Weekly Investment Commentary: Earnings beat estimates, but leading indicators cause concern
- Stocks finished higher last week, and smaller stocks experienced a boost.
- Earnings have continued to beat estimates, with domestically oriented companies leading the way.
- We remain boringly neutral on equities and would need to see improvement in manufacturing activity and trade negotiations before making any significant upgrade.
U.S. equities finished higher last week, with the S&P 500 up 1.6%, and small stocks experienced a much-needed stronger week.1 The communication services, financials and technology sectors outperformed, while utilities and energy stocks lagged.1 In the peak week of second quarter earnings results, earnings-beat rates remain elevated last week, and the U.S. economy continues to look fairly resilient. However, macro uncertainty lingered, and forward estimates continued to drop.
10 themes for investors to consider:
1) U.S. second quarter real GDP 0f 2.1% was somewhat better than expected.² Consumers contributed 2.9 points and government spending added 0.9, while inventories and trade were the biggest detractors.
2) With earnings season nearly half over, earnings have beaten estimates by 6.2%. Earnings per share (EPS) are expected to be up 2% to 3% for the quarter. Similar to the previous quarters, second quarter earnings growth is stronger for U.S.-oriented names as a result of a more robust U.S. economy.
3) The possibility of an earnings recession was among investor worries at the start of the year, along with the U.S. government shutdown, trade tensions and a flattening yield curve. While earnings have been rather soft, the much-anticipated earnings recession has not started and is not likely to materialize. However, we are concerned that earnings estimates for 2020 remain too high.
4) Consumer-spending growth continued its solid run in June. The increase in total retail sales was stronger than expected at 0.4%. As long as the labor market remains healthy, we believe consumer spending should be well insulated from global uncertainties restraining capital spending. We continue to look for consumer spending to grow faster than overall GDP in the second half of 2019.
5) U.S. manufacturing PMI fell from 50.6 to 50.0, disappointing expectations and hitting its lowest level since September 2009.³ The global manufacturing downturn has been widely attributed to the escalating trade war, Chinese deleveraging and fading benefits of the Trump tax cuts.
6) The Fed is expected to cut the fed funds rate this week by 25 basis points. We think that the justification for rate cuts at this point is questionable. Growth, employment and inflation remain close to the Fed’s goal, and the data have consistently surprised on the upside since the June Fed meeting.
7) The White House and Congress have reached a two-year deal on the budget and debt ceiling that includes a $320 billion increase in the 2020 and 2021 budget caps and a suspension of the debt limit through July 2021. We view this as a modest market positive, removing a potential significant macro headwind beyond the 2020 election.
8) We do not expect much progress in the next round of U.S./China trade negotiations this week. A deal doesn’t seem likely anytime soon, and we think investors should expect the status quo to remain.
9) Leading economic indicators, especially out of Europe, continued to be worrisome. There’s a broad-based slowdown in future demand for business loans, consumer confidence remains suppressed and the manufacturing PMI continues to fall.
10) The U.S. Department of Justice will review potentially anti-competitive behavior of several Big Tech leaders in search, social media and online retail. Although the review doesn’t pose an imminent risk to the companies most likely to be implicated — Facebook, Amazon and Google — Big Tech will clearly be in the regulatory and legislative cross hairs for the foreseeable future.
Improvements in manufacturing and trade issues are needed for markets to break out
The extremely supportive bond markets and central banks continue to prop up risk-asset markets. While the European Central Bank (ECB) confirmed this week that it is willing to do more to improve the economy, there’s not much more it can do. Market-setting rates and yields have dropped sharply, and periphery bond yields have tumbled, especially relative to economic activity. Aside from U.S. large-cap equities, most risk-asset markets have been unable to break out.
The lack of confidence in corporate earnings and the durability of the business expansion are keeping investors wary. A broader gain in risk asset prices will hinge on an improvement in manufacturing activity, a more favorable trend in trade negotiations and less uncertainty about the future of trade. While the revival of U.S./China trade talks is a positive step, given all the failures to date, investors and business executives want an actual deal.
A sustained period of better-than-expected data is likely needed to put a floor under Treasury yields and allow the stock/bond ratio to break through its trading range. While we believe deflationary worries are overblown, central banks are fearful and will maintain very accommodative policies until well after economic activity improves. We may remain boringly neutral and are holding back any significant upgrade until there are signs that manufacturing weaknesses are ending.
The lack of confidence in corporate earnings and the durability of the business expansion are keeping investors wary.
1 Source: FactSet, Morningstar Direct and Bloomberg
2 Source: Bureau of Economic Analysis
3 Source: Markit
The S&P 500 Index is a capitalization-weighted index of 500 stocks designed to measure the performance of the broad domestic economy. The Dow Jones Industrial Average is a price-weighted average of 30 significant stocks traded on the New York Stock Exchange and the Nasdaq. The Nasdaq Composite is a stock market index of the common stocks and similar securities listed on the NASDAQ stock market. The Russell 2000 Index measures the performance approximately 2,000 small cap companies in the Russell 3000 Index, which is made up of 3,000 of the biggest U.S. stocks. Euro Stoxx 50 is an index of 50 of the largest and most liquid stocks of companies in the eurozone. FTSE 100 Index is a capitalization-weighted index of the 100 most highly capitalized companies traded on the London Stock Exchange. Deutsche Borse AG German Stock Index (DAX Index) is a total return index of 30 selected German blue chip stocks traded on the Frankfurt Stock Exchange. Nikkei 225 Index is a price-weighted average of 225 top-rated Japanese companies listed in the First Section of the Tokyo Stock Exchange. Hong Kong Hang Seng Index is a free-float capitalization-weighted index of selection of companies from the Stock Exchange of Hong Kong. Shanghai Stock Exchange Composite is a capitalization-weighted index that tracks the daily price performance of all A-shares and B-shares listed on the Shanghai Stock Exchange. MSCI EAFE Index is a free float-adjusted market capitalization weighted index designed to measure developed market equity performance, excluding the U.S. and Canada. The MSCI Emerging Markets Index is a free float-adjusted market capitalization index that is designed to measure equity market performance of emerging markets. Bloomberg Barclays U.S. Aggregate Bond Index covers the U.S. investment grade fixed rate bond market. The BofA Merrill Lynch 3-Month U.S. Treasury Bill Index is an unmanaged market index of U.S. Treasury securities maturing in 90 days that assumes reinvestment of all income.
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