No matter what index you look at, the news is about the same. Stocks fell 3% to 5% overall last week, and gains for the year are pretty much wiped out. The good news is that’s not necessarily how money managers view or even trade the markets. And, at least according to Advisors Capital Management’s recent outlook, market volatility isn’t as bad as the headlines would report when looking at current fundamentals.
In an online roundtable, several portfolio managers from the RIA discussed recent volatility and what it means for current and future portfolios and markets. Here are some key points of their discussion:
1) The economy is still strong.
Charles Lieberman, chief investment officer of ACM, is upbeat on the economy despite recent volatility. He said that GDP growth has been “unsustainably rapid” at 3.5%. A slowdown wouldn’t mean a recession, and he sees 2019 going to an average of 2.5% GDP. “That’s still too fast,” he said. “When we grew at a 2% rate for the past several years it was enough to drive the unemployment rate down from 10% to below 4%. So if we go back to 2%, we’re still going to be putting downward pressure on the unemployment rate.”
2. Stocks have good fundamentals.
Lieberman also pointed out that the stock market doesn’t translate — at least in the short term — into how the economy is doing. A recession typically means an economic decline by 1% or 2%, while a strong economy is 3.5% growth, he noted.
“And yet the stock market in a good year can be up 30% or more, in a bad year can be down 30% or 40% or more. The stock market is just dramatically more volatile than the economy. And yet the underlying value of the stock market is based on the economy. It shows you how important psychology is.“
He added that the price-to-earnings multiple of the “whole market” is around 15, with many stocks trading at 13, “which is below average … But people don’t necessarily want to buy cheap. They want to buy what’s going up, and that’s part of what creates the opportunity.”
He says for the most part stocks are still “cheap,” and “if there is a bubble, the bubble is in the bond market.”
3) Don’t believe the yield curve inversion story.
Kevin Kelly, ACM’s portolio manager of fixed income, disavowed the talk of an inverted yield curve meaning a coming recession. “We just don’t see the economic fundamentals pointing to a recession in the near term,” he said, adding that in the past 40 years, the 2- and 10-year Treasuries have inverted only five times.
“What people say is every recession has been preceded by an inversion. That statement is correct. But it is not correct that every inversion is followed by a recession,” Lieberman added. “The average length of time between an inversion and a recession is over two years.” He said the inverted yield curve-to-recession link is “not a great investment tool … it’s really almost useless.”
Kelly added that “we’re looking at short-duration bonds [of] high quality because we’re not getting paid to go too far out.”
4) Algorithmic trades and ETFs can amplify market moves and cause volatility.
JoAnn Feeney, an ACM portfolio manager, noted that algorithmic trades “tend to amplify momentum trades.” This is due to how the algo Is designed; for example, it might be coded to sell if the yield curve hits a certain flatness. What happens then, she says, is it “triggers sales across the board. Folks who are using ETFs to invest [will] pull out their money. The way ETFs are structured, that means that everything inside the ETF has to be sold in proportions in which it’s held regardless of some things in there being more appealing or cheaper than other [stocks].”
Feeney said advisors should tell investors “the worst thing they could do at this point would be to pull away from equities.” Investors may have an “emotional response” that risk is higher, and some of that could include the trade conflict with China, the Fed raising interest rates or even a housing slowdown, “but when we look at the companies themselves and their ability to deliver profits and deliver growth over time, what we’re seeing is continued growth and next year’s earnings to grow [from 6% to 9%] on average for the S&P 500,” she said.
She says they look to find ways to “add positions where the dislocation between the market value and fundamental value is the greatest,” as well as having stocks in a portfolio that “are lower beta so not going to move as much as the market.”
She added that “over the long term value does outperform growth, but recently the growth of momentum trade has been outperforming,” she said. This is changing, she said, pointing out the last couple months they’ve seen a risk-off trade “is a shift by investors out of those growth momentum trades as evidenced by the sharp selloff in FANG stocks … and [a move] into more value-oriented trades.”
5) Trade is still a big question.
ACM portfolio manager David Ruff said deterioration in the trade deficit with China right now is due in some part to companies “trying to get ahead of the tariffs” that Trump has promised to increase by 25%. He also noted that “maybe the market might be expecting too much at this [time] in terms of coming to a trade resolution. I would characterize the weekend discussion [between Presidents Donald Trump and Xi Jinping] as more of a truce versus a peace treaty … but it is notable and significant that China has agreed to continue negotiations.”
He does believe China will make enough changes to “forestall” the 25% rate hike, but he isn’t hopeful that the more difficult trade issues with China, such as intellectual property theft, or “the core structure of trade of state-owned corporate model” will be solved within 90 days.
Although China may make a move toward more U.S. soybean or liquid natural gas imports, Ruff is “skeptical of anything meaningful coming in the way of structural reforms in the near term.”
He added that U.S. equities have been running about 500 basis points per year premium to foreign stocks, with 350 points of that due to foreign currency weakness/dollar strength. “A [reversion to mean] would help foreign stock performance.”
— Related on ThinkAdvisor:
- The Economy and Financial Markets: Forecasting What They ‘Might’ Do
- Why Stocks Are Declining: (No It’s Not the Tweeting)