Domestic equity markets continued to climb higher during the third quarter. The strong returns were led by large cap stocks, with the S&P 500 Index up 7.71% for the quarter, bringing the year-to-date return to 10.56%. Growth continues to outperform value, as evidenced by the S&P 500 Growth Index up +17.24% vs. the S&P 500 Value Index up +3.51% in the year-to-date period through September.
The returns for the Domestic Equity Strategies that we manage internally have largely reflected the dichotomy between growth and value. The Biondo Focus Strategy is up +30.75%, the Biondo Growth Strategy is up +25.38% and the Biondo Dividend Strategy is up +0.15% in the period ended 9/30, net of fees.
In our view, the main reason domestic equities have continued to move higher is the strength in the U.S. economy. While much attention has been focused on trade wars and tariffs, U.S. economic data has remained robust – particularly as it relates to employment, consumer spending and GDP growth. Strength in the economy has translated into robust earnings growth, particularly for growth companies thus far this year.
International equities haven’t fared as well this year. Trade tariffs and a strong dollar have both weighed on international markets in general and emerging markets in specific. The benchmark for developed markets, the MCSI-EAFE Index is down -3.76% YTD and the MSCI-Emerging Markets Index is down -9.54% in the year-to-date period ended September. A rising dollar is particularly problematic for emerging markets so it is not a surprise to see such poor performance. The dollar seems to have stabilized around current levels and does not appear to be moving higher at this point. If the dollar declines from these levels, it could be very beneficial to both developed and emerging markets.
Fixed Income markets have also had weak returns, with the Barclays Aggregate Bond Index down -1.60% for the year. The Federal Reserve has continued their policy of tightening by raising rates three times in 2018, with market expectations for a fourth later this year. In addition, the Fed has also begun to shrink its $4.5 trillion balance sheet. To do so, the central bank is selling U.S. Treasuries in order to pay for the soaring federal deficit.
As of this writing, U.S. and Global Equity markets have been under some sharp pressure as the fourth quarter begins. As we see it, markets are concerned about the following:
Since the credit crisis a decade ago, interest rates have been at historically low levels. While in large part aided by the Federal Reserve, low interest rates have forced investors further out on the risk curve. Lower borrowing costs have translated into higher corporate profits, as businesses have been able to finance growth projects. As a result, the U.S. economy has become very strong.
While for good reasons, this trend is now reversing. The Federal Reserve has hiked rates eight times since late 2015 and expectations are for continued rate hikes in the future. While it is welcome news that the economy is strong enough to support a less accommodative Fed, there is now concern about the economy overheating and the risk for inflationary pressure to appear. The September jobs report showed unemployment plunging to their lowest levels since 1969 and wage growth is the biggest driver of inflation.
As mentioned above, the Fed has signaled that rate hikes will continue. Fed chief Jerome Powell has reinforced concerns in early October by stating that the Fed has a “long way” to go in returning rates to more normal levels. Powell reiterated that rates remain below “neutral.” While conventional wisdom holds that rising rates are bad for equities, research suggests that it only becomes problematic when 10-Year Treasuries reach the 5% yield level. Even with the recent spike in the 10-Year to 3.25% in early October, rates remain well below levels that may become problematic. While every environment plays out differently, evidence has shown that rising rates from low levels are not necessarily bad for equities.
Trade tensions, particularly between the two largest global economies, are concerning. As we have stated several times in recent newsletters, inflation remains our primary threat to the bull market we have experienced in equities. Tariffs threaten confidence, can delay investment and have historically led to inflationary pressure. In early October, the International Monetary Fund (IMF) cut its 2019 growth forecast for both China and the U.S., citing the current trade battle and continued rhetoric. In our view, markets may remain jittery until we see this issue more resolved.
While periods of volatility such as we are experiencing now are never enjoyable, it is important to view the bigger picture:
- The S&P 500, currently trading at roughly 2675, is 8% off of the all-time highs
- Earnings growth is estimated at 19% for the about-to-be reported third quarter
- The longer-term indicators that we rely on appear to remain healthy
- We own what we believe to be high-quality companies run by excellent management teams
In recent months, we have reviewed portfolios to make sure that asset allocations were in line with portfolio objectives. For clients with allocations to Fixed Income, we have made every effort to be properly allocated to bonds. In our Growth and Focus strategies, we have trimmed or eliminated positions where downside risk concerned us and we have high levels of cash that should serve as a cushion if weakness continues and provide us the opportunity to take advantage of this weakness in what we believe to be great companies at more attractive prices. Of course, portfolios will feel the sting of a correction – particularly in our Growth Stocks. While not enjoyable, our experience has been great companies will reward long-term investors.
As always, we appreciate the trust and confidence that you have placed in us. We look forward to a bright future together and are always here to address your particular financial needs. All our best for a happy and healthy rest of 2018.
Joseph P. Biondo
Chief Executive Officer
Chief Investment Officer
Sources: www.letour.fr; IAS & Wealthscape – returns; Focus Financial Advisors – volatility, growth vs. value; Factset – earnings growth; Axios – Chinese tariffs; Bloomberg – US/China economies; Quodd – S&P 2018 YTD; Standard & Poors – annual earnings growth; CNBC – U.S. tariffs on China; Dorsey Wright, Bloomberg – relative strength.
The information set forth regarding investments was obtained from sources that we believe reliable but we do not guarantee its accuracy or completeness. Neither the information nor opinion expressed constitutes a solicitation by us of the purchase or sale of any securities. Past performance does not guarantee future results.