Dear Clients and Friends of Insight,
Summer has come and gone and we begin the final season of the year. Stock markets throughout the last several months have been pretty tame, especially compared to earlier in the year. Recall that stock prices declined considerably in January and February, stoking investor fear and uneasiness. What followed, of course, was a surprisingly strong rally through the spring which erased the year’s early losses. This reinforced for investors the supposed wisdom of the expression “sell in May and go away”. This strategy is founded on the idea that summer months can be more volatile than other months, and that September and October have historically been the worst months of the year for stock performance.
What we experienced since May, though, was mostly a quiet market that advanced gradually throughout the summer leading to modestly positive year-to-date results for the major indexes. We suspect the reason for calm was that investor expectations were already very low due to the continuation of sluggish U.S. and global economies, undercutting corporate earnings growth for many quarters. The fourth quarter still awaits, but so far this year we have been very pleased with the strong performance of client portfolios. Insight’s recommended equities declined less than market indexes to start the year, and also participated broadly in the market’s advancement through the spring and summer.
The onset of the final season of the year means another quarter of corporate earnings reports for Wall Street analysts to read and analyze. This four-times-per-year exercise is an enormous increase in work and stress for the investment community as they learn how earnings results compare to prior expectations and recommendations. Were expectations met? Or, was there a positive or negative “surprise”? Unexpected results can potentially lead to a substantial move in the stock price as investors recalibrate their future expectations.
We monitor the earnings reports of our investment recommendations very closely, as well. Specifically, in the table below, we tabulated the second quarter’s earnings per share (EPS) results for the 50 companies that were most widely owned in client portfolios.
|EPS RESULTS||NUMBER OF COMPANIES||% OF COMPANIES|
|In-line with Expectations||5||10|
Although there will always be some disappointments, reported results for our investment recommendations were exceedingly positive relative to expectations, and that has contributed to our strong performance results this year. We are optimistic that results for upcoming quarters will be similarly strong.
One quarter’s earnings numbers can provide some confirmation that results are on track, but we don’t believe they provide enough predictive information to determine a company’s ultimate long-term success. More importantly, we must understand what progress a company has made toward achieving their longer-term goals for growing sales and profits. As part of our research process, we develop an investment rationale which establishes three or so expectations for various business factors which we believe are most important to determining success. These factors commonly relate to a company’s market share, operating cash flow or balance sheet. Evaluating results for these variables, often reported well beneath the headline EPS results, is critical to validating or challenging our expectations for success with all of our investment candidates.
Speaking of candidates, let’s turn to the election. We share here some statistics compiled by Argus Research Company and the likely (or unlikely) impact the election may have on the stock market. For the 71 years between 1945 and 2015, a Democrat has held the Presidency 35 years and the S&P 500 stock index has increased, on average, 10.2% per year. For the 36 years that a Republican has held the Presidency the S&P 500 stock index has increased a mere 6.2% per year – a clear advantage for the Democrats.
However, results tell a different story if we include which party controls the Senate and House when categorizing each year as Democrat or Republican. When Democrats controlled two or more of the Presidency, House and Senate, then the average increase in the S&P 500 stock index was 7.7% per year, while it was up 9.2% per year when two or more were controlled by Republicans. Regardless, every year is different and we remind ourselves to be cautious of historical comparisons.
Our assessment of market conditions looking into 2017 is similar to that of prior quarters. Interest rates are likely to remain low both in the U.S. and around the globe. Earnings results should best those of 2016 as economic growth is likely to continue, but slowly. The impact from a strong dollar and a contracting energy sector is behind us, while labor and commodity costs should increase only modestly. Stock market risk is elevated, though, due to higher valuations, because company fundamentals did not improve enough to justify the rise in stock prices for many companies. For patient and selective investors there remain good opportunities particularly in technology, health care and select consumer companies.
Please let us know if you have any questions or concerns. We look forward to speaking with or meeting with many of you over the next several months. Thank you for your continued confidence and support.
INSIGHT INVESTMENT COUNSEL