www.vantageadvisors.com JULY 19, 2017 STOCK MARKETS ARE IN, AND OUT OF, SYNC The world and U.S. economy continue to grow. By some estimates, gross domestic product (GDP) growth in the United States may come in at close to 3 percent during Q2. Globally, the International Monetary Fund (IMF) now believes growth is set to rise to 3.5 percent this year, up from 3.1 percent in 2016. Economic activity is recovering in investment, manufacturing and trade. Deflationary pressures seem to be abating, leaving room for investors to consider more traditional drivers, such as corporate earnings rather than simply relying on the largesse of central bank policies to provide stimulus and stability to the global capital markets. Within the United States, investor’s focus has shifted from not only the impact of the Federal Reserve’s monetary policies, but from market valuation to earnings growth and story investments. Some believe these are signs of market froth, but nonetheless the main capital markets continue their upward push.
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www.vantageadvisors.com
JULY 19, 2017
STOCK MARKETS ARE IN, AND OUT OF, SYNC
The world and U.S. economy continue to grow. By some estimates, gross domestic product (GDP) growth in the United States may come in at close to 3 percent during Q2. Globally, the International Monetary Fund (IMF) now believes growth is set to rise to 3.5 percent this year, up from 3.1 percent in 2016. Economic activity is recovering in investment, manufacturing and trade. Deflationary pressures seem to be abating, leaving room for investors to consider more traditional drivers, such as corporate earnings rather than simply relying on the largesse of central bank policies to provide stimulus and stability to the global capital markets.
Within the United States, investor’s focus has shifted from not only the impact of the Federal Reserve’s monetary policies, but from market valuation to earnings growth and story investments. Some believe these are signs of market froth, but nonetheless the main capital markets continue their upward push.
Economic and Capital Market Commentary
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STOCK MARKETS ARE IN SYNC - AND OUT OF SYNC WITH OTHER MARKETSIf we take the four noted stock indexes above (S&P 500, Russell 2000, EAFE and EM), the average 12-month rate of return has been 21.7 percent. This compares handsomely to the non-equity indexes listed (Bonds and Real Estate) average return of -1.1 percent over the same period. The spread of the average returns noted has been a whopping 22.8 percent in favor of equity investments over the last 12 months. Most stock markets, globally, are in sync with each other. This displays a strong investor bias towards equity investment as opposed to most other mainline asset classes.
The return spread between stocks (irrespective of geographic location) and other classes has historically not been this wide. If we study the annual returns over the last 15 years of the asset classes mentioned above, the average of the four major stock index returns has been 8.6 percent. Over the same 15-year period, the “non-stock” indexes mentioned generated an annual return of 8.6 percent.
STOCK MARKET OUTLOOK- SHORT-TERM ODDITIES OCCURRINGSince early 2013, we have held the view that stock markets were experiencing their fourth secular bull market since the year 1900. We have steadfastly held that view. Over that period of time, the S&P 500 has generated a total return of 59.6 percent, or an annual return of 12.1 percent, above the normal long-term average return of around 10 percent. We continue to hold the view that the world’s equity markets are in sync with each other and the secular bull story still stands.
However, it makes sense to point out a number of oddities present in today’s investment environment:
• Sooner or later the stock market will correct in value. We have no idea when stock market volatility will increase, but it has been 251 trading days since the last 5 percent stock market “drawdown”, and 345 days since the last 10 percent price retreat. Historically, the average time between these types of corrections is 51 days and 229 days respectively. Stock prices are due for a correction.
• The stock market has set 24 new highs this year. Remarkably, the market’s maximum “drawdown” this year never exceeded 2.8 percent. If you have been waiting for a reasonable drawdown as a sign to put money to work, you are still waiting. The lack of volatility the stock market is experiencing is very unusual. This year’s 2.8 percent maximum drawdown in stock prices is the second most shallow first-half drawdown in 89 years. The average first half drawdown over the last 89-year period has been 11.2 percent.
