Weekly Market Updates

Growth has been on a roll. Based on the Russell 3000 style indexes, growth’s 18% year-to-date gain is 14% ahead of value’s 4% advance. Looking further back, this growth outperformance is nothing new. Over the past 10 years, including the entire financial crisis period of 2008 and 2009, growth has outpaced value by about 50% [Figure 1], representing the longest period of growth outperformance since style indexes began to gain a following about 40 years ago. Using Fama-French* data back to the 1930s, before the Russell indexes were created, this is the longest bull market ever for growth stocks. Due to this observation setting off contrarian alarm bells in our heads, this week we discuss the potential for a value rebound.

After years of diminished earnings ended in the third quarter of 2016, European companies have begun seeing sustained growth in their bottom lines. Ultimately, earnings drive stock prices, but the market is always trying to look forward; having strong earnings is not enough if the growth is fully priced in. That is the fundamental question with regard to stock market valuation — what are you paying for future earnings? Solid earnings in Europe are keeping price-to-earnings ratios (PE) static, while PEs on domestic stocks have been rising. This makes European equities increasingly attractive; however, currency remains a concern, as much of the recent performance of European stocks has been due to a strong euro relative to the dollar.

Investors have become increasingly concerned about the escalating North Korean threats, and understandably so. After initially shrugging off the risk, financial markets have shown increased concern over the past several weeks as the threats have become more direct (Guam) and the range of missile tests has increased (over Japan). In the latest development over the weekend, North Korea conducted its largest nuclear test and claims to have a hydrogen bomb capable of being delivered on a long-range missile. While the future of this conflict is very much uncertain, and we are sympathetic to the potential human impact of military engagement, from a market perspective, a look back at past geopolitical and military events offers a reassuring view.

The LPL Research Corporate Beige Book Barometer — our measure of corporate sentiment that reflects an analysis of earnings conference call transcripts — shows that companies remained generally upbeat during the second quarter earnings season. This is hardly a surprising outcome, given actual earnings results were very good and estimates of future earnings held up relatively well as companies provided forward-looking guidance. Earnings call transcripts analyzed took place starting in mid-July extending through the third week of August.

We think it is a good time to consider taking a little risk off the table. Two weeks ago we wrote about how stocks are probably due for a pullback given their steady advance and some of the risks facing markets. This past week (August 16), we slightly reduced equity exposure in some of our model portfolios. By doing so, we acknowledged that those risks had begun to stack up during a seasonally weak period and that the trade-off between upside potential and downside risk, at least in the near term, had become a bit less favorable. This week we discuss some of the details behind that tactical decision and reiterate our positive longer-term view. Disclaimer: Today’s eclipse did not play a role in the tactical asset allocation decision discussed in this report.

Corporate America delivered another outstanding earnings season, with double-digit earnings growth, solid upside to forecasts, and generally upbeat outlooks from corporate management teams. We have been particularly impressed with the breadth of earnings gains and upside to revenue forecasts. Strong earnings continue to provide support for the stock market at elevated valuations, with the potential for more support from a reduced corporate tax rate next spring. Here we provide an overview of the nearly completed second quarter 2017 earnings season.