October 26, 2018
Making Cents of the Markets
Be In the Know
Another week in October, another negative close. We are on pace right now for the worst October since 2008. Admittedly, this statistic is one of those data mined headlines but there won’t be any shortages of that comment in the news this weekend. This correction, in our opinion, is very different to that of 2008 and should not be compared. The underlying economic conditions are very different and this downturn is more similar to the one we experienced at the beginning of the year. We expect we are getting closer to a bottom in the markets as we approach the midterm elections held on November 6th.
Updating from last week, month to date returns of the S&P500, TSX, Dow Jones Industrials, and Nasdaq are -8.8%, -8.2%, -6.7%, and -10.9% respectively. Our Legacy portfolios are off by less than half as much of most of these, giving back -3.5% to -6.0% this month depending on the mandate. The S&P500 dipped into full correction territory intraday today, defined as a drop of 10% below its 52-week high, before rebounding and closing down 9.3% from the peak. Of note, the average stock market correction since WWII results in a 13% drop, and most dramatic selloffs take between 17 and 25 trading days to hit bottom. We have just passed the 18th trading day in the current correction. We had expected some sort of volatility and pullback leading up into midterms (which are in 10 days), and we think the markets have a bit of a disregard for underlying fundamentals right now, especially in the United States. A couple of key technology companies (now actually considered communication companies), Amazon and Alphabet, reported on Thursday, and while earnings beat estimates, the stocks were punished for slight misses on revenues and guidance which caused the market to pullback again. Even record profits for Amazon couldn’t save it from a downturn.
It should be noted that corporate earnings – which are by far the best indicator of stock price movements – are actually still great and growing. When you value a company, besides the total value of the net assets, you want to look at how profitable it is or how profitable it’s going to be. The S&P500 is on pace to see earnings growth of 26% over its number in the third quarter a year ago, the strongest it’s been since early 2011. Even if the growth rate slows, the actual amount of profit is still expected to climb. Consensus analyst estimates expect that earnings will continue to grow at a double-digit pace until at least the end of next year, despite the headwinds that are mentioned so often (trade policy, global growth, interest rates, inflation to name a few). To put those double digit expectations into context, historically, the S&P500 has averaged 8.53% operating earnings growth since 2011.
US third quarter GDP estimates reflect growth of 3.5% on the back of strong consumer spending growth. We won’t be seeing a consumer led recession anytime soon, with shoppers spending 4% more for the second quarter in a row. Strong economic growth, solid consumer spending accompanied by earnings growth in the 20%+ range, and double digit earnings per share growth expected to continue into 2019 and 2020, has led to the vast majority of market pundits and analysts viewing this pullback an opportunity. These are uncomfortable times to be an investor with all the mixed signals – but as we believe logic will again once prevail at some point – we must be ready for these opportunities.
Companies in our Legacy portfolios reporting this week are operating quite profitably overall, with Verizon Wireless, Boeing, Union Pacific, S&P Global, and Microsoft passing top and bottom lines with flying colours. Visa beat on earnings but missed slightly on revenues, while the aforementioned Alphabet handily beat bottom line earnings, but missed on revenues. Over 56% of the S&P 500’s market cap has reported Q3 earnings so far, and earnings are beating by 6.6% with 74% of companies surpassing bottom-line estimates, yet another positive sign for the economy and the markets.
We had a few of our stop loss alerts trigger this week with the pullback and as a result, we raised more cash, selling half of our positions in some mid-cap financials, global banks, and Best Buy. We’ve brought our market exposure down as this correction continues but will look to put that cash to work again once we see it start to move higher with some stability, aiming for after the midterms.
We look to cushion the fall when markets have a substantial short term decline in what we believe is still the later stages of a bull market. We see a few opportunities as many stock valuations are looking more attractive, and intend to position the portfolios in November for the next leg up in markets. We started to chip away at some of our watchlist positions as they consolidated, adding small half positions to an industrial conglomerate, JB Hunt Transport Services, and a technology name that is a leader in the growing computer, gaming, and autonomous driving areas through NVIDIA corp. We added 1.5% each of our Income Growth and US Select portfolios, so very small positions overall. We will bring those names to a full position eventually but we were (rightly) wary of adding full amounts in case markets pulled back further, which they did. We continue to think that Q4 in the equity markets will be strong once we get through the mid-term elections, regardless of outcomes, and, of course subject to changes in expectations or economic data, will capitalize on the opportunities we are seeing.
Chart Of The Week
The year-to-date returns of Canadian and US markets. With this pullback, all global markets are negative for 2018 now, with the exception of the Nasdaq:
Beyond the Markets
Many people will be celebrating an early Halloween this weekend. There’s nothing like a haunted house to get you in the spirit. Vancouver has a number of Halloween themed events and haunted houses to really spook you! To help get your scare on, here are seven places in metro Vancouver to terrify you.
The Bank of Canada announced on Wednesday it’s raising its trend-setting key interest rate to 1.75%. This is the fifth increase to the benchmark rate since last summer. Global News interviewed Lori to get her comments on what this recent rate hike means to investors. WATCH the interview here.
Real estate in Vancouver has been a hot topic for years. The news used to be all positive but now the tides have turned, and many are feeling the pinch. What happened to the hottest real estate market in the world, and should you be preparing for even more downside to housing prices in Vancouver?
Read Lori’s latest column in the North Shore News on how you can “Choose real estate investments wisely as the market shifts”. Check out the full article here.
Listen to Part 2 of our Vancouver Real Estate Series on this week’s CKNW of Making Cents of the Markets here to learn the pros and cons of investing in the stock market versus real estate.