February has kept investors on their toes. Just before the month began, Amazon, Berkshire Hathaway, and JP Morgan Chase announced their entrance into the Healthcare Market. The S&P 500 Healthcare Sector traded down 12% after the news broke. In February, the VIX (volatility measurement) climbed 176% and then fell off sharply to end the month at a more normal level. The S&P 500, Dow Jones, and Nasdaq were all down more than 8% for the month by February 8th, but ended the month down 3.6, 4.1, and 1.4 percent respectively. And just when things seemed to be settling down, on March 1, 2018 Trump announced that he would be placing a 25% tariff on imported steel and a 10% tariff on imported aluminum, causing some to fear a trade war may be brewing and the markets to fall over 1% that day.
With all of this going on, by February 8th, 2018, 64% of the S&P 500 had reported their earnings, and reported earnings growth was a robust +14.7%. The companies that reported also reported average revenue growth of +8%. By March 1st, 2018, 95% of the S&P 500 had reported earnings, and the average earnings growth increased to +15.2%, with revenue growth increasing to +8.2%. In addition to this data, U.S. Industrial Production continued to expand. New Orders for Durable Goods in the U.S. increased, the Philadelphia Fed¹s Future Capital Expenditure Index climbed, Wages grew at 2.9%, Consumer Confidence moved up over 5%, and the total level of workers voluntarily quitting their jobs increased (those who quit voluntarily usually do so to take a better job).
The headline news and volatility seemed to be telling a different story than the underlying fundamentals were. Looking at the flow of money into and out of equities as reported by the Investment Company Institute (ICI) shows in the two weeks immediately preceding the market¹s selloff, the estimated total flows into U.S. Equity Mutual Funds and ETFs was $17.4 Billion. From February 1st through February 7th, 2018 (with volatility picking up), there was a dramatic increase in outflows, with $37 Billion leaving that week, and $49.5 Billion leaving through February 21st, 2018. With the S&P 500 up 1.9% since February 7th, the data seems to indicate those investors who sold out in the first week of February may have done themselves a disservice.
History has shown that those who are most successful in the markets DO NOT time them. The ICI¹s data from January and February illustrates the frequently experienced misfortune of those who do time the markets. We like the quote from Benjamin Graham (considered by many to be one of the greatest investors in the last 100 years), which says, ³the stock owner should not be too concerned with erratic fluctuations in stock prices, since in the short term the stock market behaves like a voting machine, but in the long-term acts like a weighing machine.² Essentially, what he is saying is that it can be difficult to predict and understand erratic short-term stock movement, but in the long run, the true value of the stock becomes much more precise. It is ultimately the earnings, the quality of the earnings, and the growth of the business that will determine its long-term price.
Despite current volatility, we continue to have a favorable view on equities. Valuations continue to look reasonable, growth expectations continue to look attractive, and global economic conditions continue to be supportive of expansion. It also appears long-term interest rates are stabilizing. The rate on the 10-year Treasury increased over 44% between September 2017 and February 2018, but over the last two weeks rates have begun moving back down. We continue to expect the Fed¹s rate increases to cause a flattening of the yield curve rather than a sharp increase in long-term rates.
