US Market Viewpoints: Third Quarter 2016Submitted by Castlebar Asset Management on October 4th, 2016
Stocks headed higher again this quarter. The S&P 500 posted quarterly gains for the fourth consecutive quarter and has rallied in 12 of the past 14 quarters. The S&P 500 gained 3.3%, the Dow Jones Industrial Average added 2.1%, the Russell 2000 (small cap stocks) jumped 8.6% and the NASDAQ Composite popped 9.7% in the third quarter. Year to date, the S&P 500 is up 6.1%, the Dow has added 5.1%, the Russell 2000 has gained 6.1% and the NASDAQ is up 10.2%.
Despite the gains, the quarter was relatively quiet in terms of news. Stocks jumped early in the quarter as the post Brexit rally carried on for the first few weeks of July. Outside of that, stocks moved sideways for August and September with investors focusing on the November election and the Federal Reserve (Fed) meeting which took place in September. The Fed left rates unchanged at their policy meeting.
Technology, telecom and industrials were the top performing sectors in the quarter. Tech shares rose 10.2% as investors moved money into sectors seeking companies with better earnings growth prospects. Additionally, there were several high profile merger and acquisitions that help lift tech shares lead by Microsoft’s bid to buy LinkedIn. Telecom stocks rallied 13.3% benefiting from merger and acquisition deals and exposure to smaller size companies. Industrials added 4.2% as a stable US Dollar removed a headwind for this group. Utilities and consumer staples were the stragglers in the quarter. Utilities fell 6.6% as investors took some profits but they are still up 13.2% for the year. Consumer staples stocks have seen valuations become overvalued and the group pulled back 3.5% in the quarter.
We remain positive in the short term (next 12 months) for stocks. The current bull market for stocks is now the second longest in history. The run in the 1990’s was the longest. Bull markets don’t usually run out of steam because of old age but rather because the economic cycle runs out of gas or the Fed over does it with interest rate hikes. Neither of these appear to be a problem over the next year. In fact, looking back when stocks hit all-time highs, stocks are positive a year later 74% of the time and the average return is 8.8%. We hit a fresh all time in August of this year and are 1% below those levels today.
Stocks continue to sell at above average valuation levels. The S&P 500 is trading at 16.6 times forward earnings estimates. This is still above the 14.3 times 10-year historical average. There have been five consecutive quarters were corporate earnings have been in decline. This is the first quarter where the streak could come to an end, but it will be close. Given the elevated valuation levels corporate earnings have to turn positive before year end or we are vulnerable for a pull back. We believe earnings will be flat this quarter but will return to growth in the fourth quarter. The Fed is expected to raise interest rates one more time this year with more rate increases to follow in 2017. The Fed is slowly starting to unwind their emergency policy measures from the financial crisis. The first few interest rate hikes by the Fed should have limited impact on stocks. As rates move above 1% (at 0.25% now) we would become concerned about a pullback in stocks. This is at least 12 months away from occurring which is why we are optimistic about stocks in the near term.
The election is always a wild card and volatility is likely to pick up in the weeks before and after we go to the voting booth. Investors place too much emphasis on the election when the economy and corporate earnings have a bigger impact on your returns. The job market remains strong and the economy is meandering along. Both bode well for returns no matter which candidate is elected president in November.
You can read our 2016 Second Quarter US Market Viewpoints here.
Disclaimer: The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results.