Earnings Season Kicks Off as Markets Search for Direction

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Week in Review

Earnings season kicks off as markets search for near-term direction.

Friday was the start of Q1 2019 earnings season as major banks started to report results. JPMorgan Chase reported better than expected first quarter results. Providing a boost to major stock indices to end the week. While this was a strong start for the season, analysts expect total earnings for the S&P 500 to decline on a year-over-year basis for the first time since 2016. With an average earnings decline of -4.3%. Pressuring earnings is rising wages and material costs, low inflation to offset higher wage costs, and the roll-off of tax cuts from 2018. Companies will now likely have the same lower effective tax rate as they did the previous year following the December 2017 tax cuts.

Markets Look Up

As markets look to upcoming earnings reports for near-term direction, the International Monetary Fund (IMF) cuts its 2019 global growth forecast for the third time in the last six months. The IMF now projects the world economy will grow 3.3% this year, down from the 3.5% previously expected. Global financial officials said “the balance of risks remains skewed to the downside.” Citing factors such as increased trade tensions, policy uncertainty, and tighter monetary policy by the US Federal Reserve. Growth is expected to firm-up at 3.6% in 2020 as these risks work their way through the system.

Despite near-term earnings and economic growth uncertainty, stocks have rallied significantly since the late December lows. With the S&P 500 gaining over 23% since Christmas. Bringing it within 1% of a new all-time-high. However, it is important not to chase these strong returns as there are still reasons to remain cautious. Such as softening global growth, Brexit uncertainty, and yield curve fears. With conflicting signals and data, it is reasonable to expect volatility to persist as markets remain sensitive to major headlines. This market noise can make it tempting to make knee-jerk decisions. But as investors we need to stay committed to our long-term financial goals and risk tolerance. Staying focused on our long-term investment objectives and maintaining a disciplined investment strategy can help reduce market noise. And increase the odds of a successful outcome over time.

Chart of the Week

The S&P 500 finished the week up 50 basis points, bringing the Index to its third straight weekly gain since falling mid-March. Additionally, the Index closed over 2,900 for the first time in six months. This puts the US stock benchmark on a bullish path as it edges closer to a record high. However, investors scared from the December rout are remaining alert as new all-time highs could act as either a ceiling or floor for future prices. With new geopolitical tensions such as the Euro-US trade negotiations coming to light and old ones such as US-China tapering out, investors are remaining cautiously optimistic in the equity market.

*Chart source: Bloomberg

Market Update

Equities

Broad equity markets finished the week mostly positive as large-cap stocks outperformed small-cap stocks. S&P 500 sectors were mostly positive, with cyclical sectors outperforming defensive sectors. So far in 2019, technology and industrial stocks are the strongest performers while healthcare has been the worst performing sector.

Commodities

Commodities were positive as oil prices increased by 1.28% to $63.08/bl. This marks the sixth consecutive weekly increase for the commodity since falling to the $55/bl level over a month ago. Similar to last year, it is possible crude oil holds over $60/bl as long as supply and demand levels remain relatively stable. However, prices could continue to climb as OPEC countries are adhering to production cuts and sanctions on critical countries such as Iran and Venezuela continue to cap supply levels. Year-to-date, oil prices are up over 40%.

Gold prices remained unchanged as they rose by a meek 0.02%, closing the week at $1,290.60/oz. Ever since falling below the $1,300/oz level in March, the metal has been unable to gain traction. Additionally, Gold has been trading in a relatively tight range in past weeks as investors demand for safe-haven assets have tapered. Since gold is a US dollar-denominated asset class, it tends to perform best when interest rates are low, volatility is high, and supply and demand forces are stable. Currently, markets are recovering from the four rate hikes in 2018 and have turned more bullish on US equities. However, if ongoing geopolitical tensions were to persist and economic data were to deteriorate, the demand for gold as a safe haven asset could increase.

Bonds

The 10-year Treasury yield increased from 2.50% to 2.56%, resulting in negative performance for traditional US bond asset classes. Treasury yields continued to rise for the second straight week as overseas economic data in China showed increased bank lending- a good sign for markets. Additionally, the rebound in jobs this month helped relieve investors of economic worries, further supporting equity markets.

High-yield bonds were positive for the week as riskier asset classes rose and credit spreads tightened. As long as US economic fundamentals remain healthy, higher-yielding bonds have the potential to experience further gains in the long-run as the risk of default is still moderately low.

Asset class indices are positive so far in 2019, with commodities leading the way and traditional US bonds lagging behind.

Lesson to be Learned

“You can find good reasons to scuttle your equities in every morning paper and on every broadcast of the nightly news”

– Peter Lynch

With the fast pace of technology growth and news delivery, it is easy to find reasons to “tinker” with your investments every day. However, reacting to “hot headlines” can be detrimental to your portfolio. To be a successful investor, it is imperative to be resilient and patient, removing emotions from the equation and sticking to the plan you have laid out. By sticking to an emotion-free, disciplined investment strategy, you can avoid chasing returns and increase the odds of success in the long-run.

FormulaFolios Indicators

FormulaFolios has two simple indicators we share that help you see how the economy is doing (we call this the Recession Probability Index, or RPI), as well as if the US Stock Market is strong (bull) or weak (bear).
In a nutshell, we want the RPI to be low on the scale of 1 to 100. For the US Equity Bull/Bear indicator, we want it to read least 66.67% bullish. When those two things occur, our research shows market performance is strongest and least volatile.

The Recession Probability Index (RPI) has a current reading of 30.10, forecasting further economic growth and not warning of a recession at this time. The Bull/Bear indicator is currently 66.67% bullish – 33.33% bearish, meaning the indicator shows there is a slightly higher than average likelihood of stock market increases in the near term (within the next 18 months).

The Week Ahead

It will be a holiday-shortened week as US markets will be closed for Good Friday. Investors will continue to see if stocks can reach new highs as more companies report earnings results.

Read last week’s Investment Update.