What does “Late Cycle” economic expansion mean for your investments and how could this affect small-caps and large-caps? Learn more in this week’s edition of Steady Investor’s Week…

Are Small-Caps Due for a Turnaround? Looking purely at equity market indices, it becomes clear that small-caps have had a difficult run of it in 2017. The S&P 500 is up close to 10%, the NASDAQ is higher by approximately 15%, but the Russell 2000 (small-cap universe) is pretty much flat on the year. This performance discrepancy could be a clear indicator that we are indeed late cycle in this expansion and bull market. As the economy starts to lose a bit of steam, the pattern we have generally seen historically is large cap outperformance. Investors tend to move over on the risk curve, favoring corporations with stable earnings, dividends, and free cash flow. Small-caps generally do not fit that bill, and earnings in Q2 did not help. We now have earnings results from 76.5% of the S&P 600 index’s (small-cap) total membership, and total earnings for these small-cap companies are down -14.1% from the same period last year on +6% higher revenues, with 61.1% beating EPS estimates and 62.2% beating revenue estimates. This is a weak earnings performance relative to other recent periods. The earnings growth pace as well as the proportion of positive EPS surprises for Q2 is tracking below other recent quarters, which generally does not bode well for stocks. There may be some hope on the horizon, however, which could help give small-caps a potential year-end boost. We expect S&P 600 earnings growth to pop in Q3 and Q4, perhaps even hitting 20% in Q4.

Is Tax Reform a False Positive? There is a growing sense amongst Wall Street hopefuls that tax reform will be the catalyst for the next leg of this bull market. But is that a realistic expectation? At Zacks Investment Management, we are not necessarily pricing it in to our forecasts. President Trump has seemingly alienated a few key Republican Congressional leaders needed to advance legislation, and this week he threatened a government shutdown over funding for the border wall. But underneath what we see widely reported, there has reportedly been significant progress made between Trump’s top aides and Republican leaders in shaping tax overhaul options. Some of the consensus building has happened in key areas, including capping the mortgage interest deduction for homeowners, eliminating the ability to deduct state and local taxes, eliminating businesses’ ability to deduct interest and allowing for the “repatriation” of corporate profits from overseas. Investors should not bet on comprehensive tax reform, but we would see it is a strong positive if it ultimately passes.

The Race Between Amazon, Google and Walmart – the race is on between retail behemoths Amazon and Walmart, and Walmart has smartly enlisted Google’s help in an effort to position themselves competitively. As Amazon has linked ordering capabilities with its “Alexa” platform, Walmart will seek to do the same using Google’s Assistant. This is part of a broader race to stake out a claim in the e-commerce space, with other retailers like Macy’s devoting new resources to its online and delivery businesses. In a sense, this is what the retail future looks like.

Crude Oil’s Supply Story – many readers remember the production cuts promised by OPEC several months back, and the hanging question of whether the commitments would be kept. In all, the numbers were more impressive than many market watchers expected: according to Dow Jones, compliance with production cuts has hovered around 95% throughout the summer – an impressive feat. This has been a key contributor to the stability of crude oil markets, and now members must decide to extend or terminate the agreement. The meeting comes in late November, and could be telling for how oil prices shake out from here.

Many signs are pointing to the U.S. economy – and the markets – entering “late cycle” stages. It begs the question: how should investors position their portfolios as the bull market begins to lose steam? 

A good start to answering that question would be to review the core tenants of “Modern Portfolio Theory.” One of the keys to modern portfolio theory is diversification across non-correlated asset classes, which can help investors control for risk and potentially smooth out returns. There are other features of Modern Portfolio Theory that could help investors navigate the markets as conditions start to change. We’d encourage everyone to brush up on some of these concepts, or if they’re new concepts to you, to learn them with our newly released guide, “Making Sense of Modern Portfolio Theory.” Click on the link below for more details!


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