As we approach the 4th quarter of 2018, we would like to opine on how we see the remainder of the year playing out within the investment landscape. Soon after we gave our market outlook in the beginning of the year, there was a significant move in increased volatility which remained for the first quarter and remained for a good portion of the second quarter before giving way to any meaningful decrease in the VIX. With that, the equity market (measured by the S&P 500) certainly showed weakness and had many believing that this may be the end of the robust bull market that had offered gains of over 180% since the beginning of 2010. But in early April after barely piercing the 40-week moving average (of course, the technician in me really appreciates this), buyers stepped in and the S&P 500 has remained in an uptrend since making new closing highs just last week. In addition, overall performance is sound being up 9% year to date.
The next month or two may see a return to volatility and the market may come under some pressure as September and October have historically been months of increased market volatility and equity market weakness. With that in mind, just as we felt we could see volatility in the beginning of the year along with market weakness it was our belief as it is now that investors will look to weakness in the market as short-term and as a buying opportunity. We are also fortunate enough to have seasonality on our side the closer we get to November, which begins the best six months of stock market performance historically.
We would like to highlight a few fundamental factors that we believe are also positive at this time. Interest rates have slowly been rising as the Federal Reserve has been increasing rates to normalized levels, with the target level of 1.75 – 2.00 percent and the effective rate around 1.90 percent. We mention this because some investors fear higher rates, but historically stocks, and also commodities, perform well in a rising rate environment. Other catalysts for stocks are lower personal and corporate tax burdens which should lead to consumer spending and private sector hiring. One last positive that we would like to highlight is the August ISM manufacturing index reading that came in at 61.3 from 58.1 while the consensus was for a small decline. This is a level that came very close to the highest reading of 61.4 seen in 2004. The indicator was broad-based, although the main drivers were production and new orders. New orders are usually recognized as a leading indicator for the economy.
Two themes that we would like to highlight before closing:
- Millennials: First is the continued preference of Exchange-Traded-Funds, with 91% of Millennials saying ETFs are their investment vehicle of choice. We feel that ETFs and all ETPs will continue to gain popularity and become more widely used by investors of all levels.
- Impact Investing & ESG: Secondly, according to Nuveen’s Third Annual Responsible Investing Survey in 2017, 8 in 10 investors want to see their investments deliver competitive returns while promoting positive social and environmental outcomes. We believe very strongly in ESG and Impact Investing and feel that not only individual investors feel this way, but institutional money, which has been investing in this arena, will continue to do so and possibly increase more of their investment dollars in these investments.
In closing, we are certainly not saying everything is perfect and the market is without headline risk, which there has been plenty of during the course of 2018, but we also believe the current investment environment looks to remain positive for the equity markets.
2018 Outlook – VETS Indexes
The market, as measured by the S&P 500, is off to a very strong start, up 6% YTD and looking to build on the impressive gains of 2017.
The fact that the S&P 500 is above five percent is a meaningful indicator for continued opportunities. Since 1950, when $SPX is up greater than five percent or more for January, the full year has finished in the green twelve out of twelve times with an average gain of 24.8%. The final eleven months closed higher eleven out of twelve years with only 1987 being the outlier.
Another indicator of growth is the momentum factor within the market. The $SPX hasn’t closed below its 40 week moving average in almost two years as highlighted below; certainly, a sign of strength.
As the old market saying goes “it’s not ‘the news’, but the market’s reaction to the news that matters” and that was certainly the case for 2017. Looking back at the past year, there was plenty of headline risk both at home and abroad. These risks certainly had the potential to derail the upward momentum that market participants enjoyed during the year. There was a plethora of negative headlines to grasp, however, true to a bull market, the indices climbed a wall of worry.
As we look ahead for 2018, many of the same headwinds exist along with new and potentially more difficult obstacles to navigate:
- First, there is geo-political risk with Iran and the Middle-East region as a whole, especially with Turkey taking a more aggressive stance towards the Kurds. We continue to see North Korea act defiantly in the face of UN sanctions. Developments in the South China Sea should definitely be on one’s radar as well. For the first time in 16 years, global terrorism is not the CIA’s number one national security risk as China and Russia have been elevated to that position. Of course, here at home, there is still bipartisan brinkmanship which always gets ample media attention.
- As we direct our attention more to market specifics, valuations are by no means “cheap,” but that has been the case for several years and earnings continue to grow strongly. With that in mind, market multiples have never been the cause of a bear market. Remember, it’s the market participants who decide on prices to buy and sell and at present, they are willing to pay for higher multiples. Last year, volatility was extremely tame which contributed to stocks going a record 395 days without seeing a 5% reversal. Can this last? We think that a certain level of volatility could arise and transition stocks to a wider trading range. This wider trading range would be welcomed by active investors and also allow for those underinvested to potentially add to their equity exposure. Hence, we believe the market continues on its upward path until proven wrong.
- As for interest rates, we look to the Fed to continue their gradual hiking of the Fed Fund rates and also allow for their asset balance to shrink as debt holdings mature and roll off the balance sheet. The yield curve continues to flatten going out past ten years, but remains positive. We believe that unless there is an inversion to the yield curve, this is only something to monitor for one’s fixed income exposure. We believe with global interest rates at historically low levels and US Treasuries offering a relative high yield to other sovereign debt, demand for US debt will remain strong, putting a cap on interest rates in the debt market.
- A few critical, thematic trends that we include the following:
- We see are the continuation of growth within Blockchain and crypto-currencies.
- We believe healthcare will continue to be a place of mergers and acquisitions as R&D has given way to acquiring patents and pipelines.
- We look for the continuation of strong inflows to ETFs to be the product of choice among retail investors and especially the younger generations of investors. Last year, we saw this strategy being adopted at the institutional level as well and believe exchange-traded-products will continue to grow as an investment vehicle of choice for certain types of exposure by this group.
- Lastly, it is our belief that more and more investors care about the ethical impact of their investments in addition to performance. Hence, we look for ESG (Environmental, Social and Governance) and SRI (Socially Responsible Investing) investments to grow among the investing landscape and continue to be further defined as categories.
Thank you for reading and we look forward to checking in on 2018 with our mid-year review!