“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
Review
The broad stock market, as measured by the S&P 500 Index, rose modestly in the third quarter. The quarterly advance of 1.2% added to the strong gains posted in the first half of 2019 to bring the year-to-date return to 18.7%. This marks the best return for the first nine months of a year since 1997. The Dow Jones Industrial Average followed suit, exactly matching the S&P 500 return over the quarter. The more technology heavy NASDAQ trailed slightly during the quarter, along with the small and mid-cap focused Russell 2000 index. Similarly, quarterly returns overseas also trailed large cap domestic stocks, with international developed markets posting a 1.7% decline while emerging markets declined 5.1%.
Within the US large cap segment, investors experienced widely varying returns among the 11 industry sectors. The more defensive and higher-yielding sectors, such as Utilities, REITs, and Consumer Staples, led the way during the quarter. This was not surprising due to the decline in general interest rates experienced over the last three months. On the opposite end of the spectrum, energy and healthcare were the worst performing sectors in the third quarter.
The overall positive stock market returns have occurred despite a slowdown in the rate of growth in the US economy. The Atlanta Fed GDPNow forecast released on October 1st estimated that GDP growth decelerated to 1.8% in the third quarter. However, the US economy has managed to post positive economic growth despite the negative effects of the trade war, global economic weakness, treasury bond yield curve inversions, and polarizing deliberations on impeachment in Washington, DC.
The Federal Reserve Bank reduced the Federal Funds rate twice, each by 25 basis points, during the third quarter. This set the overnight lending rate in a range of 1.75%-2.00%. The dovish move was largely in response to slowing economic conditions around the globe. Expectedly, 30-year mortgage rates also declined in the third quarter. According to Freddie Mac, the average 30-year mortgage rate has declined by approximately 1.2% since last year’s highs, and now stands at about 3.75%. The lower borrowing rates have helped stimulate housing starts and building permits, which rose significantly to a more than 12-year high in August.
According to analysts at JPMorgan Chase, there are approximately $15 trillion in negative yielding bonds around the globe. During the third quarter, sixteen central banks lowered their interest rates. JPMorgan Chase predicts upwards of two dozen more central banks could cut rates by year end, with the U.S. Federal Reserve likely trimming rates by an additional 25 bps in the fourth quarter. Widespread global accommodative monetary policy would go a long way towards providing a ballast for higher market prices.
Outlook
Overall, traders on Wall Street continue to have confidence in the U.S. consumer.The US economy is largely driven by consumer spending, which accounts for approximately 70% of all consumption.The risk of an economic recession would likely increase if consumer spending were to pull back in a meaningful manner. This would become more likely if job losses started to occur or if consumers had concerns about their economic future.But the unemployment rate as reported by the Bureau of Labor Statistics fell to 3.5% in September.Therefore, it is hard to see a recession on the near-term horizon with unemployment near 50-year lows, consumer confidence not far from all-time highs and favorably low interest rates supporting mortgages and consumer purchases.
S&P Capital IQ reports analyst expectations of a 3.6% decline in third quarter corporate earnings versus the same period a year ago. However, the same analyst community projects a return to positive earnings growth in the fourth quarter, with expectations of a 3.5% increase year-over-year. The growth momentum is then expected to produce a 10.8% earnings expansion in 2020. Based on these expectations, the forward price-to-earnings ratio for the S&P 500 is 17.7 times versus the long-term average of 16.4 times since 2000. Therefore, we believe valuation levels are reasonable even after the out-sized stock market gains in the first nine months of this year.
According to CFRA equity research, the S&P 500 has risen an average of 4.3% in the fourth quarter and gained in price 80% of the time since 1990. Furthermore, CFRA’s Chief Investment Strategist, Sam Stovall, notes, “Since WWII, while the S&P 500 recorded its worst quarterly price and volatility performances in Q3, it posted its best average price gain and frequency of advance in Q4…….We see 2020 forecasts for low interest rates, solid economic expansions, tame inflation and favorable EPS growth going a long way in keeping this bull market alive.”
Our overall view of the stock market has remained consistent this year. We do not expect a recession in the near-term as interest rates have turned lower, inflation has been relatively contained and the labor market has remained strong. But we acknowledge the same risks to the market remain, notably the ongoing trade tensions with China, uncertainty of the resolution of Brexit, and a further weakening in the global economy. In line with our last writing, we believe the positives outweigh the negatives. Therefore, we maintain a constructive view of the stock market for the rest of the year and into 2020.
Sincerely,
Marietta Wealth Management, LLC