Second Quarter 2024 Update and Outlook

As we reach the midpoint of the year, I want to take this opportunity to share insights into the current market dynamics, key economic indicators, and strategic considerations for your investment portfolios.

Strong Start to the Stock Market

The stock market has shown remarkable strength this year, with large-cap growth stocks leading the charge.  Companies within the technology sector, particularly giants like Nvidia, Apple, Microsoft, and Amazon have dominated the gains this year while the average S&P 500 company has had middling returns.  It is hard to forecast these times of concentrated outperformance so having exposure to the whole large cap market, obviously, means exposure to these companies. On the flip side, the market leaders can quickly change, as leaders can be limited by the sheer size of the gains, so portfolios will also benefit if other stocks take the reins. In fact, we are starting to see some signs in the last couple of weeks of the market broadening out, with smaller stocks outperforming these mega cap names.

Current Economic Indicators

Recent economic data indicate the economy continues to expand - with the GDP growing at a 1.4% rate. This rate is down from 3.4% in the fourth quarter 2023[i] and leading economic indicators suggest that growth may continue at this more moderate level as the Atlanta FedNow is projecting GDP for the second quarter to stay around 1.4%[ii].  Other areas of the economy are strong but showing signs of weakness. For example, the recent unemployment rate of 3.6% shows the labor market has been at historically low levels of unemployment but the June reading spiked to 4.1%[iii]   Fortunately, the inflation statistics are still trending lower with the recent statistics moving down to the low 3% range.  Some of the stickier data points are housing related which should mean continued decreases in the coming months. [iv]  While the Federal Reserve has not implemented any rate cuts this year, there is speculation that they may consider them later in the year if economic conditions continue to weaken and inflation continues to ebb.

Positioning in Front of the Election 

With the election approaching it is interesting to note how the market typically reacts in election years.  The historical data is encouraging.  As the chart below shows, during the second half of an election year returns outpace the average year by 4.2%.  Obviously, this far from guarantees strong results for the remainder of the year, but this points to evidence that elections may not be a time to be overly cautious.

 
The first half of presidential election years tend to be sluggish, followed by a big second half

Average return, 1/1/26 – 12/31/23

Source: Morningstar as of 12/31/23. Stock market represented by the S&P 500 Index from 1/1/70 to 12/31/23 and IA SBBI U.S. large cap stocks index from 1/1/26 to 1/1/70. Past performance does not guarantee or indicate future results. Index performance is for illustrative purposes only. You cannot invest directly in the index.

Positioning and outlook

Given the current market conditions and economic indicators, we recommend maintaining a balanced and diversified portfolio. While the performance of large-cap growth stocks has been impressive, diversification across different sectors, geographies, and asset classes can help manage risks and enhance long-term returns.  Allocations to longer duration bonds should also do well if the economy weakens.  This could provide a hedge for equities that may struggle in a difficult economy.

[i] https://www.bea.gov/data/gdp/gross-domestic-product#:~:text=Real%20gross%20domestic%20product%20(GDP,real%20GDP%20increased%203.4%20percent.

[ii] https://www.atlantafed.org/-/media/documents/cqer/researchcq/gdpnow/RealGDPTrackingSlides.pdf

[iii] https://www.bls.gov/news.release/pdf/empsit.pdf

[iv] https://www.bls.gov/cpi/latest-numbers.htm

Coronavirus Update and Positioning - March 18 Letter to Clients

I wanted to give you some of my thoughts on the Coronavirus and the impact on the markets.  I think that the government is finally on board with broad efforts to stop the spread of the virus and to provide aid to people and companies most affected by the virus.  I am in favor of the current guidelines around social distancing and take a preponderance of care in your daily activities.  These efforts to slow the virus should help keep more Americans from getting sick and those that do, the proper medical assistance.  This will no doubt disrupt our lives and affect companies possibly for a longer period of time.  As evidenced by the slowing rates in China and South Korea, taking drastic efforts now should pay off down the road. 

I construct portfolios to match your tolerance for risk and to help generate the most return.  However, this is not a “set it and forget it” process.  As the risks have increased, I think additional caution is warranted. 

Typically, we judge the value of stocks based on the future cash flows the companies generate.  There are a number of inputs, but to simplify, we look at the current earnings, the expected growth, and an interest rate to “discount” those future cash flows.  Prior to the outbreak, there was relatively high certainty to those inputs; however, In the current environment, the market is struggling to know what any of those numbers are.  In addition, the ability of some companies to repay debt is also in question.  We cannot rely on past earnings or many companies to estimate their current or future earning power.  Furthermore, the risks in the market are raising the discounting interest rate which lowers the value of those future cash flows. 

Much of this uncertainty has been absorbed by the market, as the stock market has dropped so precipitously in such a short time frame.  However, I believe the virus will run its course at that economic activity will rebound and companies should go back to normal operations and return to generating profits.  I think this is a short-term phenomenon for most companies and stronger companies with good balance sheets may even come out more efficient and in a better position to grow.  As the market is forward-looking, the market should bottom well before the economy and timing that bottom will be impossible. 

