The Stock Market Rotation

There have been sharp changes in the stock markets.

Those who focus only on the headlines and indexes missed those moves. September unquestionably has been full of surprises for investors.

First, September is supposed to be the worst month of the year for stocks. Yet, we have a gain of more than 1% in the major indexes.

The second surprise is the sharp change in the winners and losers. Earlier in the year, the talk was about how the market would be dead if it weren’t for the so-called FAANG stocks: Facebook, Apple, Amazon, Netflix and Google (Alphabet). Technology was the leading sector, with health care following not far behind.

Things were very different in September. (The data that follow covers the first three weeks of the month.)

The tech sector is down 0.23%, and telecommunications is down 3.29%. Utilities, which were doing well earlier in the year, are down 2.01% for the month. Meanwhile, energy bounced back, rising 8.10% for September. Industrials are up 3.87%, financials 3.32% and materials 3.29%.

Among the major indexes, the Nasdaq is down 1.15% for the month, while the Dow is up 1.87% and the S&P 500 returned 1.21%.

Smaller company stocks also are making a comeback. For most of the year, large company stocks were the leaders, benefitting from global growth and a declining dollar. In September, the S&P Smallcap 600 is up 4.11% and the S&P Midcap 400 has returned 2.26%.

There also was a turnaround in the growth vs. value race. The S&P 500 Growth index, which still is up 18.16% for the year, rose only 0.34% for September. The S&P 500 Value index only has a 7.33% return for the year but rose 2.40% in September.

Another way to look at the rotation, provided by Bespoke Investment Group, is that the 50 best-performing stocks through August had an aggregate return of 0.14% in September. But the 50 worst-performing stocks through August had a 4.60% return in September.

Bonds also reversed course. They were doing well for most of 2017 but declined in September. For example, long-term treasuries were down 1.26% for the month, though they still are up 7.65% for the year. Other U.S. bonds had similar performances.

Commodities also saw changes. Oil is down 12.97% for 2017, and broad-based commodities are down 2.84%. But for September, oil rose 5.92% and broad-based commodities returned 1.92%. Gold had the opposite experience. It rallied most of the year and still is up 12.31% for the year. But it declined 2.16% for September.

One trend that continued was the strength of overseas markets. With few exceptions, they delivered solid returns in September. The international index EAFE rose another 2.23% in September for a 20.40% return for 2017. Emerging markets rose another 1.22% for a 2017 return of 30.21%.

The rotation out of the year’s strongest performers and into weaker performers in U.S. markets allows the major indexes to continue to deliver positive returns. Investors aren’t selling stocks to invest elsewhere; they’re selling certain stocks to buy other stocks.

Barring a month-ending crash, September will be the sixth consecutive month of positive returns for the S&P 500. Historically, six-month winning streaks are followed by another positive month about 70% of the time and by positive returns over the next three months almost 85% of the time.

While changes within the stock indexes are likely to continue, it will take a major event to reverse the upward momentum in stocks over the next few months.

The Data

Growth should continue, according to the PMI Composite Flash index, which combines PMI’s manufacturing and service sector surveys. Manufacturing growth increased for the first half of the month, with the index rising to 53.0 from 52.5. The service sector declined a bit to 55.1 from 56.9. But 55.1 still indicates strong growth. The composite declined to 54.6 from 56.0, which also indicates continued growth.

There were other signs of strength in manufacturing.

The Dallas Fed Manufacturing Survey was 21.3, up from 17.0. All components of the survey were strong, and the clear majority of respondents indicated that negative effects from Hurricane Harvey won’t continue beyond six months.

The Richmond Fed Manufacturing Index rose to 19 from 14. That’s 11 consecutive months of expansion in this index, which was well above expectations. The report was positive across the board.

These anecdotal reports were reflected in hard data this week. Durable Goods Orders rose 1.7%, compared to a 6.8% decline last month. More importantly, the core capital goods segment rose 0.9%, and last month’s 0.4% increase was revised higher to 1.1%. That gives core capital goods a 12-month increase of 3.6%.

Higher prices seem to be keeping a lid on the housing market.

The S&P Corelogic Case-Shiller Home Price Index reported increases of 0.3% for the month and 5.8% for the past 12 months.

New home sales declined sharply for August, and expectations are for a sharper drop in next month’s report because of the hurricanes. The August decline was broad-based, indicating factors other than hurricanes were at work. Sales are down 1.2% for the past 12 months.

Pending home sales also declined. Their 2.6% decrease followed a 0.8% dip last month. Pending home sales peaked in February and now are down 2.6% for 2017. Final sales of existing homes are down 1.7% so far in 2017.

Positive factors for the housing market are low mortgage rates and strong employment. Negative factors are low wage increases and higher asking prices. Also, there are reports that traditional first-time buyers are delaying home ownership because of student loan debt.

The third estimate of second-quarter gross domestic product (GDP) made few changes, increasing to an annualized 3.1% growth rate from 3.0% in the second estimate. The report is backward-looking, and thus doesn’t tell us anything new. Inflation, as measured by the GDP price index, remained a low 1.0%.

New unemployment claims rose by 12,000, bringing them up to 272,000. That’s in line with expectations. Analysts expect higher claims for a while because of the recent hurricanes.

The Markets

The S&P 500 had a slightly negative week, losing 0.04% for the week ended with Wednesday’s close. The Dow Jones Industrial Average declined 0.32%. The Russell 2000 rose 2.74%. The All-Country World Index declined 0.78%. Emerging market equities slid 3.01%.

Long-term treasuries declined 0.68% for the week. Investment-grade bonds rose 0.01%. Treasury Inflation-Protected Securities (TIPS) fell 0.11%, while high-yield bonds returned 0.08%.

The dollar finally gained 0.96%.

Energy-based commodities gained 0.87% for the week, while broader-based commodities lost 1.00%. Gold fell 2.14%.

Bob’s News & Updates

Do your heirs know how to handle an inherited IRA? If not, they’ll join the long list of heirs who made simple mistakes that triggered additional taxes and penalties. To avoid this result, be sure your heirs have a copy of Bob Carlson’s Guide to Inheriting IRAs.

Do you have a Medigap plan to go along with traditional Medicare? Did you know that one major medical event can more than wipe out years of savings from not paying Medigap premiums? Which is the best Medigap plan for you? Or should you consider Medicare Advantage? Learn more in the revised edition of “The New Rules of Retirement.

Some Reading for You

Here are two interesting pieces on inflation. This one argues that the Fed doesn’t understand what causes inflation, and that’s why it has been expecting higher inflation than has occurred. This article argues that the factors constraining inflation since the early 1980s are winding down, leading to a higher inflation bias in the coming decades.

Bridgewater Associates founder Ray Dalio talks about how valuable the mistakes he made have been.

This article explains the importance of an open mind and how to ensure you’re considering all the angles before making a decision.

I comment and link to these and other items on my public blog.