10 Oct Enjoy the Ride but Watch the Road
I have read that people generally think that a contrary or negative opinion sounds “smarter” than a positive or optimistic viewpoint. I’ve found that to be true in general and due to my cynical nature, I must confess that a contrarian viewpoint generally piques my interest more acutely as well. So, it is at the risk of some personal intellectual capital that I must tell you, truth be told, that the US markets have just concluded a very solid third quarter and first nine months of 2018. The US economy is very strong and firing on nearly all cylinders and almost everyone in the economy is benefiting. Frankly, in my estimation, the various equity and interest rate markets are reacting the way they should be, given the circumstances. Sometimes we need to just sit back and enjoy a good quarter.
As you know, my goal throughout the years in these notes is to attempt to pass on what I thought was important, overlooked, or perhaps just interesting. As I thought about the good news this quarter I realized that I could shed very little insight into a market and an economy that seemed, even if briefly, in synch with one another. Perhaps that’s a personal insight – don’t overthink a bull market. I did, however, note some interesting items along the way this quarter; so rather than dissecting last quarter too much, I’d like to just share the good numbers and then pass along (in no particular order) some of the items I noticed along the way.
Despite a notoriously bad reputation and a bit of a September slowdown, Q3 turned in a very solid performance and added to a positive trend this year. The S&P 500 added +7.71% in Q3, and the Dow Industrials an even more positive +9.63%. Large stocks on the US exchange (the S&P and Dow) were really the story because a September swoon in the S&P Small Cap 600 of -3.17% reduced smaller stock performance to “only” +4.71% for Q3. Foreign markets both large and emerging continued their mostly downward ways and close Q3 with the EAFE at -3.76% for the year and the emerging markets at -9.54% year-to-date. Likewise, Federal Reserve rate hikes continue to depress the US bond market as the Lehman US Aggregate Bond Index remains negative at -1.9% YTD.
Some notes along the way:
- As you might have noticed above, the performance differential between the US equity markets and the rest of the world is striking. At Q3 close the differential was 14.3 percentage points between the S&P and the EAFE and fully 20.1 percentage points between the S&P and the emerging markets YTD. The world’s capital seems to be flowing our way for now, but divergences tend to revert to the mean over time and I do wonder how this will play out.
- The consumer is in the best shape they’ve been in for many years. Unemployment hit a new low of 3.7% on October 4th, the lowest since 1969. Wages are rising at an average of 2.8% annually. Home prices are up +5.9% from last year and investment balances are up as well. No wonder, the Conference Board’s consumer confidence number hit 138.4 in September, the best it’s seen in 18 years. Also, easily understood, the retail sales numbers rose 6.5% over the summer months.
- The corporate tax cuts of last December appear to be working as planned. The S&P earnings growth rate for 2018 has exceeded 20% and after-tax margins have achieved a record high of 9.7%. Corporations have been raising dividends, increasing buybacks, and paying employees at a higher rate.
- Amazon and Apple both achieved a never before seen trillion-dollar market cap during Q3. I’m not sure if that has predictive value either positively or negatively but it is certainly something to take note of.
- Speaking of Amazon, their announcement of a $15/hour minimum wage was brilliant from both a political and business perspective. Despite the increased labor costs, I predict that Amazon’s margins will go up relative to their competitors that now have to pay at least $15/hour and don’t have the technical expertise and efficiencies that Amazon has. Brilliant, Mr. Bezos!
- All the good news in the US economy may come with a cost. As we’ve discussed many times over the last 10 years, the actions that the Federal Reserve has taken- very low interest rates for a very long time, qualitative easing (QE), etc. should ultimately manifest in the economy in the form of inflation. The Feds target was 2% inflation and it has only been recently that we’ve begun to run at a demonstrably higher rate – currently around 2.8% – 3%. Consequently, the Fed has begun to raise Fed funds rates more aggressively (another ¼ point last week) to combat the fear of runaway inflation. Interestingly, the 10-year Treasury Bond (a key interest rate gauge) which has been trading in a stubborn 2.8% -3.1% range broke out of that pattern yesterday to the upside (and significantly) closing today (Friday October 5th) at a yield of 3.233%.
- Mortgage rates have been rising as well settling around the 4.7% level last week – a level not seen since April 2011. Surprisingly to me, the level of mortgage applications and refi’s dropped off almost instantly. Ned Davis Research tells me that refi activity declined 38.4% year over year and purchases were up only .8% year over year.
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