This market fluctuations can be unnerving.  Please know that I am keeping a close watch of the markets on your behalf. The most important thing is your health, and the well-being of your family, friends, and neighbors.  I am available to provide guidance on some financial items like refinancing your mortgage, looking at your budgets and financial plans, and update changes to your estate planning.  Otherwise, take the opportunity to do some spring cleaning, work on projects around the house, catch up on some reading and TV shows and take some mental breaks from the news! 

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.

Market has Rallied Back to the Highs. Is it Cause for Euphoria or Fear?

The last six-months have been a wild ride for the market. The big sell-off in the fourth quarter of 2018 is fading from memory and the S&P 500 has pushed back to all-time highs.  For the factors cited for causing the market drop, not much has changed.  Trade talks with China continue, Brexit is still in limbo and growth expectations, as predicted, have moderated.  Yet, here we are, back at “record highs”

I find it humorous when the news hypes the fact that the market is making “record highs.”  Like this is a rare occurrence and a new feat of capitalism.  In fact, taking a long view, the market is usually at “record highs”, as the stock market tends to move in an upward trajectory.  It’s like saying your age is at record highs.  Well, almost.   The market does drop and it can take years to get back to previous levels, but thus far, the long-term trend is for the market to ratchet to higher and higher levels. There are many reasons for this, like: inflation, population growth, and fairly efficient allocation of capital. 

Traders and hedge funds have short time frames in which to show results.  Catching moves (in either directions) is their goal, leading to more aggressive re-positioning of portfolios.  Most individual investors have the huge advantage of a long time frame.  When you have years or decades to mark your success, sharp pullbacks and rallies can be obscured by the long-term trends.

The fact that the market is making new highs should be cause for neither euphoria or fear.  We should put our psychological biases aside and remain committed to our investing plan.  Harder said than done.  Debates over timing the market is great for dinner parties and validating our worth as investors (or financial advisors), but how does it actually translate in our brokerage statements?  It is a worthwhile question to pursue.  One thing is true, considering the 17.6% surge in the S&P 500[1], the risk-reward of investing now is less compelling than at the start of the year. 

Market momentum works both ways.  The market unraveling in December seemed to feed on itself creating an overshoot that was, in hindsight, a great buying opportunity.  Similarly, the rebound action may continue to grind the market higher.  Rebalancing your portfolio is generally a prudent tactic. Buying when the market drops and lightening as it rises to keep your portfolio anchored to an allocation sometimes helps to take advantage of volatile markets--helping both the portfolio and ego.

[1] http://performance.morningstar.com/funds/etf/total-returns.action?t=IVV&region=USA&culture=en_US

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.

How "Top Gun" Can Help You Position Your Portfolio when the Yield Curve Inverts

Maverick: “We Were Inverted”

During the iconic Tom Cruise scene in Top Gun when he details his interaction with a Russian MIG during a test flight, he explains to a shocked room (not before he removes the cool shades), that the way he was able to see the MIG while flying above it, was that “We were inverted.”  This week, in a shock to the market, the 5-year minus 2-year yield was negative, or “inverted”.  Usually, the longer the duration, the higher the yield; however, short-term interest rates are currently higher.  A more common tracked metric is the 10-year minus 2-year yield which is close to inverting as seen below.

There are several reasons why this is occurring.  The Fed (which controls short term rates) is witnessing strong domestic growth and an upward creep in core inflation.   Since interest rate changes can take time to move through the economy, the Fed preemptively will move to limit anticipated problems, i.e. runaway inflation.   By increasing rates, they can put the brakes on growth limiting inflation.  It also gives the Fed room to move rates lower if the economy slips.  On the other hand, the market (investors and traders) determines the rest of the interest rate curve.  Currently, the market has a strong demand for longer duration bond for the relative safety of government bonds due to a combination of fear of market volatility and an outlook that the Fed may have to lower rates in the coming years.

What are the implications of an inverted curve? All seven recessions since 1970 have been heralded by a yield curve inversion.  However not all inversions imply a recession.  Tom Lee, the co-founder of Fundstrat Global Advisors LLC, calculates that the 3- to 5-year yield inversion has occurred 73 times since 1954 while the economy endured only nine recessions. “5Y-3Y inversion predicted 73 of the last 9 recessions, too many false positives.”[i]

Now the question is: “What are investors to do about this?”  It really all depends on your risk appetite, holding period and allocation. While market weakness is not a guarantee, there are strong indications, like the higher VIX index, the market will be more volatile going forward.  Investors need to know how they are positioned to ensure their allocations are aligned with their capacity for risk.  At my firm, we use Riskalyze’s risk alignment software to make sure we know how much risk our clients are willing to take and to position their portfolios accordingly.  First, we determine your “Risk Number” though a short survey.  Then we analyze your current portfolio of securities to see how risky your portfolio is.  If you are interested in this, or just curious what your risk number is, click here for a short survey and check out more on Riskalyze here. 

[i] https://www.bloomberg.com/news/articles/2018-12-06/history-shows-inverted-yield-curve-is-no-death-knell-for-s-p-500

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.