Good morning. We wrote this article over the weekend to be sent out today and decided to amend the intro in response to today’s continued market selloffs. As you can tell by the title of this article, we expected a slowdown, but we take no satisfaction about being right. Remember, monetary policy has a lag and some of the actions the Federal Reserve took 1-2 years ago are coming through now. We remain confident in the strategies we have in place for the long-term.
August is always an interesting month for the market. Why? While school has started for us in Tucson, it has not started, generally speaking, in the rest of the country. It has really not started in the Northeast where the big trading desks are (New York and Boston). In addition, Europe generally takes the month of August off, and this year we have the Olympics in Paris.
Why is this important? It is my experience that senior management of the trading desks and the firms start taking holidays in August before Labour Day, and leave instructions to the “juniors” managing the desks, they want no phone calls, and no trading losses. What can happen as a result is less market activity, liquidity dries up, and we see markets having larger than normal swings on low volume. Noise, in our opinion.
This year we also have the cacophony of the markets demanding the US Federal Reserve (FED) lower interest rates to stimulate the economy. We at RMH have been of the opinion that inflation is a grave concern, and having lived through the inflationary periods of the late 1970’s we do not want a repeat of that. Remember 15% US Treasury bonds and mortgages at 11% +? The current generation of traders has not seen this.
Finally, an election year where the country is polarized. The FED will be criticized by both parties on what they do or do not do with regard to lowering interest rates. It is general consensus that they will do one rate cut before the election in September, but we at RMH will not be surpised if they wait until December. Please remember the FED has a very tough job of slowing the economy without a recession. In other words, creating a “soft landing”.
This job is made difficult by a number of major factors being out of their control:
Fiscal spending by the US Government and other governments around the world.
Price of Energy, however the US could force energy prices lower if they wanted. The US is the global marginal producer and we have ability to generate more production in both oil and natural gas thereby lowering energy prices around the world. As energy is the major contributor to inflation, why do we not do this?
Supply shocks as in cost of goods go up for a number of reasons, Ukraine, China, Middle East, and other geopolitical issues.
The next two charts are two of our favorites as we are students of market history. Every year we expect the stock market to have a decline of 10% during the year, every 2 – 3 years we expect a drawdown of up to 20%, and every 5+ years we expect a drawdown of 30% plus. Adding up the numbers below we find the following from 1980 – 2024 courtesy of JP Morgan:
- Less than 10% drawdown, 20 times
- 11 – 20% drawdown, 14 times
- 20 – 30% drawdown, 5 times
- 30% + drawdown, 5 times.
The chart below shows the annual returns of the stock market from 1927 on. 96 years of data with 26 down years means the stock market ends up 73% of the time. We remember the down swings more than we remember the ups. For instance, on October 19, 1987 the market dropped 23% in one day, the year finished up 5.25%, however, that is rarely mentioned.
Earlier in this article we mentioned the word Noise. What we mean by this is that the media sources one utilizes to get information have a different purpose than you, the client. The media sources are always an enterprise driven by profits; they answer to their owners. In return to generate returns/profits, they must generate content to attract readership (sometimes called “eyeballs”). Generally speaking, the more “catchy” or “edgy” a headline is, it attracts readership whether it is in your best interest or not.
“In the short run, the market is a voting machine, but in the long run, it is a weighing machine.” – Benjamin Graham
Soufiane Elkhattabi explains this quote well with the following analysis:
“In the short term, the stock market behaves like a voting machine. Prices are influenced by the collective mood of investors, which can be swayed by a variety of factors such as news events, earnings reports, or even rumors. This is akin to a popularity contest, where the most ‘popular’ stocks may see their prices rise, regardless of their underlying fundamentals.
Over the long term, however, the market acts more like a weighing machine. It assesses the intrinsic value of a company based on its earnings power and the quality of its assets. In this scenario, the ‘weight’ of a company’s real worth will ultimately determine its stock price.
While sentiment can drive prices in the short term, fundamentals such as earnings, cash flow, and book value tend to drive prices in the long term. Companies with strong fundamentals may see their stock prices rise over time, while those with weak fundamentals may see their stock prices fall.”
We bring this up as we go through the S&P 500 earnings. So far, we have the following results, courtesy of Factset:
Overall, 75% of the companies in the S&P 500 have reported actual results for Q2 2024 to date. Of these companies, 78% have reported actual EPS above estimates, which is above the 5-year average of 77% and above the 10-year average of 74%.
If 5.3% is the actual revenue growth rate for the quarter, it will mark the 15th consecutive quarter of revenue growth for the index.
Ten sectors are reporting year-over-year growth in revenues, led by the Information Technology, Communication Services, and Energy sectors. On the other hand, the Materials sectors is the only sector reporting a year-over-year decline in revenues.
Looking ahead, analysts expect (year-over-year) earnings growth rates of 6.1% and for CY 2024, analysts are calling for (year-over-year) earnings growth of 10.8%.
The chart below courtesy of Yardeni Research shows current operating earnings and estimates into the future look up. What is interesting in this chart is that the analysts’ earnings look up, with all of the new information incorporated into their thoughts. While slowing economic growth is a headwind, many companies, as we have mentioned earlier, are benefitting from the restructuring pains of the last several years. In addition, a lot of debt (leverage) was refinanced at much lower rates out as far as 2028.
In conclusion, do not be surprised if the end of summer and early fall brings a slow and bearish market. There will be lots of noise and some volatility these next few months, but we remain optimistic and confident in the US market over the long term. If there is one thing, we have learned over 40+ years in this industry, it is that this country’s economy is resilient.
We thank you all for taking the time and reading “Market Watch.” It is meant as an educational piece on the always evolving markets. It is something we plan on providing every month, and your feedback is very important to us.
On a personal note, RMH is now in the position to bring on new clients so please be sure to share this informational letter with whomever you wish. RMH’s focus is on the customizable investment needs of individuals, families, and foundations. We enjoy working with our clients to better understand their goals, values, and passions for what is important in their lives. In expanding our client base, we look forward to working with people who share these same desires.
Richard Mundinger, CFA
Ashlyn Tucker, M. Fin, Analyst, CFA Level III Candidate
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