Investment Recap and Outlook 3 Q2018

Transcription

1 Investment Recap and Outlook 3 Q2018

2 E Q U I T Y M A R K E T S R E V I E W A N D O U T L O O K An upturn in the domestic equity markets as well as in market volatility marked the second quarter of The S&P 500 Index returned +3.4 percent in Q2 after a -0.8 percent return in the first quarter, although there was a marked difference in returns between security capitalizations, valuations and sectors. Larger companies underperformed their small-cap peers during the second quarter, while growth outperformed value stocks and high dividend payers underperformed no/low dividend stocks. Energy, consumer discretionary and information technology stocks were the strongest performers during the second quarter; stocks within the industrials, financials and consumer staples sectors were the poorest relative performers. Emerging markets stocks, after being in positive territory for the first quarter, posted negative performance at June s close, delivering returns of -7.8 percent for the quarter. The MSCI EAFE Index (representative of developed non-u.s. equity markets) likewise returned a negative -0.9 percent for Q While it is still early in the second quarter reporting season, corporate earnings continue to follow through with relatively robust operating results. As of this writing, the expected annualized earnings growth rate now sits at 20.8 percent, with a blended sales growth rate (realized and estimated) of 9 percent. Profit margins also appear to have improved and perhaps stabilized, with the blended margin leveling out at 11.6 percent. At this level, these margin results are tied with the earlier quarter this year, and according to FactSet Research, represent the highest net profit margin for the S&P 500 constituent companies since the company began tracking the data in An interesting side note: Forward growth estimates remain positive for the balance of 2018, with expected margin growth ticking up to 11.8 percent. Earnings growth is expected to peak near current levels though. Source: Bloomberg

3 E Q U I T Y M A R K E T S R E V I E W A N D O U T L O O K This recent strength in earnings can be attributed to a number of positive developments over the past few years; among the most recent is the corporate tax bill passed late last year. Other factors include the recovery in oil prices, which in turn has pushed the energy sector into a lead position in earnings growth. Other influences are courtesy of investors leading the charge into the technology-centric stocks, driving the momentum in several consumer discretionary and information technology companies. While current S&P 500 price multiples are still reasonable given the improving earnings picture, they are slightly stretched at 16.5 times forward earnings versus the ten-year average of We remain positive regarding the global equity markets but recognize a few growing challenges. The world economy continues to grow, although at a slower pace than prior years. Concerted global central bank initiatives are still in the early stages of monetary tightening and may prove challenging for the equity markets if there isn t continuing growth recovery in corporate earnings. While equity valuations overseas are below their longer term averages, here at home price multiples are slightly ahead of those five-year averages. These valuations have been supported over the past three to five quarters by accelerating earnings, a repeatable (but more muted) trend, assuming the economies maintain respectable growth rates. Headline issues that impact equities today are threats of trade wars, rising interest rates and wage costs, all of which impact corporate profits. The threat of trade wars still weighs on global markets, and the inherent risks serve as potential threats to investor sentiment and business confidence.

4 T H E F E D, I N T E R E S T R A T E S, A N D T H E F I X E D I N C O M E M A R K E T The Bloomberg Barclay s U.S. Aggregate Bond Index delivered negative returns, off percent and percent, respectively, for Q2 and YTD Similar to Q1 trends, domestic Treasury yields increased across the entire yield curve during the second quarter. The 10-year U.S. Treasury yield touched its highest level since 2011 while the two-year yield finished at its highest level in a decade. This rise in Treasury yields was supported by positive macro-economic performance, a continuation of Federal Reserve rate increases, and an increase in European sovereign bond yields, and now increased supply issuance requirements by the U.S. Treasury Department. Credit markets also delivered mixed results during Q2 with investment grade corporate bonds delivering negative returns for the quarter (-0.98 percent) and on an YTD basis (-3.27 percent). Investment grade yield spreads continued to widen during the quarter. Investors tended to move up in credit quality, favoring the short-end of the duration curve. Our view is the U.S. bond market will produce total returns of approximately 1 percent to 2 percent over the next year, based on slightly higher yields and continued outperformance of the credit markets. We also expect that U.S. government market yields will continue to methodically increase in the second half of 2018 with the 10-year U.S. Treasury note yield finishing over 3 percent in 2018 and the shape of the yield curve to remain generally unchanged. Regarding the short end of the Treasury yield curve (i.e., two- and three-year maturities), we anticipate an increase of another ½ percent in tandem with expected Fed rate hikes in 2018.

