July 2019 Market Commentary
Over the past decade market analysts and news pundits alike have seemed to constantly forecast continued growth in the stock market…and with a few exceptions they were correct. In fact, if you had invested $50,000 in the S&P500 in 2009 it would be worth around $152,000 today after growing over 205%. Yet, today, for the first time in a long time, we are beginning to see a divergence in opinions appear in various media sources with some claiming the next great market correction is around the corner.
In large part these negative predictions grew out of worries about the continuation of the trade conflicts between the US and China and the slowdown in corporate earnings. So, are these worries warranted…should we withdraw from the market and start stockpiling our cash under our mattresses? Not quite. As intelligent investors, we must take a moment, while many other investors either head for the hills or rush recklessly further into the market, to evaluate what is really happening in the economy and position our portfolios accordingly. In particular we believe there are two recent trends that demand our attention:
- Corporate Earnings: After achieving earnings growth of around 20% last year companies are expected to only realized earnings growth of around 2-5% this year. While on the surface this technically still looks like positive growth, we believe the estimates are being artificially inflated by many companies’ stock buyback programs. These programs allow companies to buy their stock back from current investors and thus reduce the number of shares outstanding. For example, if a company has $100 in earnings and investors hold 25 shares then each share would have $4 in earnings. If, however, the firm uses a share repurchase program to buy some shares from investors so there are only 20 shares outstanding then each remaining share would now have $5 in earnings. Essentially, the company would not have become any more profitable or efficient but it effectively used the share repurchase program to report higher earnings per share. Taking such programs into consideration we believe that corporate earnings are not growing in any significant manner and are actually closer to flat compared to last year. While this definitely signals that the market is slowing down it does not signal a coming recession.
- Interest Rates: On Friday July 19th the Federal Reserve signaled that they will likely begin to decrease interest rates in attempt to support the market’s continued growth. This decision is incredibly impactful because it will be the first time since 2008 that there has been a decrease in interest rates rather than an increase. While this decision will likely lead you to earn a lower interest rate on the money you have in your bank savings account it will also likely spur some economic activity since companies and individuals will now be able to borrow money at a lower interest rate. Clearly, the federal reserve’s incentive is to continue supporting the market’s growth as long as possible and minimize the effect of any market correction, should one come at some point in the future.
As pointed out above, the slow-down in corporate earnings combined with a decrease in interest rates is a phenomenon that the market has not experienced in over a decade. Based on these observations, we believe smart investors should look at the recent changes in the market place and increase their exposure to both dividend paying stocks and value-oriented stocks:
- Dividend-Paying Stocks: Although it can be tempting to read our above observation about the slowdown in corporate earnings and assume that now is the time to withdraw from the stock market, we believe that would be an incorrect assumption. As the federal reserve decreases interest rates, the stock market actually becomes more attractive. Since investors can no longer achieve a sufficient risk-free return in their bank accounts or Certificates of Deposit (“CDs”) they are incentivized to move more money into the market in order to achieve their desired return, an action that generally benefits stocks. However, the key here is to understand that not all stocks are rewarded equally in this environment. The stocks that benefit the most from decreasing interest rates are those of companies that consistently pay or increase their dividends. This is because dividends allow the investor to have a steady stream of income in addition while still benefiting from any price appreciation the stock. Additionally, since investors know they can rely on the steady dividend income the stock price tends to be less volatile than non-dividend paying stocks when the market has a correction. In fact, according to a recent study, high quality dividend-paying stocks had an annual return of 13.4% over the past thirty years compared to 9.3% for the S&P500 and achieved this growth with less volatility (1).
- Value Investments: Value companies are companies that are currently underpriced by investors for an assortment of reasons such as short-term falls in profitability or poor management. By looking beyond these short-term inefficiencies and realizing the long-term value of such a company, an investor can buy the stock and hold it until the rest of the market realizes its full potential. This practice, called value investing, has historically been very successful. In fact, from 1996-2006 value stocks outperformed the overall market by 1.1% annually (2). Unfortunately, since 2006 value stocks have underperformed compared to more growth-oriented stocks, whose stock prices are based more on expected growth rather than actual profitability. Now that the market is growing at a slower rate and the federal reserve is lowering interest rates, however, we believe investors will start to look at value stocks as they begin to move some money away from growth companies, which are less attractive in a slowing economy. Once again, however, not all value stocks will be rewarded since many of these companies are underpriced by the market for good reasons. In this way it is important to invest in value funds or companies that are currently underpriced but have a strong possibility of achieving high growth again in the future. Specifically, we look for companies that are investing in technology, paying a steady dividend, and bringing in a strong management team.
A Final Note
As has been the case over the past few years, politics continues to play an outsized role in the investing landscape. This coming year will be no exception as we enter the election season. As a result, we expect near-term volatility in the markets particularly in investment sectors that are at risk of politicization. One such area is healthcare. As polls increasingly show that healthcare costs are Americans’ top financial concern both the President and every democratic candidate have added the issue to their agenda (3). Until more clarity is provided, we would try to avoid increasing exposure to companies that may experienced large price swings during the campaign cycle.
It is also important to remember that although we may be entering the early stages of a market slow-down, the economy and stock market are still growing. Using this time to increase a portfolio’s fixed income exposure and purchase more dividend-paying and value-oriented stocks will likely provide a more diversified portfolio that will provide more down-side protection without jeopardizing the potential for long-term growth. As always if you have any questions or would like to discuss your financial goals please do not hesitate to reach out.
Wishing you a wonderful rest of the summer,
The Glen Eagle Investment Team
1.Barrons. “Dividend Stocks Look Good After the Federal Reserve Meeting — Just Not All of Them” 6.20.19 2. Barrons. “11 Cheap Stocks to Buy as the Market Hits New Highs” 7.5.19 3. Gallup poll. “Healthcare Costs Top Financial Problem for U.S. Families”. 5.30.19
Disclosure: This commentary is furnished for the use of Glen Eagle Advisors, LLC, Glen Eagle Wealth, LLC and their clients. It does not constitute the provision of investment advice to any person. It is not prepared with respect to the specific objectives, financial situation or particular needs of any specific person. Investors reading this commentary should consult with their Glen Eagle representative regarding the appropriateness of investing in any securities or adapting any investment strategies discussed or recommended in this commentary.