First quarter S&P 500 earnings are on pace to grow almost 25%
78% of companies beat analyst earnings estimates — the highest percentage in nearly ten years
Bullish sentiment has cooled, adding to the market’s indecisive movements
Data Source: FactSet
Stock prices have been volatile this year as investors worry about trade disputes, rising interest rates, and the threat of higher inflation, among other factors.
Yet underlying fundamentals remain sound. Companies surpassed lofty earnings expectations in the first quarter. Sales trends were particularly strong during the period, indicating there is more to the earnings story than just the benefits of significantly lower corporate tax rates.
Investors must now weigh what could be conflicting forces that will be at play in the coming months.
On the heels of robust first quarter financial results, the current U.S. policy environment could provide support for equity prices as well.
On seven different occasions since the mid-1950s, U.S. fiscal conditions have been increasingly stimulative (i.e., lower taxes and increased government spending) at the same time monetary policy has tightened. The recent corporate tax cut is the most notable stimulus. In the meantime, the Federal Reserve has been slowly raising short-term interest rates.
According to BCA Research, the S&P 500 Index has risen on average 16.7% during periods where fiscal policy is more stimulative and interest rates are rising. Although history is not a guarantee of future results, these cycles have historically lasted 12 months on average. Investors would be wise to consider this point as interest rates, inflation, and economic growth continue to shape market sentiment and influence stock prices.
It is also worth mentioning that stretched equity valuations and elevated trade tensions have cooled bullish sentiment across the market.
We believe the decline in optimism from extreme highs is a healthy market development. Optimism is fickle and tends to ebb and flow over time.
According to data from BCA Research, equities tend to perform the worst when sentiment levels are deteriorating from bullish levels and perform the best when sentiment levels are rising from bearish levels. While macro concerns may be weighing on sentiment and stock prices at the moment and could do so over the near term, it is important for investors to take a step back and see the forest for the trees.
Unemployment is at multi-year lows, consumers are on solid footing, corporate earnings are growing at double-digit rates, and extreme optimism levels have faded. Although the debate about trade, profit sustainability, and higher interest rates could act to rattle investors and elevate the noise around stocks, we believe the fundamental backdrop is supportive of equity prices.
With all that said, the changing landscape for trade, higher interest rates, and mixed economic data globally could keep stock prices in a trading range over the near term, with no sustainable up-or-down movement.
In our view, stocks could have difficulty topping their January highs without a positive catalyst to increase buying momentum. If tensions ease on the geopolitical front or trade pressures with China fade, it could send U.S. stock prices higher. However, it may be some time before we see meaningful resolution on either front. Importantly, we foresee a small probability that stock prices will drop below their February lows (23,860 on the Dow Jones Industrial Average).
More broadly, recession risks are muted, fiscal and monetary policy is stimulative, and earnings are growing. We believe these factors are reasons to be cautiously positive about stocks. Healthy markets take a breather now and again to consolidate rapid price gains. If the market should pause over the next few months, investors may welcome the opportunity take a vacation as well.
As of May 9, 2018
Data source: Morningstar Direct
Standard & Poor’s (S&P) 500 Index
The S&P 500 is a basket of 500 stocks that are considered to be widely held. The S&P 500 index is weighted by market value (shares outstanding times share price), and its performance is thought to be representative of the stock market as a whole. The S&P 500 index was created in 1957 although it has been extrapolated backwards to several decades earlier for performance comparison purposes. This index provides a broad snapshot of the overall U.S. equity market. Over 70% of all U.S. equity value is tracked by the S&P 500. Inclusion in the index is determined by Standard & Poor’s and is based upon their market size, liquidity, and sector.
Dow Jones Industrial Average
The Dow Jones Industrial Average (The Dow), is a price-weighted measure of 30 U.S. blue-chip companies. The index covers all industries except transportation and utilities.
Russell 2000 Index
The Russell 2000 Index measures the performance of the small-cap segment of the U.S. equity universe. The Russell 2000 is constructed to provide a comprehensive and unbiased small-cap barometer and is completely reconstituted annually to ensure larger stocks do not distort the performance and characteristics of the true small-cap opportunity set. The Russell 2000 includes the smallest 2000 securities in the Russell 3000.
MSCI EAFE Index
The MSCI EAFE Index (Europe, Australasia, Far East) is a free float-adjusted market capitalization index that is designed to measure the equity market performance of developed markets, excluding the US & Canada. The MSCI EAFE Index consists of the following 21 developed market country indexes: Australia, Austria, Belgium, Denmark, Finland, France, Germany, Hong Kong, Ireland, Israel, Italy, Japan, the Netherlands, New Zealand, Norway, Portugal, Singapore, Spain, Sweden, Switzerland, and the United Kingdom. As of June 2, 2014.
MSCI Europe Ex UK
The MSCI Europe ex UK Index captures large and mid cap representation across 14 Developed Markets (DM) countries in Europe. With 337 constituents, the index covers approximately 85% of the free floatadjusted market capitalization across European Developed Markets excluding the UK.
MSCI United Kingdom
The MSCI United Kingdom Index is designed to measure the performance of the large and mid cap segments of the UK market. With 109 constituents, the index covers approximately 85% of the free floatadjusted market capitalization in the UK.
MSCI Emerging Markets Index
The MSCI Emerging Markets Index is a free float-adjusted market capitalization index that is designed to measure equity market performance of emerging markets. The MSCI Emerging Markets Index consists of the following 23 emerging market country indexes: Brazil, Chile, China, Colombia, Czech Republic, Egypt, Greece, Hungary, India, Indonesia, Korea, Malaysia, Mexico, Peru, Philippines, Poland, Qatar, Russia, South Africa, Taiwan, Thailand, Turkey and United Arab Emirates. As of June 2, 2014.
Bloomberg Barclays US Aggregate Bond Index (Abbreviated as Bloomberg US Agg in table)
The Bloomberg Barclays US Aggregate Bond Index is a broad-based flagship benchmark that measures the investment grade, US dollar denominated, fixed-rate taxable bond market. The index includes Treasuries, government-related and corporate securities, MBS (agency fixed-rate and hybrid ARM pass-throughs), ABS and CMBS (agency and non-agency).
Bloomberg Commodity Index
Formerly known as the Dow Jones UBS Commodity Index. The Bloomberg Commodity Index is calculated on an excess return basis and composed of futures contracts on 22 physical commodities. It reflects the return of underlying commodity futures price movements.
Dow Jones U.S. Select REIT Index
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