The Week in Review
- Earnings Beat Rate at Decade-Best
- Inflation Fears Are Overblown
- Housing Data Shows ‘Growth Problem’
- Looking Ahead
All good streaks must come to an end. February’s market gyrations have the S&P 500 on pace to snap its 15-month stretch of monthly gains. Through Thursday’s close, the index is down 4.2% for the month with four trading days to go. Not a big deal. We’re obviously not rooting for prices to fall, but we recognize the opportunity created by downside volatility for investors to pick up shares at more attractive prices.
With a market that has struck a delicate balance between fear of the unknown and fundamentals, anything from event-driven news to rumor and speculation can tip the scale into sudden declines or sustained rebounds. From our vantage point, absent a new catalyst, our investment discipline remains laser-focused on fundamentals—earnings, economic data and interest rates—not fears.
For the year through Thursday, the Dow Jones Industrial Average has returned 1.3%, while the broader S&P 500 index has gained 1.4%. The MSCI EAFE index, a measure of developed international stock markets, is up 0.5%. As of Thursday, the yield on the Bloomberg Barclays U.S. Aggregate Bond index has climbed to 3.16% from 2.71% at 2017’s end. On a total return basis, the U.S. bond market has declined 2.3% for the year.
Earnings Beat Rate at Decade-Best
As far as earnings are concerned, companies are outperforming at a level we haven’t seen since the third quarter of 2006. With more than 85% of companies in the S&P 500 index having reported fourth-quarter 2017 results, earnings are up 15.1% year-over-year. More than three-quarters of companies have exceeded analyst expectations. That’s the sixth-best beat rate over the last two decades, and an indicator of continued momentum as we head deeper into 2018.
The earnings trends are promising, and remember that the results we’ve seen don’t yet reflect the benefits of the recently enacted tax cuts, which kick in this year. Lower taxes could push earnings higher and provide companies more flexibility to reward shareholders through dividends and stock buybacks. Just this past week, several companies have reported double-digit-percentage dividend increases. Based on what companies are reporting and business-friendly tax reform, it continues to be a favorable environment for corporate earnings growth.
Inflation Fears Are Overblown
The media caterwauling about fears of rising inflation has brought to mind that classic whiny refrain from the back-seat of the family cruiser: “Are we there yet?” Wednesday’s market swoon after the release of the Federal Reserve’s January meeting minutes—and the inflation discussion therein that raised concerns about four possible rate hikes this year instead of the expected three—reminded us that traders are walking on interest-rate eggshells. But should they be? As we noted last week, our view is that higher inflation is being confused with high interest rates rather than merely higher interest rates, which remain near historic lows.
What traders who sold stocks after the minutes were released failed to consider is that a Fed that feels compelled to raise rates four times will probably be doing so in efforts to tame an overheating economy. Isn’t growth, and controlled growth at that, what we’re looking for? The trigger-happy, sell-first-and-ask-questions-later theme on Wall Street is wearing thin, and we hope you’re not getting caught up in the day-to-day hullabaloo.
Housing Data Shows ‘Growth Problem’
Sales of existing homes fell in January after a lackluster December as scarce supply continued to push prices higher and further curtailed buyers’ already limited options. Prices are up 5.8% from the same time last year, and bidding on the homes that have been hitting the market has been competitive. We’re interested to see results from the recent acceleration in homebuilding, but the reality is the housing market has a growth problem. People are well-employed and making more money, and the level of supply has so far been unable to keep pace with the rise in qualified would-be buyers.
Mortgage rates are also moving up. The rate on a 30-year mortgage, according to Freddie Mac, has risen from 3.95% at the start of the year to 4.40% this week. To put it in dollar terms, that translates into an additional $75 or so per month on a $300,000 30-year mortgage. Higher prices and mortgage rates may deter some buyers, but the increase in incomes and the impact of the new tax cuts have yet to show up in the housing market even as industry analysts report higher foot traffic than they saw last January.
Next week, we return to a more bountiful slate of economic reports after a relative lull in recent weeks. We’ll see indicators on manufacturing; new home sales, home prices and pending home sales; durable goods; a second estimate of fourth-quarter economic growth; consumer confidence and consumer sentiment; car sales; construction spending; Fed Chair Jerome Powell’s Congressional testimony; inflation; and personal income, spending and savings.
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Please note: This update was prepared on Friday, February 23, 2018, prior to the market’s close.
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