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Race to the Oval Office Quarterly Investment Review & Outlook – September 30, 2016 Summary International Markets Are Also up This Year

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Race to the Oval Office Quarterly Investment Review & Outlook – September 30, 2016 Summary International Markets Are Also up This Year The Savides Group | Assisting clients with their financial needs since 1985. Race to the Oval Office Quarterly Investment Review & Outlook – September 30, 2016 Summary International markets are also up this year. The Currently the news is dominated by the Presidential following table shows market results and comparative candidates’ race to the Oval Office. Regardless of who values for the first nine months of 2016: wins, stock returns have historically been positive in the Market Return and Value Table Source: Bloomberg year of an election and the year following. Stocks have Total Trailing Dividend Market done reasonably well through the first three quarters of Return YTD P/E Yield 2016. The economy has been in slow-growth mode, S&P 500 7.8% 19.6 2.1% US Small Cap 11.6% 19.9 1.4% but now appears to be picking up steam potentially Emerging Mkt Int’l 16.0% 13.5 2.5% allowing improvement in corporate revenues and Develop. Mkt Int’l 1.7% 17.6 3.4% earnings. Thus, our outlook for stocks generally As shown in the table, Emerging Market stocks, which remains positive. include countries like Brazil, India, China, and Russia, A Look Back have had very strong returns so far this year. Markets Elections, and particularly the presidential election, in these countries hadn’t done well for the last several dominate the news. The time until we vote is getting years as China’s growth rate slowed significantly short and the polls are currently predicting the race to resulting in reduced orders, particularly for the oval office is tight. On a recent trip to visit friends commodities, hurting commodity producing emerging in northern Germany and Norway, the number one market countries. However, valuations on a P/E basis question was, “what do you think of Donald Trump?” in both Emerging Market and Developed Market Europeans are following the US election very closely. countries appear attractive compared to the P/E on domestic stocks. So far, election campaigning doesn’t seem to have had much impact on financial markets. Stock returns for The US is considered to have had the strongest the S&P 500 Index have been close to 0% for the last economic recovery versus other major economies from two months with little market volatility. An upward the 2009 recession. On the recent trip to northern move in the market earlier this year puts the total return Germany, the economy there appeared to be strong. for the first nine months of 2016 at 7.8%. We noticed many new homes being built, a lot of scaffolding and cranes for commercial construction, Commentary in the financial press has suggested and there were large numbers of semi-trailer trucks on valuations for stocks are above long-term averages, but the road hauling loads. The very low European interest nowhere near historical highs. The reference is usually rates appear to be having a positive impact. The to the price-to-earnings (P/E) ratio. For the S&P 500 interest rate being paid on one new home loan was a Index, the P/E ratio on the last 12-months earnings very attractive 2.8%. Homes are considerably more was about 19.6. The long-term average is expensive there than in the US and the low interest approximately 16. The P/E ratio is considered to be rates are improving affordability. very high when it gets above 25, with the high water mark reaching almost 30 in 2001. Thus the stock Note also the dividend yield column in the above table. market at a P/E of 20 doesn’t appear to be alarmingly In contrast to the yields available on stocks, US overvalued, with the added fact that our current low Treasury notes with a 5-year maturity provided a yield interest rate environment makes these higher P/E of 1.15% at the end of the quarter and the yield on 10- values more sustainable. year maturity notes was 1.60%. High quality corporate ©2016 Robert W. Baird & Co. Incorporated. Member NYSE & SIPC. Robert W. Baird & Co. 777 East Wisconsin Avenue, Milwaukee, Wisconsin 53202. 