1Q earnings are in full swing and growth expectations heading into the reporting period increased from 12.2% on December 31st to 18.5% currently. Normally, expectations get whittled down during the quarter and then earnings post a modest surprise off depressed expectations. With the earnings preannouncement ratio exceptionally low, stocks may be priced for perfection. However, earnings growth is expected to accelerate even further in the coming quarters as companies report better top-line growth. This should bode well for strong cash flow in 2019 that can be used for wage increases, dividends, buy-backs, and capex.
The performance of the top quintile of capex spenders will be an important barometer for the efficacy of the tax package. Continued outperformance over companies more inclined to buy back stock would suggest better productivity, low unit labor costs, a pick-up in earnings, and a longer business cycle. Until recently, capex spenders have not outperformed the companies spending on other outlets of cash (share repurchases, cash, dividends, M&A, balance sheet repair) since 2010.
While this reporting period may be an opportunity for the market to grow into a more attractive multiple, there are political risks in nearly every sector. We are inclined to own the companies most levered to fiscal policy during this time of uncertainty. Investors are focused on trade policy and the Mueller investigation but the implications of fiscal policy outweigh the effects of trade policy and the investigation seems like more noise than anything else. Congress passed $200bn of tax cuts and $100bn of new federal spending. This is more than 1.6% of GDP and we expect an additional $500-700bn of repatriated funds over the coming months. Conversely, trade policy is only $50-60bn of tariffs. To put things in perspective, the market is up just 3.3% since the tax bill was introduced in Nov.
Stocks advanced last week during a volatile week dominated by corporate earnings reports. Energy outperformed as crude oil inventory levels fell below their five-year average for the first time since 2014; also, data for the first quarter will likely show the highest global demand since late 2010. And, OPEC and Russian oil ministers suggested at a private meeting in Saudi Arabia that they could extend an agreement on production limits into 2019. Disappointing earnings results for tobacco companies triggered sharp losses for Phillip Morris International (-17%) and Altria Group (-11%) in the Consumer Staples sector. Yields for short and intermediate-term bonds rose; the yield on the 2-year and 10-year U.S. Treasury Notes hit their highest levels of the year. The yield difference between long-term and short-term bonds has narrowed as the demand for long-term bonds remains strong. Global economic data remain broadly positive: retail sales increased in March, both industrial production and housing starts grew faster than expected. And, China’s first quarter GDP rose 6.8%; industrial production increased 6.0% and retail sales increased 10.1%. The IMF maintained its 3.9% global growth forecast for 2018 and 2019.
Corporate earnings also point to strengthening economic conditions. Thus far, 85 companies in the S&P 500? Index have reported results; of these, 69% have met or exceeded analysts’ sales estimates and 87% have met or exceeded analysts’ earnings per share (EPS) estimates. Since the start of earnings season, the forecast for corporate EPS growth has increased from 17.3% to 18.3%. Meanwhile, concerns over possible trade disputes have dissipated somewhat. Canadian Prime Minister Justin Trudeau stated that he sees “an opportunity to make significant progress” on NAFTA; the U.S. is hoping to reach a deal for a renegotiated agreement within the next few weeks. And, China declared plans to remove foreign ownership limits for automotive companies within the next four years. Geopolitical tensions have also abated. No military actions have followed last Friday’s military strikes against Syria. And, South Korean President Moon Jae-In announced that North Korea may be ready for complete denuclearization while allowing the U.S. military to remain in South Korea.
This week, over 170 companies in the S&P 500? Index, including Verizon, Lockheed Martin, Visa, United Parcel Services, Starbucks, and ExxonMobil, report results. Technology companies will also be in focus with earnings reports from Alphabet (parent company of Google), Facebook, Amazon, Microsoft, and Intel. The sector, which accounts for roughly a quarter of the Index, will likely play an outsized role in determining the market’s near-term direction.
*Source: Strategas and Pacific Global Investment Management Company
Chart reflects price changes, not total return. Because it does not include dividends or splits, it should not be used to benchmark performance of specific investments.
Last Week's Headlines
1. Business activity grew at a solid clip in New York State, according to firms responding to the April 2018 Empire State Manufacturing Survey. The headline general business conditions index, at 15.8, remained firmly in positive territory, although its seven-point decline from its March level pointed to a somewhat slower pace of growth. Similarly, the new orders index and the shipments index suggested ongoing, albeit more measured, growth, with the first index falling eight points to 9.0 and the second declining ten points to 17.5. Delivery times continued to lengthen, and inventories moved higher. Labor market indicators pointed to a small increase in employment and significantly longer workweeks. The indexes for both prices paid and prices received remained elevated. Firms’ optimism about the six-month outlook waned sharply, with the index for future business conditions plunging twenty-six points to its lowest level in more than two years.
2. Advance estimates of U.S. retail and food services sales for March 2018, adjusted for seasonal variation and holiday and trading-day differences, but not for price changes, were $494.6 billion, an increase of 0.6 percent (±0.5 percent) from the previous month, and 4.5 percent (±0.5 percent) above March 2017. Total sales for the January 2018 through March 2018 period were up 4.1 percent (±0.5 percent) from the same period a year ago.
3. Manufacturers’ and trade inventories, adjusted for seasonal variations but not for price changes, were estimated at an end-of-month level of $1,928.8 billion, up 0.6 percent (±0.1 percent) from January 2018 and were up 4.0 percent (±0.3 percent) from February 2017.
4. Industrial production rose 0.5 percent in March after increasing 1.0 percent in February; the index advanced 4.5 percent at an annual rate for the first quarter as a whole. After having climbed 1.5 percent in February, manufacturing production edged up 0.1 percent in March. Mining output rose 1.0 percent, mostly as a result of gains in oil and gas extraction and in support activities for mining. The index for utilities jumped 3.0 percent after being suppressed in February by warmer-than-normal temperatures. At 107.2 percent of its 2012 average, total industrial production was 4.3 percent higher in March than it was a year earlier. Capacity utilization for the industrial sector moved up 0.3 percentage point in March to 78.0 percent, a rate that is 1.8 percentage points below its long-run (1972–2017) average.
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