Growth & Dividends Strain for Lead
Posted on October 12, 2018
U.S. stock markets pushed higher during the third quarter of 2018. Many of the same themes we have been highlighting the past several quarters continue to persist. Since the beginning of the year investors have clearly shown a bias for growth stocks over their dividend-paying counterparts. However, more recently we have seen dividend-paying companies participate in the market rally and keep pace with the rest of the broader stock market. This is happening while interest rates continue to move modestly higher, which is a good sign from our perspective. We are finding good relative value among dividend-paying companies considering they continue to post solid business results but have lacked a commensurate stock price increase. We are content to own stocks that move sideways (or even lower) for a period of time as long as the underlying business fundamentals are moving in the right direction.
For the majority of our client base, we remain steadfast in our belief that a combination of growth stocks and income-producing stocks provides better risk-adjusted returns and a more-predictable investment experience over long time periods. With that said, our clients’ goals continue to dictate how we invest and the proportion we allocate across various investment opportunities (stocks, fixed-income, and cash primarily).
On September 26th, the Fed announced their decision to raise the Federal Funds rate by another 0.25%. The target range for the Fed Funds rate is now 2% – 2.25%. Interest rates moved higher again over the past several weeks in anticipation of the Fed’s decision. We expect the U.S. economy to remain quite strong through the end of the year, giving the Fed the justification to continue to raise rates. However, the continued flattening in the yield curve (when short-term interest rates rise faster than longer-term rates) remains an issue. As also noted in our Current Outlook, the real risk is that short-term interest rates rise above long-term rates, leading to an “inverted yield curve.” Interest-rate movements coupled with competing tariffs between the U.S. and China (most notably) are the two primary market risks on which we remain focused.
Our bias for stocks over bonds will remain as long as stocks offer more compelling risk-adjusted expected returns. Considering our belief that interest rates will continue to rise, we remain cautious with our bond purchases. Bond prices fall as interest rates rise (all else being equal); therefore, we believe bonds will continue to be exposed to price risk as we move forward. Reasonable people can disagree regarding the forward prospects of the broader stock market, particularly in the short-term, but it is a virtual certainty that when interest rates rise, bond prices fall. As a result, we will continue to emphasize shorter-maturity bonds for clients who desire income generation and/or reduced volatility. When rates rise, shorter-term bonds don’t drop in price as much as longer-maturity bonds.
Despite the risks we highlight above, there are certainly more positive economic data points than negative, and we continue to be pleased with corporate earnings results. Even considering the rally in broader stock markets, valuation levels remain quite reasonable. So the continued rally in stocks is not unwarranted. After all, stocks should trade higher on the back of better business results.
International stocks have performed poorly relative to U.S. stocks this year. While we have limited our direct exposure to emerging markets due to outsized risks, we do own some individual companies headquartered abroad and have been allocating dollars to developed international markets where appropriate. We will continue to evaluate those opportunities as well. Contact us if we may assist you with your investment or estate administration needs. www.sancapgroupinc.com
Ian N. Breusch, CFA
Chief Investment Officer
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