Approaching the midpoint for 2018, The Dow Jones Industrial Average is down 2%; the S&P 500 Index is up 1% and the NASDAQ 100 up 8%. Six months ago, for all of 2017, all three indices were up 25%, 19% and 28%, respectively. Those surges reflected recoveries here and abroad from the severe pressures in 2007-2009 that threatened global economies with a widespread depression.
Some of the recent lackluster performance could be attributed to a seasonal slowdown that often affects the stock market between May and October. It seems more likely to me that the strong advance last year ran a bit ahead of itself, prompting the market pausing to catch its breath.
Stocks will be tested and, quite possibly, boosted upwards by the coming in July of a new round of corporate earnings reports. For the quarter ending in June, the estimated earnings growth rate for the S&P 500 is 19.0%. If the actual growth rate for the quarter reaches 19%, it will mark the second highest earnings growth since Q1 2011 (19.5%).
Stocks remain in an uptrend, however, there are scattered storm flags from varied pressures. One is the “yield curve,” an indicator that has become a hot topic on Wall Street. The yield curve is the difference between interest rates on short-term government bonds and long-term bonds. Typically, long-term rates are higher as investors perceive a strong economy that could produce higher prices from inflation. Lately, long-term rates are holding around 2.85% while short-term rates are around 2.5%. This difference of only .35% is near the levels seen just before the 2007 recession.
Attention should be paid to this indicator although it may currently be exaggerated by Federal Reserve actions and basic indicators are quite favorable. Unemployment is at an 18-year low, corporate investment is picking up steam, and consumer spending shows signs of rebounding. Some economists even have said that economic growth could be accelerating to as much as 5%. It is, of course, possible that current economic vigor only reflects a short-term stimulus from tax cuts. Fresh earnings reports will provide us new guidance.
A recent study reinforces my belief that selection of superior stocks provides greater returns than attempts to trade or time the market. The study covered 90 [!] years of stock returns from around 25,000 stocks. Of these, a tenth of all the gains from this stock universe came from five stocks: Apple, Exxon, Microsoft, IBM and GE. The top 50 stocks accounted for two fifths of the total while over half returned less than Treasury bills.
These five leaders all built economic “moats,” a term popularized by Warren Buffett. This refers to a business’ ability to maintain competitive advantages over its competitors in order to protect its long-term profits and its market share from competitors.
The search today for lasting leaders prompts the handful of modish companies known as the “FAANG” stocks: Facebook, Amazon, Apple, Netflix and Google. I continue to recommend Amazon (AMZN-$1,690) and Apple (AAPL-$185), dominant growing companies that have staked out Mr. Buffett’s “moats.” Of the top five in the long-range study, IBM and GE are both down over the past five years while Exxon is about even.
Exxon’s inclusion illustrates the continuing importance of energy providers. The International Energy Agency expects moderate global demand for oil to continue despite increasing use of renewable and low-carbon substitutes. The IEA estimates 50 million electric vehicles on the road in 2025, up from 2 million today. This would reduce oil demand by about 2%.
Oil prices continue to rise in parallel with economic growth. U.S. oil prices are at their highest level since 2014. This quarter, energy stocks are the top performers in the S&P 500 with the sector poised to ring up an overall 12% gain, its best since 2011. Energy companies are boosting their dividends and the S&P 500 energy sector is yielding 2.7%, almost a full point ahead of the S&P as a whole.
I am adding Occidental Petroleum (OXY=$83) as a new buy. Oxy explores and produces oil and gas globally. It also has substantial chemical and energy transportation segments. Earnings are gushing with $4.65 estimated for the full year, up from $.80. This quarter’s earnings will be released the first week in August and current estimates are for $1.17, up from $.10. Its stock yields 3.7% with four straight years of increases, making it particularly suited for retirement accounts.
Tony Crowell manages stock portfolios for individuals and their trust and retirement accounts with CROWELL•ROBERTS Investment Counsel, a registered investment advisor in Laguna Beach since 1995. [email protected] 949.494.1376/800.697.2622