The S&P 500 gave up just over 4% during September. Though not even halfway to an official correction, the ups and downs of the last month have a few eyebrows raised. This is particularly true against the backdrop of one of the quietest summers on record. Over the course of the month, the market has been wrestling with a growing list of economic and policy concerns. The delta wave, labor shortages, supply chain bottlenecks, and waning consumer confidence have dragged down expectations for economic growth and given rise to fears of stagflation. At the same time, the market has had to digest a near-constant stream of developments out of Washington as Congress works to pass a budget, raise the debt ceiling, and negotiate infrastructure and a large fiscal and tax package. All things considered, the market has held up well. In fact, looking under the surface, we are seeing some green shoots of an improving economy.
The action in the S&P 500 has been a bit misleading in terms of broader market performance. We must remember that the index is heavily concentrated in just a few tech, communications, and discretionary growth companies. The average stock entered a soft patch several months ago as delta picked up steam. In fact, the average stock in the S&P 500 had already corrected by more than 10% from highs by mid-month. Much of the market looks washed out with the delta slowdown already priced in. The stocks levered up to reopening had subtly been improving over recent days and caught a nice bump on Friday from Merck's Covid antiviral announcement. The so-called "value" stocks appear to have some room to run with delta finally slowing, consumer prices continuing to rise, and interest rates turning higher.
On the other hand, we may just be in the early innings of the "growth" correction. In the middle of the month, the yield on the 10-year US treasury abruptly turned higher. Growth stocks have struggled when rates have moved up this year. This is because a higher interest rate raises the discount rate on a company's future earnings. For growth companies, much of their value is tied to future earnings, and so changes in the discount rate are quite meaningful at the margin. If delta is, in fact winding down, we could see inflation concerns resume and push the 10-year rate back towards 2%. Again, this is good for value stocks at the expense of growth stocks.
Another potential green shoot is a fiscal and tax package that is looking watered down from its earliest iterations. Moderate members of congress are making headway in cutting the size of the proposed bill roughly in half. This means that some of the more drastic provisions in terms of taxes, spending, and regulations are likely to be softened. We still expect that some of these things will get through, but on a relative basis, it is shaping up to be marginally more favorable to the companies.
The negotiations have a long way to go and could cause more bumps in the road, but we remain focused on the bigger picture.
1. Stocks remain the best, and we believe, in many ways, the only option for investors seeking real returns.
2. Companies have adjusted to and thrived in a variety of environments. We expect the future will be no different and that companies with an intense focus on their long-term strategic goals will ultimately be successful
3. Right now, management teams are focused on driving efficiency through their organizations. We think productivity is a great untold story and can have a significant impact on earnings growth in the years ahead.
Preston May, CBE®
This report was prepared by Donaldson Capital Management, LLC, a federally registered investment adviser under the Investment Advisers Act of 1940. Registration as an investment adviser does not imply a certain level of skill or training. The oral and written communications of an adviser provide you with information about which you determine to hire or retain an adviser. Information in these materials are from sources Donaldson Capital Management, LLC deems reliable, however we do not attest to their accuracy.
An index is a portfolio of specific securities, the performance of which is often used as a benchmark in judging the relative performance to certain asset classes. Indexes are unmanaged portfolios and investors cannot invest directly in an index. An index does not charge management fees or brokerage expenses, and no such fees or expenses were deducted from the performance shown. Past performance is not a guarantee of future results. The mention of specific securities and sectors illustrates the application of our investment approach only and is not to be considered a recommendation by Donaldson Capital Management, LLC.
S&P 500: Standard & Poor’s (S&P) 500 Index. The S&P 500 Index is an unmanaged, capitalization-weighted index designed to measure the performance of the broad U.S. economy through changes in the aggregate market value of 500 stocks representing all major industries.