With the September Fed meeting behind us and the US Presidential Election ahead we are in between days it seems, like waiting for Godot, waiting for a catalyst to change the investment landscape be it political, economic or otherwise. In the meantime, investors are exposed to many different crosswinds that muddle the investment process.
The corporate earnings picture has been declining for 5 straight quarters. Q3 for the S&P 500 is expected to decline -2.3% making it six declines in a row yet 2017 earnings expectations show an increase of 14.8% year over year. On the GDP front Q3 consensus is at 2.8% and Q4 at 2.4%. These follow 1.1% for Q1 and 1.4% for Q2. Consumer Confidence in the US surprised to the upside yesterday however the manufacturing PMI printed 49.4 in August, down from 52.6 in July, while service rose to 51.9 in September from 51 in August to reach a 5 month high. Wages and housing – the main drivers of inflation – have been modestly better but capital investment is declining or flat suggesting the improvement in wages is not reliable or sustainable. And we have a sanguine Fed, or at least the appearance that they are optimistic.
When we look outside of North America we see that Europe has lots of challenges, the most pointed being nagging deflation and a banking sector with some serious problems at Deutsche Bank (Germany) and Monte Paschi Bank (Italy). We will certainly hear more about these two in the coming days and months. Japan can’t imagine
inflation growth let alone conjure it nor convince the markets that its convinced of its own plans China is somewhat of a mystery but with rumours of debt piling up higher than the known print of 250% of GDP (whisper is 300%) it seems like its a mysterious time bomb.
Crosswinds aside, markets are not in too bad of shape though slightly extended at present, and continue to reflect a bias toward portfolios that are convex or that display balanced risk between pro-growth and pro-cyclical themes.
MAJOR INDICES & RATES
Speaking of interest rates, this rolling 5 year chart of performance has looked different in each of the last 5 years (4 charts below). Seasonality at the asset class and individual security level translates forward or back – it migrates – based on the overall market structure.
RELATIVE STRENGTH: HEAT-MAPPING
This long term comparative chart of pro-cyclicals (US financials, grey) vs. defensives (US utilities, back) is representative of how convexity plays out in portfolio management. Defensives have outperformed since the end of 2007…
…but since Brexit (June to August 2016) financials were better. As of September utilities took the lead again. This is one picture of why managing assets using convexity helps to reduce the importance of “Fed speak” or business headlines, examples of powerfully distracting forces. While you may own both at times, some areas are to be traded and others invested.
We recently sold SNC based on a technical breakdown. The company lowered guidance today to $1.30-1.60 vs. forecast of $1.50-$1.70 We try not to love our holdings and why sometimes shoot first. We’ll revisit the stock again.
In general, balancing risk instead of asset classes reduces the need to be right at each market pivot.
Robert Sneddon, Portfolio Manager, email@example.com