Monthly Markets Memo - August 2017
by Dan Zalipski, CFA & Scott Rosenquist, CFA
U.S. Equity indices declined over the past month as negative headlines continued to fuel uncertainty in the U.S. markets. Events related to healthcare legislation, geopolitical tensions on the Korean peninsula, and doubts surrounding President Trump’s agenda all contributed to the decline in U.S. equities over the past month. Smaller company stocks were hit harder than the larger companies - more on that below.
International equities however, held up noticeably better than their U.S. counterparts, yet still declined over the past month. Fixed income produced mixed results. Higher quality sectors rallied as investors sought safety, with the biggest moves corresponding to the tension surrounding North Korea. The higher yielding and below investment-grade issues declined slightly, yet remain positive on the year. Commodities were flat, yet volatile as the price of oil continues to fluctuate in the mid to high $40 range.
Small Companies Seek Clarity
Small publicly traded U.S. companies were expected to be one of the biggest beneficiaries of President Trump’s agenda. The sector, represented by the Russell 2000 index, surged approximately 17% between election night and the end of 2016. By comparison, the S&P 500, representing the largest companies in the U.S. rose roughly 7% in that same period of time. The events over the past month seem to be casting a shadow of doubt throughout the market as investors begin to question if the highly anticipated agenda will ever get on track.
With the failure to repeal the Affordable Care Act, heated words and threats between North Korea and the U.S., civil unrest at home, and a new wave of terrorist attacks in Europe, it’s no surprise investors are questioning what may lie ahead. Nowhere is this more evident than within those small publicly traded U.S. companies. The sector has given up almost 6% since peaking in late July, and is barely holding in positive territory for 2017. The S&P 500 is slightly positive over the past month, yet is firmly in positive territory with a 9% gain for 2017.
Much of this divergence can be explained by two things: earnings and forward-looking expectations. On the earnings side, small companies delivered slower growth compared to the larger companies. The larger companies have also benefited from having a higher percentage of their revenue generated in international markets. The international markets have delivered higher growth rates than the U.S. this year, and a weaker dollar is further enhancing those overseas profits. Looking forward, smaller companies appear to have a rough road ahead of them compared to their larger counterparts. In addition to rising input and labor costs putting pressure on their profits, investors are concerned that the tax reform efforts expected to boost those small companies may be out of reach in the near-term. Larger companies, for now, should continue to benefit from their broader exposure which helps reduce the impact from some of the uncertainty at home.
The U.S. equity markets have been experiencing historically low volatility this year. As of this writing, only 8 of the 162 trading days thus far in 2017 saw the S&P move more than 1%. By comparison, 2016 saw the S&P move 1% on 47 of its 252 trading days. Investors across the marketplace have begun to brace for an expected increase in volatility as the bull market trudges along.
Economist Hyman Minsky argued that extended periods of low volatility results in volatility moving higher. The relative stability in the markets can lead to complacent investors. This leads to buying riskier assets and an increase in the use of leverage to enhance returns. When volatility spikes and the market declines, those investors often find they cannot stomach the extra risk, and move to liquidate the assets. The excess selling can add fuel to the fire, so to speak, increasing volatility further. At this point, investors mostly agree that it’s not a question of if volatility will return, but when.
Have a well-thought financial plan that is not dependent upon correctly guessing what will happen in the future.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendation for any individual. Although general strategies and / or opinions are revealed, this post is not intended to nor does it represent or reflect transactions or activity specific to any one account. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. All data and information is gathered from sources believed to be reliable and is not warranted to be correct, complete or accurate. Investments carry risk of loss including loss of principal. Past performance is never a guarantee of future results.