Equity Outlook

Navigating market curveballs

It isn’t tough to be good from time to time…What is tough, is being good every day.

-Willie Mays

In his 1997 New Year’s Rules for the Winning Investor, Luis Rukeyser laid out a few suggestions which, like many of Mr. Rukeyser’s musings, have proven timeless. Among those which remain apropos are: I will not let political bias color my economic outlook and I will not expect to hit a home run every year. We would add that, despite the fanfare that home runs bring in both baseball and investing, it is important to remind ourselves that consistency is what typically gets you into the hall of fame. Among his Rules, Mr. Rukeyser also reminds us that markets will get ahead of themselves from time to time, and investors will periodically, and often irrationally, stampede to the exits. During these periods of inefficiency, he suggests investors keep the faith – and reap its benefits. Irrational behavior presents opportunities for process-driven long-term investors. Although the world is certainly a different place than it was in 1997, the underlying theme of calm and rational investing remains as relevant today as it did then.

Mr. Market at Bat

After the stampede to the exits left investors reeling in December 2018, the first quarter brought a market rally of a magnitude not seen in nearly ten years. The 13.6% return of the S&P 500 marked the largest quarterly increase since the 15% increase of the 2009 third quarter. Even with the 20% dip in December, the first quarter results brought the cumulative return of the S&P 500 up to 319% since the market bottom in March of 2009.

When considering what factors drove performance during the first quarter, we find that quality, as defined by the MSCI Quality Index, was a major factor. During the period, the index returned 16.9%. Meanwhile the 10.6% return of high dividend and 10.0% return of defensive stocks lagged the broader market. Traditionally, investors seek defensive sectors as safe havens, but renewed optimism and a dovish Fed led investors away from those protections. Certainly, the growth factor has impacted returns; however, we note that many large growth companies have built fortress-like balance sheets and are so ingrained in the economy that many demonstrate quality characteristics that typically reserved for more staid companies.

While investors have reaped the benefits of exceptional returns, earnings growth has also generally kept pace. The forward price-to-earnings ratio of 16.4x remains in line with the 25 year average, and well below the post crisis peak reached at the end of 2017. However, earnings estimates have declined. Should economic weakness emerge and corporate results fall, investors may find valuations higher than current estimates indicate.



On Deck

Over a given period, equity returns are driven by four major elements – earnings growth, dividends, multiple expansion/ contraction, and currency translation. Since the Global Financial Crisis (GFC), easy monetary policy, modest economic growth, and low inflation produced record revenues without corresponding increases in costs. This environment led to record net-profit margins for many U.S. companies.

Last year, earnings growth was easily the greatest positive contributor, but that boost was subdued by multiple contractions. So far this year, the opposite is true; revenue growth has slowed as wage and material costs have increased, pushing earnings expectations down, while investors are paying higher multiples for stocks. In fact, FactSet notes that higher wage costs, combined with other increased input costs, resulted in fourth quarter profit margins falling by 1.7% to 10.1%.

Despite the decline, margins remain at levels higher than nearly all of the past decade. Indeed, wage growth has increased steadily since about the beginning of 2013, but has not reached the 50-year average of 4.1% since 2007. The March reading of 3.3% was below long-term trends, but what is important is it is higher than in recent years, and indications are for an upward trend.

While corporations deal with increasing costs, investors are likely to focus on the consumer and corresponding topline growth. In this environment, companies with strong pricing power should hold the upper hand, especially if there is an appearance of economic weakness. Should we begin to see increasing signs of a slowing economy, the trend of large blue-chip stocks outperforming should continue. Large companies usually have a more diversified business and better access to capital markets. Investors also tend to seek shelter in blue-chip type companies. While lower-beta companies typically lag more speculative stocks during economic expansion periods, these higher quality names typically are more likely to weather the storm during economic dislocation.

Be Mindful of the Curveball

With the record earnings of 2018, corporations ramped up their share buyback programs. J.P. Morgan measured 2018 announced buybacks in excess of $900bn, an all-time record. 2019 is already on pace to eclipse those numbers, which should impact returns. While buybacks help bolster the price of a particular company, a major criticism is that they distort earnings per share results and can potentially mislead investors. After a year with such significant earnings growth, it is prudent for investors to take caution in this environment as companies may offset margin pressure through creative means.

While the potential outcomes of a game seem fairly certain, Brexit seems to have an unlimited amount of confusing and esoteric outcomes. This uncertainty is likely to contribute to ongoing headwinds for U.K. and Eurozone stocks in the short-term. For now, this continues the trend of political issues hampering growth since the GFC. In fact, U.S. stocks have outperformed the MSCI EAFE for over 11 years, resulting in cumulative outperformance of over 125%. However, this underperformance may present opportunities. 

Setting aside the political hurdles and taking Mr. Rukeyser’s advice, a longterm investor may find that there are many good companies now trading at attractive valuations because of this political discord. It is likely that parliament will kick a Brexit resolution down the curb a few more times. Investors should expect corresponding volatility. However, well-run global companies, incidentally headquartered in the region, might offer investors significant upside at attractive prices.

There are three things you can do in a baseball game. You can win, or you can lose, or it can rain.

