Despite yet another quarter of uninspiring corporate earnings growth, equity markets rallied in the 3rd quarter with the S&P 500 posting a total return of 3.9%, bringing year to date performance to 7.8%. Even in the months following the surprise Brexit vote, international markets did not disappoint, as U.K.’s stock market proved to be among the best performing, up 10.5% year to date. Bond prices backed up slightly, with the 10-Year U.S. Treasury yield climbing 12 basis points, yet still down 67 basis points from the end of 2015.
As is often the case, investor sentiment quickly moved past an early year rough patch that found a low on February 11th with the S&P 500 closing down 10.5% for the year at that time. As of September 30th, year to date performance is firmly planted close to a number that should have most market participants feeling positive on the year. What we find is quite the opposite – most investors will likely tell you that there is nothing that feels good about equity markets in their current state. The reason, you ask? We think there are two:
1. Lack of Earnings Growth:
A central theme to our 2016 market forecast focused on earnings growth, or lack thereof. Over the last several years, markets had benefited more from price/earnings multiple expansion, and less from true corporate earnings growth. This trend is still in place as investors continue to pay a premium for the same level of corporate earnings. Said another way, investor risk appetite appears to be strong.
2. Lack of Investment Alternative:
The investing community loves acronyms, and T.I.N.A seems to be the new favorite in town. The “There Is No Alternative” to stocks investment thesis is widespread. Put simply, liability investors (pension funds, insurance companies and even retirees) need to meet a desired rate of return on their investments to meet future cash flow demands, and fixed income instruments do not offer investors an attractive opportunity set to achieve their goals. It would appear that investor hands are “prodded” into assuming more risk. It may not feel good, but capital seeks the highest return, and equities are the only asset class currently in the running.
When taken together, a lack of earnings growth coupled with an investor that feels “boxed in” to taking risk, one can understand why there exists a general feeling of uneasiness amongst the investment community.
As the 4th quarter commences, investors need not look far for market moving events. The Federal Reserve has pushed the possibility of a rate hike into the final quarter, economic data may be firming up (e.g., Industrial Production, New Home Sales and Money Growth), earnings season is upon us, and if that were not enough, there’s the U.S. election. Any one of these events has the potential to re-direct -or- confirm the current state of the market. Many in the investing community have opined that markets favor stability, and it appears that the 4th quarter may provide markets little in the way of a clear path forward. There is little reason to believe that the secular bull market that began in 2009 is not going to continue; however, given these events, we feel the likelihood of increased volatility as we head into the final quarter of 2016.
David M. Kirkpatrick, CFP®
SVP, Portfolio Manager
Charles A. Williams, CFP®,CTFA®
SVP, Portfolio Manager
Brian A. Barker, CFP®, AIF®
SVP, Director of Asset Management