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6 T H E F E D, I N T E R E S T R A T E S, A N D T H E F I X E D I N C O M E M A R K E T Recent economic trends have caught the attention of the Federal Reserve, including the recovering job markets, consumer consumption and business investment. Sustained improvements in leading economic indicators mirror the upturn in small business confidence, manufacturing resurgence and, perhaps surprisingly, global trade. While the facet may be at risk given recent trade rhetoric, these economic positives are becoming more visible in most recent GDP reports. Although the nation s growth rate for the first quarter of 2018 booked a respectable 2 percent (versus 2.9 percent for the prior fourth quarter, 2017), expectations for the upcoming quarter are more aggressive; one estimate from the Atlanta sits at a possible 4.5 percent. How the Fed interprets this data relative to balance sheet management and monetary policy remains to be seen. It may be likewise aggressive. To date the Fed has raised the federal funds rate target in Q2 with the new range set at 1¾ percent to 2 percent. Now nine months into its stated bond purchase process, the Fed also continues to signal its expected increase in money market rates in the second half of the year and additionally to raise Fed funds rates to at least 3 percent by the end of As 2017 came to a close, both the ECB and the Bank of Japan began sending preliminary signals that they would also begin reducing monetary liquidity over the coming year. Given lingering monetary, economic and geopolitical uncertainty to date, the commencement of the policy shift has likewise become uncertain this year. China has also become more accommodative in its banking efforts, offsetting the recent trade and trade-tariff tiffs with the United States. How this trade skirmish ends has yet to be written, but China does have a seemingly endless supply of currency reserves (and significant U.S. Treasury holdings) that could potentially help any efforts to sustain a U.S. trade battles.

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8 E M P L O Y M E N T, H O U S I N G A N D T H E C O N S U M E R The first quarter s closing jobs report was a strong testament to the continuing employment growth trends of the past few years. Nonfarm payrolls for June were up by 213,000 positions, posting strength across several sectors, including manufacturing, professional & business services and healthcare. The number of people in the workforce jumped by 102,000 while those unemployed rose by 499,000 (the latter because of more people entering the job search). With the increase in those entering the job markets, the unemployment rate rose from its prior 3.8 percent to 4 percent. It is also interesting that wage growth is still lagging given the strengthening job markets. Most recent data noted hourly wages were up 2.7 percent over the past 12 months. Because of the increasingly tighter labor market that is reflected in numerous business and regional Fed reports, initial jobless claims are at a 48-year low. This data point was reflected in the recent government report noting that there were 6.6 million job openings available today.

9 E M P L O Y M E N T, H O U S I N G A N D T H E C O N S U M E R Housing data has experienced mixed reviews recently, with new home sales off in June and at their lowest level in eight months. While weaker, actual sales were still up by 2.4 percent over the prior year and 6.9 percent in the first half of 2018 versus this time last year. Several factors may have contributed to the decline, including a 50 basis point increase in fixed mortgages and a still declining new home inventory trend of 5.7 months. In terms of positives, the total inventory of all houses on the market today is at a 35-year low; prices have declined with the median sales price of a new home now at $302,100, off -4.2 percent from last year; mortgage rates still sit at historically low levels; and from a credit perspective, delinquencies and foreclosure rates are at an 11-year low. The consumer has retained the optimism that led into Job growth has helped buy consumer confidence and consumption. Retail sales were up for the quarter, with certain category wins reflective of the changing demographics of younger consumers. The largest gains were in the e- commerce sales channels, up nearly 11 percent for the ninth consecutive quarter. Other noteworthy gains were gas station sales, up 9.9 percent because of higher fuel prices; and building materials, reflective of the tight housing markets and do-it-yourselfers. Aside from covering the increasing wallet-spending from wage growth, consumers also added to their debt but not debt ratios. Consumer credit rose last quarter by $24.6 billion against a consensus estimate of $12.5 billion. Revolving credit was up $10 billion, the sharpest increase since November

