Better Results Versus the Seasonal Norm as We Close Out September…What’s Next?
“Stock markets climb the wall of worry.” – Old Wall Street Proverb
Whew…we’ve made it through two months of the three-month “Amen Corner” season in the market, and investors have come through in fine fashion so far. August, September and October have rough reputations for stock market returns. In fact, September has historically been the weakest month of the calendar year for the S&P 500, generating a -1 percent average monthly return going back to 1928. This September, it rose roughly 2 percent1. That percentage is not too shabby compared to the historical averages. Impressively, this benchmark advanced 21 percent in the first three quarters of 2019, marking the best nine-month start to a calendar year since 19971. And, of course, this is on the heels of comparisons of December 2018 to the negative backdrop in 1931. We heard prognostications by many back then that recession would ensue in short order in 2019, earnings would turn negative, and cash and defense would be “all that” this year.
That dire scenario is not quite the way things played out. U.S. stocks did better than fine and reducing one’s equity position when trading resumed on December 26 could have been a mistake. We had the conviction to stay the course, because the data remained supportive of advancing equity prices, despite the plentiful items on the wall of worry list. Market and individual stock fundamentals and valuation levels painted a good picture for returns in 2019. They still do in our view.
Led by concerns over potential policy mistakes on the part of the Federal Reserve and on the tariff front, the wall of worry was lengthy at the end of 2018 and hasn’t shrunk as we’ve moved through the year. If anything, it lengthened. It now includes attacks on Saudi oil pipelines and concerns of an oil price shock, potential military conflict in the Middle East as economic sanctions increasingly irritate Iran, heightened expectations for an ugly campaign in the upcoming 2020 U.S. presidential election, and concerns over the fall-out from an impeachment inquiry conducted in the House. The “yield curve has inverted” was a loud battle cry for the bear camp (until it recently un-inverted). Yet, according to the October 1 issue of The Wall Street Journal, we just experienced the best nine-month return in more than 20 years through Sept. 30, 2019. How can this be? What’s next from our perspective?
Climbing the Wall of Worry
As noted above, there’s an old Wall Street proverb, “The stock market climbs a wall of worry.” What inspired this adage? It’s simple — the stock market tends to do this time and time again. In fact, we embrace the wall of worry, particularly when negative headlines appear in the media during a time when fundamental, valuation and technical data (the FVT’s, as we call them) remain supportive. The existence of this wall reflects investors’ healthy skepticism about the future and their respect for risk factors. This keeps valuation levels in check and adequate cash on the sidelines for dry powder to keep the market advancing at a healthy, steady pace. No doubt, after a productive 2017, the market has seen ample volatility during the last 15 months or so, with some months generating their best monthly returns in decades, only to be followed by others that reported their worst monthly returns in decades.
That said, despite this roller-coaster return pattern, the market is up just over 4 percent on a trailing 12-month basis through the end of September and sits only 4 percent below all-time highs set back in July 20191. This is hardly a disaster and represents, to us, a bit of a reprieve from prior years’ robust returns. This is healthy from our perspective. It sets the stage for further appreciation in a positive earnings growth, reasonable valuation, low inflation/low interest rate environment. Historically, this type of setting has been very fertile for stocks.
Our experience is that the true times to worry include:
- When there is no wall of worry and investors are giddy and euphoric, or,
- When the wall of worry list is long and the FVT’s are plummeting…this occurs when the items on the wall actually are impacting the data in a decidedly negative way.
Neither holds true today, in our view. The fundamentals (economic growth, earnings growth, credit markets, etc.) are moderating but remain positive. Valuation (price-to-earnings, dividend yield and earnings yield) is reasonable to attractive. Technical market data (investor sentiment, breadth in stock market leadership, price momentum and long-term stock price trends) are quite positive. The table below illustrates the healthy nature of the FVT’s that give us conviction at times when skepticism runs high.
Actually, there is another Wall Street proverb, “Bear markets slide down the slope of hope.” This advance is anything but based on hope. The chart above reinforces that it appears to be on solid ground. In addition, the beginnings of bear markets are generally preceded by signs of this unsubstantiated hope creeping or surging into the market. Examples of these signs might include investors rushing into equities (reflected by excessively large flows into stock funds, robust mergers and acquisitions and IPO activity), while negative fundamental signs are surfacing (rising interest rates, weak credit markets conditions, etc.) The chart below shows the absence of these signals that occurred at prior market tops.
