Stocks extended their recent rally with the TSX rising 1.3% for the week and the S&P 500 rising 2.3%, leaving both indexes less than 6% off their all-time highs1. Continued optimism regarding the U.S. - China talks, higher oil prices, and an agreement to avert a U.S. government shutdown provided investors with enough reasons to increase their appetite for risk. Economic news was mixed in the U.S., with the Bureau of Labor Statistics reporting a surge in job openings, while retail sales and industrial production disappointed. As the economic cycle matures, we expect a more balanced mix of encouraging and underwhelming economic readings.
Source: 1. Bloomberg
Positive developments in the trade talks between U.S. and China were the fuel that kept global stocks rising last week, temporarily pushing worries about slowing economic and earnings growth into the background. Disappointing declines in U.S. retail sales and industrial output appeared to be due to short-term disruptions, and despite mixed earnings results, we think company outlooks were generally reassuring. Investors became more optimistic that continuing progress in resolving trade tensions could provide the impetus for better global economic growth as well as rising earnings over time.
Solid Progress in China Trade Talks, but Issues Remain
Reports of significant progress in resolving the trade tensions with China were good news for investors, who have been concerned about current conditions as well as the additional negative impacts of a higher 25% tariff rate scheduled to go into effect on March 1. Reports that the deadline could be extended by 60 days to allow more time to hash out an agreement were also positive. But difficult issues remain, and progress may not continue to be as quick or smooth as it has been recently, leading to periodic worries and volatility in response. We believe a trade agreement, even if long in the making, would add a catalyst for better global economic growth to other positive drivers for international investments, including attractive valuations, low unemployment in the eurozone, higher dividends and earnings relative to Canadian and U.S. equities, and our expectation for a flat to weakening U.S. dollar. For these reasons we recommend broad-based international equities for long-term investors.
Economic Releases Contain More Noise, Fewer Signals
U.S. job openings reached a record high in December, another signal of a strong U.S. job market that we think will be a key support for modest economic growth ahead. But other economic indicators suggested slowing conditions. Weaker-than-expected retail sales and industrial production in the U.S. prompted economists to lower their estimates for economic growth and raised recession concerns. However, we think both indicators reflected more noise rather than being a true signal of weaker economic conditions ahead.
We think many economic releases over the next few months could contain more noise than usual due to the recent U.S. government shutdown, the stock market pullback in December, and recent winter storms. When the economic news is mixed and noisy, it's important for investors to stay focused on the longer-term indicators which continue to suggest slower but still positive growth ahead.
Earnings Growth Slowing as Expected
With two-thirds of S&P 500 companies having reported fourth-quarter results so far, earnings are on track to have grown 13% from a year ago, marking the fifth straight quarter of double-digit earnings growth1. Though strong by historical standards, this rate signals a longer-term downshift in earnings growth this year. Moreover earnings increased last year even as equity returns fell 4.2%, setting the stage, in our view, for positive equity returns in 2019 but lower than the 9.8% average return over the past 3 years2.
Reassuring Signals Reduced Major Concerns
Stocks have provided strong returns so far this year, as worries about continuing Federal Reserve interest rate increases and trade disruptions have lessened. Those were two of the three major concerns that triggered December's pullback. Over the past few weeks, concerns that the Federal Reserve would continue to raise short-term rates too quickly or too much have diminished as the Fed has indicated it will be patient, cautious and wait to raise rates. Progress in the trade negotiations with China soothed fears about trade disruptions and higher tariffs ahead. And while there are still worries about slower economic and earnings growth, recent signs suggest both remain positive- and near longer-term average rates.
The rebound from December's sell-off has been supported by still-healthy earnings and economic conditions, and the price-to-earnings ratio for the S&P 500 is in line with its 20-year average, making U.S. large-cap stocks attractively valued, in our view. Moreover, opportunities exist in small- and midcap and international equities, which we think are trading at attractive valuations to large-cap stocks and to their own histories1.
We continue to expect uncertainty tied to Fed actions, politics and trade talks, and slowing global growth will continue to add volatility, but the positive fundamentals and valuations suggest a rocky but rising road ahead for stocks. This week, the short-term noise in the U.S. economic data was overshadowed by the progress in the trade negotiations. But if the noise, uncertainty and volatility become louder, remember what's important to you – your long-term goals -- and ignore the short-term noise.
Sources: 1. Factset, 2.Factset, performance measured by the S&P 500 index.
Nela Richardson, PhD
Kate Warne, PhD, CFA
|S&P 500 Index||2,776||2.5%||10.7%|
|10-yr GoC Yield||
Source: Bloomberg, 02/15/19. Bonds represented by the iShares Core U.S. Aggregate Bond ETF. Past performance does not guarantee future results.
The earnings season hits full steam in Canada, with 42 companies of the TSX Index reporting earnings this week. Important economic news includes December retail sales reported on Friday. South of the border, U.S. markets are closed on Monday for President's Day.
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