Market Strategy Radar Screen Weekly May 21, 2018

Keep On a Rock’n Me Baby

Markets fluctuate as trade, interest rates and oil prices capture investor attention

Good news traversed the transom over the weekend as Treasury Secretary Steve Mnuchin said the US was “putting the trade war on hold.” Reports coming out of the trade talks so far have been mixed adding weight to the Secretary’s remark. Asian markets showed some signs of relief on the news with stocks in the region trading mixed with a broadly positive bias as we prepared to go to press.

Last week the S&P bounced between gains and losses moving lower in three of five trading sessions to close the week off a little over one half of one percent. The Dow Jones Industrial Average and the NASDAQ Composite (some 40% weighted in tech or tech-related stocks) also closed lower for the week respectively shedding 0.5% and 0.7%. However, the S&P 400 (mid-caps) managed to eke out a gain of just under a quarter of one percent while the Russell 2000 (small caps) advanced a relatively robust 1.2% in the same period.

Even as the S&P 500 first-quarter earnings season continued showing solid revenue and earnings gains, stocks in that benchmark have had difficulty in rousing much investor enthusiasm. On the other hand, the small caps segments (Russell 2000 and the S&P 600) have grabbed investor attention as they are considered to have less exposure internationally and greater focus on the domestic US economy. So far this year, our market cap agnostic approach has benefitted the performance of our asset allocation.

As of last Friday with some 93% of S&P 500 companies having thus far reported, firstquarter earnings have risen 23.5% on the back of 8.1% revenue growth. Ten of the 11 sectors have delivered double digit earnings growth with the relative laggard (real estate) showing earnings up over 8%.

A mix of trade war risk, yields creeping higher on US Treasuries (last week saw the 10-year at 3.19%—its highest level since 2011) and the rising price of oil (WTI at its highest levels since 2014) dampen levels of enthusiasm that pass through the markets on any given session.

That said, substance over rhetoric—whether it’s news of progress in the discussions taking place between the US and China or a sense that inflation so far remains moderate enough to consider the Fed might be able to continue its process of interest rate normalization without derailing stocks—appears to keep investors not just focused on the apparent risks on the landscape but on opportunities as well.

On a year to date basis the respective outperformance delivered by the information technology and consumer discretionary sectors and by the Russell 2000 in our view points to investors’ belief that US economic growth is likely to remain at a healthy enough pace to feed revenue and earnings growth in highly cyclical market segments for the next several quarters.

The energy sector’s recent swing from laggard to outperformer acknowledges in our view rising global demand as the US expansion moves ahead and as international economies continue in their respective recoveries. That said, the pickup in global economic activity recently is proceeding at a somewhat slower pace being not without some concern about risks of trade wars that could disrupt commerce for countries heavily dependent on exports and intertwined chains of production.

The Week Ahead

In the week in front of us investors focused on the financial sector will likely pay close attention to the House vote on Tuesday on an overhaul to the 2010 Dodd-Frank financial legislation. The Senate has already voted to cut back compliance rules.

On Wednesday the Federal Reserve releases the FOMC minutes from their meeting earlier this month. Traders and investors will parse the minutes for clues for any subtle changes in monetary policy. We expect the minutes to show the Fed remains committed to the process of normalization while vigilant for any untoward levels of inflation that might emerge at some point.

Also on Wednesday the Census Bureau releases new home sales figures for April that are expected (based on established surveys of economists) to be slightly lower than the prior month.

On Thursday the National Association of Realtors releases existing home sales figures. Expectations are for little change from the prior month.

On Friday traders and investors will look at durable goods orders to gauge the health of production and demand. Also on the last day before the Memorial Day weekend look for the University of Michigan’s consumer sentiment report.

In our view the fundamentals remain attractive for further upside in equities stateside and globally in the months ahead so long as progress persists in trade talks with China and among the members of NAFTA, and so long as the Fed remains sensitive to the economy in its process of interest rate normalization.

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