A final point in discussing the wall of worry is that this list has evolved each year since the recovery began in 2009, but it has remained long throughout. In 2009, when the market bottomed, the wall of worry arguments by the bears not to get re-invested in stocks included such assertions as:
- Earnings growth is driven only by cost cuts, not revenue growth
- The consumer is in a cave choking on debt and will never spend again
- We will be over-taxed and over-regulated from now to infinity
- Watch out for those bank stress tests
- The “Hindenburg Omen”—negative cross of the 50 and 250 day moving average
Investors assumed worst-case outcomes on these headlines and missed the improvement in the data. First, it became less worse, then stable, then good. If you weren’t watching the data and stayed glued to the headlines, you avoided stocks like the plague…and did so at your peril. The stock market advanced more than 26 percent in 2009, in the midst of these negative headlines2. In 2010, it was midterm election fears and concerns about potential tax hikes that led the wall of worry list.
In 2012, fears centered on fiscal cliff, and even on something as inconsequential as troubled banks in Cypress (a very small island in the Mediterranean). To put this in context, assets of Cypress banks totaled roughly $113 billion at the time versus a $17 trillion U.S. economy and Apple’s market cap of less than $1 trillion2. If paralyzed by these worries, one could have bypassed the 32 percent return in the S&P 500 in 20131.
In 2016, it was the triumvirate of plunging oil prices, Brexit and Trump’s seeming success in the presidential election campaign that, amongst other items, spooked investors and could have caused one to miss the 8 percent second-half return in 20161 and the 21 percent return in 20171.
Fast forward to 2019. The worry list has quickly expanded from trade and Fed policy concerns and yield curve flattening to include the impeachment inquiry moving forward in the House. We’ve seen potential impeachment proceedings arise two times in modern history. The first time was during the Watergate/Nixon era in the 70s. The second time was in the mid-90s during the Clinton presidency. In the former case, the economy was a mess and battling stagflation. In the latter, the economy was on solid footing. Not surprisingly, the market struggled in the 70s as the Nixon resignation brewed. On the other hand, the market was just fine in the mid-90s when Clinton was impeached by the House and then acquitted by the Senate. The takeaway is that the FVT’s trump the political winds…no pun intended. So goes the economy and earnings, so goes the market. We would expect 2019 to be no different on this front.
Bottom line: Time and time again, these wall of worry items didn’t necessarily impact the data but instead inspired temporary panic attacks where folks jumped to worst-case outcomes and conclusions on the issues. During these moments, pullbacks turned out to be excellent buying opportunities, and the wall of worry fears seemed to be exaggerated. When data was released after headline fears were expressed in the media, it showed the FVT’s to be solid. We think the fact set today is similar…FVT’s remain healthy. We see any panic attack or pullback that may happen as an opportunity. We will only adjust our view if these wall of worry items truly negatively impact the FVT’s.
Balance is Appropriate
While the data remains constructive in the aggregate, psychology remains vulnerable, and policy disappointments could occur and soften investor confidence and eventually the data as well. While we envision the market advancing further during the next twelve months, we do view the market as vulnerable to a temporary market pullback given the nervousness emanating from the current wall. For that reason, we feel it best not to be heroic or tilted to extremes in portfolio positioning. Within equities, some suggest the cyclical, economically sensitive stocks are cheap and will reward investors most going forward. Others believe defense is the answer…stay in the sectors that aren’t so dependent on a strong economy to benefit. We think that a blend of the offense-oriented cyclicals, the more defensive, consistent growth, and high-growth areas is the prescription for this market. On days when investors maintain a “risk-on” view and see trade risks de-escalating, the cyclicals perform quite nicely. On days when investors lean skittish, the defense provides ballast. At this point in the cycle and news flow, we think balance is key. If we see a decided change where a shift in positioning is appropriate, we will report to you and act accordingly.
2Statista.com & macrotrends.net
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