10 M A N U F A C T U R I N G A N D R E G I O N A L S U R V E Y S June s NABE Business Conditions Survey was another strong reflection of a stabilizing domestic economy, and respondents reported improving sales growth, hiring intentions and capital spending trends. It is also noteworthy that at the time of the survey, trade fears had not impacted any near term plans. Other positive data points included a rebound in industrial production for the quarter s end, reflecting an overall growth rate of 3.8 percent over last year. The ISM Manufacturing PMI report was also positive in June, trending along the multiyear high and likewise reflecting new orders, production and employment at solid growth levels. Of interest was the upside surprise in supplier delivery times, now sitting near 40-year highs, much of which is probably attributable to supply chain tightening and perhaps a few trade-sensitive industry supplier vulnerabilities. The regional Fed indexes continue to mirror the private business industry surveys. The Richmond Fed Manufacturing Index reflected an improving growth in the factory sector and capital spending intentions holding strong. These data trends were also echoed in the Chicago, Philly and New York Fed reports. Here, closer to Texas, the Dallas Fed quarter-end report highlighted its general business activity index, which is up and at its highest reading since Continuing the trend, the employment index was at a six-year high, while the raw material prices index hit its highest reading since 2011 (Is inflation around the corner?). Also good news: Expectations about future business conditions and manufacturing were all in solid growth territory.

11 G L O B A L D Y N A M I C S Trade fairness or threat of trade wars has been the one significant issue impacting the global markets. The unknown path that this issue may take has impacted foreign company earnings as well as U.S.-based, multinational corporate revenues. This sparring has not been received well by investors and has lately been the catalyst for market volatility. While no single tariff threat would be a growth-killer to the economy here at home, the spillover impact is worrisome. A number of countries that are part of the global supply chain become at-risk in this environment. Ultimately, threatened tariffs become additional taxes levied on the global economies which might reverse the global recovery of the past few years. There is no reason to think this becomes a worst case scenario, but we should always be mindful of managing the increasing market risks today. Recent dollar strength, along with a few geopolitical/economic issues have had a spillover impact on several overseas markets. Brexit is back in the news with the U.K. still working, two years after the EU exit vote, to understand the economic impact of their go-it-alone stance. Foreign automakers have felt the wrath of new trade levies as has one or two targeted countries, with China coming to mind. The back-and-forth rhetoric around trade negotiations have impacted the Asian markets while also threatening the livelihood of a number of peripheral nations that serve as supply links to China s export markets. While the jury is out on whether trade talks with China will succeed, there may be some success with recent conversations between the U.S. and Europe. It is much too early to declare some semblance of victory, but it appears that President Trump and European Commission Chief Jean-Claude Juncker have agreed in principle to work together toward eliminating tariffs. This might help dampen what has already served to worry an auto industry already facing higher production costs because of retaliatory trade costs.

12 G L O B A L D Y N A M I C S Absent the trade issues (or perhaps because of) overall business sentiment in Europe has slipped a bit. France is leading the downturn, as seen in its composite manufacturing index. Another consideration is weakening German sentiment, the latest being the fourth negative consecutive reading pushing sentiment to its lowest level since Countering the negative aspects, we see roughly 80 percent of the global PMI reporting levels still in expansion territory, which in turn represents regions with future growth and investment opportunities. Today a number of these markets are relatively cheap and in a few instances the emerging markets, for instance are in oversold territory and selectively represent great entry points for more patient investors. Price multiples are historically below their long-term averages, and great companies still exist that help diversify portfolio, trade and geographic risks and reflect economies growing at greater trajectories than here at home.

