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Market Downturn & Looking Forward November 27, 2018 Update

We have a lot to be thankful for over the last few years in the market with its strong gains.  Now many investors feel like beheaded American turkeys at Thanksgiving. Turkeys aren't the only ones getting slaughtered.

Our concern for market values is only relevant when we need cash and have to sell. We do not want to lock in market losses in a downturn.  That is why I recommend a "participate yet protect" bucket of money that only participates in market gains, not losses, as an alternative when investments are down, and cash is needed.

Earnings Stronger than Expected
The underlying earnings that ultimately drive equity valuations continue to be healthy and growing.

With 96% of S&P 500 companies reporting 3rd quarter results, Factset reports that the earnings growth rate is up to 25.9% - far exceeding analysts' estimates from 9/30 (19.3%).

78% of companies have beaten earnings estimates vs. the consensus long-term "beat" ratio of 67% (marketwatch.com).  The usual beating of expectations reflects the usual conservatism of companies issuing "guidance" - in other words, outlook - which analysts incorporate in their estimates. This guidance is designed to “under-promise and over-deliver,” to set up earnings "beats," which might send the stock higher when earnings results do beat estimates.

FUN FACT: In the S&P 500, there are actually 505 stocks because five of the companies in the index have two classes of common shares.

Earnings Outlook
While equity markets have been spooked by geopolitical events, higher interest rates, trade war concerns, and fears of an overheating economy, the most critical factor in equity market valuation - earnings data - suggests continued fundamental strength. 

Remembering that historically earnings have beaten the estimates, Factset reports current forward earnings growth estimates for the S&P 500 are as follows:

Q4 2018: 13.6% earnings growth
Full Year 2018: 20.4%
Q1 2019:  4.9%
Q2 2019:  5.4%
Full year 2019: 8.8%  

These projections predict solid - although moderating - growth estimates after over 20% growth in 2018 and 23% in 2017.

Forbes reports: "For investors questioning if the bull market can continue for the next several years, or whether now is a good time to initiate new equity positions, the underlying trend in earnings growth suggests the answer is yes."

Using a chart comparing S&P 500 stock values to earnings since 1989 Forbes concludes: "It is apparent that barring some major unforeseen event, equity markets are likely to continue their ascent.  We are currently experiencing historically strong earnings growth coupled with a strong pro-business political environment. It’s highly likely that the remarkable equity bull run still has some gas left in the tank."  

Cetera Investment Management on 11/20/2018 did an excellent commentary that discusses the recent market sell-off and investor concerns as a pdf at  http://dhutch.news/CReport_11_2018  

The Wall Street Journal 11/21/2018 has an excellent video "Bear Necessities: The Charts That Predict Market Downturns"

Is a bear market on the horizon? WSJ markets reporter Riva Gold analyzes the four chart trends that came before the dot-com bubble burst and the financial crisis hit and how they relate to the current market. 

The bottom line is while nothing is for sure, past bear indicators are mostly not present in today's market. So the best guess conclusion is we are just in a healthy correction within the current long-term bull (up) market.  The short video is at  http://dhutch.news/BearMarketIndicators

Much ado has been made of the large-cap” FANG” stocks with large declines (23% for one) since October started. But ignored is their large year-to-date gains including one that was up 105% since the start of last year!  Bigger rallies beget bigger corrections. The recent price action needs to be looked at in context. Even after the painful selling at the start of Thanksgiving week, the S&P 500 is higher than it's been any time in history up until 11 months ago.

Ultimately, the one certainty in the stock market is that nothing's for certain. And as of now, we're not in a bear market. 

That was something to be thankful this past Thanksgiving.

Action Plan Recommendations
Instead of “dumb” index funds with no stock selection based on individual company outlooks, or similar ETF’s (only make sense for traders, not investors), I suggest managers with long-term track records of outperformance compared to the category they invest in, and compared to the risk taken (Alpha vs. Beta in investment terms) – not just raw returns.

While more volatile, smaller companies may have favorable opportunities, with less foreign market revenue reliance, potentially not affected negatively as much by a strong U.S. dollar, and often more hidden opportunities than the widely followed large companies.

For those who want to build an ark for some of their funds for more protection I recommend a strategy that participates in part of equity gains without downside risk and not having to recover market losses to have future annual gains, backed by a strong insurance company All guarantees are based on the claims-paying ability of the insurance company.  I will provide more detailed information on request.

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