The stock market suffered large drops in August and September. The S&P 500 was down -5.3% for the year.
3rd Quarter Results:
Several events, both international and domestic, contributed to a turbulent market.
At the beginning of the quarter, investors were actively discussing the possibility of Greece leaving the Euro currency, and markets were convinced the Federal Reserve would be raising interest rates in September. Rated were not raised. However, Greece meekly accepted the German-led bailout package and all eyes shifted east as concerns increased about China’s economy.
A surprise, although modest, devaluation of the yuan currency helped trigger a sharp drop in global equity markets in late August with the S&P 500 falling -12% from its high reached in July. The S&P then bounced back briefly from its August 25 low but dropped an additional -2.5% in September, ending the quarter down -6.4%. This marked the first negative quarterly return of the index since 2012.
On the homefront, health-care stocks fell more than the overall market during the quarter, down about 11%. This was particularly marked in the biotech section of healthcare. Analysts attribute the slide to a larger problem of growing political hostility to drug research and development. Presidential candidate Bernie Sanders and House Democrats send a letter to Valeant Pharmaceutical threatening a subpoena and demanding the drug maker justify price increases for two heart rhythm medications. Valeant share dropped 17% in one day.
Hillary Clinton rebuked price gouging and promised to introduce price controls on pharmaceuticals. Enthusiasm for such central planning is rising among Democrats and even some Republicans on Capital Hill.
4th Quarter Outlook:
The stock market has made a recovery from the bad results of the 3rd quarter. The market is up almost 5% since September 30th. One of the prime reasons may be only temporary. Investors, concerned about a rise in interest rates, were pleased that nothing happened in the 3rd quarter. In theory, the Federal Reserve did not raise rates because inflation, at about 1.8%, is below the Fed’s target of 2.0%. The real reason for this inaction is probably that the economy remains somewhat subdued. If the economy picks up, it is likely that rates will be raised, perhaps in December.
Profits for S&P 500 companies slipped 0.7% in the second quarter from a year earlier. This was the first decline since the third quarter of 2012. Profits are expected to fall in the 3rd quarter by 4.5%, which would be the first time since 2009 that earnings fell two quarters in a row. However, it has to be remembered that the culprit for these drops is the oil sector.
The price of oil has dropped from over $100 bbl. to less than $50 bbl. over the past year. This has obviously put a strain on oil profits. Oil company earnings are expected to be down 65% in the third quarter compared to last year. Taking out the oil sector, earnings would rise by 3.4% for the past quarter which is not great but not negative.
Strategists expect that we will have a rally in the 4th quarter. This is due to the fact that signals of a U.S. recession have not materialized. Expectations remain for a modest but healthy 2.5% annual rate of increase for the domestic economy. Unemployment is at its lowest level since early 2008. Consumer spending, a major growth driver, is picking up. Growth stocks, shares of companies that tend to reinvest earnings into expanding the business instead of paying out dividends, are also faring better than the broader market. This suggests that many investors still believe that the economy will accelerate. Estimates for the year-end value for the S&P 500 come in at 2177. That is about 180 points higher than current values. This would mean that this index would climb by about 8% for the year which is quite good.
The Firm's Strategy:
While many client portfolios went down 3rd Quarter with the rest of the market, they continued to outperform the major indices.
As indicated above, healthcare stocks suffered more than the broader market in the 3rd quarter. Many portfolios contained the Vanguard Healthcare fund which declined, but was down 9% compared to the industry’s decline of 11%. This was in part due to the fact that the fund was invested only 14% in the biotech area, the sector that suffered the biggest losses in the past three months. The Vanguard Healthcare fund was still up +3.7% through September, which helps explain why most portfolios held up better than the market. In addition, bonds were positive in the 3rd quarter as a result of investors moving dollars into safer areas other than equities. The GNMA fund which many clients own was up 1.4% for the year.
We sold a portion of many clients' equities in late August to protect the portfolio from the risk of a large drop. We will reinvest these dollars based on market conditions.
Overall, clients portfolios remain safe. We have a portion of the portfolio in money markets, bond funds, and healthcare which is a solid base for protection. We are optimistic that the market will continue to recover and be positive by the end of the year. ~ Bruce A. Kraig, MBA, CFP
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