Third Quarter 2023 Update and Outlook

The stock market declined in the third quarter after a strong start to the year.  The S&P 500 dropped 3.3% but, as of the end September, the S&P 500 Index had notched a 13.0% gain for the year. The big worry at the beginning of the year was an impending recession.  Fast forward nine months, and the economy has displayed remarkable resilience, leading some analysts to believe that we may evade a recession and experience a "soft landing."  

One of the main reasons for the recent weakness in stocks has been the increase in long-term interest rates.  While the Fed controls the short end of the curve and has raised rates from zero to 5.50%, buyers and sellers in the market determine the long-term rates.  Since July, the longer dated yields have moved from 3.75% to over 5%. 

Long-term bond rates are instrumental in valuing assets. Two or three years ago, income producing assets were highly sought after, as interest rates were incredibly low.  Today, however, these assets are devalued as they compete with these more attractive bond yields. 

While long-term rates have pushed down stock prices, this weakness may be an opportunity.  If inflation continues to drop, the economy dips into recession, or geopolitical risks increase, long term rates could drop. This reversal could support asset prices in the months to come.  

The Fed has been waging war against inflation since March of 2022 and seems to have the upper hand. The Consumer Price Index has dropped from 9.1% in July of 2022 to 3.7% in September[1]. Drilling down on some of the inflation numbers makes the numbers look even better, as the lagged effect of a dropping housing market has not yet fed into these inflation numbers.

The economy, while resilient, has shown signs of weakening. Home builders’ sentiment has been dropping since the middle of the year and is the lowest level since January. [2] Also, the Leading Economic Index (“LEI”) has been trending lower and points to lower economic activity. In the chart below, there is a strong correlation between a low LEI and economic recession, which are shown in the gray areas.

As for global risks, it is hard to separate the investing from the terrible and horrific events in Israel and mourn the loss of innocent civilians, but it does reinforce a focus on investing in the US and other stable regions.

The opportunity we see in these higher rates has shifted our portfolio allocations. We had been focused on shorter duration bonds for income, thinking this was the better risk/reward option.  Now with higher rates out the yield curve, we have been allocating more into longer duration bonds.

[1] https://ycharts.com/indicators/us_consumer_price_index_yoy

[2] https://www.nahb.org/news-and-economics/press-releases/2023/10/mortgage-rates-well-above-7-percent-continue-to-hammer-builder-confidence

Disclosures: Standard & Poor’s 500 (S&P 500) is an unmanaged group of securities considered to be representative of the stock market in general.  Indexes are unmanaged and do not incur management fees, costs, or expenses.  It is not possible to invest directly in an index.  The future performance of an investment or strategy cannot be deduced from past performance.

The Growth Rally Continues: 2nd Half 2019 Outlook

The 2019 stock market rally continued in the second quarter, with the S&P 500 tacking on another 4.3%, giving the S&P a 18.5% return for the year.  With earnings tracking to a modest 2.6%[i] growth rate for 2019, this gain is mostly due to the Price/Earnings multiple expansion.  The market is clearly more expensive today than it was at the beginning of the year.  At the current forward P/E of 16.9, the market is trading slightly ahead of the 10- year average of 14.8.  A major reason for this is the Federal Reserve changing course and pumping liquidity into the market by signaling their openness to lower interest rates.  As the 10-year bond yield has dropped from 2.6% to below 1.9%, the options for investment returns have shrink in the bond market, pushing investors into other areas, including the stock market.

Growth has outperformed Value

All stock sectors though are not benefiting equally.  We have seen tremendous divergence between value and growth stocks with growth trouncing value.  Over the last 5 years, the Russell 1000® Growth Index beat the Russell 1000® Value Index by almost 6% per year (13.4% vs 7.5%). Much of the market history have favored the exact opposite.  For the prior 19.5 years, value outperformed by over 1.5%/year (10.5% vs 8.9%). [ii]

What has caused this notable performance change in Value versus Growth?  In a recent report from Ned Davis Research[iii], they point out how a number of reasons for this. First, the mere fact that value had historically outperformed had market participants overweight in this direction. This may had led to over-valuations in value stocks, in effect, removing the advantage. The second is somewhat counterintuitive.  They have found that value stock outperformance requires a stronger growth economy.  Growth stocks can grow regardless of the underlying economy, while many value stocks need a booming backdrop to succeed. This makes sense for banks, which require a decent spread between short-term rates and long-term rates, typically happening during booms. Another value sector, commodity-based companies earn excess profits when material shortages occur, also typically in a bustling economy. Since the end of the financial crisis, the economy has been slowly and steadily improving, not quite reaching the “escape velocity” that value stocks need.  

When will Value be Back in Favor?

The fact that the market has rewarded growth for an extended time may not indicate it is changing any time soon. This is, in part, due to changes in our economic cycles. As the economy has shifted from manufacturing to consumption, the economic cycles have lengthened due to the more stable consumer spending pattern versus shorter manufacturing cycles.  Even with the long period of growth, the Federal Reserve is still pumping the economy with low rates and expectations are for even lower rates in for the next few years.  In their report, Ned Davis points out 12 Indicators which help them to determine which indicators are pointing to Growth or to Value and only 2 are leaning toward Value versus 6 for Growth (4 are neutral).  Furthermore, they argue that the biggest driver of a switch is the economy reaching escape velocity. Therefore, with the Fed still needing to help the economy, they see this trend continuing. 

Here at APG Capital, I see reasons to be cautious, namely valuations are elevated and significant political risks. We are favoring a modest underweight to equities, but within our equity allocation we are sticking to a growth theme as these companies continue to disrupt industries. 

