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Focus on the Fundamentals


With the selloff in the markets yesterday, many are questioning if this is the start of something bigger or another dip in the longer run upward. What might have confused the matter more for investors was the myriad of potential causes for the selloff. The culprits were the usual suspects, Federal Reserve and their hiking rates, the Producer Price Index rising, softening economic numbers outside of the United States, trade tensions rising to trade wars and rising short-term yields in high grade debt that is competing with money flows into risk assets.

The biggest sell off occurred in the Nasdaq Composite which was up 17.42% through the first three quarters, is now up 8.21% for the year. Over the last 30 years, the average annual return in the Nasdaq Composite is 10.99%, which is near where it is annualized currently for the first three quarters. Compare that to the S&P 500 which has had an annualized total return of 9.11% as has the Russell 3000, which covers 98% of all investible domestic equities. With the extra 20% return one would naturally assume volatility would be higher. The standard deviation of total returns in the Nasdaq is 46% higher than that of the S&P 500. In layman terms, to achieve a rough 2% annualized return, you must be willing to withstand 46% more volatility.

In the last three decades, regarding the Nasdaq Composite, there has been 113 months where the close for the month was a correction of 5% or lower. That is 31% of the time and the average close for those months was a correction of 9.8%. Coincidentally, the intraday low yesterday from its recent high was 9.4%.

While there are some pressures to be cognizant of there are also some fundamentals that should be driving the decisions whether to buy this dip or sell into it.

The GDP estimate for the third quarter should come in around 3.00-3.50%. This could vary a bit due to the impact of natural disasters on the short run. Looking ahead, if one looks at the Federal Reserve Atlanta Bank’s GDP 4th quarter estimate, it is running at 4.20% currently. This is a highly volatile and fluid number and has typically run high in the initial stages of the quarter but is still pointing to more pronounced growth.

The discussions about the Federal Reserve getting too hawkish, should look at the trend of raising rates relative to the five previous cycles. The rate of change is running at a much more anemic level than those in the past, and that is considering it is coming from an all-time low set in the Fed Funds Rate where it stood at 0% for nearly seven years. You will also notice that the Federal Reserve Wage Trend forecast as it is compared to the Fed Funds rate has risen dramatically and looks to remain high for some time. While this can impact margins, it also impacts top line revenue numbers as it increases disposable income.

Consumer confidence numbers continue to be elevated as does the NFIB small business optimism index. The conference board consumer confidence current conditions stand at 173.1, a level only exceeded during the 1999-2001 period over the last 50 years. The NFIB small business optimism index, which has been measured since 1974, is at its all-time high.

When we look at the consumer component, it’s no wonder they are feeling so positive; they have never attained such net wealth or cash on hand.

In addition, we have not seen such positive liquidity measures in the percentage of debt to assets. Currently, total household debt to total assets stands at a three-decade low of 12.8%.

With consumers and consumption making up nearly 70% of the U.S. economy, it is important to monitor their perceptions and overall balance sheet metrics. We see that earnings will probably cool off a bit, but this looks to be largely priced in. Once the midterm elections are concluded and the DEFCON 1 propagation turns out to be another in a long line of speed bumps, we will then turn our attention to the next breakdown. Along the way, the fundamentals will continue to drive the long-term results. We still see positive fundamentals relative to the negative and continue with our belief that markets will be better in the long run, despite the likely higher volatility throughout the rest of the year.

 

CRN: 2018-1011-6941 R

This commentary is for informational purposes only. All investments are subject to risk and past performance is no guarantee of future results. Please see the Disclosures webpage for additional risk information at commentary-disclosures. For additional commentary or financial resources, please visit www.aamlive.com.

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Effective, June 10, 2016, please note that Gene Peroni left Advisors Asset Management (AAM) to become President of Peroni Portfolio Advisors, Inc. Peroni Portfolio Advisors, Inc. ("PPA") is an investment advisor independent of AAM.

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