May was a down month: 5 thoughts about strategy and context
It seems the news cycle is having a Chicken Little moment about market turbulence in May. We believe it is constructive to have a perspective larger than just these past 30 days.
- In the first four months of the year the S&P 500 Index was up 17.6%* and the Dow Jones Industrial Average was up 14.0%*. In the month of May, the S&P 500 was -6.6%* and the DJIA -6.7%*. The net result for both is positive, with the S&P and the Dow posting returns through May 31st of 9.8%* and 6.4%* respectively. In a year of modest earnings growth, we did not assume that 17.6% or 14% in four months was a sustainable pace.
- The narrative about trade and tariffs with China has the time frame wrong. This is not a short-term tactical issue that will be resolved with a near term “deal.” Economic competition with China is the front burner strategic issue for the next 50 years, what we are working through now is something akin to the opening moves in a very long-term chess game. This does not get resolved with a trade agreement. Your investment strategy must account for the opportunities and the risks that accompany this long-term issue.
- If the tariffs are enacted, there will be a cost to earnings and economic growth. It is reasonable that the market discounts that risk. In round numbers the potential impact to S&P 500 earnings has been estimated to be around 5% in 2020, and the economic impact has been estimated to be around 0.5% of GDP. The risks are not infinite, but it is realistic that tariffs could contribute to a slower rate of growth. This unto itself is not enough to be the end game to use another chess analogy.
- Post May correction, the market multiple moved to approximately 16.4x consensus estimated earnings for the S&P 500 for 2019**, and earnings growth for 2018-2019 is estimated to be 4.7%**. This kind of valuation and the expected earnings growth are historically unremarkable, while there are expensive pockets in the market, broadly speaking the market does not look overpriced. The outlook for earnings growth this year is modest and begs for critical thinking and selectivity.
- While the economic expansion is likely to continue through this year, incorporating a strategy to manage for cyclical risk is vital for investment success over the next several years. We monitor the relevant data closely and are prepared to make defensive adjustments when the data turns. Blind faith is not our strategy. Risk management will matter much more than it has over the last ten years.
Summary: Long-term investors will want to guard against the impulse to treat a volatile month as the impetus to shift into tactical reaction. View the economic competition with China as a permanent element of the marketplace, do not expect that there is a quick fix to change complex global issues.
Expect the economy to progress, but a modestly lower pace. Think critically about chasing expensive stocks.
Source:*Yahoo Finance; **S&P CapitalIQ
