Can the latest rally continue? Investors look to earnings for the answer  

David Joy – Chief Market Strategist, Ameriprise Financial
Weekly markets commentary — Jan. 14, 2019

 

The rally in U.S. equities that began on the day after Christmas continued last week, as the S&P 500 climbed 2.5 percent, bringing the total for the rebound to 10.4 percent. Stocks have risen on nine of the twelve trading days throughout this period. Each of the eleven sectors in the index has advanced, but it has been cyclical groups that have led the way, including energy, consumer discretionary, communication services, industrials and technology. 

Financial stocks have been market performers since Christmas, rising a little more than 10 percent, and they have a big week ahead of them as fourth quarter earnings season kicks off with banks leading the way. Attractive valuations within the group have caught the attention of investors, but whether earnings season will provide enough of a catalyst to convince the skeptics remains to be seen. 

Overall, Factset anticipates 10.6 percent earnings growth in the quarter, the fifth straight quarter of double digit growth. But, earning expectations for 2019 continue to fall, with average growth of just 2.4 percent expected in the first half and 6.9 percent now expected for the full year, roughly one-third the pace of 2018. Investors will also be listening carefully to what management teams have to say about the anticipated future impact of the ongoing trade war with China. Over the weekend, China reported trade volumes for December that were far weaker than expected. 

Stocks need strong earnings to continue their rebound 

Stocks will no doubt need a strong earnings season to continue to rebound, as the broader averages are beginning to run into resistance and are no longer considered oversold. The S&P 500 currently sits 1.5 percent below its 50-day moving average 2635, and 5.6 percent below its 200-day moving average at 2743. 

The VIX index of expected equity volatility fell for the third straight week, closing at 18, down from 21 the prior week, and well off its Christmas Eve peak of 36. 

In further evidence of receding risk aversion, high yield credit spreads narrowed for the second straight week. The spread between the Bank of America High Yield index and the ten-year Treasury note contracted by 50 basis points, after having narrowed by 25 the prior week. Currently, at 455 basis points, the spread has now narrowed by 89 basis points from its January 3 wide of 544. But just as stocks have yet to retrace their fourth quarter selloff fully, high yield spreads remain elevated from their October 2 low of 314 basis points. 

Politics remain a focus in the U.S. and Europe 

In addition to earnings, politics will remain in focus, on both sides of the Atlantic. In the U.S., the government remains partially shut in what is now the longest closure on record. The impact on furloughed workers, and the general public from services not delivered is beginning to test the patience of the citizenry. For investors, the absence of timely economic data handicaps their ability to make fully informed judgments. 

In the UK, parliament is set to vote on Prime Minister May’s Brexit deal and seems headed to certain defeat, amid reports of efforts among some lawmakers to extend the March 29 deadline or even to reverse the decision to leave the European Union. And in Greece, Prime Minister Tsipras faces a vote of no confidence after the defection of a coalition partner in a political dispute over Macedonia. But in a moment containing more than a touch of irony, economists warned of too much of a good thing after Greece said that its 2018 primary budget surplus would be roughly 4.5 percent, exceeding both expectations for the second straight year and the 3.5 percent target established in its third bailout, which it exited in August.