US Markets March: Tech stocks shine, Fed interest rate trajectory swings to a cut.
Portfolio NAV jumps 12.3% in Q1 as markets topple old records.
Just like that, we’ve already seen out the first quarter of 2019, and what a start to the year it has been. Cast back to the opening days of January, few could have predicted such a turnaround following an abysmal revenue downgrade from Apple (APPL) and underwhelming US factory data.
But the stock market is flying high, notching up achievement after achievement. As investors piled back into riskier assets the S&P 500 recorded its best quarter in the last decade, and the best opening quarter since 1998.
As it turns out, the key to massaging the nerves of the market has, in many respects, been soothing reassurances - none more so than that first communicated by the Federal Reserve in January around a more cautious path to lifting rates, and reaffirmed at its March meeting. Given mixed economic data, plus the angst markets feel every time slowing global growth gets a mention, we don’t see a catalyst for a rate hike, rather a rate cut.
The US government - when not shut down - has also been keen to see to it that markets held their rebound. At the hint of any anxiety, the Oval Office has been quick to casually remind an impatient market that US-China trade negotiations are progressing well - notwithstanding the lack of detail. Here we are, with discussions longer than expected, it almost seemed an April Fools’ Day prank was in store for the market.
The treasury yield curve for 3 month and 10 year bonds inverted in March for the first time since 2007, often deemed a recession warning sign. Our outlook remains upbeat. Company earnings have largely outperformed, energy prices are rising, and US economy fundamentals appear fairly stable, even if subdued. As far as the latter, jobs growth has been excellent, despite recent hiring data slipping. There has been modest increases in wages and consumer confidence, albeit inflation, housing and manufacturing remain quiet.
“The key to massaging the nerves of the market has, in many respects, been soothing reassurances”
The highs and lows of corporate earnings
With the quarter concluding, only a small selection of companies reported earnings in March. Among higher profile businesses, there were mixed results.
Target (TGT) and Costco (COST) highlight the retail sector isn’t prepared to roll over just yet. TGT announced its best result in years, with higher sales, earnings and store traffic, while COST produced a resounding earnings beat. Both climbed 10.5% during March. We attribute their impressive results to price positioning as big-box staple retailers, and favour Costco.
Strong growth in China helped Nike (NKE) top earnings forecasts and meet revenue targets, but it lost 6.1% due to subdued North American growth. Expectations were likely built into its all-time high share price before reporting, but we’re excited by China growth prospects.
Despite surpassing consensus targets leading software companies Salesforce (CRM) and Adobe (ADBE) came under scrutiny as they tamed outlooks. Both businesses, with expectations reset and a strong history of beats, recovered from their sell-offs.
Fedex (FDX) missed revenue and EPS forecasts, also lowering its 2019 earnings guidance for the second time in 3 months. While a 5% slide in shares reversed by month’s end, we would be concerned by passive global economic growth, competition levels and squeezed margins.
In a crowded market there were no shortage of winners and losers, but tech stocks led the way. IBM (IBM) jumped 24.1%, Facebook (FB) moved 27.2% higher and Apple (APPL) leapt 20.4%. Cisco (CSCO) was another standout, gaining 24.6% as input prices fell and it smashed revenue and earnings forecasts. Elsewhere, Exxon Mobil (XOM) enjoyed a stellar run, up 18.5% after a huge earnings beat and higher oil prices, while Citibank (C) climbed 19.5%.
At the other end of the scale, Kraft-Heinz (KHC) dived 24.1% following its huge write-down. Biogen (BIIB) slumped 21.4% as one of its clinical trial drugs for Alzheimer’s failed. Watch out for competition in its other area of focus, multiple sclerosis. Macy’s (M) downgraded guidance in January, plummeting 19.2%. Lastly, CVS Health (CVS) declined 17.7%, reigning in its full-year earnings forecast and posting an impairment. We’re bearish due to lower medication prices and reimbursements, plus increased competition from Amazon.