• We aren’t big fans of the VIX (Chicago Board Options Exchange Volatility Index) , a well followed stock market volatility measure), but it is worthwhile to note that over the last 20 years, the VIX index quote has closed lower than 10, on only 11 occasions. Seven of those occasions occurred in June 2017. This begs the question, “Is the current fundamental environment the most benign we have seen over the last 20 years? We think not.”
Month of June
2nd Quarter Year-to-Date Trailing
12 MonthsTrailing 2 Years
S&P 500 Index 0.60% 3.10% 9.30% 17.90% 10.70%
Russel 2000 3.50% 2.50% 5.00% 24.60% 7.80%
MSCI EAFE -0.20% 6.10% 13.80% 20.30% 3.90%
Emerging Markets 1.00% 6.30% 18.40% 23.80% 4.30%
U.S. Agg Bond Index -0.10% 1.40% 2.30% -0.30% 2.80%
• The S&P 500’s return so far this year has been dominated by five stocks. The FAAMG constituents are Facebook, Apple, Amazon, Microsoft and Google. These five stocks are the largest (by market capitalization) stocks in the S&P 500. In fact, they constitute 13 percent of the S&P 500 index capitalization, showing the S&P 500 is a somewhat growth-oriented concentrated index. Even more surprising is the fact that these five stocks have constituted a full 27 percent of the S&P 500 return over the last 12 months. If you were unfortunate enough to only have owned the other 495 stocks in the S&P 500 you would have underperformed the index by 6.6 percent. A reasonably narrow market is a sign of a mature market.
All of this leads us to the view that stock market price volatility may indeed accelerate as the year continues to march forward. We believe the global stock market remains in a secular bull trend. Downdrafts in stock markets, if they occur, may prove to be short-lived and somewhat shallow. But, the probability of rising market volatility needs to be recognized.
BASICS BEHIND THE UNDER-PERFORMANCE - SUPPLY AND DEMANDThe world is currently demanding more oil for consumption purposes than ever before. Oil imports into consuming countries are up and oil consumption in the United States has risen this year. Remember, the world’s economies are showing a strong growth profile as compared to last year or the year before. Demand isn’t really the problem here.
Supply is the problem. Net production cuts are occurring, but not rapidly enough. OPEC has cut production quotas and extended them to March 2018. The 21 nations which are participating in supply cuts are collectively attempting to reduce production by 1.8 million barrels per day. Most participating countries are coming close to achieving their quotas. The United States is not a participating country nor is Libya or Nigeria.
In looking at the United States, domestic oil production has risen to 9.3 million barrels per day, up from a production rate of 8.4 million barrels per day in September last year. At that time, oil prices were at $47 per barrel. So, OPEC’s oil production cuts have been mostly offset by rising U.S. oil production. Consequently, OPEC’s production cuts haven’t had the intended effects of raising oil prices.
INVENTORIESAlong with current supply/demand trends, oil inventories are something to watch. U.S. commercial petroleum inventory levels are declining, but from a very high level. From earlier this year, oil inventories have declined by about 4 percent but still remain 14.1 percent above their 5-year average level for the current month. The same trend also applies for other OECD (Organization for Economic Cooperation and Development) countries.
WHERE THE RUBBER MEETS THE ROADMost wonder about economic implications of falling oil prices. From a positive perspective, oil prices and gasoline prices have an obvious positive correlation. All oil (net) consuming countries (most western societies fall in this bucket, including the United States) are net beneficiaries of falling oil prices. Except for companies in the oil patch, most industries are net users of oil products. With the exception of oil companies, declining prices help both consumers and corporations alike. How much will consumers benefit by falling oil prices? A good rule of thumb is for every $1 decline in oil prices, gasoline prices should decline by about $.02. Oil prices have declined so far by $12 per barrel. Consequently, gasoline prices have declined by about $.25 per gallon.
What about oil and related companies? It is good to remember that with rising production levels, oil and natural gas throughput should also rise. It is also important to understand that future throughput is partially a function of pricing - the higher the price for oil and gas, the more drilling will take place, and throughput could rise.
Economic and Capital Market Commentary
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