We believe fundamentals drive long-term returns. Despite some ongoing worries about the pace of global growth, we think fundamentals are still supportive overall. Stay positive and keep a long-term prospective!
US consumers are on a cross road: after spending aggressively earlier this summer, as retail sales surged 0.8% in July, shoppers turned hesitant last month. To be sure, sales did rise 0.4%. However, after backing out higher spending on autos, sales were flat, with declines at furniture outlets, restaurants, and department stores. Per Value Line only a stellar showing online prevented a slowdown. The softer retail results, meantime, were countered by large increases in housing starts and building permits in August due to lower mortgage rates.
Softer consumer spending and actions from other central banks around the globe (see below) prompted The Federal Reserve to reduce interest rates once more. In fact, leading up to the recent Fed meeting, the only question was whether the rate cut would be a quarter point or a half point. The former prevailed. The European Central Bank’s aggressive rate cut increases the likelihood that the Fed will take additional action in the next 12 months, especially if higher oil prices, following the recent attacks on Saudi Arabia’s oil production, or other instability in the region, lead to slower economic growth worldwide.
Fed’s Bullard on Yields
In his interview with Jeremy Siegel, James Bullard, president of the Federal Reserve Bank of St. Louis, did not back down from advocating a 50-basis point cut in the Funds rate at the Fed’s last policy meeting, dissenting from the majority decision to lower just 25 basis points. He maintained that the increased uncertainty over U.S. trade policy had a significant effect on foreign economies and impacted business decisions in the U.S. Further supporting his dissent, Bullard indicated that, “we just have to face up to the idea it is an extremely low interest rate environment globally and U.S. yields can’t get too out of line from those global yields, even though our economy is somewhat better than some other places in the world.” Professor Siegel concurred, indicating that although U.S. growth rates are about 1% above that in Europe, our interest rates, relative to inflation, were 2% to 3% higher. In fact, Bullard agreed that the “neutral Fed funds rate,” that funds rate which is neither expansionary or contractionary, might be below the new 1.75% to 2.00% range.
The global expansion is caught in a tug-of-war between geopolitical drags and macroeconomic policy supports. Although the single largest geopolitical drag is linked to trade conflicts, nearly all recessions over the past half-century have been preceded by oil price spikes. While the recent attack on Saudi Arabian oil production will not likely result in the type of price spike that should raise concern, the attack reminds us that an already-sluggish global economy is vulnerable to threats from multiple geopolitical flashpoints. At the same time, a significant monetary policy response has provided an important cushion. Per JP Morgan 16 central banks have cut rates as the global policy response to the threat from geopolitical drags gathered steam thus far this quarter. Although geopolitical drags have weighed heavily on business sentiment, producing a sharp deceleration in global capex and manufacturing output, this slowdown has remained largely contained as policy supports have delivered lower borrowing rates and rising equity prices — developments supporting consumer spending and service-sector activity. These divergences had netted out to still-solid, trend-like GDP growth and still-healthy labor market outcomes, thus representing a limited threat to the expansion from geopolitical drags.
Valuation Spread and Regime Change
Recently, we witnessed a huge rotation from Growth leadership to Value and this transition could become a sustainable trend if history is any indication! Per Empirical Research Partners, historically the range of outcomes after a momentum’s worst-quintile monthly loss has been vast: the best outcome was +63 percentage points of outperformance in the year after a momentum hiccup in February 1999; the worst outcome was a further (50) points of underperformance after momentum stocks imploded in March 2000. So, in the nutshell we can go anywhere from here. However, bringing valuation spreads into the equation can improve the insight. In the subset of momentum crashes of a similar magnitude to this one that also began with valuations spreads above one standard deviation, the past leadership struggled to reassert itself (We saw the spread going above 1 standard deviation in August). In 13 such episodes the former high-flyers underperformed over the following year in 10 of them, with a median relative return of (10) percentage points. On the flip-side, stocks in the best quintile of Empirical’ s valuation super factor have led the market by almost +5 points this month. Such performance is good enough for the top 3% of history. But once again that’s not an outlier outcome when one considers where the valuation spread started the month; they’d expect about one in every 10 months to deliver a similar or better value return when the spread is above one standard deviation. As they’ve pointed out before, statistically-speaking such value runs are likely to continue when the spread starts high. Value stocks outperformed over the subsequent year in all 16 past episodes where the spread was above one standard deviation and value delivered a one-month pop similar to this month’s return. The median outperformance was+23 percentage points, not including the initial month.
Valuation Spread (Source: Signet Financial Management):
The information and opinions included in this document are for background purposes only, are not intended to be full or complete, and should not be viewed as an indication of future results. The information sources used in this letter are: WSJ.com, Jeremy Siegel, PhD (Jeremysiegel.com), Goldman Sachs, JP Morgan, Empirical Research Partners, Value Line, Ned Davis Research, Citi research and Nuveen.
Past performance may not be indicative of future results.
Different types of investments and investment strategies involve varying degrees of risk, and there can be no assurance that their future performance will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful.
The statements made in this newsletter are, to the best of our ability and knowledge, accurate as of the date they were originally made. But due to various factors, including changing market conditions and/or applicable laws, the content may in the future no longer be reflective of current opinions or positions.
Any forward-looking statements, information and opinions including descriptions of anticipated market changes and expectations of future activity contained in this newsletter are based upon reasonable estimates and assumptions. However, they are inherently uncertain and actual events or results may differ materially from those reflected in the newsletter.
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