Companies representing 15% of the S&P 500 market cap reported first quarter results this week. The results: mixed. Earnings were up from one year ago, but forecasts already imbedded this into their prices, creating varied results. Overall, US company earnings are up on average over 15% and sales are up 7% from one year ago. However, Wall Street already expected this. As a result, we experienced some volatility.
The US Stock Market increased by nearly 3% early into the week and quickly erased those gains on Thursday, and continued to drop on Friday as heavyweights Intel and Apple dropped sharply when analysts released downbeat Q2 projections. Over the near-term, markets may remain choppy, given all the economic and political crosscurrents. However, the fading trade fears, strong earnings, and solid economic growth may eventually bode well for equity markets.
Tax Reform – Report Card
Now that the Tax Cuts and Jobs Act has been in place for a few months,
how has it impacted our economy
? Naysayers say this will largely do nothing outside of helping corporations and businesses return more to their wealthy shareholders at the expense of long-term deficits. Advocates say that supply side economics works – when profits go up, capital investment goes up, and wages follow. So, what has happened so far?
- More Investment - In March 2018, the Morgan Stanley Composite Capital Expenditure Index which tracks this data reached its highest level since it started in 2006
- Pay Raises – The average increase in wages as of March 2018 was the highest three-month number since mid-2009
- Faster Growth - The Organization for Economic Cooperation and Development has boosted its forecasts for real U.S. economic growth in 2018 and 2019 to nearly 3% to reflect the impact of the new tax plan. That is nearly one percentage point higher than the forecasted numbers prior to the tax plan
- Dividend Growth – The share of big companies in the U.S. and Europe expected to raise dividends is forecasted to be the highest in at least a decade
From an individual perspective, most estimates still show that your personal income taxes will be roughly $4,000 lower on average, come tax season next year.
Still, with tax planning there is no free lunch and it is far too early to see the long-term impacts. The tax plan is relying heavily on supply side economics that assumes that the increase in economic growth will create larger pools of cash from which the government can tax, albeit at lower rates. Critics still worry the numbers don’t match up and this will result in increased deficits that dig us further into a long-term hole.
Large Growth Stocks may be heated
Eugene Fama and Kenneth French – distinguished scholars and Fama a Nobel Memorial Prize winner – are best known for their research on portfolio theory and asset pricing. In their studies, they found some predictable trends in the stock market. Notably, value stocks beat growth stocks and smaller companies outperform larger companies, over time.
What exactly is a growth or value stock? Largely, it depends on the price you are paying compared to the company’s actual earnings. If you pay a higher price for lower earnings, it is typically listed as a growth stock. Value stocks tend to have much lower price to earnings ratios and pay higher levels of dividends. Think of companies like Amazon as a growth stock and companies like IBM as a value stock.
According to data generated via Morningstar using the Russell 1000 Value and the Russell 1000 Growth indexes for our analysis, we find that in the past 10 years large growth stocks have outperformed large value stocks by roughly 3.5% per year. Additionally, large growth stocks have outperformed large value stocks seven of the past eleven calendar years. Last year was a marquee year for large growth stocks, as they averaged over 30% in 2017, or nearly 17% higher than large value stocks. Of course, past performance is not an indication or guarantee of future results.
What does it mean for investors today? Although it’s impossible to predict whether value stocks will beat growth stocks in 2018, it is important to make sure that the recent success of 2017 did not distort your allocations, giving your portfolio higher levels of exposure to large growth companies. If you haven’t done so lately, we recommend you speak with a professional to review analysis and to provide recommendations to reweight or rebalance your portfolio to an optimal asset allocation. Otherwise, you may set yourself up for higher levels of drawdown risk, should the market go through a sizeable correction.