U.S. Equity returns have been solid over the past five years with the S&P 500 Index, the Russell 1000 Large-Cap Index and the Russell 2000 Small-Cap Index all generating annually compounded growth rates of +14–15% for the past five years. Through three quarters of 2017, the returns have been +14%, +14%, and +11%, respectively. The equity markets have been strong, with sound basis as we’ll detail ahead. In our opinion, risk management is the way forward in equities. With proper sector and position exposure, and a focus on high-quality companies, we still see value in the market.
Value investing lagged growth by a wide margin through 2017’s third quarter. The S&P 500 Value Index’ almost +9% return trailed that of the Growth at +19%, and the Russell 1000 Value’s nearly +8% appreciation similarly fell short of the corresponding Growth’s rise of +21%. This value-lagging-growth phenomenon was evident down the market-cap spectrum: the Russell 2500 Value’s +6% appreciation paled next to the Growth’s +17% return in the mid-cap space, and the Russell 2000 Value’s +6% was less than the Growth’s +17% amongst small-cap stocks. Growth-versus-value trends vacillate over time; the spread in 2017 thus far has been the opposite of that in 2016.
The fact that lower-quality stocks outperformed their higher-quality brethren…is evidence that investors are, on the margin, seeking risk.
The prospect of low-for-the-foreseeable-future interest rates and optimism about U.S. tax reform have pushed up equity indices. U.S. equity fear, as measured by the CBOE Volatility Index (VIX) has ebbed by more than –32% through nine months of the year. The fact that lower-quality stocks outperformed their higher-quality brethren (those rated B-or-worse by S&P returned +10% versus less-than +9% for those rated B-plus or better) is evidence that investors are, on the margin, seeking risk.
Stubbornly-low interest rates and a flattened yield curve play a part in this risk-seeking equity environment. The yield on the 2-year Treasury note ended the third quarter at 1.47% compared with 1.22% at the beginning of the year. At the same time, long-term yields have generally fallen as the 10-year U.S. Treasury yield dipped to 2.33% from 2.44% at year-end 2016. The combined movements have flatted the yield curve, hindering companies like financials and causing some stir among economists.
Stock market and investment pundits yammer that equity valuations are lofty by many measures, but prices don’t appear expensive relative to interest rates, by our reckoning. Absent a credible threat that interest rates jump unexpectedly—an event that Central Banker transparency seems to decry—or a credit-market meltdown of a Lehman scale, we still find value in the market.
Absent a credible threat that interest rates jump unexpectedly—an event that Central Banker transparency seems to decry—or a credit-market meltdown of a Lehman scale, we still find value in the market.
As we look toward the end of the year and expectations for 2018, our conversations with management teams indicate the U.S. economy is grinding ahead. For example, the consumer and industrial electronics cycles remain strong. Industrial production is decent, fueled by what is believed to be a bottom in the oil-and-gas end markets and perhaps a new level of oil stability above $50 a barrel. U.S. commodity production seems to be ramping up, and even previously depressed mining businesses are rebounding. On the financial side, bank-management teams indicate that small and mid-sized business owners’ tones remain guarded about various small-business, end-market growth prospects.
At Silvercrest, we take a bottom-up approach to stock selection, and we seek to outperform in whatever the macro-environment brings. We remain constantly diversified across sectors, limit our exposure to individual positions, and doggedly pursue high-quality investments. Finally, our risk-management process protects us from over confidence.
This communication contains the personal opinions, as of the date set forth herein, about the securities, investments and/or economic subjects discussed by Mr. Vogel. No part of Mr. Vogel’s compensation was, is or will be related to any specific views contained in these materials. This communication is intended for information purposes only and does not recommend or solicit the purchase or sale of specific securities or investment services. Readers should not infer or assume that any securities, sectors or markets described were or will be profitable or are appropriate to meet the objectives, situation or needs of a particular individual or family, as the implementation of any financial strategy should only be made after consultation with your attorney, tax advisor and investment advisor. All material presented is compiled from sources believed to be reliable, but accuracy or completeness cannot be guaranteed.
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