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Strategic Insights

Volume 7, Edition 25 | July 16 - July 20, 2018

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A Dose of Reality

Doug_Walters Doug Walters | Articles

Read Time: 5:00 min

072018_main

The S&P 500 tread water this week as investors traded off positive earnings results with rising trade tensions. Meanwhile a FANG stock showed it was mortal…

Market Review

Contributed by Doug Walters

U.S. equities had trouble finding solid footing this week as investors balanced a generally positive start to the earnings season with continued escalation of the trade rhetoric, particularly as it relates to China.

Double Negative

The second quarter earnings season is underway, with about one-sixth of the S&P 500 having reported. Earnings are ahead of expectations, but perhaps more importantly, so are sales. One company not impressing analysts was a “FANG” stock, Netflix (NFLX). We discuss this in our Spotlight section below.

Offsetting the positive sentiment around earnings growth is rising geopolitical uncertainty. As we discussed last week (A Second Wind), politics and global relations are likely to play a significant role in market sentiment this year. This week there were two events which raised investor uncertainty. The first was the Helsinki summit between Trump and Russian President Putin, which put the President at odds with many of his Republican constituents. The second was a meaningful heating up of the trade dispute with China. In an interview, President Trump said he is prepared to impose tariffs on $500bn of imported Chinese goods, which is virtually all of our Chinese imports. In response to the U.S. measures, China is targeting pressure points like soybeans. China is the world’s largest importer of soy and is threatening tariffs that would pinch Trump-supporting soybean growing states.

Despite the uncertainty, we still see a strong economic backdrop and, as always, wouldn’t recommend trying to time a market top. Rather, we would continue to focus on diversification and owning securities with the quality to whether a market pullback.

Spotlight: FANG-dangled

This week Netflix reported second-quarter results. Despite reporting growth that most companies can only dream of, they fell short of expectations. From their recent peak, Netflix shares are down 13%. Such is the risk of a stock that is pricing in perfection.

Netflix is one of the so-called “FANG” stocks – Facebook (FB), Amazon (AMZN), Netflix, and Alphabet (GOOGL). The FANG stocks have had an outsized impact on equity performance this year. In fact, before Netflix’s slide, these four stocks accounted for about 40% of this year’s total return for the S&P 500. If we add Apple and Microsoft to the mix (FANGMA?), the percentage jumps up to 62%. So nearly two-thirds of this year’s returns can be attributed to just six stocks.

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The problem is, some of these stocks are extraordinarily expensive. For example, the average forward Price-to-Earnings ratio of Amazon, Netflix, and Facebook is 78x. Compare that to Microsoft, Apple, and Alphabet at just 22x. Despite the stellar momentum-driven performance of some of these FANGs, history has taught it is wise to avoid sky-high valuations in the long run.

Strategy Update

Contributed by Max Berkovich , Aleksey Marchenko

STRATEGIC ASSET ALLOCATION

All that Glimmers, Isn’t Gold

U.S. Equities advanced higher for another week (barely) as earnings season officially kicked off. Bonds had a quiet week as the 10-year U.S. Treasury remained unchanged. Gold continued its decline this week and is on track to be down for the fourth month in a row.  Speaking of gold…

  • Rising interest rates are considered to be bad for gold prices, as investors reallocate capital to interest-bearing products.
  • The rise in the U.S. dollar against major currencies also hurts gold as some view buying gold to be a safety net against a weak dollar. With the dollar rising, demand for gold diminishes.
  • We view gold as an important diversifier in a portfolio. While some commodities can be costly to own, as they require complex financial structures (futures, etc.). However, we use the SPDR Gold Trust(GLD) ETF to gain gold exposure. It is inexpensive and backed by actual gold reserves in a vault.

STRATEGIC GROWTH

Walk Away

The Consumer Staples sector was the top laggard this week, but Health Care was next in line as solid earnings, were “only” solid. Industrials, on the other hand, were the leading sector. In other strategy news…

  • CNBC mergers expert Davide Faber claims that Qualcomm Corp. (QCOM) could walk away from its chase for NXP Semiconductors NV (NXPI). Due to the continued souring of U.S.-China relations, it is looking less likely that Chinese regulators will bless the combination of the two strategy holdings. Qualcomm CEO hinted that they would buy back $20-$30 Billion of its shares if it ended the process and paid NXP the $2 Billion termination fee. Qualcomm reports earnings on the 25th. Look for the deal to overshadow results.

STRATEGIC EQUITY INCOME

Renewed Interest

Interest rate sensitive sectors Telecom and Utilities were laggards, while the Consumer Discretionary sector was the leader thanks to a solid retail sales report. Surprisingly, with all the bank earnings, the financial sector was neither a leader nor a laggard, but individual names did see some hefty volatility post results. Notably…

  • BB&T Bancorp (BBT) was stung by fear of a pursuit of a costly acquisition. Bank of New York Mellon (BK) was dragged down by unfavorable investment management results. M&T Bancorp. (MTB), on the other hand, surprised investors with a better net interest margin and US Bancorp (USB) had positive credit related metrics. Non-bank BlackRock Corp. (BLK) had mixed asset flow results and insurer Travelers Co. (TRV) was roughed up by catastrophic losses of $488 Million.
Indices & Price ReturnsWeek (%)Year (%)
S&P 500 0.04.8
S&P 400 (Mid Cap)0.15.1
Russell 2000 (Small Cap)0.610.5
MSCI EAFE (Developed International)0.6-3.2
MSCI Emerging Markets-0.5-7.6
S&P GSCI (Commodities)-1.23.4
Gold-0.9-5.7
MSCI U.S. REIT Index-1.4-1.5
Barclays Int Govt Credit0.0-1.9
Barclays US TIPS-0.7-1.7

The Week Ahead

Contributed by Aleksey Marchenko

We are at the Heart of Q2 Earnings; ERGO Company Reports are the Main Event

Earnings will take center stage during the week with no less than 25 companies we own in the strategies reporting.

  • Technology earnings will be the main focus for Strategic Growth and the Energy sector for Equity Income.

Rate decision from European Central Bank (ECB) will be announced Thursday morning.

  • No rate hike from the ECB is expected, but comments surrounding tightening of monetary policy may bring some volatility to the fixed income markets.

Gross Domestic Product (GDP) will be the most important economic release, with MarkIt Purchasing Managers Index (PMI) for manufacturing and services, Durable Good Orders and a read on Consumer Sentiment also on the calendar.

  • GDP growth is estimated to advance to 2.1% vs. previous year of 1.9%.
  • Preliminary Markit PMI for manufacturing and services are expected to remain near 3-year highs, signaling a healthy expansion.
  • Durable Goods Orders are predicted to grow by nearly 3% in June vs. the prior month.
  • The Michigan Consumer Sentiment Index is slated to remain near a 14-year high, but below March levels.

Organization of Petroleum Exporting Countries (OPEC) will meet on Thursday morning to most likely reiterate their previous decision to increase supply.

  • Since oil prices bottomed in 2015, OPEC has done a great job in managing supply to stabilize prices. While additional supply is coming online from both Russia and Saudi Arabia, those countries have stuck to the agreement and maintained oil production caps.

About Strategic

Founded in 1979, Strategic is a leading investment and wealth management firm managing and advising on client assets over $1 billion.

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