The year is half done, and though it does not feel like it, the S&P 500 has eked out a total YTD return of 2.7%. The Dow Jones Industrials are negative YTD, while dividend focused equities have lagged mightily. After hitting new highs at the end of January, broad markets were hit by a correction of 10% and continue to careen down the highway sideways. Markets have been all over the road like a texting teenage driver. If the market is positive, why does it feel like we’re the participant in the demolition derby who has won the race, but is left beaten to a pulp?
The Bull market has been running for ten years, and we are experiencing increasing dispersions of re-turns across geography, sectors, and asset classes, combined with rising volatility. This bodes well as a signal for impending change. Note: I did not use the term impending doom, because that would imply we actually know what is coming down the road. The current environment can perhaps be described as mixed messages, with some good news, some pain, and really ugly international and emerging markets. Oh, and let’s not forget the trade war.
The technology sector continues to roar, as have small cap growth stocks. The so-called momentum trade is handily beating value and dividends YTD. Average market returns are barely above zero, while whole sectors are significantly below. Sector returns can and often do reverse quickly, so remaining diversified and keeping your focus on your long term goals is critical.
US GDP is strong, unemployment is at historic lows, and corporate earnings are demonstrating solid growth. This economic scenario should imply continuing progress for equities. The risk is that the technology sector has accounted for fully half of the gains for the S&P 500, with some support from rising oil prices, and therefore energy.
It remains to be seen if this trend can continue. There is evidence of performance-chasing behavior by active money managers as well as by retail investors, and this has resulted in some extreme valuations. Netflix at 266 time trailing earnings, anyone?
As long as the economy remains in a solid growth mode, the laggards will recover, while the greatest risk lies with the leaders (FAANG). This is not the time to chase last quarter’s winners.
Don’t look for help from bonds. Fixed income investments, with the exception of preferred shares and floating rate bonds, have been negative YTD. Rising interest rates result in lower bond prices, it is that simple. As the Federal Reserve continues to raise the fed funds rate, bond yields are pushed upward in a strong economy. Until the economy starts to show weakness, this will continue to limit opportunities in fixed income, except for very short-term assets that benefit from rising rates.
International investments and emerging markets in particular, have experienced losses across the board. This from a combination of forces:
- The Trade Wars.
- Rising US Interest rates, which make for a strong dollar.
- Continuing flow of capital to the US from the rest of the world seeking a safe haven.
- Lower US corporate taxes making the US more attractive to foreign capital
The story from the first of this quarter remains the same. Markets remain volatile, moving sideways. It is critical to pay attention to increasing relative divergences in asset valuations, and in-vest accordingly. Indeed, more recent gainers are Utilities, REIT’s, and dividend-payers, as it is increasingly recognized they have trailed other sectors substantially. We are investing cautiously.
It looks like we’re in for a long hot summer so keep a cool head as market volatility gets heated. Periods of change represent both risk and opportunity.