Equity and Balanced accounts outperformed their benchmarks during the strongest quarter for the S&P 500 since 2013. Value was added by concentrating in select technology stocks and avoiding defensive sectors. Balanced accounts’ excess returns were largely driven by the strength of equity positions.
Equity markets’ outsized gains are all the more remarkable if one recalls the predominant financial headlines of the last three months:
- Turkey’s financial implosion;
- potential emerging market contagion triggered by (you pick ‘em) China, Argentina, Brazil, Venezuela or Turkey;
- an extremist (both Left and Right) government coming into power in Italy;
- Federal Reserve Board tightening;
- tariff wars;
- turmoil in Washington;
- the end of FAANG (whether by regulation or earnings/subscriber shortfalls).
None of these issues have disappeared but perhaps they were:
- already discounted in securities prices;
- not as scary as the headlines suggested (small problems don’t sell newspapers);
- or the trend of strong economic growth and rising corporate profits in the United States overwhelmed them.
Until we see an end to favorable economic trends, we will take our headlines with a grain of salt.
During the course of the third quarter, we increased our invested position by adding to the healthcare sector. New investments in the area were driven by superior products introductions, merger-driven revenue synergies and revitalized management efforts. Opportunistic (i.e. price weakness) purchases included a streaming video provider and the leading commercial aerospace manufacturer. Exposure to social media was reduced due to earnings pressure while an animal health provider was eliminated after achieving our price target.
Turning to the current economic environment, our thoughts have not changed much since last writing. The domestic economy is growing robustly while overseas conditions are less clear. Auto and housing activity are demonstrating classic late cycle behavior although significant downside is not likely near term. Inflation is rising but not at an alarming rate. Gaming the tariff situation is futile but we did note that emerging market equity markets actually rallied on the most recent tariff escalation. Maybe they are “putting in a bottom” but it is too early to parse through the full impact of a trade war.
After trading in a tight range for about six months, bond yields are up significantly as investors are now willing to price in higher domestic growth. With real rates still below historic norms, there is plenty of headroom. Expect the Fed to continue policy normalization. Fixed income portfolios are prepared for this scenario.
Given equities’ rip roaring third quarter gains (S&P 500 performance annualized at over 30%), a period of digestion would not be surprising. That would not invalidate the current trend of economic growth and rising corporate profits driving stock prices. With no recession in sight for the foreseeable future, some investors have embraced a “good news is bad news” mentality. They theorize that a strong economy will push interest rates up to levels that either choke off economic growth or pressure valuations. Eventually this will be correct but eventually can take a long time.
Enjoy the fall foliage for us. We will be focused on third quarter earnings (and maybe a Yankees playoff run).