Our Top Market Takeaways for the week ending July 19, 2019.

Markets roundup

Stock markets around the world continue to wade through murky waters. The S&P 500 is down –0.6% this week as healthy economic data stokes questions about how many interest rate cuts the Fed will actually deliver (good news is bad news these days). In Europe, Germany’s growth rut and the revival of a no-deal Brexit outcome has kept a lid on gains in the STOXX Europe 600, which is unchanged as of Thursday’s close. For Asia, investors are weighing the significance of signs of stabilization in economic activity in China and a lack of clarity on trade talk progress. The MSCI Asia ex-Japan was up slightly (+0.1%) as of Thursday’s close.

Over the next couple of weeks, investors will turn their focus to corporate earnings results. Recall that changes in equity prices are driven by two forces: changes in future earnings expectations, and changes in what the market is willing to pay for exposure to those future earnings (said a different way, changes in valuations). 

Global growth has been weak, and that will weigh on earnings growth.

So far this year, valuations have risen by +18.2%, while stock prices are up +19.5%. In other words, the overwhelming majority of the gain has come from an increase in valuations. As for changes in earnings expectations? They’ve contributed a measly +1.3%, which is a sign that investors have muted expectations for corporate earnings growth in the foreseeable future.

Year-to-date, the S&P 500’s return has been driven by an increase in valuations—not earnings Stacked area chart highlighting the sources of the S&P 500’s return since January 2019. Forward multiples (valuations) rather than earnings increases have helped drive price return of the S&P 500 in 2019.

For the second quarter specifically, our outlook is calling for modest earnings per share growth of +1.0% year-over-year (which is a bit more constructive than consensus expectations, which are calling for a slight contraction). Earnings growth is weak for three main reasons: a shaky economic growth backdrop, trade-related anxieties, and a strong first half of 2018 that’s tough to compare to. The results we’ve seen so far have mostly come from banks and internet companies, and have delivered few significant surprises (save for Netflix, which sank on the back of subscriber growth and retention figures that missed expectations by a long shot). Index level earnings growth is likely to be uninspiring this quarter, but investors already understand that. Global growth has been weak, and that will weigh on earnings growth. As a result, investors have been herding into stability and bright spots. The question for investors is: When should they rotate back into the sectors that have been punished?


Perhaps the best example of investors flocking to stability and shunning cyclical sectors is the dispersion between “low volatility” stocks and “value” stocks. Right now, low volatility stocks are outperforming value stocks by the greatest degree in over 10 years.

Why? Over the long term, earnings growth drives stock prices, but over the short term, “factors” can be just as powerful. Factors are just characteristics that certain securities have. The characteristic that low volatility stocks have is that their price doesn’t move around that much. The characteristic that value stocks have is that they seem undervalued on a price-to-earnings, price-to-book, or price-to-sales basis. Over the last three months, low volatility stocks have outperformed value stocks by over 6%. 

Low volatility stocks are outperforming value stocks by the greatest degree in 10 years Single line chart showing the relative performance of the S&P 500 Value Index vs. S&P 500 Low Vol Index. Since the start of 2018, Low Vol has been consistently outperforming the Value Index, not outperforming to the greatest relative degree in the past 10 years.

So do we think it is time to rotate from safety to value? We aren’t convinced yet. First of all, valuations are a function of the discount that investors are applying to future earnings streams. When risks to those earnings streams rise, investors have to discount them more, which results in lower valuations. Therefore, “value” stocks tend to be concentrated in sectors that have more variable earnings prospects because of their exposure to cyclical parts of the economy (Financials, Automakers, Energy and Airline stocks are stalwarts in value indices). While there may be some convergence between value and low volatility, we don’t believe that a reacceleration in the cyclical parts of the economy is very likely in the near term. Therefore, we would rather barbell the Technology and Communication Services sectors (which have what we believe to be sturdier growth characteristics) with the more defensive Consumer Staples and Healthcare sectors, while we continue to watch for developments in the macroeconomic backdrop.


We would love to know, and apparently so would over 1.7 million other people who RSVP’d “yes” to an online invitation to an event called Storm Area 51, They Can’t Stop All of Us. Before you start gathering your spacesuits and tin hats, we’ll note that the event is nothing more than a viral internet gag meant to bring a smile to earthlings’ faces. That said, the hype around the event has reportedly generated enough interest to cause hotels near Area 51 to sell out, and coaxed a response from the U.S. Air Force, which said that it is “ready to protect” the military base. No word on whether a certain Nevada-raised author is making a trip home for the event…

All market and economic data as of July 2019 and sourced from Bloomberg and FactSet unless otherwise stated.

We believe the information contained in this material to be reliable but do not warrant its accuracy or completeness. Opinions, estimates, and investment strategies and views expressed in this document constitute our judgment based on current market conditions and are subject to change without notice.


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