Investment Committee & IA Department News – November 2016

BREAKOUT OR BREAKDOWN?

With the S&P 500 having spent the last 3 months in a tight 3% trading range, the question on the mind of many investors relates to the direction that this range-bound market ends up moving in and how a Trump Presidency may influence it. Prior to the election outcome, very few had the stated expectation that the market would surge higher with a Trump Presidency, the way that it has the few days following. Further, if we go back to 1901, a Democratic President and split Congress has led to 10.2% annualized returns and a Republican President with Republican Congress has led to 7% annualized return. So what gives with the initial overnight downturn and eventual 5% swing in the positive direction along with continued further strength in the days following?

Is it as easy as to just find solace in that the market is positive 73% of the time in any given year (since 1926-2015) anyway? While we should find peace in this reality from a long-term perspective, it’s not quite that simple. We know that this aging bull market has been in a very slow growth cycle, and therefore a catalyst in this later stage becomes critical. In fact, this expansion that began in 2008-2009 is the slowest in history, averaging just 2.1% annually since Q3 of 2009, while typical expansions average 3-5%. However, because the cycle has been weaker, an argument can be made that it can potentially last longer than the historical norm, as bull markets simply don’t die of old age.

As far as catalysts are concerned, simply moving beyond one of the most volatile and controversial Presidential elections in U.S. history, is a heck of a start, regardless of outcome. After moving past the pre-election stress and uncertainty, perhaps we can recall that there has been an expectation of growth pick-up in the second half of the year, all along. In fact, just recently and prior to the election outcome, we saw the initial estimate of third quarter GDP at 2.9%, the strongest pace in two years, which exceeded both the 2.5% forecast and the second quarter’s anemic 1.4% growth rate. As we further assess other economic indicators, we realize that all 10 metrics in assessing the Conference Board’s Leading Economic Indicators were all either fair or strong, with all trends either stable or improving.

As stock prices ultimately follow earnings over time, it’s also refreshing to see that with 85% of the companies in the S&P 500 having reported earnings for Q3 2016, 71% of S&P 500 companies have reported earnings above the mean estimate and 54% of S&P 500 companies have reported sales above the mean estimate. Furthermore, the blended earnings growth rate for the S&P 500 in Q3 is 2.7%. If the index reports growth in earnings for the quarter, it will mark the first time the index has seen year-over-year growth in earnings since Q1 2015, when it was 0.5. If we take these stable to improving fundamentals here domestically and overlay them with what appears to be a continued stabilizing Chinese economy and a Federal Reserve that has expressed a willingness to allow a “high pressure economy” in an effort to stimulate growth, we realize there are multiple facets to help support this post-election market strength.

With these factors, along with the hopeful expectations around fiscally stimulative policies out of a Trump Presidency, it’s a little easier to justify the recent market advance. The market is demonstrating an excited focus around less regulation, increased spending, and lower taxes, as these are all pro-growth policies, but the key will be to get execution, as it’s all hope and expectation at this point. JP Morgan mentions in an 11-10-16 Equity Strategy Note, that corporate tax reform policy alone could result in an incremental $10-$15 boost to S&P500 Earnings Per Share, which could potentially equate to 150-250 S&P 500 points at the market’s current multiple .

Worth noting, however, is that these are just the positive mentions around expected Trump policies, but many of these policy initiatives result in rising deficits, higher rates and higher inflation, which can serve as market challenges to overcome. On the election night alone, we saw the 10 year Treasury move from a yield of 1.72% to over 2.07% in short order, which is a staggering move higher in rates. Additionally, the concerns around a Trump Presidency in pre-election time centered around trade protectionism and international relations, all which remain to be seen and have to be assessed as time moves on. While the S&P 500’s first reaction to President-elect Trump has been a positive one, a diversified portfolio with the appropriate level of negatively correlated and or non-correlated assets to equities remains very important for long-term financial success.

Additionally, as the year-end approaches, it’s a great time to step back and assess your time horizons and investment objectives with your advisor. During that time, it’s wise to re-confirm your tolerance for risk, especially while the markets sit near all-time highs. This exercise will help confirm your asset allocation that your investment team at Krilogy continues to carry out for you and keep in proper balance. These efforts will go a long way to providing the necessary peace of mind around your own financial plan.

1 Ned Davis Research, Inc. Copyright 2016(c)Ned Davis Research, Inc. All rights reserved.)
2 Represented by the S&P 500® Index from 1926-2015 Index returns represent past performance, are not a guarantee of future performance, and are not indicative of any specific investment. Indexes are unmanaged and cannot be invested in directly.
3 Lafferty, David. Capital Market Notes, NATIXIS. September 2016.
4 The Conference Board’s Leading Economic Index (LEI) is a composite average of individual economic indicators designed to capture turning points in aggregate economic activity better than any individual component. ISM=Institute for Supply Management. Source: FactSet, The Conference Board.
5 Butters, John. Earnings Insight. FactSet Research Systems, Inc. November 4, 2016. FactSet.com
6 Id.
7 Dubravko, Lakos-Bujas. Equity Strategy And Quantitative Research. U.S. Equity Strategy. JP Morgan. November 10, 2016. JP Morgan Chase & Co. (Not for redistribution).