Lead by the healthcare sector (up +14%), the S&P 500 posted a +7.7% gain for the 3Q. The industrial sector’s +9.5% gain also contributed as did tech’s +8.5%. Other sectors were not so fortunate. The energy, real estate, and material sectors were either flat or negative with rising rates most likely the culprit. The 10-year Treasury’s yield ended the Q at 3.06% up from 2.85% three months earlier with the Fed officially raising short term rates on September 26. All indications are that interest rates will ratchet higher.
Interestingly, the healthcare sector is considered somewhat of a “safe haven.” Given ongoing tariff threats and a Fed chair committed to rate hikes, it is not surprising that investors would tilt toward these defensive stocks. There is no change in our cautious outlook. Admittedly, economic growth is strong, yet valuation measures we follow are flashing caution. Investors needing income and owning income producing stocks should gird themselves for further price declines as rising rates will serve to push down prices even though income flows should remain constant.
On average, our healthcare stocks performed well. One of them (a leader in veterinary medicine) and a second (developer of injectable collagenase for both clinical and cosmetic uses) were both up over +30%. Our pharma which produces biosimilars (the generic equivalent of large, intricate compounds) was up +29%.
As explained above, all our interest rate sensitive securities suffered with the uptick in rates. Electric utilities were down as well as preferred stocks. Many of our income producing Closed End Funds (CEFs) were also down for the same reason. The threat of tariffs was particularly hard on our capacitor manufacturer which has extensive operations and sales in Japan (rumored to be on the hit list). We did have one company, inventor of a blood thinner reversal agent, that did not share in the robust healthcare gains. Sales for that product and their own blood thinner won’t begin in earnest until 2019.
On price weakness, we added to our previous position in a software company that facilitates data analytics of wireless 5G, the next generation. Selling to massive telecom companies (think AT&T) is a complex operation; the company’s sales have been pushed out until these large contracts are inked. We used the recent rise in oil prices to terminate our positions in two global leaders in the gas and oil business. Along with the entire energy sector, the stocks had languished on depressed oil prices. While some modest energy recovery is underway, we judged that to be more an opportunity to sell the positions rather than adding to them.
October 1, 2018 Paul F. Rodgers, CFA
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