines strike doubt and fear in people’s hearts and minds that bad decisions are made. We think the economic positives all around us significantly outweigh the negative headlines that the popular press perpetuates. Have a plan (or make one) and stick to it because market timing does not work.

Equity Update:

Earnings Season Wrap Up: June expectations for Q2 S&P 500 earnings were for 6 percent growth. Each week has seen that number climb higher with S&P 500 earnings now tracking at roughly 10.2 percent growth. Small cap stocks have continued to struggle with earnings on pace to actually decline -8 percent versus a year ago. Tax reform could be a saving grace for Small caps who tend to be in a higher tax bracket.

Despite two successive double digit growth earnings seasons, stocks beating their estimates have not been rewarded. Generally, when stocks beat their earnings estimate they respond by going up. For the first time since Q2 of 2000, stocks beating their estimates have seen flat returns rather than upward rewards. This is not tremendously concerning unless earnings fail to validate high valuations in subsequent quarters.

The chart below illustrates some of the trends we have discussed. The dark blue bar is the S&P 500. The light blue bar represents those companies who generate most of their sales in the U.S. The green bar represents those companies generating most of their sales outside the U.S.

Key Takeaway:   Companies doing business abroad have outperformed companies doing most of their business at home by a handy margin.

BBT-perspectives-market-monthly-august-2017-earnings-insight-q2-2017

Performance Update: In July, International markets and especially Emerging Markets continued their win streak versus U.S. markets with a tailwind-aided weak U.S. dollar. For example, the three month performance for the MSCI Europe Ex-UK index was up 7.4 percent of which 7.35 percent was due to the dollar’s decline and only .05 percent was due to the rise of the European markets. Periods of relative outperformance by International stocks versus U.S. stocks often go in multi-year cycles. Periods of International outperformance also frequently correlate with periods of dollar weakness.

Also notable is the significant YTD performance gap between the growth and value investing styles with growth stocks leading value stocks by a whopping 10 percent. This has been led by technology stocks which represent a third of the growth index and generate almost 60 percent of their sales revenues abroad. It will be difficult for that degree of performance gap to continue. The value style is dominated by the financial sector and stands to gain from the recently concluded Comprehensive Capital Analysis and Review (CCAR) released on June 28 by the Federal Reserve. Essentially, the Fed gave the U.S. banking a system an “A” in capital adequacy which means many banks will return capital to shareholders via dividend increases and share buybacks. As this occurs and coincides with further rate increases by the Fed, the financial sector could benefit greatly. Going forward we think a balanced approach between the two styles makes sense.

Bottom Line: We continue to expect equities to outperform fixed income into 2018. Earnings remain robust with upside surprises validating U.S. valuations which could set the stage for further advances. High expectations for fiscal reform have quieted but they have not gone away and are not priced into U.S. stocks presently. Even a slimmed down version of tax reform (tax cuts) could benefit U.S. earnings by another 5-7 percent without even considering the economic activity that could result. Finally, we continue to think International stocks have good prospects led by Europe with improving economies, cheaper valuations, double digit earnings growth and better dividends. Stay invested.

BBT-perspectives-market-monthly-august-2017-Stock-Index

Bond Update:

The bond market continues to move within a very tight interest rate range. The bond market is seemingly as data dependent as the Fed. The Fed has a dual mandate of full employment and price stability and lately, these two data points are at odds as we saw another robust employment report for July but another anemic inflation report immediately after. Odds for the next rate hike bounce between December and March. Wage inflation is a key data point the Fed is watching as they do not want to get behind the curve with the trajectory of their tightening.

Wage growth has flat-lined at around 2.5 percent which is the first time in post WWII history that an economic recovery has not seen its wages inflate by 4 percent or more. A rapid rise in wage inflation is unlikely any time soon but as low unemployment persists and the economy continues to grow we think it is a matter of when, not if wage inflation surfaces.

Bond investors remain in a “keep your coupon” best case environment. High quality, short duration portfolios continue to make sense. High yield spreads remain quite low and don’t provide adequate compensation to warrant an overweight in portfolios at this late stage of the recovery.

BBT-perspectives-market-monthly-august-2017-Bond-Index

Final Thoughts:

  • We continue to think that stock returns will outpace bond returns for the next 12 months.
  • Positive economic and earnings growth will continue to do more to aid the market than ugly distractions like North Korea will do to hurt the market.
  • Earnings growth is broad based including Europe and Japan.
  • The Fed is on track to begin balance sheet reduction in September, but further rate hikes will be sensitive to inflation data especially regarding wages.
  • Washington has a full plate after recess including the 2018 budget, the federal debt ceiling and tax reform. Uncertainty around these could be the next source of volatility.

 

August, 2017

BBT-perspectives-market-monthly-august-2017-feature

“Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves.”

Peter Lynch

The bull market just turned 100 months old. For history buffs, that makes it the second longest running bull market in history trailing only the dot com era of the 90s. In this month’s Market Monthly, we discuss one of the more fatal emotionally-driven investment decisions investors make. Market timing! Robust global economic and earnings growth, accommodative central banks and likely fiscal stimulus all argue for continued expansion. Geopolitical tensions, Washington turmoil and the extended duration of this recovery can all test the resolve of investors. History shows that time IN the market beats timing OF the market handily over time.

