May the Factors Be with You
Doug Walters
On this May the 4th, we note that there is a light side and a dark side to investing with invisible forces driving stock returns. We call these forces persistent factors…
Contributed by Doug Walters , Max Berkovich ,
Stocks were flat this week thanks only to a Friday rebound on the back of a better-than-expected jobs number. International equities took the opportunity to narrow the year-to-date return gap with a decent performance thanks to renewed signs of life in the European economy.
Headlines this Week
- The U.S. economy added 263,000 jobs in April, beating Street consensus of 181,000 jobs. Unemployment moved to a 50-year low of 3.6%, while average hourly earnings grew 3.2% year-over-year. Wage growth!
- The U.S. Federal Reserve (Fed) has reiterated their stance on holding rates steady. The Fed sees no strong case for cutting or hiking rates in the near future, but they did lower the excess reserves rate from 2.40% to 2.35%. This rate is what the Fed pays banks for deposits they keep at the central bank in excess of what they are required to have.
- Earnings update: Over 77% of companies in the S&P 500 Index have reported their earnings. The Health Care sector has posted the most substantial earnings growth thus far, followed by the Real Estate and Utilities sectors. The laggards are Energy, Information Technology and Communication Services.
- Inflation in Europe accelerated faster than expected as consumer prices rose 1.7% in April from a year earlier. Any signs of growth in the European economy should help boost its stock markets.
Spotlight: Investing with the Force
There is a light side and a dark side to investing with invisible forces driving stock returns. We call these forces “persistent factors.” Some of these factors you are familiar with, like Quality and Value. Others, like Small Size, Price Momentum, and Minimum Volatility are equally as important, but perhaps less known. What all these factors have in common is that they have been shown academically and empirically to outperform the broader market over time. There is a dark side to factors as well. These are factors whose fortunes rise and fall over time but are ultimately doomed to underperform. One such example is Growth stocks. Historically, Growth has underperformed persistent factors like Value, yet in the late stages of this economic recovery, Growth stocks are striking back. In fact, they have enjoyed significant success over the past few years. We see many investors turning to the dark side, chasing Growth, but we believe that investors should position themselves for the return of the persistent factors. We place these positive forces at the core of our portfolios. Despite Growth’s dominance this year, we see Quality starting to shine, and expect as the economic cycle progresses, other persistent factors will begin a proper rebellion.
The Week Ahead
- Earnings from microchip equipment maker KLA-Tencor Corp. (KLAC), health care distributor McKesson Corp. (MCK), and online travel agent Booking Holding Inc. (BKNG) will be an appetizer as our focus will be on the May 8th Walt Disney Co. (DIS) report, particularly given the recent success of the Marvel movie.
- Economic data will have an inflation focus as both the Consumer Price Index and Producer Price Index numbers will be released.
- High-level Chinese officials, including Vice Premier Liu He, are due in Washington to negotiate the later stage of the trade agreement.
- Central bank focus will be on a rate decision from the Bank of Japan and several U.S. Federal Reserve officials are scheduled to hit the speech circuit.
- This weekend will be the “Woodstock of Capitalism,” the annual shareholder gathering in Omaha for Warren Buffet’s Berkshire Hathaway. The carnival-like gathering includes a multi-hour Q&A session with the value investing legend.
- Finally, May the 4th (Star Wars Day), the Kentucky Derby, and Cinco De Mayo make for a festive weekend.
Stock Highlights from Max
Earning Season Volatility
The REIT sector was the top performer this week, but we just have one holding there so we’ll give a nod to the Health Care sector which edged out Financials. The biggest laggard this week was the Communications sector thanks to a disappointing earnings report from…
- Alphabet Inc. (GOOG,GOOGL), the parent company of Goggle and YouTube, beat earnings expectations but missed on revenue. The company highlighted that expenses are climbing faster than its revenue is growing. Data Centers and content acquisition at YouTube were specifically sighted. Also, a $1.7 Billion fine from the European Union hit the numbers this quarter.
- Apple Inc. (AAPL), on the other hand, beat expectations. More importantly, it demonstrated strong growth in “Services” and boosted revenue guidance for next quarter. 5G hype and a $75 Billion stock buyback program only fueled the fire.
- Another delicious earnings report came from Mondelez Int’l Inc. (MDLZ), which surprised investors with a 3.7% organic sales growth number. The company was also able to raise prices and expects similar organic growth in the upcoming quarter.
- CVS Health Corp. (CVS) joined the good news parade as well. The pharmacy and health insurance company topped expectations and raised guidance. Hopefully, this is a prescription that will heal the ailing health care sector.
- Not all news from earnings were good. Cognizant Technology Solutions (CTSH), the outsourcing and consulting company, disappointed investors by missing estimates and slashing its outlook. The negativity centers on weakness in financial services and healthcare. The company has been a steady operator; hence a miss caught investors off-guard.
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