Three Reasons Investors Should be Optimistic

November 9, 2018  | by Ryan Driscoll

Market Commentary

The markets are certainly making investors uncomfortable lately. However, market corrections, especially late in the cycle should be expected and can be healthy.

We have experienced five sell-offs (and recoveries!) of similar magnitude in the last five years. Unfortunately, 2018 brought the markets back to a more normal level of volatility after investors were lulled into a sense of riskless comfort in 2017. Despite the recent market instability, we still see three reasons to be optimistic.

The Good News

First, it’s an election year and history shows that the S&P 500 pulls back an average of 19 percent in mid-term election years dating back to 1962 (14 mid-term cycles) but in the year after the mid-term the S&P 500 climbs an average of 31 percent.

Second, the economy is historically strong. In aggregate, every metric still supports the notion that the domestic economy is steadily growing. GDP, employment, and inflation back the FOMC’s stance that rate increases are justified to prevent the economy from overheating. Also, rates are still very accommodative by historical standards.

Finally, corporate earnings are strong. Through November 6th, more than 80 percent of reporting companies in the S&P 500 index have released 3rd quarter 2018 earnings. Of those, approximately 86 percent grew, while the overall average earnings growth rate is 27.2 percent as seen in the chart below. Earnings are coming in four percent above analysts' expectations, with overall growth now above the second quarter rate. Sales metrics are also beating for the quarter and, forward looking, management has been guiding above the consensus for earnings outlooks.

img_CH1_Earnings_Per_Share_Percent_Change

The Other Side of the Story

Corporate America is benefitting from the 2017 fiscal package; however, this may be the high point in the earnings cycle as increased tariff costs, the tight labor market and rising debt costs start to impact revenue. The tariffs have slowed timber and grain shipments, raised the cost of textiles and heavy-equipment materials, and compressed margins for chip- and toolmakers. Overall, the negative repercussions have been universal across U.S. corporations but have had relatively modest impact so far. This may be due to a timing effect as the implementation of the second round of levies on Chinese goods only started on September 24th.

Another headwind to earnings could be the impact of higher rates on consumers. Autos, housing and credit cards will gradually get more expensive for consumers as the Fed continues to raise rates into 2019. A 4.6 percent mortgage rate seems high to a first-time buyer who has only known the accommodative policies of the last 10 years; but the wealth effect of employment and potentially higher wages could serve as an offset.

As we enter the final quarter of 2018, it is apparent that the convergence of quantitative easing in the aftermath of the financial crisis and the added fiscal stimulus of the late cycle tax reform bill last year has resulted in domestic economic growth north of almost four percent, an unemployment rate south of four percent and steadily rising (but not explosive) inflationary pressures. However, the economy runs in cycles and, ultimately, while economic cycles don’t die of old age, there may certainly be turbulence on the horizon. In this environment, we still maintain a slight bias for equities over fixed income and prefer credit over duration. We also believe that certain parts of the private markets offer attractive potential returns.

Authors

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Ryan Driscoll is responsible for trading, investment analysis. He is a member of the Treasury Solutions team since its inception. Ryan is an active participant in the investment and rebalancing process, manages the quarterly reporting process and is actively engaged with Treasury clients. Prior to joining Commonfund, Ryan worked at Sailfish Capital Partners, a multi-strategy fixed income fund, where he served on the Emerging Markets team. Prior to that, he was on the fixed income team at Grantham, Mayo, Van Otterloo & Co. and was an equity/fixed income trader at Loring, Wolcott and Coolidge, in Boston. Ryan received his B.S. in Finance and M.S. in Global Financial Analysis (with Distinction) from Bentley College. He is a CFA Charterholder and is a member of the Boston Securities Analyst Society and CFA Institute.
Ryan Driscoll
Director, CFA

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Disclaimer

Information, opinions, or commentary concerning the financial markets, economic conditions, or other topical subject matter are prepared, written, or created prior to printing and do not reflect current, up-to-date, market or economic conditions. Commonfund disclaims any responsibility to update such information, opinions, or commentary. To the extent views presented forecast market activity, they may be based on many factors in addition to those explicitly stated in this material. Forecasts of experts inevitably differ. Views attributed to third parties are presented to demonstrate the existence of points of view, not as a basis for recommendations or as investment advice. Managers who may or may not subscribe to the views expressed in this material make investment decisions for funds maintained by Commonfund or its affiliates. The views presented in this material may not be relied upon as an indication of trading intent on behalf of any Commonfund fund, or of any Commonfund manager. Market and investment views of third parties presented in this material do not necessarily reflect the views of Commonfund and Commonfund disclaims any responsibility to present its views on the subjects covered in statements by third parties. Statements concerning Commonfund’s views of possible future outcomes in any investment asset class or market, or of possible future economic developments, are not intended, and should not be construed, as forecasts or predictions of the future investment performance of any Commonfund fund. Such statements are also not intended as recommendations by any Commonfund entity or employee to the recipient of the presentation. It is Commonfund’s policy that investment recommendations to its clients must be based on the investment objectives and risk tolerances of each individual client. All market outlook and similar statements are based upon information reasonably available as of the date of this presentation (unless an earlier date is stated with regard to particular information), and reasonably believed to be accurate by Commonfund. Commonfund disclaims any responsibility to provide the recipient of this presentation with updated or corrected information. Past performance is not indicative of future results. For more information please refer to Important Disclosures.