Weekly Investment Commentary: Trade tensions easing, but U.S. interest rates weigh on investors
Equities were mostly lower last week, with the S&P 500 Index ending the week down 1%.1 This is the first time since late June that the S&P 500 has fallen two weeks consecutively. Some of hardest hit areas included small caps, emerging markets, consumer discretionary, technology and communication services, while defensive stocks were mixed.1 The utilities sector gained nearly 2%, making it the standout performer. The 10-year Treasury yield jumped 0.2% to end the week at 3.23%.1
- U.S. stocks ended lower for the second week in a row amid concerns over the path of interest rates.
- Trade tensions eased with the signing of a new agreement between the U.S., Canada and Mexico, but negotiations with China still weigh heavily.
- Earnings growth should remain strong, but could fall short of levels reached in recent quarters.
Weekly top themes
1. The September jobs report came in lower than expected, but revisions offset the slower pace. Payroll gains (134,000) were lower than consensus estimates, but revisions for prior months were up significantly. The labor market continues to be on a winning streak with the unemployment rate reaching a nearly 50-year low, with average hourly earnings remaining firm.
2. The U.S., Canada and Mexico reached a surprise trade deal, but China is still a concern. The new deal, which may not be substantially different from NAFTA, includes benefits for U.S. automakers and dairy farmers. With this new agreement, negations with China remain the final significant trade dispute.
3. The Federal Reserve (Fed) is signaling higher rates. By dropping “accommodative” language in his recent statement, Chairman Powell indicated that the Fed would try to offset U.S. economic strength with tighter monetary policy. He also indicated that the Fed may raise rates “past neutral,” implying that additional hikes are on the horizon, which may have rattled the markets.
4. Rising rates may cause an end of a benign era for risk assets. Benchmark Treasury bond yields broke through a 37-year trend line on the upside, reaching seven-year highs. We reiterate our stance that returns on stocks, bonds and cash will likely be below their long-term historical averages over the next one, three and five years.
5. Earnings growth should remain positive but may show signs of slowing. Current third quarter earnings growth estimates are just under 20%. Following back-to-back quarters of approximately 25% earnings growth, these lower estimates reflect continued concerns about potential higher costs, the stronger dollar and trade tensions.
Stock prices should continue to rise, but bond yields and non-U.S. economic growth are concerns
We remain mildly constructive towards equities given the positive earnings backdrop. Consistent with the ongoing global economic expansion, 12-month forward earnings continue to inch higher. While corporate profits may slow in the coming year, earnings growth should remain sufficiently strong to further support an advance in equity markets. However, additional significant gains in equity prices may depend on easing of concerns over non-U.S. economic growth and the behavior of the U.S. bond market.
While last week’s agreement between the U.S., Mexico and Canada reinforces our belief that trade outcomes will better be than threatened, the path forward could still be bumpy, especially as the U.S. and China remain at an impasse. Political uncertainties in Europe and isolated problems in emerging markets could continue to weigh on sentiment toward non-U.S. economic growth.
Even if protectionist threats recede and global growth firms, bond yields will still likely increase, restraining valuations. As a result, we think U.S. market returns will be modest. Given solid U.S. economic growth, moderately rising inflation and the ongoing unwinding of the balance sheet, the benchmark 10-year Treasury yield is poised to move irregularly higher, creating further headwinds for valuations.
1 Source: FactSet
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