U.S. stocks rose last week after refocusing on fundamentals

David Joy – Chief Market Strategist, Ameriprise Financial
Weekly markets commentary — Jan. 13, 2019

U.S. equities began the new year exactly where they left off last year, by establishing yet another record high of 3,257.85 in the S&P 500® Index on the first day of trading. But that positive market sentiment was suddenly halted on day two by news of the U.S. drone strike in Iraq. The immediate reaction in markets came as expected. Stocks fell, while oil, bonds, gold, and volatility all rose. Overall, the reaction in stocks was relatively contained, as investors attempted to assess the likelihood and extent of further escalation between the U.S. and Iran. Having said that, stock markets in the Middle East were down sharply in Sunday trading, with Egypt down 4.7 percent, Kuwait down 4.1, UAE down 3.1, and Saudi Arabia, Qatar, and Bahrain all down in excess of 2 percent, according to Bloomberg. 

The reaction in bond markets was also pronounced. The yield on the U.S. ten-year note plunged nine basis points on Friday, to 1.79 percent, its lowest yield in the past month. The two-year fell six basis points to 1.52 percent. 

Of course, all eyes were on the oil market due to the importance of the Middle East to global production. Brent crude spiked 3.6 percent to $68.70 a barrel, its highest level since last April. 

The question now is retaliation. How, when, and where will Iran choose to settle this score? And will it lead to a series of back and forth responses between the U.S. and Iran, and possibly allies and sympathizers of both sides, that could spiral into a broader conflict? Iran presumably has a number of possible targets to consider, ranging from American troops on the ground in the region, commercial and military ships in the Persian Gulf, and cyber-attacks directly on the U.S. –something it has done before – on the banking system and certain infrastructure assets. 

The bottom line for investors is to stay the course

For investors, it is important not to overreact to Friday’s events. History is full of examples of geopolitical crises that in the moment looked ominous, yet from which markets eventually recovered. That is not to say that one should be complacent, either. The current situation certainly may deteriorate, and markets may remain under pressure as a result, especially with stocks at record highs and valuations well above average. But until we know more, the best response is to stay the course. 

U.S. manufacturing numbers decline yet again, while the U.S. consumer continues to remain strong

Somewhat lost in all the attention paid to the Iranian confrontation on Friday was the Institute for Supply Management (ISM) report on U.S. manufacturing in December. Rather than showing some improvement, albeit while still contracting, the index showed further deterioration, to the weakest level since 2009. The juxtaposition of the market optimism of the past few weeks in response to the announcement of a phase one trade deal with China on one hand, and the hard evidence of damage done to manufacturing by the trade war on the other, is a stark reminder that the production component of the U.S. and global economy has endured real hardship. December was the fifth straight month of contracting activity. Headlining the economic calendar this week is the December jobs report. The Bloomberg consensus anticipates the addition of a healthy 162,000 new non-farm jobs, and an unemployment rate unchanged at 3.5 percent. Such a strong report would reinforce the view that the consumer sector remains healthy enough to offset the weakness in manufacturing and keep the economy rolling. 

Fourth quarter earnings season is up next in the economic calendar

Also somewhat overlooked is the fast approaching fourth quarter corporate earnings reporting season. According to FactSet, earnings are expected to decline 1.5 percent.1 If they do, it will be the fourth straight quarter of year-over-year decline. However, actual results can be anticipated to exceed expectations, so this could turn out to be the first quarter of earnings growth in the last four. Revenue growth is estimated at 2.6 percent, which would be the weakest in almost four years. For the 2020 calendar year, analysts expect earnings growth to rebound by 9.6 percent.2 Our own forecast assumes roughly half that rate.