– Casey Stengel

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The Developmental Leagues

When looking for opportunities, developing countries continue to stand out as an attractive area for investors. The recent shift from a commodities based disparate group of companies to a tech heavy collection of relatively modern economies dramatically changed the characteristics of what investors see as an emerging market stock. Today, the MSCI Emerging Market Index has as high a percentage of technology companies as the U.S., and they are primarily domiciled in Asia.

Also, when looking at these companies, we see the outpaced growth of the local consumer impacting the potential future of these companies in a positive manner. Where demographics are a headwind to growth for developed nations, Emerging Markets are poised to benefit from a definitive advantage of population growth.

Amidst the conflated consequences of the ongoing trade disputes, China has taken meaningful steps to stimulate its local economy. In February, Premier Li Keqiang announced significant tax and fee cuts nearly twice as large as initial estimates. However, mixed in with fiscal discussions, Chinese leaders also began discussions of opening major components of the local economy to outside investors and “promoting stable foreign investment growth.”

With all of this in mind, it is important for the investor to remember that a company does not have to be domiciled in these countries to take advantage of these changes. It still remains a better investment strategy to consider opportunities based on each company individually.


One of the biggest wildcards for this year remains the impact of the dollar. The changing value of the dollar is likely to impact returns, not just for foreign investments, but also for U.S. based multi-national companies. As the differential between U.S. and international interest rates has continued at a multi-decade high, the dollar has maintained its relative strength. However, many analysts believe the dollar is trading at premium, and predict a weaker dollar in the short-term. What has foiled currency analysts so far this year is unexpected weakness abroad propping up the greenback. If the weaker dollar story is to play out, we would have to see the gap between U.S. and foreign rates close. 

Defense to me is the key to playing baseball.

– Willie Mays


Baseball is one of the only sports where the team on defense has the ball. However, when playing against the market, investors also control the ball. All the decisions an investor makes, from asset allocation to stock selection, are in their hands. Successful investors embrace a rigorous investment process, consistent with an appropriate risk tolerance and goals. As they execute the strategy, they mitigate market risks through high quality investing and diversified portfolio construction - it is like creating a game plan based on a good scouting report.

Once you have the plan, you have to be good at executing it every day. While the temptation to swing for the fence often arises, it is reliably picking up singles and doubles that is the best route to long-term success. Although, Willie Mays certainly hit his share of home runs, what is often remembered about that Giant’s Kid was his unfailing play in both the field and at the plate; it is also the main reason for his place in the hall of fame. In stock investing it is no different: hits are picked up through consistently executing a process-based plan every day – that is the path to your own hall of fame career.

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This material contains forward looking statements and projections. There are no guarantees that these results will be achieved.

Investing involves risk including the potential loss of principal. There is no guarantee that a diversified portfolio will outperform a non-diversified portfolio in any given market environment. No investment strategy, such as asset allocation, can guarantee a profit or protect against loss in periods of declining values. Past performance is no guarantee of future results. Please note that individual situations can vary.  Therefore, the information presented here should only be relied upon when coordinated with individual professional advice.

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International investing involves special risks not present with U.S. investments due to factors such as increased volatility, currency fluctuation, and differences in auditing and other financial standards. These risks can be accentuated in emerging markets.

Investments in stocks of small companies involve additional risks. Smaller companies typically have a higher risk of failure, and are not as well established as larger blue-chip companies. Historically, smaller-company stocks have experienced a greater degree of market volatility than the overall market average.

Equity investments tend to be volatile and do not involve the guarantees associated with holding a bond to maturity.

In general, the bond market is volatile as prices rise when interest rates fall and vice versa. This effect is usually pronounced for longer-term securities. Any fixed income security sold or redeemed prior to maturity may be subject to a substantial gain or loss.

Fixed income investments are subject to various risks including changes in interest rates, credit quality, inflation risk, market valuations, prepayments, corporate events, tax ramifications and other factors.

The investor should note that vehicles that invest in lower-rated debt securities (commonly referred to as junk bonds) involve additional risks because of the lower credit quality of the securities in the portfolio. The investor should be aware of the possible higher level of volatility, and increased risk of default.

Municipal bond offerings are subject to availability and change in price. If sold prior to maturity, municipal bonds may be subject to market and interest risk. An issuer may default on payment of the principal or interest of a bond. Bond values will decline as interest rates rise. Depending upon the municipal bond offered, alternative minimum tax and state/local taxes could apply.

The price of commodities is subject to substantial price fluctuations of short periods of time and may be affected by unpredictable international monetary and political policies. The market for commodities is widely unregulated and concentrated investing may lead to higher price volatility.

Investments in real estate have various risks including possible lack of liquidity and devaluation based on adverse economic and regulatory changes.

Other Sources: Bloomberg; California.gov; Russell.com; First page index returns are calculated on a total return basis using the following indexes: S&P 500 (SPX), MSCI World (MXWO), MSCI Emerging Markets (MXEF), BofA Merrill Lynch U.S. Treasuries 1-10 years, BofA Merrill Lynch U.S. Agencies 1-10 years, BofA Merrill Lynch U.S. Corporates 1-10 years A-AAA, BofA Merrill Lynch U.S. Municipals 1-10 years A-AAA, Russell Top 200 Index, Russell 1000 Index, Russell Midcap Index, Russell 2500 Index, Russell 2000 Index, Credit Suisse High Yield Index (CSHY), MSCI U.S. REIT Index (RMZ Index).