Provident Investment Management

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September Investment Comments

Cautionary Signs or False Signals?

The 30-year Treasury bond recently yielded just over 2%, an all-time low.  Think about it:  investing one’s money for three decades for a negative return after taxes and inflation are factored in.  Usually long-term Treasuries perform well during periods of economic uncertainty, especially at the onset of a recession.  That’s the initial message investors perceive from this low bond yield.

 Another cautionary sign is that the Treasury yield curve is partially “inverted.”  A “normal” yield curve is upwardly-sloping, meaning that investors demand a higher yield in exchange for taking on the risks of investing over a longer period of time.  The 30-year Treasury typically yields more than the 10-year, and the 10-year more than the 2-year or a 90-day Treasury bill.  An inverted yield curve occurs when the opposite is true, that short-term Treasuries pay better than long ones.  This is rational only when the outlook is for lower interest rates as long-dated bonds will appreciate more than shorter bonds when interest rates fall.  Recently, shorter maturities like the 2-year and 5-year Treasury and the 90-day bill yielded more than a 10-year Treasury.  The 30-year bond still yields about half a percentage point more, hence the term “partial inversion.”

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August Investment Comments

A famous investor once said, “Most of the time the Fed is not that important; occasionally it’s the only game in town.”  While the Fed is not the only thing that matters in the current environment—trade, for one, is another notable factor driving markets—one could certainly make a reasonable case that it has been the primary influence on market performance since the back half of 2018.  Last year, markets sold off following the Fed’s September 2018 meeting when, for the eighth time since 2015, it increased its target overnight lending rate and no longer referred to its own monetary policy as “accommodative.”  Subsequent to that meeting, Chairman Jerome Powell also stated his belief that the Fed was still a “long way from neutral” (i.e., rates that are neither stimulative nor contractionary), implying several more rate hikes were on the way and sending markets lower.

 In December, the Fed again increased rates while also signaling two rate hikes for 2019.  This was more aggressive than the market was anticipating, particularly in light of global economic uncertainty and ongoing trade disputes.  In response, markets took another leg down, declining a total of nearly 20% between the end of September and the Christmas Eve low.  For the year, the S&P 500 fell 4.4% despite earnings growth of approximately 20%.

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July Investment Comments

After ten years of mostly steady expansion, the industrial economy currently looks tired.  Transportation, energy, and basic materials stocks have been among the market’s worst performers in the past one and three months.  The statistics confirm investors’ concerns.  April’s industrial production estimate showed annualized growth of less than 1%, about half its previous pace.  In May, the manufacturing Purchasing Managers’ Index (PMI) logged its worst monthly reading since 2009.  Statistics are noisy estimators, but it would be nearly impossible to generate data that bad purely by chance.

 Yet non-industrial indicators continue to hold up.  Retail sales and consumer spending are advancing steadily.  Consumer confidence, surveyed by the University of Michigan, remains strong. Measured unemployment is just 3.6%.  A slowdown in the economy’s industrial “engine” would have signaled a wider recession historically, but the industrial cycle just doesn’t seem to matter like it once did.  The American worker and consumer is doing just fine thanks, steel or no steel.

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June Investment Comments

After the market hit all-time highs in late April, May marked the return of volatility as trade negotiations with China broke down.

 It all started on Sunday, May 5th when President Trump issued a tweet indicating the Chinese had backtracked on already-negotiated promises to write into Chinese law changes covering areas like intellectual property, subsidies, and forced technology transfers.  China wanted to issue regulations to support these changes, but in the past regulations haven’t been enough to change behavior.  In response, Mr. Trump chose to increase existing tariffs on approximately $200 billion of Chinese goods from 10% to 25% starting June 1st.

 It appears the reason for China’s change in position stems from misinterpretation of various comments from the President as well as internal Chinese politics.  Mr. Trump has called for interest rate cuts from the Federal Reserve, a request that usually indicates economic weakness.  Public comments that trade negotiations were going well and belief that an agreement was imminent gave China the impression that Mr. Trump had to make a deal.  Further, hard-liners within the Communist Party resistant to market reform expressed their displeasure at the proposed trade agreement.

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May Investment Comments

After a strong start to 2019, markets have recovered from the significant declines experienced in last year’s fourth quarter.  Much of the rebound can be attributed to the relatively abrupt pivot by the Federal Reserve at the start of the year to be patient with further rate increases, versus a prior indication of multiple expected rate hikes in 2019.  At its most recent meeting in March, the Federal Reserve went a step further by indicating it no longer anticipates raising rates at all this year, while also pulling back on plans to shrink its balance sheet.  These moves were well-received by the market, which was somewhat perplexed by the Fed’s prior bias toward raising rates in what looked to be an environment of slowing global growth and well-contained inflation.

The U.S. economy is expected to grow in 2019, but at a slower rate than the 2.9% growth posted a year ago.  The Atlanta Fed’s GDPNow estimates Q1 growth of 2.3% and consensus expectations for full year GDP growth are closer to 2.0%.  This slowdown isn’t necessarily cause for alarm, as the data point to an environment that remains positive.

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April Investment Comments

“With our policy rate in the range of neutral, with muted inflation pressures and with some of the downside risks we’ve talked about, this is a good time to be patient,” according to Federal Reserve Chairman Jerome Powell.  Comforting statements like this have helped restore investor confidence just as Powell’s confusing statements last year may have triggered the fourth quarter market stampede.  It is not unusual for new Fed Chairpeople to get their messaging wrong at first.

 At this point last year, investors were concerned about rising inflation and higher interest rates.  Fast forward twelve months and it appears that we might be in that fabled Goldilocks economy – not too hot, not too cold.

