Published October 3, 2014
With the third quarter of 2014 in the books, many of our clients find themselves entrenched in the fall weekend ritual of college football, anticipating the bursting orange, yellow and red leaf change across the Southeast, and wondering rhetorically, “Where has the year gone?”
As the South State Private Wealth portfolio management team huddled late in September to plan out the remaining few months of the year, we took time to reflect on the impressive rise of the stock market over the past several years, and the stubbornly low interest rates that have plagued investors hungry for higher interest payments. The historically low interest rates present worldwide continue to lead to our belief that in the search for decent real returns (returns greater than inflation), the stock market has been one of the only games in town, and has led to an aggressive move higher in price/earnings multiples in recent years. In the 64 months since the market bottom in March of 2009, the S&P 500 Index is up roughly 190% as of September. As illustrated below, this places the current advance at greater than all but four bull markets tracked since 1928, and well above the average of 165%.
So, where do we go from here? While we do acknowledge that equity valuations are stretched, we also do not see anything disruptive to stocks, providing the only realistic means of real return in a global economy growing well below its capabilities. While trying to draw a parallel between where we stand in this market, a reminder from the recent stinging Gamecock loss to the Tigers of Missouri provides maybe one of the best analogies. Missouri, known affectionately as the “Show Me” state, is a perfect reflection of where our belief lies on the future performance of the markets—both for stocks and for bonds. While the true beginnings of the “Show Me” slogan are lost to time, the most widely known legend attributes the phrase to Missouri’s U.S. Congressman Willard Duncan Vandiver, who served in the United States House of Representatives from 1897 to 1903. While a member of the U.S. House Committee on Naval Affairs, Vandiver attended an 1899 naval banquet in Philadelphia. In a speech there, he declared, “I come from a state that raises corn and cotton and cockleburs and Democrats, and frothy eloquence neither convinces nor satisfies me. I am from Missouri. You have got to show me.”
“Show me”, that is where we believe the future lies when it comes to any stock share price appreciation going forward. CEO promises of better days just around the corner are starting to fall on deaf ears. Share price reliance on some off in the future “could be” is starting to give way to present day economic realities. Given overall valuations are stretched on stocks, the likelihood for a continuation of price/earnings multiple expansion for the stock market as a whole is limited at best. Companies that drive bottom line growth, whether organically, tactful balance sheet mastery or through shrewd mergers/acquisitions, will be the recipients of additional money being invested into their shares.
A quick review of equity indices finds the S&P 500 is up 0.6% for the third quarter, its seventh straight advance and longest rally since June 1998. It has not had a four-day losing streak this year and has not fallen more than 10 percent in three years. The technology-heavy Nasdaq 100 Index jumped 5.2% in the three months. Small-cap stocks haven’t had the same success. The Russell 2000 Index is down 7.7% for the third quarter, and has dropped 8.9% from a record reached in March 2014 as investors have sold smaller company’s shares.
Despite signposts indicating that the Federal Reserve will likely raise rates, U.S. Government bond rates have not responded, largely because of the subdued European and Japanese economic outlook and corresponding rock bottom interest rates in much of Europe and Japan. As a point of reference, while investors can currently earn a paltry 2.51% yield on ten year U.S. Treasury bonds, that may seem to be a bargain compared to a 1.3% yield on French bonds, 0.9% yield for German ten year paper, and an astounding 0.5% yield for both Japanese and Swiss government bonds maturing in 10 years. We believe the bond market’s direction can also be summed up with a “show me” ultimatum. Until global growth rates, as well as inflation, “shows up”, there is little impetus for rates to rise.
The fourth quarter calendar will be busy, with October marking the end of the Fed’s Quantitative Easing program and mid-term elections in November. If that wasn’t enough, we then quickly transition into the holiday retail season. Equity markets during the last few days of the third quarter were choppy, a trend that we see likely to continue during much of the fourth quarter. Unless the fundamental data suggests otherwise, our portfolios remain positioned for a slowing down of the current business cycle as the economic tailwinds (e.g., low interest rates) begin to taper.
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