Summary:

North Korea: Tensions with North Korea are not new but they have undoubtedly escalated. This could continue to cause spurts of elevated volatility but in the long run is likely to be overrun by positive economic and earnings news. Newspapers think war will break out while we think that ultimately, negotiations will break out.

Time in the Market Beats Timing the Market: Any of us can make an occasional timely market move but none of us can correctly and consistently time the market and expect to succeed. In the nine years since the Day that Lehman Died (high emotion) in September 2008, we conclude that buy and hold looks pretty good over time.

Equity Update: YTD trends continue to show strength in international markets with tailwind returns from a weaker dollar. Fundamentals support further equity advances into 2018 but not without occasional bouts of renewed volatility. Another positive earnings season is behind us and active managers continue to enjoy success. Don’t count out tax reform yet.

Bond Update: “Keep your coupon” is still the mantra for best return expectations from the bond market. Unexpected wage inflation could prompt the Fed to tighten more aggressively but is more likely to be a 2018 event.

North Korea:

There is clearly cause for concern around escalated geopolitical tensions surrounding North Korea. The rhetoric from North Korean leader Kim Jung Un is disturbing. The United Nations vote to impose tougher sanctions on North Korea to publicly punish their nuclear ambitions reportedly will strip North Korea of a third of its exports. This could test the North Korean people’s resolve toward their leader over time but regime change might be a stretch. Markets have a history of geopolitical conflict but often don’t respond absent a corresponding economic crisis or shock to the financial system at large. Headlines suggest that war is on the brink of breaking out but it is more likely that negotiations are on the brink of breaking out behind the scenes. Chinese President Xi Jinping will be a key player to cool tensions in any negotiations between China and the U.S.

Markets last week responded modestly to escalating tensions yet South Korea’s KOSPI Stock Index has still gained over 14 percent YTD. While markets have not experienced knee jerk reactions to recent geopolitical conflict, the spike in volatility we saw last week was unsurprising and could signal growing concern beneath the surface of recent record highs. Consider the table below that offers a history of other significant geopolitical events and market reactions. We don’t suggest that each event was the only catalyst behind subsequent market behavior but only proof that markets survive and advance.

Event Date Day of + 60 Days + 125 Days + 250 Days
Pearl Harbor 12/7/1941 -3.8% -10.5% -5.6% 3.7%
JFK Assassination 11/22/1963 -2.8% 11.8% 15.7% 23.9%
Nixon Resigns 8/9/1974 -0.9% -7.1% -2.8% 6.7%
Iraq Invades Kuwait 8/2/1990 -1.1% -11.3% -3.0% 10.0%
World Trade Center Bombing 2/26/1993 0.2% 2.4% 3.8% 6.3%
911 Terror Attacks 9/11/2001 -4.9% 10.0% 12.2% -14.3%
Iraq War 3/20/2003 0.2% 12.1% 17.2% 28.3%

We can’t dismiss the seriousness of this escalation but often the bully who starts a fight either backs down or ends up flat on his back. Don’t be reactive and stay the course.

Time in the Market Beats Timing the Market:

Successful investing is very difficult to achieve without consistency and discipline. Market timing is an emotional decision often made with limited data that usually leads to inconsistent and disappointing results. Anyone can time the market and get it right occasionally but not consistently. It is like shooting a good round of golf at your annual outing and thinking you’re ready for the Masters. Consistency and discipline matter.

Sometimes when emotions run high, people make poor decisions that are motivated by fear. At the markets bottom in 2009 some folks said, “I can’t take it anymore.” Last year, people were fearful of the election. At record highs some delay investing while waiting for a correction while others go “all in” for fear of missing out. We suggest an alternative path when those emotions surface at times of high valuations or turbulence.

Disciplined dollar cost averaging is one way to put new cash to work by investing incrementally over regular time intervals during periods of concern. For fully invested portfolios, periodically rebalancing your portfolio back to the asset allocation consistent with your risk comfort zone never goes out of style and may be appropriate now.

The chart below is revealing about the results of market timing. The time frame is from the day that Lehman went belly up on September 15, 2008 to August 10, 2017.

It asks: If you had $100 on the day that Lehman failed (a very emotional day), how would you have performed under the following scenarios? (Annualized returns)

  1. Buy and hold the S&P 500 +10.74%
  2. Buy the S&P 500 and exclude the 20 best days -2.21%
  3. Buy the S&P 500 and exclude the 20 worst days +27.08%
  4. Buy the S&P 500 and exclude the best and worst 20 days +12.22%

The results are startling.

September 15, 2008 – the day that Lehman died.

BBT-perspectives-market-monthly-august-2017-S&P-500

The chart above is a bit busy but makes our point well. The best (B) and worst (W) days clustered in the fall of 2008 immediately after Lehman and the summer of 2011 when S&P downgraded U.S. debt.

Bottom Line: This is timely now because even though markets have not seen much volatility, the world has. Often it is during these times when headlines strike doubt and fear in people’s hearts and minds that bad decisions are made. We think the economic positives all around us significantly outweigh the negative headlines that the popular press perpetuates. Have a plan (or make one) and stick to it because market timing does not work.