1-800-RW-BAIRD. www.rwbaird.com First Use: 10/2016. Page 1 of 4 Race to the Oval Office, continued. bonds and publically traded CDs add a little more to Energy remains the weakest sector of the economy. So those yields. Even so, stock yields look attractive by far, oil prices are staying under $50 per barrel compared comparison, especially since dividend income has the to over $100 per barrel before the decline. Layoffs and potential to increase over time. other cost reductions have been made worldwide. There are three large offshore drill rig supply ships In past quarterly reports, we noted a lack of corporate sitting idle in the Bergen, Norway harbor. Recently, the revenue growth, especially among industrial companies, Organization of Petroleum Exporting Countries for the last several years. Despite the lack of revenue (OPEC) made a surprise announcement that it intends growth, companies were improving earnings by cutting to reduce oil production to lift oil prices. OPEC costs and buying back shares of their stock. Another expects to work out details of the plan at its November corporate tactic for improving revenues and earnings is meeting. Even Saudi Arabia is feeling the pressure of acquiring companies in similar or related businesses. So lower prices and has made plans to cut government far this year, announced buyouts have totaled almost spending including wages. Whether OPEC will actually $1.1 trillion. Recent examples of notable acquisitions make cuts remains to be seen. include: With the very low level of interest rates that has • Anheuser-Busch InBev buying SAB Miller persisted for some time now, some investors over the • Bayer plans to buy Monsanto past year or two increasingly looked to stocks paying • Abbott Labs buying St. Jude Medical generous dividends as something of a substitute for • Johnson Controls acquired Tyco Int’l bonds. Stocks within sectors that have traditionally • Microsoft is buying LinkedIn paid higher dividends, like telecommunications and Expected benefits provided by acquisitions include an utility companies, have benefitted from this demand. opportunity to: However, as shown in the table below, there seemed to be a reversal of this trend during the third quarter. 1) Reduce costs and improve efficiency, Whether this is a trend that continues remains to be 2) Reduce the cost of internal product seen. Perhaps investors are anticipating the long development (especially true in technology awaited rise in interest rates. and health care sectors), S&P 500 Total Investment Return by Sector 3) The acquiring company becomes a bigger First 6 Months of 2016 Compared to 3Q 2016 Source: Baseline and broader supplier, which is more valuable 1st 6 3rd S&P Sector to its customers. Months Quarter Consumer Discretionary -0.1% +2.5% Investors in the company being acquired typically do Consumer Staples +9.0% -3.3% well as a result of the premium buyout price. However, Energy +14.3% + 1.6% Financials -4.1% + 4.0% investors in the acquiring company often don’t do well Health Care -0.5% + 0.5% for a period of time. Compared to peer companies, the Industrials +5.2% +3.6% newly combined company is faced with merger related Information Technology -1.2% +12.4% expenses and higher interest expense from the Materials +6.2% +3.2% Telecommunications +21.8% -6.6% additional debt which is typically taken on. As a result, Utilities +21.2% -6.7% there is often pressure on profit margins, earnings S&P 500 +3.7% + 3.9% growth and return on capital until the merged entity can digest the acquisition. ©2016 Robert W. Baird & Co. Incorporated. Member NYSE & SIPC. Robert W. Baird & Co. 777 East Wisconsin Avenue, Milwaukee, Wisconsin 53202. 1-800-RW-BAIRD. www.rwbaird.com First Use: 10/2016. Page 2 of 4 Race to the Oval Office, continued. A Look Ahead growth rate in the first quarter. Slow economic growth Presidential Election - With the race to the Oval Office in has been attributed to a prolonged slump in inventory full swing, a few comments putting presidential investment. Some economists believe there is a need elections into historical context seems appropriate. for higher inventory levels and have adjusted their This year’s election is rather unusual in that neither third-quarter growth forecasts upward from less than Presidential candidate appears to be viewed even by 3% to over 3%. The following is a chart showing the many in their own party as an ideal candidate, let alone inventory-to-sales level since 2011. the general populous. Also, strong supporters of each Inventory-Sales Ratio, Retail Ex-Auto nominee seem convinced that if the other candidate is Source: Baseline 1.4 elected the US is doomed. However, we doubt the country is doomed no matter which candidate is 1.3 elected, and we expect the near-term impact on 1.2 1.1 financial markets will be minimal. The December Fed 1.0 meeting is likely to be more market moving in the Ratio, SAAR 0.9 short-term. 2012 2013 2014 2015 Looking back at election years since World War II, the 2011 average return on stocks in the year of the election has Inventory cutbacks over the past five quarters have been 10.2% and the average return in the year after the hindered economic growth. Good job growth along election has been 10.0%. Through September, the S&P with low gasoline prices and increased bank lending 500 Index return is 7.8%, implying the market still has provides a strong backing for raising inventory levels.
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