What’s on Tap: ‘Peak Earnings’ Is Not ‘Peak Oil’

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  • Trade Talk vs. Trade Wars as USMCA Replaces NAFTA

  • Labor Department Reports Positive Job Growth Trend

  • Don’t Buy ‘Peak Earnings’ Hype

  • Looking Ahead to Inflation Gauges and Consumer Sentiment

Before a slight pullback yesterday (and further consolidation today), investors and traders pushed the Dow Jones Industrial Average to a record midweek, thanks to evidence of more, not less, economic growth in the U.S. Consumer and business sentiment is holding strong, and activity in both the manufacturing and service sectors—essentially, the entire economy and its employee base—continues to be in expansion mode. Unemployment is lower than it’s been in nearly 50 years. The Federal Reserve, confident that we’ll see more economic growth, is signaling the probability of more interest-rate hikes.

Of course, we’re not letting all the good economic news go to our head. We’ll address some of our concerns below. But before we do, know that for the year through Thursday, the Dow Jones Industrial Average has returned 9.6%, while the broader S&P 500 has gained 10.1%. The MSCI EAFE index, a measure of developed international stock markets, is down 3.0%.

As of Thursday, the yield on the Bloomberg Barclays U.S. Aggregate Bond index has climbed to 3.58% from 2.71% at 2017’s end. On a total return basis, the U.S. bond market has declined 2.3% for the year. Bond prices have been falling this week on the heels of better economic data (referenced above) and an upbeat assessment from Fed Chair Jerome Powell. The yield on the 10-year Treasury bond touched 3.23% early Friday morning, its highest point since mid-2011. We certainly understand that, for many bond investors, any loss can be frustrating given bonds’ reputation as a fairly stable asset. The silver lining to rising yields is greater income that, with time, will lessen the impact of any initial drop in prices.

Trade Talk vs. Trade Wars as USMCA Replaces NAFTA

The framework for a revamped North American Free Trade Agreement (NAFTA) announced this week brought some welcome relief to investors concerned over trade. After Mexico made a deal with U.S. negotiators in August, Canadian officials came to terms with the two countries, paving the way for a renamed U.S.-Mexico-Canada Agreement (USMCA).

The newly negotiated deal, which still needs to be ratified by Congress, retains much of the existing NAFTA structure, albeit with some key changes, primarily in how it affects the auto and dairy industries. The USMCA requires that at least 30% of cars (increasing to 40% by 2023) must be constructed by workers making at least $16 an hour—a stipulation that may shift more production to the U.S., but one that could also lead to higher prices for car buyers.

Trade with our neighbors has a direct impact on profits and jobs across industries and borders. We are glad to see that, with a willingness to negotiate, a deal can be reached. Success with regard to USMCA may embolden the White House to continue to apply tariff pressure on China in the belief that imposing duties (or the threat thereof) generates good negotiating leverage. They may be proven right. But we’ll await the facts on the ground before making any decisive investment move. 

Labor Department Reports Positive Job Growth Trend

U.S. consumers remain on the job. While today’s Labor Department report on hiring and unemployment showed that employers created only 134,000 jobs in September (which was below expectations), the report marked eight straight years of monthly gains—a streak twice as long as the previous record.

In our estimation, the lower-than-expected September total may have been impacted by Hurricane Florence, as well as the shrinking pool of available workers to fill new positions. At the same time, the headline unemployment figure fell to 3.7%—its lowest point since 1969.

As jobs go, so goes the U.S. consumer, and (typically) as goes the U.S. consumer, so goes our economy. The positive jobs trend reflects the health of our economy and bodes well for continued expansion.

Don’t Buy ‘Peak Earnings’ Hype

“Stock buybacks” were a hot topic on Wall Street and in the press a few weeks ago (view our most recent special report “Strong Buybacks: Pubic Enemy Number One?”). Today it’s the concept of “peak earnings” that’s got tongues wagging. Our problem with this term is that it brings to mind the old “peak oil” days, when it was thought that oil production had plateaued and there would be less and less oil available until there was none left—something called “terminal depletion.” That theory is now largely debunked.

We disagree with the “peak earnings” terminology and the implication that earnings will be going away. Rather, it’s the rate of earnings growth that is peaking. Corporate tax cuts have been a huge catalyst for higher rates of earnings growth. This tax-induced “sugar high”—earnings growing at 20% year-over-year rates every quarter—is simply not sustainable. We still expect to see greater earnings in the upcoming third-quarter reporting season and ensuing quarters. Again, it’s the rate of growth that’s peaking, not the potential for absolute growth. 

Looking Ahead to Inflation Gauges and Consumer Sentiment

Next week’s data includes reads on small business confidence, inflation gauges, inventories and consumer sentiment before the following week when third-quarter earnings reports will begin to round out the fundamental view on where the economy’s been and where it’s headed.


If you’d like to learn more about our tactical or fundamental strategies, please contact Steve Johnson at 844-587-7393 or info@bravercapital.com.

Please note: This update was prepared on Friday, October 5, 2018, prior to the market’s close.

This material is distributed for informational purposes only. The investment ideas and expressions of opinion may contain certain forward-looking statements and should not be viewed as recommendations or personal investment advice, or considered an offer to buy or sell specific securities. Data and statistics contained in this report are obtained from what we believe to be reliable sources; however, their accuracy, completeness or reliability cannot be guaranteed.

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