Equity Update:

Earnings Season Wrap Up: June expectations for Q2 S&P 500 earnings were for 6 percent growth. Each week has seen that number climb higher with S&P 500 earnings now tracking at roughly 10.2 percent growth. Small cap stocks have continued to struggle with earnings on pace to actually decline -8 percent versus a year ago. Tax reform could be a saving grace for Small caps who tend to be in a higher tax bracket.

Despite two successive double digit growth earnings seasons, stocks beating their estimates have not been rewarded. Generally, when stocks beat their earnings estimate they respond by going up. For the first time since Q2 of 2000, stocks beating their estimates have seen flat returns rather than upward rewards. This is not tremendously concerning unless earnings fail to validate high valuations in subsequent quarters.

The chart below illustrates some of the trends we have discussed. The dark blue bar is the S&P 500. The light blue bar represents those companies who generate most of their sales in the U.S. The green bar represents those companies generating most of their sales outside the U.S.

Key Takeaway:   Companies doing business abroad have outperformed companies doing most of their business at home by a handy margin.

BBT-perspectives-market-monthly-august-2017-earnings-insight-q2-2017

Performance Update: In July, International markets and especially Emerging Markets continued their win streak versus U.S. markets with a tailwind-aided weak U.S. dollar. For example, the three month performance for the MSCI Europe Ex-UK index was up 7.4 percent of which 7.35 percent was due to the dollar’s decline and only .05 percent was due to the rise of the European markets. Periods of relative outperformance by International stocks versus U.S. stocks often go in multi-year cycles. Periods of International outperformance also frequently correlate with periods of dollar weakness.

Also notable is the significant YTD performance gap between the growth and value investing styles with growth stocks leading value stocks by a whopping 10 percent. This has been led by technology stocks which represent a third of the growth index and generate almost 60 percent of their sales revenues abroad. It will be difficult for that degree of performance gap to continue. The value style is dominated by the financial sector and stands to gain from the recently concluded Comprehensive Capital Analysis and Review (CCAR) released on June 28 by the Federal Reserve. Essentially, the Fed gave the U.S. banking a system an “A” in capital adequacy which means many banks will return capital to shareholders via dividend increases and share buybacks. As this occurs and coincides with further rate increases by the Fed, the financial sector could benefit greatly. Going forward we think a balanced approach between the two styles makes sense.

Bottom Line: We continue to expect equities to outperform fixed income into 2018. Earnings remain robust with upside surprises validating U.S. valuations which could set the stage for further advances. High expectations for fiscal reform have quieted but they have not gone away and are not priced into U.S. stocks presently. Even a slimmed down version of tax reform (tax cuts) could benefit U.S. earnings by another 5-7 percent without even considering the economic activity that could result. Finally, we continue to think International stocks have good prospects led by Europe with improving economies, cheaper valuations, double digit earnings growth and better dividends. Stay invested.

BBT-perspectives-market-monthly-august-2017-Stock-Index

Bond Update:

The bond market continues to move within a very tight interest rate range. The bond market is seemingly as data dependent as the Fed. The Fed has a dual mandate of full employment and price stability and lately, these two data points are at odds as we saw another robust employment report for July but another anemic inflation report immediately after. Odds for the next rate hike bounce between December and March. Wage inflation is a key data point the Fed is watching as they do not want to get behind the curve with the trajectory of their tightening.

Wage growth has flat-lined at around 2.5 percent which is the first time in post WWII history that an economic recovery has not seen its wages inflate by 4 percent or more. A rapid rise in wage inflation is unlikely any time soon but as low unemployment persists and the economy continues to grow we think it is a matter of when, not if wage inflation surfaces.

Bond investors remain in a “keep your coupon” best case environment. High quality, short duration portfolios continue to make sense. High yield spreads remain quite low and don’t provide adequate compensation to warrant an overweight in portfolios at this late stage of the recovery.

BBT-perspectives-market-monthly-august-2017-Bond-Index

Final Thoughts:
  • We continue to think that stock returns will outpace bond returns for the next 12 months.
  • Positive economic and earnings growth will continue to do more to aid the market than ugly distractions like North Korea will do to hurt the market.
  • Earnings growth is broad based including Europe and Japan.
  • The Fed is on track to begin balance sheet reduction in September, but further rate hikes will be sensitive to inflation data especially regarding wages.
  • Washington has a full plate after recess including the 2018 budget, the federal debt ceiling and tax reform. Uncertainty around these could be the next source of volatility.

Sources: Strategas Research Partners, Evercore ISI, FactSet, Goldman Sachs Global Investment Research, Morningstar

This piece is produced by BB&T’s Wealth Portfolio Management Team.

The information set forth herein was obtained from sources, which we believe reliable, but we do not guarantee its accuracy. Neither the information nor any opinion expressed constitutes a solicitation by us of the purchase or sale of any securities. Diversifying investments does not ensure against market loss and asset allocation cannot eliminate the risk of fluctuating prices and uncertain returns. Past performance does not guarantee future results.