13 This commentary is furnished for informational purposes only and is not investment advice, a solicitation, an offer to buy or sell, or a recommendation of any security to any person. Managers opinions, beliefs and/or thoughts are as of the date given and are subject to change without notice. The information presented in this commentary was obtained from sources and data considered to be reliable, but its accuracy and completeness is not guaranteed. It should not be used as a primary basis for making investment decisions. Consider your own financial circumstances and goals carefully before investing. Certain sections of this commentary contain forward-looking statements that are based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not indicators or guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Past performance is not indicative of future results. Diversification strategies do not ensure a profit and cannot protect against losses in a declining market. All indices are unmanaged and investors cannot invest directly into an index. You should not assume that an investment in the securities or investment strategies identified was or will be profitable. NOT FDIC Insured NO Bank Guarantee MAY Lose value.

14 D I S C LO S U R E S Frost Investment Advisors, LLC is registered as an investment advisor with the SEC. Registration does not imply a certain level of skill or training. This report has been prepared for informational purposes and does not replace the statements you receive directly from your custodian. This information is provided to you in combined form, solely for your convenience and ease of review. It is not to be used as investment advice, a solicitation, an offer to buy or sell, or a recommendation of any security to any person. The information presented in this report was obtained from sources and data considered to be reliable, but its accuracy and completeness is not guaranteed. Values shown should only be used as a general guide for portfolio values and may vary from the actual liquidation values. Do not rely upon this report for tax reporting. The source of all price information for tracked positions is one or more third party vendors and may include the use of substitute prices where prices are not readily available. Substitute prices may be based on trades up to 30 days prior to the reporting date. Please review and compare this statement to the statement provided by your custodian. If there is a discrepancy between the statements, please contact Frost Investment Advisors, LLC immediately. However, keep in mind that this report s quarter ending balances may differ from the custodial statements provided by your custodian. Various reasons for these balance differences may include, but are not limited to, unsettled trading activity, different pricing sources, delayed reporting of dividend payments by either the custodian or mutual fund company, or correcting entries processed after quarter-end. If your asset management fees are deducted directly from your custodial account(s), your monthly statement from your custodian will include a separate line item showing the deduction of the fee from your respective account(s). In the event that corrections are made to the account, a restatement of previously reported data may be necessary. Such data restatement may include: Beginning Value, Income Received, Contributions, Withdrawals, Ending Value, and/or Account Performance. If you have any questions concerning the data represented in this report, please contact your adviser immediately. Securities are not FDIC insured and are not guaranteed. Securities are subject to investment risk, including possible loss of the principal amount invested. Returns shown represent past performance and are not predictive of future returns. The investment return and principal value of an investment will fluctuate so that an investor securities, when redeemed, may be worth more or less than their original cost. Returns and asset values do not include non-publicly traded assets such as real estate, mineral interests, closely held companies, limited partnerships, notes or loans. Returns are calculated including accrued income on a time and dollar weighted basis. Results reflect the reinvestment of dividends and other earnings. Annualized compound returns are used for periods greater than 12 months. All investment strategies have the potential for profit or loss. Changes in investment strategies, contributions or withdrawals may materially alter the performance and results of your portfolio.

15 D I S C LO S U R E S (continued) Unless otherwise indicated, returns are presented gross of management fees and other expenses. The deduction of investment management fees, as well as other expenses, will have an adverse, compounding effect on the investment performance of the portfolio. For example, an $100,000,000 portfolio charged an investment management fee of 0.25% annually of managed assets earning a 6% gross-of-fee annualized rate of return over a five-year period would have a market value of cumulative gross of fee returns over five years of 33.8% (6% annualized) and a cumulative net of fee return of 32.18% (5.74% annualized). Investment advisory fees are described in Part 2 of our Form ADV and your client agreement. Economic factors, market conditions, and investment strategies will affect the performance of any portfolio and there are no assurances that it will match or outperform any particular benchmark. Indexes are presented to provide you with an understanding of their historic long-term performance, not to illustrate the performance of any security. The indexes themselves are not investments, are unmanaged and do not incur the various fees or expenses incurred by an investment portfolio. It is not possible to invest directly in an index. If there have been any changes in your financial situation or investment objectives, or if you wish to impose any reasonable restrictions on the management of your account, please contact your adviser.