Market Outlook October 2018

Overview

The US stock market was on an absolute tear this summer. S&P 500 went up by 7.65% and completed its best 3rd quarter since 2013. Despite the February correction, the US stocks managed to recover from the 10% drop. All major indices reached a series of record highs at the end of August and September.

IndexQ1 2018Q2 2018Q3 2018YTD 2018
S&P 500 Large-Cap (SPY)-1.00%3.55%7.65%10.37%
S&P 600 Small-Cap (IJR)0.57%8.69%4.87%14.64%
MSCI EAFE (VEA)-0.90%-1.96%1.23%-1.62%
Barclays US Aggregate Bond (AGG)-1.47%-0.18%-0.08%-1.73%
Gold (GLD)1.73%-5.68%-4.96%-8.81%
Source: Morningstar

 

The US Economy remains strong

Markets have largely shrugged off the trade war fears benefiting from a strong economy and high corporate earnings.

US Unemployment remains low at 3.9% in July and August, levels not seen since the late 1960s and 2000.

Consumer sentiment is at a multi-year high. The University of Michigan Consumer Sentiment Index hit 100.1 in September, passing 100 for the third time since the January of 2004.

Business optimism hit another record high in August.  The National Federation of Independent Business’ small business optimism index reached the highest level in the survey’s 45-year history. According to NFIB, small business owners are planning to hire more workers, raise compensation for current employees, add inventory, and spend more on capital investments.

A hypothetical 60/40 portfolio

A hypothetical 60/40 index portfolio consisting of 30% US Large Cap Stocks, 10% US Small Cap Stocks, 20% International Stocks, 33% US Fixed Income and 7% Gold would have returned 3.06% by the end of September.

IndexAllocationReturn
S&P 50030%3.11%
S&P 60010%1.46%
MSCI EAFE20%-0.32%
Barclays USAgg Bond33%-0.57%
Gold7%-0.62%
Hypothetical Performance3.06%

 

US Equity

I expect a strong Q4 of 2018 with a record high holiday consumer and business spending. While stock valuations remain elevated, robust revenue and consumer demand will continue to drive economic growth.

After lagging large-cap stocks in 2017, small-cap stocks are having a comeback in 2018. Many domestically focused publicly traded businesses benefited massively from the recent corporate tax cuts, higher taxes on imported goods and healthy domestic demand.

This year’s rally was primarily driven by Technology, Healthcare and Consumer Discretionary stocks, up 20.8%, 16.7%, and 13.7% respectively. However, other sectors like Materials, Real Estate, Consumer Staples, Financials and Utilities are either flat or negative for the year. Keep in mind of the recent reshuffle in the sector classification where Google, Facebook, Netflix and Twitter along with the old telecommunication stocks were added to a new sector called Communication services.

Sector performance

SectorPerformancePrice perPrice toDividend
YTDEarningsSalesYield
as of 10/3/2018(TTM) (TTM)(%)
Communication Services-1.91%22.6x1.3x4.83%
Consumer Discretionary13.72%16.5x1.0x1.27%
Consumer Staples-5.50%15.1x1.0x2.86%
Energy8.67%14.0x1.2x1.74%
Financials0.29%15.2x2.1x1.91%
Health Care16.71%18.2x1.2x1.86%
Industrials4.73%15.7x1.1x1.85%
Information Technology20.86%14.8x2.1x0.90%
Materials-3.56%13.2x1.1x1.79%
Utilities0.77%17.1x1.3x3.70%
Source: Bloomberg

 

I believe that we are in the last few innings of the longest bull market. However, a wide range of sectors and companies that have largely remained on the sidelines. Some of them could potentially benefit from the continued economic growth and low tax rates.

International Equity

The performance gap between US and foreign stocks continues to grow. After a negative Q1 and Q2, foreign stocks recouped some of the losses in Q3. Furthermore, emerging market stocks are down close to -9% for the year.

Bad economic data coming from Turkey, Italy, Argentina, Brazil, Indonesia, South Africa, and China along with trade war fears put downward pressure on foreign equity markets. Additionally, rising right-wing sentiments in Italy, Austria, Sweden, Hungary, and even Germany puts doubts on the stability of the European Union and its pro-immigration policies.

In my view, the risk that the financial crisis in Turkey, Argentina, and Italy will spread to other countries is somewhat limited. However, the short-term headwinds remain, and we will continue to monitor these markets.

Brexit

Another major headline for European stocks is the progress of the Brexit negotiation. While soft Brexit would benefit both sides, a hard exit could have a higher negative impact on the UK.

I remain cautiously positive on international stocks. According to WSJ, foreign stocks are trading at a 12% discount over US equity on price to earnings basis. This year created value opportunities in several counters. However, the issue with European and Japanese stocks is not so much in valuations but the search for growth catalysts in conservative economies with an aging population.