“In a crowded market there were no shortage of winners and losers, but tech stocks led the way”
Our portfolio saw another month of positive growth in March, with Net Asset Value (NAV) growing 2.4%. Although lower than the gains of 5.7% in February and 3.8% in January, it was in line with the Nasdaq Composite, and well ahead of both the Dow Jones and S&P 500.
Gains on equities were 1.6% of March’s opening NAV, led by Apple, McDonald’s (MCD) and Alphabet (GOOGL). McDonald’s, up 3.3% across March, made the news after announcing its largest acquisition in over 20 years. Improving trade negotiation sentiment carried Google and Apple higher 4.5% and 9.7% in turn. The former launched its game streaming service, which we like for revenue diversity in a growing area, whereas the latter was upgraded by Bank of America and we think stands to gain from a US-China trade treaty. Equity and index options yielded returns of 0.2%, while AUD futures facilitated 0.8% asset growth.
Total realised income was 1.4%, including the above futures, plus closure of our position in Facebook. We sold FB at $169.18 after the company’s third in command, and head of WhatsApp, both left the company disagreeing with Mark Zuckerberg. Our concerns relate to the proposed strategic direction towards a privacy-based platform of services. Also concerning were repeat failures at resistance and the large bias of put options over calls for June, with a $160 strike price. Unrealised income totalled 3% of the portfolio’s starting NAV.
There were no notable movements in forex during March, with the USD/AUD settling at 1.4091, down from 1.4097. At March 31 the cash balance accounted for 36% of all assets.
By the end of the first quarter, portfolio Net Asset Value (NAV) lifted 12.3%, outperforming the Dow Jones (up 11.2%) over the same period. Equities delivered returns of approximately 10.7%, with contributions particularly weighted towards the following stocks:
· Apple (APPL) - up 20.4% in Q1; we increased our holdings
· Alibaba (BABA) - up 33.1% in Q1; we maintained all our holdings
· Facebook (FB) - up 27.2% in Q1; we closed our position in March
Out of 20 positions held across the first three months of 2019, 17 delivered positive returns to the portfolio, and only one (CME Group: CME) stretched our preferred tolerances.
Equity and index options, comprising puts and calls over the range of stocks held in the portfolio, provided modest gains of 1.1%. With as many as 44 positions opened, the overwhelming majority (84.1%) of trades resulted in small (positive) returns.
Total realised income was 2.8% of portfolio NAV at the start of the year, with the majority via gains in equities such as Facebook and Nike, as well as Australian Dollar futures contracts. Unrealised income accounted for 3.3% of the portfolio’s starting NAV.
In terms of currency action, futures for the Australian Dollar June ’19 contract delivered a small portfolio gain of 0.8%. Although there were large forex movements during specific periods in the quarter, by the end of March these fluctuations balanced out to have a negligible impact on portfolio NAV. Cash levels meanwhile, grew by 33.6% on account of portfolio gains being liquidated, although these may be redeployed in coming months.
Upcoming earnings results
The reporting floodgates are set to open in the second half of April, as the major banks kick off the latest round of quarterly reports. Thereafter, several software and tech giants will be in the spotlight, including Netflix, IBM, Facebook, Microsoft, Amazon and Google. In between, an assortment of industrial bellwether stocks will also set an early tone.
Economic data and events to watch
With hiring slumping during February, the numbers for March’s nonfarm payrolls could provide context as to a possible trend, or as we think, a temporary blip. We do not expect any surprises in the Fed meeting minutes for March, with members already seemingly vocalising their outlook, nor inflation to be anything other than tame.
Subdued retail sales are something we don’t see improving yet, one reason we’re avoiding brick and mortar retailers. Having expected US-China trade negotiations to conclude last month, there may actually be more substance to the affair than we first thought, but any sugar hit could be short-lived given markets are near all-time highs.