Market Digest 3.13.19

The Gap Between Cheap and Expensive

Last week's pullback notwithstanding, the stock market has staged a strong comeback since its drop last December. The S&P 500 had its best two-month start to a year since 1991. However, value stocks - companies with solid fundamentals that are priced below those of its peers - seems to have missed the rally. According to AB Bernstein, this year, value stocks lost 1.04% through the first week in March, versus the S&P 500′s more than 11% gain. Cheaply priced stocks are getting cheaper as expensive stocks have gotten extremely pricey. That has pushed the valuation gap to its widest point in 70 years (see first exhibit below).

What's driving the market? Growing optimism over a potential trade deal with China, and the Fed's willingness to pause interest rate hikes have been the main drivers of the gains. Some observers have thus argued that the market rebound is not fundamentally driven, as earnings and growth expectations have come down. Deutche Bank's chief international economist noted earlier this month that, “Either markets have to come down to where growth expectations are, or growth and earnings expectations have to move higher to justify current market valuations.” Where does that leave value stocks? Since 2006, value has lagged as investors rushed to growth or low-volatility stocks (see second exhibit above). The rationale was that cheap stocks are cheap for a good reason. But growth and value stocks historically rotate leadership and with the dispersion of valuations so far above historical norms, an inevitable reversion to the mean will push low valuations upward.

Market Update

A mixture of discouraging data, global news and technical drivers led to profit-taking last week and all major equity indexes were down. The US Department of Labor reported job growth of only 20,000 in December - well below expectations and the smallest increase since September 2017. The European Central Bank cut its growth forecast for 2019 to 1.1% and announced it would keep interest rates unchanged through at least the end of the year. The S&P 500 Index slipped below its 200-day moving average, a threshold that some technical traders and analysts watch closely. Utilities and real estate stocks held up best last week while energy and industrial stocks were among the worst performers.

Economic News

Employment Report As mentioned above, the headline jobs report number last week was disappointing - just 20,000 nonfarm payrolls were created in February. However, the payrolls data is just part of the story.   A 2 tenths decline in the unemployment rate to 3.8% and a 2 tenths rise in average hourly earnings to 3.4% (as highlighted in the chart above), offer evidence of continued strong conditions in the labor market.  And although construction and retail jobs were down last month, demand jumped in professional and business services. There was also a rise in temporary workers which shows employers are scrambling to build up their staffs.

Tailing Off Pure dumb luck may play more of a role in money management anyone wants to admit. Analysts at S&P Global recently examined the returns of more than 2,400 investors. Unsurprising to us, less than a third were able to beat their benchmarks in the three years ending September 2015 on an after-fee, annualized basis. Even those that were able to initially deliver alpha failed to extend their winning streaks in subsequent years. To see if cyclical market conditions might have skewed their results, they redid the calculations using a rolling quarterly average. Using that metric, outperformance persisted in the first year but declined dramatically thereafter. Their advice? Picking managers based on past performance is not a wise strategy.

The Water Cooler

March Madness Get your brackets ready! Selection Sunday - when the selection committee announces all 68 tournament teams - is this weekend. Play-in games start two days later and the final four / national championship game will be played in Minneapolis on April 6 and 8. Brackets will be posted on sports sites like ESPN and CBS Sports as soon as the field is set. As you probably know, your odds of filling out a perfect bracket are not good. In fact, they are lower than your odds of winning the lottery, getting struck by lightning, and having a boa constrictor emerge through the pipes in your toilet all on the same day . Your chances of nailing every pick are 1 in 9.2 quintillion! But no matter, even if you only win a few bucks off your friends or coworkers, or if you loyally pick your alma mater only to lose it all, filling out your bracket is part of the fun. Besides we all know who the real winners are: beer and pizza companies. According to  Wallethub , American beer companies produce an average of 14 million barrels a month, but that number will bloat to somewhere between 17-18 million barrels in March. Pizza orders also increase by 19%. Good luck! 

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