June 5, 2018

With the current year’s gains for the S&P 500 at a paltry +2.28% as of last Friday, one would think the economy had hit a wall of macro-economic headwinds that would explain this ho-hum performance. The Dow has actually fared worse, with a decline of -0.34% while Nasdaq is ahead by +9.43% and the Russell 2000 has gained 7.32% while setting a new all-time high last week.

I wrote recently of three major obstacles that the market had to contend with if the primary bull trend was going to win out. All three have since retreated: (1) The yield on the 10-year Treasury breached 3.1% less than two weeks ago and has since declined to 2.9%. (2) WTI crude oil traded as high as $71.84 per barrel as recently as May 23 and ended Friday at $65.81/bbl. And (3) the upstart U.S. Dollar Index (DXY) hit a fresh six-month high on May 29 of 95.02 before settling back to close last week out at 94.15.

The very short-term selling pressure for all three of these key components afforded the market a brief sigh of relief against a steamy set of geopolitical circumstances that would take a Sunday sermon to fully explain. Without getting into the specific details of each, I find it nothing short of impressive that the S&P 500 this past week is making a fresh attempt at breaking out of its trading range to the upside, in spite of this world of hurt. Only time will tell in the days ahead, but against the following laundry list of external matters that are mouthwatering news stories to the financial media, the tale of the tape is impressive.

Investors are having to contend with pricing in newly-announced tariffs on Europe, Canada, Mexico, and possibly China; a populist Italian movement that wants out of the euro; a historic vote of no confidence that unseated Spain’s prime minister; complete government chaos in Venezuela, Argentina, and Brazi; a summit with North Korea that may well produce nothing of real or lasting value; the ratcheting up of economic sanctions on Iran; and a growing crisis of confidence in emerging market currencies.

Instead of getting caught up with these new dramas being played out on the global stage of politics and currencies, in addition to the afore-mentioned trio of a rising dollar, oil, and bond yields, investors have embraced what matters most to the stock market – the economy. Consumer confidence, revised GDP, the payrolls report, average hourly wages, the pace of manufacturing, new orders, and domestic oil production were all higher. It was a clean sweep for the economic calendar. In baseball, this is “hitting for the cycle.”

The U.S. economy is the largest in the world. At an estimated $20.4 trillion in 2018, the U.S. represents a quarter of the global economy. Here is the IMF’s ranking of the Top 10 economies during 2017:

The U.S. economy is bigger than the entire 28-nation European Union, whose combined 2017 GDP was $17.3 trillion. It is also about equal to the three Asian giants of China, Japan, and India, combined. The following pie chart of GDP distribution is based on the World Bank listing of global GDPs as of 2016:

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

The Debunking of Q1 “Peak E120arnings as Fake News

The Friday jobs report was heavily reported, but Friday’s big underreported news event was the sharp upward revision of second-quarter GDP growth. The Atlanta Fed’s model currently forecasts second-quarter GDP growing at a stunning 4.8% annual pace. They say that’s because the forecasts for second-quarter real consumer spending growth and second-quarter real private fixed investment growth increased from 3.4% and 4.6%, respectively, to 3.5% and 5.4%, respectively, after the jobs report (from the U.S. Bureau of Labor Statistics), the construction spending report (from the U.S. Census Bureau), and the Manufacturing Report on Business (from the Institute for Supply Management) were released on Friday.

This revision marks a recent acceleration of economic activity, which was corroborated by FactSet’s latest “Earnings Insight Topic of the Week,” also released on Friday. The report stated that:

“During the first two months of the second quarter, analysts increased earnings estimates for companies in the S&P 500 for the quarter. The Q2 bottom-up EPS estimate (an aggregation of the median EPS estimates for all the companies in the index) rose by 0.2% (to $39.07 from $38.98) during this period. How significant is a 0.2% increase in the bottom-up EPS estimate during the first two months of a quarter? How does this decrease compare to recent quarters?

“On average, the bottom-up EPS estimate usually decreases during the first two months of a quarter. During the past five years (20 quarters), the bottom-up EPS estimate has recorded an average decline of 2.7% during the first two months of a quarter. During the past ten years, (40 quarters), the bottom-up EPS estimate has recorded an average decline of 3.7% during the first two months of a quarter. During the past fifteen years, (60 quarters), the bottom-up EPS estimate has recorded an average decline of 2.9% during the first two months of a quarter.”

This fresh bottom-up earnings estimate is significant in that the estimated year-over-year earnings growth rate for Q2 2018 has increased from 18.6% on March 31 to 18.9%. All 11 S&P sectors are predicted to report year-over-year earnings growth. Seven sectors are projected to report double-digit earnings growth for the quarter, led by the Energy, Materials, and Information Technology sectors.

Because of the upward revisions to sales estimates, the estimated year-over-year sales growth rate for Q2 2018 has increased from 7.8% on March 31 to 8.6% today. Ten of the 11 sectors are projected to report year-over-year growth in revenues. Four sectors are predicted to report double-digit growth in revenues: Energy, Materials, Information Technology, and Real Estate.

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

Not knowing if the market can tune out the noise factor of all that is occurring outside U.S. borders, there is a growing case for a summer rally as second-quarter earnings season approaches. For Q1 (with 98% of the companies in the S&P 500 reporting actual results for the quarter), 77% of S&P 500 companies have reported a positive EPS surprise and 77% have reported a positive sales surprise, according to FactSet.

If past is prologue and Q2 sales and earnings post a similar trend to that of Q1, then all this back and forth for the S&P will very likely give way to an upside breakout. Money is flowing into the U.S. from all around the world as a safe haven trade. Seeing the underlying market fundamentals strengthening like this argues that the least path of resistance for equities is higher, and maybe sooner than we all might think.

About The Author

Bryan Perry

Bryan Perry

Bryan Perry is a Senior Director with Navellier Private Client Group, advising and facilitating high net worth investors in the pursuit of their financial goals.

Bryan’s financial services career spanning the past three decades includes over 20 years of wealth management experience with Wall Street firms that include Bear Stearns, Lehman Brothers and Paine Webber, working with both retail and institutional clients. Bryan earned a B.A. in Political Science from Virginia Polytechnic Institute & State University and currently holds a Series 65 license. *All content of “Income Mail” represents the opinion of Bryan Perry*


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