Weekly Market Update (November 04 – November 08, 2019)

By Angelo Kourkafas November 08, 2019

Stocks extended their recent gains, finishing higher for the fifth straight week. Recent signs of progress on trade negotiations, along with better-than-expected corporate earnings, has helped recession fears to subside over the past month, boosting investor sentiment. With the global growth backdrop starting to stabilize, Treasury yields climbed to their highest level in three months. Uncertainties, especially on the trade front, remain, but on a positive note, earnings are expected to bottom out this year and reaccelerate next year to a mid-single-digit pace. Given current reasonable valuations, we think this sets the stage for moderate returns as we advance in this bull market.


Bottom Lines Help Stocks to a New Top

There are plenty of issues garnering the market's attention of late, including ongoing trade issues, political drama, Fed rate maneuvers, and geopolitical uncertainties. But one of the more fundamental drivers has also been in focus most recently -- corporate earnings results – which are contributing to the market's ascent to new highs.  

With roughly 90% of S&P 500 companies having reported results, the third-quarter earnings season is near its end. Corporate profits are on track to register a small decline (-1% as of 11/8/19) compared with a year ago. However, results have been better than expected (or feared), joining forces with the latest signs of progress on trade negotiations to help push the stock market to a fresh record last week1. Here are three takeaways from the recent corporate earnings results:

  1. Better-than-expected earnings reflect a resilient economy – 78% of companies have exceeded consensus earnings expectations, which is due in part to depressed estimates. Remember, it was just a few months ago that the prevailing view among the markets was for an oncoming U.S. recession. In addition to some encouraging economic readings lately, the results from corporate America may be another confirmation that the economy is on better footing than previously feared.  That said, overall earnings for 2019 are now expected to grow at a tepid 2% pace. This is partly due to the challenging comparison to 2018, when earnings rose by 21% (driven by the tax reform)2. But lower profit gains also reflect the backdrop of modest GDP growth and weak business investment (driven by caution and uncertainties stemming from the trade dispute).
  2. Still caution, even as market has rallied – Defensive sectors that are less sensitive to the economic cycle, like health care and utilities, are seeing the fastest earnings growth this quarter, while cyclical sectors like energy, materials and consumer discretionary are lagging. Additionally, companies with greater dependence on international revenue (>50%) are experiencing weaker earnings than those with less international revenue (<50%)2. These trends tell us a few things:
    • First, the outlook for global growth will remain an important driver for stocks. Uncertainty related to ongoing trade tensions, the disruption of supply chains, a stronger U.S. dollar, and lower foreign demand, have all been headwinds for U.S. companies with a significant international presence. While uncertainties remain, several risks have lessened over the past month with some de-escalation in U.S./China trade tensions, a pullback in the U.S. dollar from a 52-week high, and signs of stabilization in leading economic indicators.
    • Second, weakness in cyclical sectors may be turning a bit. The slowdown in global growth has taken a toll on the demand for commodities, oil prices have declined almost 30% from a year ago, and third-quarter earnings for the energy sector are 38% lower. However, we don't anticipate a repeat of those declines for oil, and it is worth noting that energy's impact on the broader market has been reduced, as it now represents less than 5% of the S&P 500 (the lowest level in at least 25 years) vs 14% in 20081. Positively, earnings results from an important cyclical sector -- financials, and more specifically, banks -- have been solid, highlighting the strength of the U.S. consumer, a key driver of growth for the U.S. economy. 
    • And importantly, the strength of the defensive sectors, relative to cyclicals, as the market has moved to new highs signals that there is still a fair bit of caution (if not pessimism) in the market. It's often said that markets climb a wall of worry, and this would support that claim. A prevailing sense of optimism (and worse, euphoria) in the market can create complacency, raising the probability of shocks and surprises. We don't anticipate the market maintaining its current trajectory uninterrupted, but the evidence of cautious optimism appears reasonably favorable for the bull market to continue more broadly.
  3. Earnings are still a pillar of support, albeit a shorter one – The direction of corporate profits is a powerful driver of the direction of the stock market over time. For periods of time, the two can decouple. For instance, last year's 20%-plus earnings jump wasn't matched by S&P 500 price performance (much of that was anticipated and showed up in 2017's sizable gain). Similarly, we don't think the current soft patch in earnings growth is a trend that will snuff out the bull market.  This quarter's earnings deceleration is not the first in this expansion. S&P 500 earnings in 2015 - 2016 declined for five consecutive quarters, driven by a slowdown in the Chinese economy, a rising U.S. dollar, and a decline in oil prices – all of which took their temporary toll on S&P 500 profits.  Some of the same headwinds are also present today but have not put a dent in profits to the same extent as they did back then. For example, in the first quarter of 2016 earnings declined 8.5% vs flat to slightly down currently1. We think rising labor costs (the burden of the encouraging trend in wage growth) will be a headwind to profit margins (which, it should be noted, are still at well-above-average levels), while weakness in manufacturing and an elevated U.S. dollar may constrain revenue growth. That said, the earnings growth rate is expected to bottom out this year and reaccelerate next year to a mid-single-digit pace. Given current reasonable valuations, in our view, we think this sets the stage for moderate returns as we advance in this bull market. Over the last 60 years, when earnings rose at a mid-single-digit pace (4%-9%), the stock market delivered an average annual return of 9.5%3.

Sources: 1. Bloomberg, 2. FactSet, 3. Morningstar Direct, Edward Jones calculations

Craig Fehr, CFA
Investment Strategist

Angelo Kourkafas, CFA
Investment Strategy Analyst



Index Close Week YTD
Dow Jones Industrial Average 27,684 1.2% 18.7%
S&P 500 Index 3,093 0.9% 23.4%
NASDAQ 8,475

1.1%

27.7%

MSCI EAFE 1,976.65 0.5% 14.9%
10-yr Treasury Yield 1.94% 0.2% -0.8%
Oil ($/bbl) $57.41 2.2% 26.4%

Bonds

$111.81 -1.0% 7.5%

Source: FacSet, 11/08/19.  Bonds represented by the iShares Core U.S. Aggregate Bond ETF. Past performance does not guarantee future results. 

The Week Ahead

The earnings season is winding down this week with a little less than 10% of the S&P 500 companies reporting earnings. The bond market is closed on Monday for Veteran's Day. Important economic data being released include inflation on Wednesday and industrial production and retail sales on Friday.

Review last week's weekly market update.

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