The temperatures in Alabama weren’t the only thing that was hot during the notoriously scary month of September, as equities posted their best September in nearly 71 years. Much of the strength came during the second half of the month on better-than-expected economic news which beat back worries about a double dip recession. With an unexpected drop in initial jobless claims and good reports on personal income, consumer sentiment and more mergers and acquisition news, investors jumped back into the equity pool head-first and turned September into one barnburner of a month to say the least.
Equities were up sharply for the month of September as the Dow Jones Industrial Averages was up 7.7 percent; the Standard & Poor’s 500, up 8.8 percent; the Nasdaq, up 12.0 percent; and the Russell 2000, up 12.3 percent. And as we’ve already mentioned, the month posted the largest net gain for a September in 71 years.
However, with all of the excitement over the past month, stocks were looking somewhat “toppy,” so when all of the shouting was over, we found that the last week of the month was somewhat of a downer. On the last week of the month, the Dow ended lower by 0.28%, and now rests at a level of 10,829.68. The Nasdaq fell 0.44% this past week and is presently at the 2,370.75 mark. This also happened to be the Nasdaq’s first down week in the past five. And the S&P 500 fell by 0.21% to 1,146.24. Meanwhile the smaller-cap stocks continued their recent tear as the Russell 2000 rose 8.28 points or 1.23% to 679.29.
In addition, stocks had a decent third quarter, despite a rough ride throughout the summer months. Thanks to the September boost which more than offset August’s precipitous drop, the Dow was up 10.4 percent for the quarter; the S&P 500 , up 10.7 percent, the Nasdaq, up 12.3 percent; and the Russell 2000, up 10.9 percent. However, on a year-to-date basis, those figures are much more tepid. For the year-to-date tallies, the major indexes are as follows: the Dow, up 3.9 percent; the S&P 500, up 2.8 percent; the Nasdaq , up 4.5 percent; and the Russell 2000, up 8.6 percent.
Thus with the market experiencing one of its best months in history, it’s tempting to get caught up in the emotion of such a big rally and go whole-hog long. However, keep in mind that fears of a double-dip recession are by no means forgotten. The current puzzle facing investors is whether to hop aboard the stock market train rally and hope for greater gains? Or, take their profits now? As we all know, the historical track record for stocks in October can be rough and loaded with drama, so it might by helpful to survey the current economic landscape and attempt to figure it out.
On the bullish case, the best reason for the market to continue higher is based upon the earnings outlook. The current earnings estimates for the S&P 500 are about $94 for next year. That is only a P/E of 1.2, which is historically below average. Once could easily see that climb to 14 or so without any fear of being overvalued. Now consider the earnings yield of the market versus the risk free rate in the 10-year Treasury. The earnings yield on the S&P 500 stands at 8.2%, which is an incredibly attractive return versus the 2.6% for the 10-year Treasury. And although there are other reasons to be bullish, none are stronger than these two, so let’s leave it at that for now.
On the bearish side of this case, the economic recovery is certainly not as strong as expected at this stage. With the most recent quarterly GDP coming in at only +1.7% growth, the majority of the recent economic data is either showing a leveling off of activity or a modest decline. Many economists point out that this is a classic “soft patch” in the midst of a normal recovery. Unfortunately, economists have a terrible record of predicting changes in direction for the economy, so the fear is that this soft patch devolves into a double-dip recession.
Thus the debate between the bears and the bulls will continue to march on as we close out the year. The takeaway here is to be mindful that the market may turn at any time. That turn of events may be for the better, if earnings really do come in more like $94 or greater for the S&P 500. Yet it may also turn for the worse. So the most prudent strategy would be to hedge your bets with a blended portfolio of large caps and small-caps with strong balance sheets and high dividend payers, along with some alternative investments. (That’s exactly what we’re doing here in our portfolios at Money Management Services, Inc.) However, bear in mind that we’ll be ready to change that “tack” should the preponderance of the evidence dictates.
With respect to the bond market, with more indications that the Fed could embark on another stimulus put the prospect of an eventual increase in short-term interest rates still further out into the future. The key two-year note ended the week at a yield of 0.422%, down from 0.444% the previous week. Farther out on the yield curve, the benchmark 10-year Treasury note yield continued to recede after ticking up in early September. The 10-year note yield dropped on the week to 2.513% from 2.609% the previous Friday. Unfortunately, ultra-low interest rates have unintended consequences when you consider that savings on mortgages are offset by lower returns to savers.
This week will give important indications as to the course of the economy. Third quarter earnings season kicks off with Alcoa’s report after the markets’ close on Thursday. The discussion of the future outlook will obviously play a big role in shaping investors’ expectations for the rest of the year. The key event this week will obviously be the September employment report, with consensus forecast calling for unchanged non-farm payrolls, including the layoffs of 75,000 temporary census workers. The jobless rate could tick up if more discouraged workers re-enter the labor force. In addition, this will be the last employment report before the November elections, so the numbers will be even more politically charged than usual.
Here’s hoping that the markets continue northward as we enter the month the notoriously difficult month of October, but keep in mind that all of us here at Money Management Services, Inc. will be doing everything possible to keep our portfolios ‘righted’ as the month unfolds. Until next time!
Sources: Barron’s, The Wall Street Journal, The New York Times, The Financial Times, Bespoke Investment Group, Zacks Research