Week 46 Sitrep

Stock market indexes around the world marched higher last week on a combination of news events. We had the continuation of better-than-expected corporate earnings results, positive comments from the Fed chairman, expectations of a “Phase One” trade deal with China, and positive momentum on a peaceful Brexit in the headlines last week. Granted, those last two have the reputation of giving us as many market headaches as they do pleasures. Even Friday, President Trump stated that the “White House wasn’t totally convinced” that eliminating tariffs was the right thing to do today.1 The U.S. stock market declined on the news but went on to rally throughout the rest of the day to finish at a new all-time high.


Source: J.P. Morgan Asset Management, Weekly Market Recap, 11/11/19

 

The benchmark S&P 500 Index has posted positive returns over the past five weeks consecutively. The index has recently broken out of a sideways pattern that started in December 2017. While the pattern had a slight uptrend in place, we also saw increased volatility that sent the market down over four different time periods. Many analysts note that when the market moves above a long-term trend like this, we often see continued strength in stock prices in the months to come.2

Source; Bespoke Investment Group, The Bespoke Report, November 8, 2019

 

Stock sectors moving higher this past week include energy, materials and industrials based on better-than-expected earnings. Financial stocks continue to move higher as well on the expectation of higher interest rates boosting their profitability.3 The largest companies continue to enjoy the benefit of better stock returns in 2019, however all asset classes have seen strong double-digit returns. The technology sector is now up more than 40% for the year, while most others are up at least 20%.

Source: J.P. Morgan Asset Management, Weekly Market Recap, 11/4/19

 

We have seen a few recent research articles questioning the current all-time highs for the broader stock market indexes. One of the common statistics we have heard is that only 64% of stocks in the S&P 500 are trading above their 50-day moving average.4 That would imply that the increase in the index has not benefited all stocks and there are many stocks NOT at all-time highs. However, we would also note that the sectors with very few stocks above their 50-day moving average are traditionally defensive sectors.

Source; Bespoke Investment Group, The Bespoke Report, November 8, 2019

 

A key driver of recent stock performance has been better-than-expected corporate earnings results. As of Friday, 75% of companies show earnings results that have beaten their analyst expectations. Actual earnings results are showing earnings down 2.4% for the quarter compared to the 3rd quarter of 2018.5 As we’ve discussed in recent letters, the small decline in earnings results is not worrisome to us given the very strong earnings growth in 2018 due to the tax bill. Clearly, the energy sector was the most concerning sector when analysts began reducing earnings expectations over the summer. However, 56% of energy companies have reported stronger-than-expected earnings results while 33% have missed their earnings estimates.6

Source; Factset Insight, S&P 500 Earnings Season Update, November 8, 2019

 

Overall, U.S. companies are still reporting that earnings will continue to be slower in the 4th quarter. Despite the warnings that earnings would be lower, U.S. companies have continued to outperform their lower guidance. More important, the stock price of companies that are beating earnings expectations have performed quite well. John Butters of Factset Insight reports that the average company beating earnings estimates is seeing their stock price rise by 2.3% from the two days before earnings are reported until two days after the earnings are reported. Butters states that this is the best price reaction to earnings reports since 2014.7

Source; Factset Insight, S&P 500 Earnings Season Update, November 8, 2019

 

The top three sectors for positive earnings surprises are technology, health care and financials. Each of these sectors has seen more than 70% of companies beating their earnings estimates in the 3rd quarter. Bespoke Investment Group also notes the strong stock performance from companies who are beating their earnings estimates, but it is also important to recognize that the market is not very friendly when companies miss their earnings estimates.8 For example, companies in the technology sector that underperform earnings expectations are down nearly 8% in stock price after their earnings report.

Source; Bespoke Investment Group, The Bespoke Report, November 8, 2019

 

Our supply/demand indicators continue to show increasing demand for U.S. stocks. The trends have expanded for our long-term, intermediate and short-term indicators. The resources and materials indicator remains in a “bear” status but has recently surged getting closer to switching to bull status. That change in trend is a result of the recent earnings results and positive stock performance discussed above. While still in bull status, the fixed income indicator has fallen in recent weeks as interest rates have risen. Remember that bond prices and yields are inverted; as the yields have moved up recently, the price of bonds is falling. When an indicator turns negative, we would begin to look at reducing risk in the appropriate assets.

Interest rates have risen quite rapidly in recent weeks. The 10-year U.S. Treasury has moved from 1.46% over the summer to a current 1.94%. Many analysts believe the rise in rates is a direct result of comments from Fed Chairman Powell. Last week, Chair Powell was quoted that “we would need to see a really significant move up in inflation that’s persistent before we would consider raising rates to address inflation concerns.”9 The market took that as an assurance that the Fed will be accommodative for future growth.

Source: J.P. Morgan Asset Management, Weekly Market Recap, 11/11/19

 

Historically the stock market does well when the Fed is slow on raising interest rates. The bond market interpreted Powell’s comments as a sign that economic growth will be allowed to run higher without Fed interference, thus the higher interest rates.10 The change in the yield curve was quite significant as we saw a rapid move higher in longer maturity interest rates.

Source; Bespoke Investment Group, The Bespoke Report, November 8, 2019

 

While we do not believe interest rates will continue to rise in a similar fashion, investors need to be prepared to see continued volatility in interest rates. While we continue to see an improved outlook for the U.S. economy, the European economy remains weak relative to the rest of the world. Obviously, the key risks going forward remain a peaceful resolution to Brexit, the uncertainty of the U.S. election (and the resulting changes in tax policy that could result) and the final status of pending trade deals. Remember that the House of Representatives is sitting on a very favorable new trade agreement between the U.S., Canada and Mexico. The House has opted to delay their vote on the trade deal pending the outcome of their impeachment proceedings. We anticipate higher risks present in the global stock market for 2020 and will adjust portfolios accordingly.

If you’d like to schedule a time to discuss your portfolio or the markets in detail, please feel free to call our office at (281) 616-5935 or send an e-mail to cameron.malott@engravewealth.com. We welcome the opportunity to sit down with you and learn more about your situation so we can help you optimize your portfolio to meet your financial goals for years to come.

Engrave Wealth Partners Investment Committee

Bill Day, CFP®, CIMA

Taylor Parker, CFP®

Greg Parker


Footnotes:

1. CNBC Halftime Report, 11/8/19
2. Bespoke Investment Group, The Bespoke Report, 11/8/19
3. Bespoke Investment Group, The Bespoke Report, 11/8/19
4. Bespoke Investment Group, The Bespoke Report, 11/8/19
5. Factset Insight, John Butters, S&P 500 Earnings Season Update, 11/8/19
6. Factset Insight, John Butters, S&P 500 Earnings Season Update, 11/8/19
7. Factset Insight, John Butters, S&P 500 Earnings Season Update, 11/8/19
8. Bespoke Investment Group, The Bespoke Report, 11/8/19
9. Bespoke Investment Group, The Bespoke Report, 11/8/19
10. Bespoke Investment Group, The Bespoke Report, 11/8/19

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