Fixed Income

Rising Fed rates and higher inflation have driven bond prices lower so far this year. With inflation rate hovering at 2%, strong employment figures, rising commodity cost, and robust GDP growth, the Fed will continue to hike interest rates. I am expecting one more rate hike in December and three additional hikes in 2019.

I will also continue to monitor the spread between 2-year and 10-year treasury. This spread is currently at 0.23%, the lowest level since 2005.  Normally, a negative spread, i..e 2-year treasury rare higher than 10-year is a sign of a troubled economy.

While modest, individual pockets of the fixed-income market are generating positive performance this year. For instance, short duration fixed income products are now yielding in the range of 1.5% to 2%. The higher interest is now a compelling reason for many investors to keep some of their holdings in cash, CDs or short-term instruments.

With 10-year treasury closing above 3% and moving higher, fixed income investors will continue to see soft returns on their portfolio.

Gold

Gold is one of the big market losers this year. The strong dollar and robust US economy have led to the precious metal sell-off.  While the rise cryptocurrency might have reduced some of the popularity of Gold, I still believe that a small position in Gold can offer a buffer and reduce the overall long-term portfolio volatility. The investors tend to shift to Gold during times of uncertainty.

Navigating market highs

With S&P 500, NASDAQ and Dow Jones hitting all-time highs, how should investors manage their portfolio?

Rebalance

End of the year is an excellent opportunity for reconciliation and rebalancing to your target asset allocation. S&P 500 has returned 16.65% in the past five years, and the chance that equities are taking a big chunk of your portfolio is very high. Realizing some long-term gains and reinvesting your proceeds into other asset classes will ensure that your portfolio is reset to your desired risk tolerance level as well as adequately diversified.

Think long-term

In late January and early February, we experienced a market sell-offs while S&P 500 dropped more than 10%. Investors in the index who did not panic and sold at the bottom recouped their losses and ended up with 10% return as of September 30, 2018. Taking a long-term view will help you avoid the stress during market downturns and allow you to have a durable long-term strategy

 

If you have any questions about your existing investment portfolio or how to start investing for retirement and other financial goals, reach out to me at stoyan@babylonwealth.com or +925-448-9880.

You can also visit our Insights page where you can find helpful articles and resources on how to make better financial and investment decisions.

About the author:

Stoyan Panayotov, CFA is the founder and CEO of Babylon Wealth Management, a fee-only investment advisory firm based in Walnut Creek, CA. Babylon Wealth Management offers personalized wealth management and financial planning services to individuals and families.  To learn more visit our Private Client Services page here. Additionally, we offer Outsourced Chief Investment Officer services to professional advisors (RIAs), family offices, endowments, defined benefit plans, and other institutional clients. To find out more visit our OCIO page here.

Disclaimer: Past performance does not guarantee future performance. Nothing in this article should be construed as a solicitation or offer, or recommendation, to buy or sell any security. The content of this article is a sole opinion of the author and Babylon Wealth Management. The opinion and information provided are only valid at the time of publishing this article. Investing in these asset classes may not be appropriate for your investment portfolio. If you decide to invest in any of the instruments discussed in the posting, you have to consider your risk tolerance, investment objectives, asset allocation and overall financial situation. Different investors have different financial circumstances, and not all recommendations apply to everybody. Seek advice from your investment advisor before proceeding with any investment decisions. Various sources may provide different figures due to variations in methodology and timing,

About Stoyan Panayotov

I am a fee-only financial advisor and the founder of Babylon Wealth Management. As fiduciary advisors, we provide bespoke wealth management and personalized financial planning to busy families in the Bay Area and nationally. Many of our clients are tech workers, physicians, business owners, professionals preparing for retirement and young families looking to build financial independence.

I started Babylon Wealth Management to help young families and successful professionals build, grow and preserve their wealth. Being a fee-only financial advisor, I never earn sales commissions or sell investment products. Furthermore, I am committed to acting in my clients’ best interest by providing trusted advice and bespoke wealth management solutions. I enjoy helping clients develop robust and personalized long-term financial plans to achieve their personal and financial goals.

After completing a bachelor’s degree in Accounting at Varna University of Economics in Bulgaria, at the age of 23, I moved to New York City to pursue a Master of Business Administration at Pace University. I was fortunate enough to have a full merit-based scholarship and finished graduate school with no student loans. Upon completing grad school, I joined the ranks on Wall Street for nearly two years. I specialized in risk management and option strategies for equity and fixed income products for Deutsche Bank and Wells Fargo. In 2006 I obtained a highly recognized CFA designation.

Living in New York without family support was a life-changing experience for me. II arrived at JFK Airport on August 24, 2002. I stayed in a hostel for two weeks and later moved in with three of my fellow Bulgarian students into a one-bedroom apartment in the Bronx. There was a time in life when all I owned was $200, just enough to pay for the next month’s rent. Many times, I contemplated returning to Bulgaria, but somehow, I always pushed through life’s adversities. I’ve learned to appreciate each moment, big or small, that life presents. These challenges have helped me develop strength and flexibility, which supports my practice as a financial advisor.

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