Equity markets rose modestly for the second-straight week on strong earnings and hopes for a Brexit deal. The S&P 500 Index has climbed to roughly 1% of an all-time high but is having a hard time breaking through the July highs.
Though we remain early in earnings season (15% of the S&P 500 having reported), it has been encouraging, with 84% beating earnings estimates and 64% topping sales estimates. Earnings appear set for their third-straight quarterly decline for the first time since 2016. With revenues set to increase, profit margins expected to contract for the third-straight time – the first such occurrence since the financial crisis. The contraction is most prominent in the Energy and Technology sectors and is driven by wage pressures and rising input costs. The market is rewarding upside reports, with companies beating gaining 1.9% and misses seeing a 1.2% decline, suggesting that equity markets embed cautious results. This is a busy weak for earnings, with 126 of the S&P 500 reporting.
Few details have emerged in the agreement between the U.S. and China, though Chinese Vice Premier Lie He said on Saturday that the two sides have made “substantial progress.” He committed to boosting IP protection. China registered its weakest quarter of growth in 27 years, though there are some early indications that recent stimulus spending is supporting growth. Chinese investors have been resilient despite the uncertainty, with the Shanghai index up 18% this year. Domestic investors have become less reactive to news in China, perhaps reflecting fatigue and the “false positives” recently experienced.
The Fed has entered a quiet period leading to the FOMC meeting next week. The most recent official to speak, Vice Chair Clarida, said the Fed will “act as appropriate,” but they are not on a set interest rate path. The Fed futures curve shows a 91% chance of a cut versus 73% last week, and the quiet period means officials would be unable to change market expectations. Expectations for an additional cut in December remain modest at 24% for the second-straight week.
Political uncertainty is quite elevated across the globe (Brexit, Hong Kong, Spain and the U.S.), and is unlikely to fade in the foreseeable future. A measure of global uncertainty shows a record reading in August dating back to 1997, easily eclipsing the Asian crisis, 9/11, the European debt crisis, and the 2016 election. The market embeds nervousness around these issues, so a resolution to any of them would be a positive catalyst.
Global investors were surprised and encouraged last week with the announced revised Brexit deal between U.K. Prime Minister Johnson and the European Union. A vote was expected in Parliament on Saturday, but they instead passed a vote withholding support until it is passed into law, forcing Johnson to request an extension. The E.U. will likely grant an extension until February, but only after Parliament votes down the measure. The euro and pound have recovered over the last several weeks in in hopes for a deal, and a moderating dollar should help support domestic earnings.
Year-to-date, large caps have beat small caps, growth has beat value and domestic outperformed international. Last week those trends were all reversed. Credit spreads remain tight, though interest rates have bounced from recent lows. After briefly inverting, the spread between the 10-year and 2-year Treasury yield has stretched to 0.20%, the widest level since July
What to Watch
Earnings announcements accelerate next week, with nearly 20% of the S&P 500 reporting third-quarter results. Economic data is relatively light, with existing home sales on Tuesday, durable goods and PMI on Thursday and consumer sentiment on Friday.
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