APG Capital Asset Management recently hit its 2-year anniversary and we are so thankful for the continued trust and confidence of our clients.

[i]https://www.factset.com/hubfs/Resources%20Section/Research%20Desk/Earnings%20Insight/EarningsInsight_070319.pdf

[ii]  https://indexcalculator.ftserussell.com/ICStep4DR.aspx

[iii] Clissold, Ed, “US Featured Report: Will Value ever outperform again”, Ned Davis Research, May 30, 2019.

Advisory services offered through APG Capital Asset Management, a Member of Advisory Services Network, LLC.

Phone: 713-446-3233  Website: www.apgcap.com

All views/opinions expressed in this newsletter are solely those of the author and do not reflect the views/opinions held by Advisory Services Network, LLC. Indexes are unmanaged and do not incur management fees, costs, or expenses.  It is not possible to invest directly in an index.  The information and material contained herein is of a general nature and is intended for educational purposes only.  This material does not constitute a recommendation or a solicitation or offer of the purchase or sale of securities.  The future performance of an investment or strategy cannot be deduced from past performance.  As with any investment or investment strategy, the outcome depends upon many factors including investment objectives, income, net worth, tax bracket, risk tolerance, as well as economic and market factors.  All economic and performance data is historical and not indicative of future results.  All information contained herein is derived from sources deemed to be reliable but cannot be guaranteed.

Happy New Year and Checklist for 2019

Well, we made it!  The calendar clicked over to the New Year which is the traditional time to look back on your accomplishments of the past year and reevaluate areas that need help.  Why do we need such an arbitrary date to make us take stock of things? It seems like we should be doing this all the time, but sometimes it takes a new year to wake us up and see the things that we need to work on.  Maybe all the reasons to procrastinate are over (the holidays ARE such a busy time!) and everyone is talking about goals and resolutions for the new year.

If your finances are on the list of areas that you feel needs attention, you should consult with an Investment Advisory Representative that is associated with a Registered Investment Adviser. Investment Advisers registered with the SEC or a state securities regulator are fiduciaries and are subject to the duty of loyalty and due care with their clients. They must place the client’s best interests above their own and are typically compensated by asset management fees.  While a host of professionals call themselves “financial advisors” including insurance agents/representatives and stock brokers, they do not operate under the fiduciary standards and are generally compensated on a transactional basis. It is important to find a Financial Advisor that has the knowledge and philosophy that matches you and your family’s needs. 

As we start the New Year, here are some ideas that most of us should consider.

New Year’s Checklist

•          Check your 401-k contributions. The annual amounts have increased to $19,000 and, if you are 50 or older, to $24,000. 

•          Are you earning interest on your cash?  Most banks are still paying miniscule amounts of interest on savings accounts. With the Fed having raised interest rates 9 times (cue Ferris Bueller), you have better options like money-market accounts or CDs.

•          Review your IRAs to make sure beneficiaries are listed and accurate.

•          Review your will (you have one, right?) and ensure your beneficiaries and choice of executor are up-to-date.

•          And in the words of Ferris – “Life moves pretty fast. If you don’t stop and look around once in a while, you could miss it.

Hope you and your families have a healthy and prosperous 2019!

Adam

Advisory services offered through APG Capital Asset Management, a Member of Advisory Services Network, LLC.

Phone: 713-446-3233  Website: www.apgcap.com

All views/opinions expressed in this newsletter are solely those of the author and do not reflect the views/opinions held by Advisory Services Network, LLC. Indexes are unmanaged and do not incur management fees, costs, or expenses.  It is not possible to invest directly in an index.  The information and material contained herein is of a general nature and is intended for educational purposes only.  This material does not constitute a recommendation or a solicitation or offer of the purchase or sale of securities.  The future performance of an investment or strategy cannot be deduced from past performance.  As with any investment or investment strategy, the outcome depends upon many factors including: investment objectives, income, net worth, tax bracket, risk tolerance, as well as economic and market factors.  All economic and performance data is historical and not indicative of future results.  All information contained herein is derived from sources deemed to be reliable but cannot be guaranteed.

Do Traders Need A Financial Advisor?

Why would a commodity trader, a master of buying and selling some of the most volatile markets need to hire someone to help manage their wealth? Actually, there are some very good reasons an independent advisor can benefit you and your family in the long run:

Focus on What You Know: With a demanding profession, the burden of managing your assets may be a secondary concern. With an independent advisor, you are hiring a fiduciary who is looking out for your best interests.  An effective advisor will construct and manage a portfolio consistent with your objectives, allowing you to focus on the markets that should matter most—the ones you are trading—without worrying that your long term goals are at risk.

Harmful Myopia and Impulse Trading: While you are focused on your particular market, it is easy to extrapolate the fundamentals of your niche to the broader markets, even when that correlation may not exist, thus clouding your judgment. This may lead to rash “dump it all” or “buy everything” moves in your portfolio. Instinctual moves may be appropriate for your trading book, but may do irreparable harm to your longer term goals of paying for your children’s college and funding your retirement.

Make Lemonade from Lemons: With a volatile-earnings profession, there are tactics you can employ to take advantage of your lumpy income. For example, during low earnings years, consider Roth IRA conversions or opportunistically take long term capital gains on appreciated assets. On the flip-side, in high income years consider contributing to a Donor Advised Fund to lower your taxable income.

Separating the goals and risk profile of your job from that of your general overall wealth is critically important. Hiring a professional wealth manager for the bulk of your nest egg makes a lot of sense, for both your peace of mind and your wallet.