 U.S. economic growth in 2018 was the highest since before the Great Recession.  The current year is likely to be lower due to sluggishness outside the U.S. and the lack of incremental stimulus from tax cuts and extra government spending last year.  Some economists peg growth below 2% while many have it in the mid 2’s for 2019.

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March Investment Comments

So far, 2019 has been kinder to investors than was the finish to 2018.  A combination of stronger-than-expected earnings, a more accommodative Federal Reserve, and a strong labor market has supported the full recovery from December’s 9% loss for the S&P 500.

On the earnings front, results are coming in better than expected.  According to FactSet Earnings Insight authored by John Butters, fourth quarter 2018 earnings are projected to grow 13.3% for firms that make up the S&P 500 index.  This is a fairly solid reading as 66% of companies have already reported.  If this earnings growth rate holds it will mark the fifth consecutive quarter of double-digit earnings growth for the index.

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February Investment Comments

Volatility returned to the stock market in 2018, ending the gentle melt up that investors had enjoyed.  The S&P 500 dropped at least 10% in three separate months last year—February, October, and December.  Stocks battled back bravely from the first two corrections, but a weak December finally torpedoed the S&P’s 2018 performance.  After a -9% showing in the final month, the index ended the year down 4.4%, breaking a nine-year streak of positive total returns.

From its September intraday peak to its December nadir, the S&P declined a hair more than 20%, the traditional line demarcating a bear market.  The index has since come back more than 10%.  If the rebound holds then we may have just experienced the shortest bear market in history, lasting only about 48 hours.  Traders sometimes speak of “purely technical” moves, and we have to say that an exactly 20% drop followed by a sharp rebound does suggest that something other than economic and business fundamentals took control of the joystick for a minute.

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January Investment Comments

Investors hoping for a year-end rally have instead been treated to increased market volatility.  A near 5% decline in its first week was the market’s worst start to December since 2008, though this drop followed what was the S&P 500’s best week in almost seven years.  The recent turbulence is reflective of an environment where both market bulls and bears have valid arguments to support their stance.

Topping the list of current concerns is the U.S.-Chinese trade dispute.  The market initially celebrated what appeared to be a positive meeting between President Trump and Chinese President Xi Jinping following the G20 summit.  This meeting resulted in a 90-day postponement in tariffs on $200 billion in Chinese imports that were expected to jump from 10% to 25% at the start of the year.  However, the initial positive interpretation of the meeting was subsequently brought into question given reports of “significant differences” in the two governments’ versions of what was agreed upon at the dinner.  Markets also did not respond favorably to President Trump’s tweet days after the meeting proclaiming himself a “Tariff Man.”

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December Investment Comments

Despite October’s market drama, anxiety over the recent election, and hand-wringing over the durability of the economic expansion, the stock market seems to be on sound footing.  Economic growth appears solid and valuations are reasonable thanks to the impact of lower corporate tax rates.

Third quarter Gross Domestic Product (GDP) rose at a 3.5% annualized rate.  As always, there are pluses and minuses.  The most important component of GDP is consumer spending, which rose at a very satisfactory 4.0%.  Imports surged, which is not unusual when U.S. economic growth is faster than other developed countries.  Pre-buying ahead of tariff increases likely played a role as well. Imports have the effect of reducing GDP.  Largely offsetting this was higher government spending and increased inventories.

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November Investment Comments

November’s midterm elections are likely to result in a divided congress.  Forecasting website currently predicts an 85% chance that Democrats win control of the House but only a 19% chance the Senate swings blue as well.  A surprise sweep by one party could cause further asset price volatility as investors contemplate the implications for the important 2020 elections.  As 2016 proved, unlikely things can happen.

October is a famously volatile month.  1929’s Black Tuesday and 1987’s Black Monday both occurred in October.  This year, the S&P 500 dropped more than 5% during the first two weeks of the month.  Pullbacks of any magnitude have been rare during this long bull market.  One notable feature of this retreat was that it failed to spare the high-growth technology companies who had long been the market’s most resilient leaders.  Although smaller companies generally fared worse than large ones, and Netflix, both of which had approximately doubled over the prior 12 months, both dropped about 10% (Netflix would recover on the back of its Q3 earnings announcement). Alphabet—a.k.a. Google—has now only about matched the overall market over the past year.  Facebook fell way off the pace when its stock declined more than 20% in late July.  The unstoppable FAANG (an acronym from the first letters of these tech giants) trade is not necessarily over, but it looks vulnerable.

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October Investment Comments

Against a backdrop of tariffs, Federal Reserve interest rate increases, and emerging market struggles, the S&P 500 steadily advanced to a new all-time record in late August.  This has now become the longest bull market in history, measuring 9½ years from the low of March 9, 2009.

Common sense would dictate that what goes up must come down.  However, in the long-term the market’s value is a function of corporate earnings growth, and that has been stellar.  According to FactSet Research, second quarter S&P 500 earnings growth was 25%, supported by a 10.1% sales advance.  Analysts expect third quarter earnings to grow 20% and full calendar year 2018 growth of 20.6%.  A one-time event, corporate tax reform has accounted for about half of the earnings increase, but accelerating sales supported by a strong U.S. economy is an ongoing market driver.

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September Investment Comments

U.S. economic indicators appear quite strong and supported an impressive 4.1% annualized growth rate in second quarter Gross Domestic Product.  Underlying growth would have been 5.1% excluding inventory de-stocking; ups and downs in inventories typically correct themselves the following quarter.

Retail sales growth also remains solid, up 6.4% from last year.  After inflation, real retail sales growth is 3.5% and may be a reasonable measure of trendline economic growth.  Consumer optimism, an excellent employment environment, and the impact of lower withholding from last year’s tax cuts suggest spending growth will continue.

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