Investment Insights: Living up to (earnings) expectations

Wade Balliet
Posted by Wade Balliet
Investment Strategy

This weekly report presents insights from our Global Investment Management team.

After a week-long volatility binge, financial markets seem to be enjoying renewed vigor on the back of the third-quarter earnings season and some positive economic data.

Male worker in a large China textile shop, writing on a pad while surrounded by hundreds of brightly colored bolts of fabric.Losses mounted from earlier in the month through mid-last week as longer term rates spiked due to growth concerns and the pace of Fed hikes. The S&P 500 slumped 6.69%, while global stock markets declined 6.46%, according to MSCI data. As quickly as stock prices dropped, they were back on the rebound. The S&P 500 rallied higher, gaining 3.01% in the last three trading days and the 10-year Treasury subsided to 3.16% yesterday. Better-than-expected manufacturing data, and slight disappointments in employment and inflation measures – which may cause hesitation at the Fed – seem to have boosted investor appetites, along with heady expectations for earnings results in the coming weeks.

Recent earnings seasons have been some of the best on record, and this quarter may end up joining that list. Fueled by corporate tax cuts and a strengthening economy, U.S. companies have posted astounding double-digit earnings growth of around 25% over the last two quarters. According to FactSet data, earnings expectations for the third quarter came in at about 19% – still considerably higher than the long-term average, which is just above 10%, based on Bloomberg data. Only 52 of the 500 companies in the S&P have reported so far, but results are on pace to reach or exceed expectations. Not only have all but one of these companies posted positive earnings growth, but the average growth rate is just under 22%. While expectations are high, geopolitical events and international trade will have tangible consequences for earnings going forward as foreign exchange and tariffs hit company balance sheets.

China continues to be a central topic when discussing international trade or global growth. The trade dispute with the U.S. remains heated as both sides refuse to budge over key issues that are seen as critical to their respective economies. The current tally is $250 billion worth of tariffs levied against imports to the U.S. – which amounts to roughly half of all imported goods from China – versus about $100 billion in tariffs from the Chinese government, which accounts for about 75% of all U.S. exports to China. Despite the restrictions on trade, China’s exports to the U.S. have never been higher. August marks the highest-ever monthly trade surplus with China, according to the U.S. Census Bureau, at $34 billion and September may be even higher.

The Global Investment Management team continues to see upside potential for stocks, particularly as robust earnings push prices higher. However, as we have said in the past, our team sees a parallel increase in risk that may skew further toward domestic markets as valuations rise. While earnings have been the main reason for the drastic gap in performance between U.S. stocks and international ones, that disparity may begin to reverse. We see stocks maintaining modestly positive performance for the year, while continuing to outperform bonds.

Chart showing various market returns as of 10/16/18

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Investing involves risk, including the possible loss of principal and fluctuation in value. Economic and market forecasts reflect subjective judgments and assumptions, and unexpected events may occur. Therefore, there can be no assurance that developments will transpire as forecasted. The information in this newsletter is for informational purposes only and is not intended to be investment advice or a recommendation. Nothing in this newsletter should be interpreted to state or imply that past results are an indication of future performance.

Fixed income securities are subject to interest rate, inflation, credit and default risk. The bond market is volatile. As interest rates rise, bond prices usually fall, and vice versa. The return of principal is not guaranteed, and prices may decline if an issuer fails to make timely payments or its credit strength weakens.

International securities involve additional risks such as currency fluctuations, differing financial accounting standards, and possible political and economic instability. These risks are greater in emerging markets.

Diversification and asset allocation do not ensure a profit or guarantee against loss.

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