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Market Commentary, November 2019

Trade Sentiment

While hopes for a grand trade agreement seem to be dissipating, concerns of significant escalation also appear to be waning as progress towards an initial US-China trade agreement was reported last week. Chinese officials even went as far as to say that some existing tariffs may be rolled back by each side as part of the agreement. Further speculation has occurred that an agreement may be signed by Donald Trump and Xi Jinping at a NATO conference taking place in London in early December. Other positive trade news involves the possibility that the US Department of Commerce will hold off on imposing tariffs on European automobiles later this week.

Recession Fears

Fears of a recession have mildly subsided in recent weeks as market participants have become more optimistic that a trade deal may be reached. Additionally, the recent earnings season has buoyed sentiments with the average corporation and the average consumer showing healthier balance sheets. Major US equity indices hit record highs last week, and bond yields rose sharply while the yield curve steepened. Other safe-haven assets such as gold and the Japanese yen also fell, suggesting that investors’ risk appetite has increased. Finally, other data, including the US jobs number coming in well above expectations and a slightly improved European manufacturing PMI report  (The Purchasing Managers' Index) and European services sector report, all provided a mild measure of hope. (PMI is an index of the prevailing direction of economic trends in the manufacturing and service sectors. It consists of a diffusion index that summarizes whether market conditions, as viewed by purchasing managers, are expanding, staying the same, or contracting.)

Q3 Earnings Season

As reported by FactSet on November 8th, 2019:

  • With 89% of the companies in the S&P 500 reporting actual results, 75% of the companies that have reported a positive EPS surprise and 60% of S&P 500 companies have reported a positive revenue surprise;
  • Regarding valuation, the forward 12-month price-to-earnings (P/E) ratio is 17.4. This P/E ratio is above the 5-year average of 16.6 and above the 10-year average of 14.9; and
  • For Q3 2019, the blended earnings decline for the S&P 500 is -2.4%. If this figure holds, the index will have reported three straight quarters of year-over-year earnings declines for the first time since Q4 2015 through Q2 2016.

As FactSet goes on to say, “it is also interesting to note that S&P 500 companies are seeing the best price reaction to positive EPS surprises in 5 years. Companies in the S&P 500 that have reported positive earnings surprises for Q3 have seen an increase in price of 2.3% on average from two days before the company reported actual results through two days after the company reported actual results.”

Over the past five years, companies in the S&P 500 that have reported positive earnings surprises have witnessed a 1.0% increase in price on average during this 4-day window. Thus, the market is rewarding positive EPS surprises more than average during this Q3 2019 earnings season. If the final percentage for the quarter is +2.3%, it will mark the largest average price increase over this four-day window for S&P 500 companies reporting positive EPS surprises since Q3 2014 (+2.6%).

While speculation abounds as to why this is happening, conventional wisdom would say that it is due to lower expectations coming into this quarterly earnings season. Many companies provided negative EPS guidance, and this earnings season was supposed to be quite meager. The large number of upside surprises has thus led to positive reactions that are greater than normal.

Around the World

Two members of the Monetary Policy Committee of the Bank of England unexpectedly voted for a 25-basis-point cut in the bank’s base lending rate, saying that “growth has slowed materially amid negative business investment and moderating consumer spending.” The consensus expectation is that investment will turn positive in 2020 once uncertainty over Brexit has been mitigated.

Household spending in Japan jumped nearly 10% in September, ahead of an increase in the country’s sales tax from 8% to 10%. That is the largest monthly gain since 2001. While the increase in consumption was expected, the magnitude of the gain exceeded expectations.

In Summary

Even though growth is slowing around the world, there seem to be less immediate concerns regarding future growth trends. Not only has sentiment around global trade improved, but The Federal Reserve shifted its tone, saying that the “current stance is likely to remain appropriate.” Given that The Fed seems reasonably content with the Fed Funds rate in the current range of 1.50%-1.75%, we believe that the Fed will only change rates (up or down) if there is a material difference in the outlook. To this end, with the increased probability that the Fed will hold through 2020, the backdrop for risk assets has shown signs of improvement.