October 6, 2017

While Jim is away on vacation, other members of the TBA Investment Committee will write the market comment.  Today’s comment is from Jim Vogt.

As we enter the final quarter of 2017 and approach earnings season, I thought it would make sense to take a brief review of what has worked, what has not worked and what we can expect going forward as we close out a solid global expansionary year.

To recap the past nine months:

  • The Dow Jones Industrial Average, S&P 500 and Nasdaq Composite are up 15.3%, 14.0% and 23.6%, respectively, thru the first three quarters of 2017. Impressive to say the least.
  • Growth stocks are far outpacing traditional value names with the S&P 500 Growth Index advancing 19.0%, and the S&P Value Index “only” up 8.3%. Either number would be a great year for investors, but taking on added risk, or not concerning yourself with historically high valuations, resulted in more short-term gains for the go-go growth stock investors.
  • Although small cap stocks have rallied recently, they are lagging the larger, more recognized and globally diversified companies.
  • Speaking of global, the rest of the world continues to impress with the Eurozone stock market index and emerging market indices up 27.2% and 28.6%, respectively. A massive rebound, as globally synchronized money printing measures mimic our markets from a few years ago helped fuel the rise.
  • The US Dollar has declined by over 8% on a trade-weighted basis. This benefits a lot of the larger, globally diversified corporations as earnings translated back to US dollars gives a boost to final reports.
  • Outside of copper and gold, most commodities have been range bound, providing some relief to the input cost side of the earnings equation.
  • Short-term rates have risen, but long-term rates have not seen much movement. The 10-year US Treasury started the year with a 2.45% yield and today is at 2.36%.  However, the 3-month T-Bill rate has doubled from the start of the year, jumping from 0.53% to 1.06%.

Simply put, if you’re in the equity market, it is likely your portfolio has grown above a historical trend line so far.  This makes sense as global economies are quickly coming out of a recession to join the US in posting positive top-line revenue growth, leading to expanding earnings.

Looking forward, we have to balance the risk vs. reward scenario from a macro perspective.  On the positive side of the ledger; leading economic indicators are impressive, inflation is not a concern, employment is still rising, wage increases are steadily above inflation but not overheating, the housing market continues to expand, consumer confidence is as high as it has ever been, household debt relative to income is dramatically lower than a decade ago, interest rates remain attractive for borrowers, volatility is non-existent, and there is the potential for lower taxes.  The power of a global expansion is showing more signs of expanding.  Basically, there has been no indication of anything on the horizon that would typically precede a recession.

On the risk side of the landscape valuations from many measures are at peaks not seen since the year 2000 (an ominous time to invest).  Corporate debt levels have risen substantially, but are offset by substantial overseas cash balances.  The Federal Reserve is increasing its quantitative tightening measures with higher rates and a declining balance sheet which pulls liquidity from the market.  Cryptocurrencies + junk bonds + art collections all show signs of being in bubbles created by excess capital.  Money-losing “unicorns” are rising in valuation with minimal prospects for actual earnings and a record $12.7 trillion in auto loans + credit cards + student loans is leading to higher delinquency/default rates.  These issues are a real concern and will have to be dealt with, but as long as corporate profits are expanding and interest rates aren’t skyrocketing, equities should continue to yield results, albeit short-term corrections are likely.

As a reminder, the S&P 500 has had a drop of at least 7% for each year since 1996.  The blue chip index has not dipped more than 3.2% in the past eleven months!  We aren’t expecting a sizeable correction, but then again no one is…and that’s when it usually happens.

Earnings updates start next week and pick up steam through the middle of October.  We have already seen decent results from the likes of Nike#, Oracle#, FedEx# and Accenture# which were met with mixed reactions. Slightly more volatility during this reporting cycle would be quite normal.

The estimated earnings growth in the third quarter for the S&P 500 constituents is 4.2%, eerily similar to the 4.4% stock market advance during the quarter.  Energy and Technology sectors are expected to show the highest growth, while Consumer Discretionary (led by retail) earnings should show a year-over-year decline.  Guidance given by management going forward will be even more critical as we prepare for 2018.  Future earnings are expected to grow in the low double-digit range.  These projections have a historical tendency to be overly optimistic.  October has a habit of being a time when corporations give year-end guidance and some commentary on the following year. Anything less than robust optimism may result in stock price corrections.

Adding to the historically volatile month is tax-loss harvesting.  Many mutual funds have an October-end for tax purposes.  Fund managers will look to sell stocks that are down from their purchase price, causing some dislocation in the markets as selling is exacerbated based on lowering your taxes and not on the fundamental value of the underlying company.  One thing that I have not seen discussed much on tax reform is what that does to the taxable investment landscape.  On the flip side of this, how many investors have held on to their stocks with massive gains, FANG stocks for instance, in hopes of waiting for lower tax rates in 2018?  If, somehow, the political landscape in DC changes and something actually gets accomplished this year on tax reform, how many investors will reallocate their holdings in Facebook#, Apple#, Netflix and/or Amazon in order to reduce risk as they have become outsized positions among many investors.

Funny things happen as we get towards year-end.  2017 could bring a wave of mispriced opportunities derived from investors distaste for paying taxes, or approval of lower taxes on winners.

Our recommendation remains the same.  Stick to your asset allocation.  Do not extend yourself. Review your financial plan.  Update your goals and objectives.  Stay the course.  Everything looks great now, but that is no reason to deviate from your long-term plans or take on added risk.

Birthdays: Elisabeth Shue of Back to the Future fame, turns 54.

Jim Vogt, 610-260-2214

Additional information is available upon request.

# – This security is owned by the author of this report or accounts under his management at Tower Bridge Advisors.

Additional information on companies in this report is available on request.  This report is not a complete analysis of every material fact representing company, industry or security mentioned herein.  This firm or its officers, stockholders, employees and clients, in the normal course of business, may have or acquire a position including options, if any, in the securities mentioned.  This communication shall not be deemed to constitute an offer, or solicitation on our part with respect to the sale or purchase of any securities.  The information above has been obtained from sources believed reliable, but is not necessarily complete and is not guaranteed.  This report is prepared for general information only. It does not have regard to the specific investment objectives, financial situation or the particular needs of any specific person who may receive this report.  Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed in this report and should understand that statements regarding future prospects may not be realized.  Opinions are subject to change without notice.

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