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Capital Market Impact Weekly market commentary

Trade optimism drives modest rebound in equities

OCT. 14, 2019

Highlights

  • President Trump announced a “phase 1” deal was reached between the U.S. and China. Specifics at this point are limited to delayed tariff implementation and agricultural purchase, with non-specified progress on more structural issues that will require phases 2 and 3. The news was sufficient to break a three-week losing streak for equities, but skepticism is warranted given the whipsaws driven by trade headlines over the past year.
  • The Fed announced a plan to buy $60 billion per month of Treasury bills to provide excess reserves to support markets. Until July, they had been shrinking the balance sheet by $50 billion. When combined with the two rate cuts already implemented and the 1-2 additional by year-end, Fed policy is in sharp contrast to a year ago. Core CPI was released last week showing the highest year-over-year growth since the financial crisis. This is in sharp contrast to the Fed’s preferred inflation metric (core PCE deflator) which is quite low.
  • An important Democratic debate will be held Tuesday, with the DNC choosing to allow 12 candidates to participate versus 10 at the previous one. National polls show Joe Biden holding a narrow lead over Elizabeth Warren (28% vs. 26%), though the Predictit betting site sees a strong lead for Warren (47% vs. 21%). Watching market and sector movement on Wednesday could be telling, as Biden is seen as more pro-business than Warren.

Review

  • Equity markets managed a modest gain for the first time in four weeks in reaction to the announcement of a trade deal between the U.S. and China. The rally was viewed with a fair degree of skepticism though, as trade headlines have caused many whipsaws over the past year.
  • On Fed purchases, Chair Powell was clear that this policy does not resemble the previous quantitative easing programs, though it effectively does the same thing. Expectations for rate cuts have moderated a bit on China trade news, with a 75% chance of a rate cut in two weeks and a 27% chance of an additional cut in December. Inflation metrics are sending mixed signals, with September core CPI at the highest level from a year ago since the financial crisis. The Fed’s preferred inflation metric (core PCE deflator) shows more modest growth, and September’s reading isn’t released until after the October meeting.
  • This week marks the unofficial start to earnings season, led by several high-profile bank announcements. A trend has emerged where managements announced the fewest updates to third-quarter guidance since 2000, reflecting the high degree of uncertainty. Per Factset, earnings are expected to fall by 5% (the largest decline since 2016) despite 3% revenue growth. Of the 22 companies that have already announced third-quarter results, currency headwinds were discussed the most (11 times), followed by weather (8), Europe (7) and labor costs (7). Interestingly, only five mentioned tariffs. Currently, estimates for 2020 show 11% earnings growth on 5% revenue growth, though there is likely risk to that number.
  • Similar to market whipsaws around China, Brexit deal optimism drove European markets higher last week. While progress was made in negotiations, the E.U. warned that the current plan is insufficient, and P.M. Johnson warned that the U.K. must be willing to have a “hard Brexit” at the end of the month. Industrial production surprised to the upside in Europe, growing at 2.8% from a year ago versus 2.0% last month. European companies have benefited from a 5% decline in the euro versus the dollar over the past 12-months, though it has seen recent stabilization.

What to Watch

  • Macro and trade headlines are likely to give way to earnings reports as the key catalyst for market movement. Economic data includes retail sales and industrial production on Tuesday, housing starts on Wednesday and leading indicators on Thursday.

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Disclaimers

  • This material is not a recommendation to buy, sell, hold or roll over any asset, adopt an investment strategy, retain a specific investment manager or use a particular account type. It does not take into account the specific investment objectives, tax and financial condition, or particular needs of any specific person. Investors should work with their financial professional to discuss their specific situation.

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