Goldman Sachs says this is an annus horibilis for professional money managers. It might not be so great for regular investors, either.
As the first full week of May began on Monday, the S&P 500 had eked out a gain of 1.81 percent on the year. Yes, all the noise, turmoil and anxiety in the markets the past four months has left us less than 2 percent higher.
Somehow, reminding ourselves that it could have been worse – that as of the end of January, the benchmark index was more than 3.5 percent in the red – doesn’t serve as much consolation, especially if you were counting on U.S. stocks to deliver at least a respectable follow-up to last year’s impressive rally. It doesn’t help to know that Chinese equities are down more than 7 percent so far this year, leading emerging markets funds to a dismal to flat performance.
Like the weather in the northeastern U.S., where temperatures remain unseasonably cool and spring stubbornly refuses to fully materialize, you can’t help feeling that it really shouldn’t be like this.
And the folks at Goldman Sachs would probably agree with you.
“For many equity portfolio managers the calendar is turning into an annus horribilis,” the firm’s equity strategy team wrote in a note to clients on Friday, with a third of the year now over. The benchmark returns – those on the S&P 500 and other big indexes – are bad enough. Worse still, they note, is the fact that nearly 90 percent of large-cap growth and value fund managers are doing even worse, while a typical hedge fund is losing money.
The outlook, according to Goldman’s strategists, isn’t much brighter: Their 12-month target for the S&P 500 is 1,950 — a potential return, they note, of just 4 percent.
Goldman’s David Kostin doesn’t come right out and say that the markets are behaving in an irrational fashion, but he points out some important oddities. Consider the release of last Friday’s employment data, when the Labor Department announced that an astonishing 288,000 new jobs were created during April. That blew the economists’ forecast figure – 218,000 – out of the water, and was the highest figure recorded in years.
Logic suggests that the stock market would celebrate, right? Especially given that it hasn’t budged much in the last month. Theoretically, the labor report’s signal of surprising economic strength should have given investors confidence that the current stock market valuation (closer to 16 times earnings than 15) is reasonable. Nope. The market was little changed, and 10-year Treasury prices stayed at 2.6 percent. Clearly fear or anxiety remain at the forefront.
We’re caught in the kind of market that only the most agile of traders can love. It is one characterized by rapid shifts in direction, a lack of clear leadership, inconsistent economic data and general confusion about what’s going to happen next. In other words, it favors those who are willing and able to take short-term positions and switch them at a moment’s notice.
First and foremost, there are far too many sources of anxiety all battling for investors’ attention, and all of them came to a head in April. In spite of the robust job creation numbers, there remains tremendous uncertainty about the economy.
The winter’s deep freeze meant that the initial estimate of first-quarter U.S. GDP growth was a measly 0.1 percent.
Global news continued to be bearish. Saber-rattling in the Ukraine borderlands intensified over the course of April, while China’s economic picture grew bleaker still.
First quarter earnings were, ahem, underwhelming. As has become the pattern, expectations started off high toward the beginning of January, when companies opened their books for the quarter, and gradually were talked down as the weeks progressed. Whether it was because of the weather or other factors, the results were unspectacular. Profit margins, as Goldman Sachs noted, are likely to remain stuck in the same range 8.8 percent or 8.9 percent range as last year. That will mark the third year in a row in which margins haven’t budged.
What is changing, however, is the market’s leadership. The Federal Reserve is slowly bring to a halt its third and final wave of quantitative easing. That is helping to direct investors’ attention to different kinds of stocks: energy, materials, bigger pharmaceuticals, technology companies and industrials.
These are the businesses that tend to do better in the later stages of an economic recovery, and that’s what the Fed is telling us – via the taper – we’re in right now. In contrast, there was a lot of bloodshed earlier in the month among the high-growth, highly valued, riskier (and sometimes smaller) companies that tend to be prized for their ability to deliver growth in the earlier stages of a recovery.
Even so, the broader index has fared better than the headlines might have suggested. For instance, Howard Silverblatt, senior index analyst at S&P Dow Jones Indices, notes that while 41 of the S&P 500 companies have fallen 10 percent or more this year, 110 companies have managed to post a gain of at least 10 percent. (Chesapeake Energy managed to post a gain of 10 percent during the month of April alone, an impressive feat.)
Suck it up, suggests Michael Wilson, chief investment officer at Morgan Stanley Wealth Management. (Well, he uses significantly more diplomatic language, but that’s the gist of his argument in a recent article written for the firm’s clients.) “We think these changes in leadership are normal and an indication of an economy moving into a more mature growth phase,” he notes.
Besides, quite frankly, what are your options? Emerging markets? As already noted, China is going to continue to be a major drag on one part of that universe, and Russia will be on another. Commodities? Without a clear pattern of global economic growth, all you’d be doing is speculating that some kind of shortage spurs a price spike. Not the safest way to generate investment returns, as opposed to trading profits. Bonds? With the Fed tapering, we’re in uncharted territory. Sure, there may be some room to run, but by and large the segments of this market that are most equity-like (and least vulnerable to interest-rate moves) are also most overvalued.
There may be some interesting spots to pick up exposure outside the United States – Japan has been a big laggard this year, although what is unfolding, policy-wise is a long-term tale. But like the weather – the spring that still feels too much like the last blast of winter for many of us – April’s stock market performance may be something we want to grumble about briefly and then try to forget. The more we let it affect our long-term decision making, the worse off we may find ourselves – as too many traders have discovered.
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