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Markets settled as attention shifts to earnings

OCT. 22, 2018
  • Equity markets settled following a tough three-week period, with economic data and earnings results overcoming continued trade pressure and geopolitics. Only 17% of the S&P 500 has reported so far, with a better-than-average percentage beating on the top and bottom line, though the magnitude of the beat is below average. Also, the market is not rewarding companies that are beating, with an average decline of 0.5% in the two days before and two days after a beat. This compares to an historic average of +1.0%. Growth is tracking towards 20% for earnings and 8% for revenues. While trade and cost pressures are a focus of managements in conference calls, the headwind from the dollar is most frequently referenced. This will be an interesting week, with nearly 1/3 of the S&P 500 reporting.
  • Economic data continues to surprise to the upside, with impressive readings on leading indicators, job openings and industrial production last week. The primary weak spot for the economy continues to be housing, with existing home sales falling at the fastest pace in two years. Many are blaming low inventory levels, though the combination of high prices and 5% mortgage rates for the first time in eight years is harming affordability.
  • The trade war with China is having a clear impact on China, with GDP for the third quarter at a lower-than-expected 6.5%. Their equity markets were down roughly 30% since January before a 3% jump on Friday and a 4% rally on Monday (most since March 2016) following a coordinated effort by officials to calm markets. Over the weekend, the government announced details of a personal income tax cut. There is growing speculation that Presidents Trump and Xi will meet at the G20 meeting in Argentina next month, though sources over the weekend noted that Trump has no intention of easing tariffs. Domestic investors have largely shrugged off the challenges in China, though the emerging market indexes and even developed market indexes are apprehensive.

  • Equity markets were roughly flat, with value stocks beating growth, and large caps ahead of small. Bond-proxy sectors, like consumer staples, real estate and utilities were higher, while “risk-on sectors” such as consumer discretionary, energy and materials lagged. Volatility remains elevated, with the VIX near 19 on Monday.
  • Interest rates have settled, with the 10-year yield at 3.19% on Monday versus the recent high of 3.23%. Credit spreads continue to be well behaved, as they are not indicating the same stress of equity markets.
  • Crude prices fell sharply last week, and are 10% off the recent high as stockpiles have built.
  • Europe: We are in the late innings for a Brexit deal, and a range of possible outcomes still in play. Prime Minister May is set to tell Parliament that 95% of the deal has been agreed, though she is under increased pressure from her Tory party, with the possibility of a “do over” in play. Questions have arisen surrounding the May 29, 2019 deadline, with a concrete deal and a new vote unlikely to occur before that date. Italy is watching closely to negotiations, as tensions continue over their deficit-driven budget deal. Moody’s lowered their credit rating to the lowest level of investment grade, and credit spreads spiked to 340 basis points. Comments from both sides over the weekend drove a rally in their bonds Monday.
  • Technology: Shares in the technology sector have been hard hit recently, with the sector losing 7% this month. A bifurcation is beginning to develop between the momentum-based technology shares that drove returns over the past three years and the more stable-growth companies. The FANG names are up 9x as much as the S&P 500 since the beginning of 2015, but have fallen an average of 19% since their recent highs. Netflix rallied nearly 10% early last week around earnings, but ended the week with a 2% loss. This group tends to represent the technology space to many investors, though there is a growing divide between momentum and quality performance.

What to Watch

  • Earnings will continue to drive the news, with the largest week for announcements ahead of us. Economic data could also drive markets, with PMI data on Wednesday, durable goods and pending home sales on Thursday, and third-quarter GDP and consumer sentiment on Friday.

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