Everyday, Everyday I Have the Blues
By John Stoltzfus,
Chief Investment Strategist
Mid-Summer Market Strategy Musings
Stocks managed to eke out gains last week as solid corporate earnings offset trade skirmish concerns stateside
With the first half of the year in the rearview mirror and the first three weeks of the third quarter “in the box,” the resilience of the US equity market has been pronounced thus far in 2018 considering all the challenges perceived, projected and real that have crossed its path as the calendar pages turned from the start of the year.
Solid and improving economic fundamentals along with the effects of last year’s tax reform have underpinned corporate revenues and earnings, given a boost to job gains and retail sales and been reflected in the stock market more or less depending on traders’ and investors’ mood on any given day.
With Q2 earnings season now well underway and with just 17% (85) of the S&P 500’s 497 companies having thus far reported results as of last Friday, earnings are up 22.5% on back of revenue growth of just over 10%. Of the companies reported thus far, 87% have posted a positive earnings surprise and 77% have reported a positive revenue (sales) surprise.
FX (Money Matters)
Among currencies, the dollar’s strength based on the DXY index (composed of the developed-market currencies including the euro, British pound, Japanese yen, Canadian dollar, Swiss franc and Swedish krona), this year appears much more dramatic from its low in February (up some 6.6% against the DXY basket) than it looks when measured against the DXY from January, where it’s up just 2.5% from the start of the year.
Should the dollar move higher over the next few quarters, its strength could have considerable negative impact on revenues and earnings US multinationals get from abroad in the second half of the year.
“For now economic and corporate fundamentals appear in good shape and offer positive offsets to trade concerns.”
The dollar’s recent strength can broadly be attributed to a number of things including:
As a result of the dollar’s strength against the currencies of many developed-market currencies as well as those of most emerging and frontier markets, returns from foreign equities held by US dollar-based investors this year have been negatively impacted, compounding losses in those markets from idiosyncratic causes (those related to foreign domestic causes whether economic, sector or company-specific reasons).
Interest Rates: 10-year Treasury yields off their earlier highs, but Fed still in normalization mode
A rise in market-priced interest rates reflected in the 10-year Treasury yield has carried that benchmark’s yield from 2.41% at the start of the year to as high as 3.11% on May 25th. Since then, the yield has vacillated some, closing last Friday at a yield of 2.89%.
The strength of US economic data through much of the first five months of the year raised concerns among investors as to how high (and at what pace) the Fed might raise its benchmark rate over the course of 2018.
Added risk from the potential impact of a prolonged period of tariff-related trade dysfunction appears (along with what we’ll suggest is some recent normal cyclical slowing in the US and in other regions of the world) to have contributed to the 10-year Treasury yield moving lower from its peak in May.
We believe that the longer it takes to reach trade agreements within the various regions of the world thus far impacted by the tariffs (and the subsequent retaliatory actions), the more likely it is the Fed will maintain or even slow its process of interest rate normalization. For now we continue to expect the Fed to raise rates one more time this year, most likely in December.
For now we look to the likelihood of some degree of progress in trade talks to surface sometime between now and October (before the mid-term elections), which likely would provide some relief from the trade risk concerns that currently overhang the market. We expect consumer sentiment and equity prices worldwide would get a boost from any relief from trade risk tensions.
We believe investors will at this juncture do best to practice patience and maintain adequate diversification within asset classes as things get sorted out at the geopolitical level. For now economic and corporate fundamentals appear in good shape and offer positive offsets to trade concerns. So long as fundamentals continue strong, episodes of market volatility that might lie ahead could well prove later in hindsight to have been opportunities to seek babies that get thrown out with the bath water.
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