September is historically the worst calendar month of the year for stock market returns. Since 1950, the average September return for the S&P 500 index is -0.7%. Additionally, negative news which could affect stocks appear to be piling up including the impacts of Hurricanes Harvey and Irma, North Korea nuclear tests, the now extended deadline for debt limit talks and the continued Washington gridlock. The strong stock market optimism from the beginning of this year seems to have faded and, with stock market valuations above historical averages, the fear is “what goes up must come down”.
We don’t dismiss any of these risks but, as investors, we understand that predicting near-term movement of markets is impossible. Most bear markets are accompanied by a recession and, importantly, current indicators of the economy show we are still in a modest and steady expansion. The stock market’s performance this year has been driven more by strong earnings and economic strength than the promise of stimulus from President Trump’s agenda. This year has been a good reminder that politics makes for good headlines and feverish emotions, but policy change in Washington moves slowly. Additionally, while President Trump’s executive changes have been grabbing headlines most will have little to no immediate economic impact.
The U.S. economy expanded at a 3.0% annual rate in the second quarter and is on track for 2.2% to 2.9% growth for the third quarter. While not explosive, the growth this year had been stable and steady. In addition, company earnings and revenue growth were excellent in the second quarter, up 10.3% and 5.2%, respectively. The global economy is also expanding with Global PMIs (purchasing manager’s index) showing synchronized uptrends, which has not happened since 2010. Even Japan has surprised to the upside with second quarter GDP growth of 2.7%. Yes, equity valuations are elevated based on various historical metrics. However, valuations don’t predict market pull-backs but rather are guides for what returns we should expect over longer periods.
Throughout the year, we’ve actively adjusted portfolio positions to reflect our current views of the investment opportunities. As an example, after observing that bond pricing for lower quality bonds was at a premium, we reduced our exposure to lower-quality credit, focusing exclusively on investment grade bonds, which have also historically acted as a more effective buffer to stock market weakness. Additionally, where appropriate, we diversified our alternative investment exposure to include investments structured to provide attractive, non-correlating returns to both bonds and stocks and should offer some protection if bond yields increase. In equities, we continue to follow our disciplined process and have reduced or sold positions when valuations have become excessive and we continue to find and add quality companies at attractive valuations.
The constant discipline of reducing positions or asset classes as they grow in size and weight within the portfolio and redeploying proceeds in investments which are relatively more attractive helps keep your portfolio risk profile appropriate as well.
Despite the concerns hanging over stock markets, we recognize the impossibility of calling market tops and predicting short term returns. By constructing high quality portfolios and diversifying into attractive, and lower correlating investments, we should be able to weather any volatility in the months ahead.
We welcome your thoughts and feedback.