July 29

It’s different this time?

By David Nelson, CFA

Facebook’s (FB) blow up as well as Netflix (NFLX) earlier in the month has investors wondering just how much further we can push the growth trade. Over the last decade the spread in performance between growth and value is off the charts. I’ve never seen it this wide in my career. (Close to 100% over the last decade)

S&P 500 Growth vs Value 10 years

In the last few month’s there has been a near capitulation into large cap growth at the expense of value. ETFs like the S&P 500 Growth ETF (IVW) are up well beyond the S&P 500 this year while its value counterpart (IVE) is at the flat line. Fund flows between the two confirm the move.

S&P 500 Growth vs Value YTD

The cloud, 5G, and AI are all terms that evoke a near Pavlovian response to purchase growth stocks at any price. Before you paint me as a heretic, I love growth stocks too. They represent the future and continue to dominate our spending habits but when everyone moves to one side of the boat accidents happen.

We’ve seen this movie before

It’s not the first time we’ve heard the phrase “It’s different this time.” We’ve seen this dynamic before coming out of the internet bubble in 1999. No one wanted to own anything with a hint of value. REIT and other dividend managers were on suicide watch. REIT yields were 8% but firms like Lehman were selling leveraged products to triple your return in index favorites like (CSCO). Reversion to the mean is a powerful force on Wall Street.

S&P 500 Growth vs Value 2000-2007

For the next 8 years up until the financial crisis Value outperformed growth by nearly 50%. Before you rush out to put on this trade I’ve been wrong on this call before. I made it back in 2014 and it only lasted for about 3 months before growth came roaring back

This is where it gets frightening

The growth and FANG trade has become so popular retail investors and for that matter many advisors have loaded up to the exclusion of all else. It’s not uncommon for me to come across an account that is nothing but FANG, with anywhere from 25-50% in a given security. Security concentration works great right up until the time it doesn’t. All I’m saying is that this growth love fest needs a rest.

Earnings & the FED

We’re half way through earning’s season and already the percentage of firms beating estimates has surpassed last quarter. (60%) We’re tracking 24% year on year growth. Not sustainable but 10% growth for the next few years is. There’s not a lot to criticize in that picture but of course investors are all about “what have you done for me lately.” Every time we get good news like Friday’s monster GDP print, traders sell into it.

If I had to point to one concern it’s the FED. A headline print of 4.1% likely confirms the FED will make good on its pace for normalization. Meanwhile, the yield curve is flashing red.  I think Powell and the rest of the team need to consider that central banks around the world still have funds rates close to zero. That puts enormous pressure on the long end of the curve. Expect nothing from the FED this month but investors we’ll be parsing every word looking for any change in the hawkish rhetoric of the last few months

Trade War – News from the front lines

China has a math problem – China only imports about $130 Billion in goods from the U.S. while their exports to us are anywhere from $350 – $500 Billion. Matching dollar for dollar despite the rhetoric isn’t an option. However, there are other weapons and are already being put to the test. Continued weakness in their currency helps boost exports but in the long run hurts them just as much as it does us. Forget about the goal of making the Yuan a reserve currency.

China Bear Market

If you’re keeping score, US markets are still putting in a respectable year. China is down about 12% YTD and well into bear market territory from the highs last year

If Trump can expand on some of the good news from last week’s meeting with European Commission President Juncker, that could put added pressure on China to at least come back to the negotiating table.

Director of the National Economics Council Larry Kudlow
Kudlow Face the Nation
The press conference that followed showed that at least for the moment the escalation between Europe and the US was on hold. Even this weekend White House Economic advisor Larry Kudlow hinted we may get good news regarding NAFTA.

China is a problem for Europe as well and if the US and our allies can join forces to push back against China’s protectionist game plan, odds of a victory go up dramatically. China is easing everywhere and getting defensive. They’ve cut the reserve requirement for commercial banks and are easing regulatory norms to stimulate credit growth.

The one advantage President Xi has over Trump is time. China thinks in decades. We think in terms of an election cycle. That’s a reality every US President faces. Xi could easily hold off on any negotiations until after the mid-terms. If the House or Senate flips, I would expect him to stick with the tough guy talk