As CNBC and other news stations reported calamity in the stock markets around the world last week, I felt this would be a good opportunity to discuss how we currently view the markets and the economy. And though stocks rebounded some today, there could always be more volatility tomorrow.
It is entertaining to discuss theory’s, historical trends and statistics in an effort to guess what the markets will do tomorrow, next week, next month or even by the end of the year. Theory’s or statistics such as the January Barometer, which is the hypothesis that stock market performance in January (particularly in the U.S.) predicts its performance for the rest of the year. I have also heard that February is only up 54% of the time making it the 3rd worst month to invest. I am not even sure that statistic is correct or not. But it fun to talk about. So, what is the cause for the volatility?
Are investors rebalancing and taking profits at the slightest sign of volatility? Are investors concerned about inflation and believe that the Federal Reserve Bank will tighten monetary policy quicker than what is expected? Are investors weary or fearful that the market has had 14 consecutive months of positive returns and feel it cannot continue to keep going up and that we are at the top? Perhaps the markets are all just overpriced.
All of these theories or concerns could be playing apart in the most recent sell off. But we feel all of these concerns are not taking into account the bigger picture. When the economy is growing, and individuals are consuming goods, then businesses should be expanding and making a profit which in turn means their stock price should go up. Pretty simple.
How is the economy?
- A combination of loose monetary conditions, solid labor markets, healthy global trade and higher commodity prices led global growth to expand in the second half of 2017 at rates last seen nearly seven years ago.
- The United States had strong growth on the back of robust consumer spending, which was driven by continued job growth, increased wages, high stock prices and rising housing prices. Moreover, high levels of business confidence propelled capital expenditure. China also contributed positively to Q4’s robust reading as the economy defied fears of a pronounced slowdown, expanding at Q3’s stellar rate of 6.8% in Q4.
- Global growth is expected to remain strong this year. Despite monetary tightening in the U.S., financial conditions remain loose across the globe as other key central banks such as the BoJ and the ECB flood financial markets with cheap money. Loose monetary conditions are supporting consumer confidence and capital expenditure. Solid global economic dynamics are tightening job markets, which is reflecting positively in household spending.
What about Inflation and Monetary Tightening?
- The Federal Reserve has already started selling treasuries in an effort to unwind the 4 Trillion-dollar quantitative easing from the financial Crisis. Last quarter they started selling $10 Billion a month. Each quarter they will increase that monthly amount by $10B until they reach $50B a month. At that rate, it will still take over 7 years to completely unwind $4 Trillion dollars.
- The other defense that the Fed has to combat inflation is to raise the Fed Funds Rate in an effort to encourage savings and reduce consumption. The expectation was for three rate increases in 2018, but some analyst is raising that expectation to four times this year. The current rate is at 1.25% well below the 5.25% it was at back in 2007.
How are companies’ earnings and profits?
- Earnings Scorecard: For Q4 2017 (with 50% of the companies in the S&P 500 reporting actual results for the quarter), 75% of S&P 500 companies have reported positive EPS surprises and 80% have reported positive sales surprises. If 80% is the final number for the quarter, it will mark the highest percentage since FactSet began tracking this metric in Q3 2008.
- Earnings Growth: For Q4 2017, the blended earnings growth rate for the S&P 500 is 13.4%. All eleven sectors are reporting earnings growth for the quarter, led by the Energy sector.
- Earnings Guidance: For Q1 2018, 25 S&P 500 companies have issued negative EPS guidance and 25 S&P 500 companies have issued positive EPS guidance.
- Expectation of growth from the tax reform could have been a big contributor to January’s exceptional returns. However, the actual results from the tax reform will not start to be reflected in corporate spending or expansion until later this year. We do expect tax reform continue to help corporate spending throughout 2018 and into 2019.
Reported by factset.com as of January 2, 2018
Can the stock market continue its bull climb?
This recovery is turning out to be one of the longest recoveries on the books, but one of the weakest as well. The U.S GDP surpassed 3.0% for the first time just last quarter. Fundamentals have not changed. However, this recent market turmoil may be triggering a change in sentiment – something to watch going forward.