In January we published our Winter Market Review, stating that the major equity markets were in the most obvious bull market of the last century. As if on cue, the S&P 500 index laughed at our article and dropped about 10% in 10 trading days. For the remainder of the year, the S&P 500 index has been trading in a range that bottoms at approximately 2580, the same basic price it traded at in November of 2017, as illustrated in the following chart. The S&P 500 index (light blue line) is now trading near the top of the range (orange box), and above its own 190 day simple moving average (dark blue line).
We do not forecast the capital markets. Our investment management approach looks to build portfolios of companies with high free cash flow based on actual earnings. We do evaluate individual companies in the context of the broader macro-economic environment. As the financial news continues to invade our limited attention spans, our clients have been sharing a few similar concerns.
To help answer the four questions above, we can first look at the current strength of a broad stock index and then examine the current strength of corporate earnings. As opposed to making a forecast, we try to be objective and evaluate the evidence-in-hand to determine the probability of good things happening relative to the probability of bad things happening in the equity markets.
Value Line has been providing market research and data since 1931. The Value Line Geometric Composite Index is the original index that the firm released, and launched on June 30, 1961. It is an equally weighted index using a geometric average. Because it is based on a geometric average, the daily change represents the median stock price change.
So how does this average compare to the last time stocks formed a top and entered a new bear market? If we look at the index 139 after the S&P 500 hit the high in 2007 versus the same chart 139 days after the peak in 2018, it is obvious that our current situation is much more favorable than in 2007. Using simple moving averages of 120-170 days, the chart on the left clearly shows the index rolling over, increasing the odds of bad things could happen. The chart on the right is almost the exact opposite, with all of the slopes of the moving averages moving up.
Our second data dive is a look at the strength of corporate earnings. Equity markets are efficient pricing mechanisms when measured over the longer term. As earnings updates are announced, economic data and geo-political events unfold, market participants immediately update their opinion on the impact of that information on the companies they own. To gauge the health of corporate earnings, we can look not just at current price for a company, but we can also look at future earnings estimates to gauge business momentum. Aggregating this information for all companies in the S&P 500 Index allows us get reasonable insight into the health of the market as a whole.
The following table details the average earnings growth estimated by analysts following companies in the S&P 500 index. As estimates are revised, the average is re-calculated each month. The most recent calculation shows that earnings are expected to grow by more than 15% in the fourth quarter of this year. With strong earnings estimates, it is unlikely that the U.S. economy would see a recession until late 2019 at the earliest.
With seemingly bullish evidence-in-hand, does that mean equity markets will continue to move higher? Will the S&P 500 move to new all-time highs as we have seen in the technology sector and small cap stocks? The answer is: To Be Determined. We feel the current probability of good things happening in the equity markets is better than bad things happening.
Does all of this information mean that you should change your asset allocation and invest more into the stock market? The answer is maybe. Market outlook is never enough of a reason to change your investment plan. Our job is to help you focus on what matters and what is important. Our commitment is to meet with you this year to review your unique life situation with the desire to help you live a life of significance.
• Past performance may not be indicative of future results. Therefore, no current or prospective client should assume that the future performance of any specific investment, investment strategy (including the investments and/or investment strategies recommended by the adviser), will be profitable or equal to past performance levels.
• This material is intended to be educational in nature, and not as a recommendation of any particular strategy, approach, product or concept for any particular advisor or client. These materials are not intended as any form of substitute for individualized investment advice. The discussion is general in nature, and therefore not intended to recommend or endorse any asset class, security, or technical aspect of any security for the purpose of allowing a reader to use the approach on their own. Before participating in any investment program or making any investment, clients as well as all other readers are encouraged to consult with their own professional advisers, including investment advisers and tax advisors. Munn Wealth Management can assist in determining a suitable investment approach for a given individual, which may or may not closely resemble the strategies outlined herein.
• Any charts, graphs, or visual aids presented herein are intended to demonstrate concepts more fully discussed in the text of this brochure, and which cannot be fully explained without the assistance of a professional from Munn Wealth Management. Readers should not in any way interpret these visual aids as a device with which to ascertain investment decisions or an investment approach. Only your professional adviser should interpret this information.
• The S&P 500 is an unmanaged index used as a general measure of market performance. You cannot invest directly in an index. Accordingly, performance results for investment indexes do not reflect the deduction of transaction and/or custodial charges or the deduction of an investment-management fee, the incurrence of which would have the effect of decreasing historical performance results.
• The Value Line Geometric Index is an unmanaged index used as a general measure of market performance. You cannot invest directly in an index. Accordingly, performance results for investment indexes do not reflect the deduction of transaction and/or custodial charges or the deduction of an investment-management fee, the incurrence of which would have the effect of decreasing historical performance results.