Earnings to the rescue? Earnings to the rescue? http://www.federatedinvestors.com/static/images/fed-logo-amp.png December 6 2018

Earnings to the rescue?

There may be some near-term volatility but the longer-term upside story remains strong.
Published July 19 2018
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With near-term market risks seemingly balanced between upside and downside—a 5% move is possible either way—we’re holding steady to the modest reduction we made a month ago to the equity overweight in our stock-bond portfolio model, taking some profits while awaiting the next leg up. 3,100 on the S&P 500 remains on our year-end horizon, suggesting 10-11% upside from current levels. Before getting there, however, we may need to work through a little more volatility, with the five factors below the principle drivers. 

  • Earnings The Q2 earnings season is off to a good start, with full-year forecasts grinding ever higher (unusual this late in the year) and consensus 2018 S&P earnings now at nearly $160. Our biggest concerns heading into the reporting season were how the trade-war talk might bleed into tone and guidance calls for the cyclicals, how a flattening yield curve might impact the tone on bank earnings calls and how the strong dollar might impact tech. To date, bank guidance on the Fed/yield curve has been reassuring, with banks generally reflecting other sources of earnings growth beyond the curve. We’ll have to wait on the other two fronts: the big cyclical names have yet to report, and tech is coming next week.
  • Trade/confidence The muted reactions to the robust earnings so far may be rooted in all the uncertainty across the cyclical/industrial side of the economy due to President Trump’s trade negotiation strategy. The recent escalation with China marked a new period of rising concern among many economic players and until we get some clarity on where this all settles, it may be difficult for these sectors to advance.
  • Putin controversy Ironically, Trump’s recent poor performance in Europe has, in our view, raised the odds of a “trade deal” of some kind being delivered before the election. The president doesn’t like looking bad and knows he did just that. A victory on trade would vindicate his at times volatile negotiating tactics. Some kind of rapprochement with China could be in the offing, in part because the situation there is deteriorating. Its economy is slowing and this week’s devaluation suggests Beijing is getting nervous, motivating it to act as well. While the entire trade picture with China is complicated and will take months if not years to resolve, a one-off deal along the lines of the soybean import agreement discussed a few months ago could defuse tensions and produce some positive headlines for Trump. We do think any good news on trade at this point is almost completely unexpected and could be the catalyst the market needs for an upside breakout.
  • Fed Another near-term risk but longer-term positive could be our central bank. While we will soon be focusing on its likely September rate hike, the real news could be increased dovish guidance, along the lines of Chair Powell’s “for now” comments this week before the Congress. As the economic acceleration slows and the inflation numbers start to normalize following this year’s dollar strength, we think the Fed may soon signal it doesn’t intend to hike rates forever. Our view is once it gets the benchmark rate to 2.5% in December or February, it may only have one or two more hikes left. As this bleeds into the market, it could also provoke a Q4 rally this year. Right now, market consensus has the Fed on autopilot with quarter-point hikes every two or three months until it pushes the economy into a recession. We think Powell has no interest in doing this and won’t.
  • Midterm elections Another key market worry is the potentially destabilizing impact on economic policy should the Democrats take control of the House and take up impeachment proceedings against the president. While all the polls suggest this is coming, we think it is going to be closer than people think and that the Republicans might even squeak by with a win. As the campaigning is proceeding, we see the Democrats overplaying their hand, generating better-than-expected turnout from Republicans and middle-ground independents who might be frightened off by the rising Bernie Sanders wing of the Democratic Party. Couple this with a victory on trade, the second Supreme Court nominee going through, the improved economy and strong job market, and the Republicans could surprise. An unexpected victory would be market positive. 

Our main advice: remain focused on the longer-term positives. There are too many strong macro and fundamental drivers in the market’s favor. Among sectors, we like Energy, Industrials, Financials and Tech, with the first three trading at or near support and likely to benefit as economic uncertainty around trade and the Fed lifts. This is where there is still very good value in the market; if the market is going to climb to our 3,100 target, it almost has to do so through these stocks. As for tech, these big growth compounders just keep getting bigger, and most of the up-move we’ve seen has been paid for with their cash-flow growth. We think this is really a case where “the rich get richer” and would add to them on any pullbacks through earnings season.

Tags Equity . Markets/Economy .

Views are as of the date above and are subject to change based on market conditions and other factors. These views should not be construed as a recommendation for any specific security or sector.

Diversification does not assure a profit nor protect against loss.

S&P 500 Index: An unmanaged capitalization-weighted index of 500 stocks designated to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. Indexes are unmanaged and investments cannot be made in an index.

Yield Curve: Graph showing the comparative yields of securities in a particular class according to maturity. Securities on the long end of the yield curve have longer maturities.

Federated Global Investment Management Corp.