Weekly Market Update (August 13 – August 17, 2018)

Canadian stocks were unchanged and U.S. stocks were higher on the week but took a choppy path to get there. Worries of financial and currency turmoil in Turkey, renewed trade talks between the U.S. and China, and strong earnings reports all took turns driving daily market moves. Now that the second-quarter's earnings season is nearly over, we expect geopolitical events and policy changes to play a larger role in market moves, and these can prompt greater volatility. However, we expect better economic growth and double-digit earnings increases to provide support for rising stock prices over time.

For much of 2018, the stock market has been in a tug-of-war between policy risks and strengthening economic and corporate fundamentals. Two key forces were at play for the markets last week: 1) escalating worries about a falling currency and economy in Turkey, and 2) the tail end of earnings season for U.S. corporations. Each took its turn behind the wheel, with the former driving early-week losses, while the latter, along with news of trade talks with China, spurred the strongest one-day rally in the Dow since April. The issues drove sizable swings in the week, but we think they also provided important read-throughs that offer insight into what may lay ahead for the markets.

More than just Turkey trouble – Turkey's currency, the lira, has plunged 22% against the U.S. dollar in recent weeks, sparking worries of an economic and debt crisis in the country.¹ The weakness in global stock markets may be the result of Turkey rekindling fears of 1997's Asian financial crisis (which began with a collapse of Thailand's currency) or 2011's eurozone debt crisis. However, we'd note that Turkey's GDP is smaller than Florida's, so perspective is warranted.

Our read-through: 

• First, we believe the market's negative response to Turkey's currency crisis is likely less about the country's economic challenges and more about the focus it puts back on tariffs, which the Trump administration has proposed as part of the developing situation with Turkey. 
• Second, this highlights the weakness occurring within the broader emerging markets, which is a larger threat to global GDP. 
• Third, the fact that Turkey's domestic issues have roiled global stocks suggests that markets are still responding to potential risks (big or small). This can be viewed somewhat positively in that market peaks are often characterized by a sense of euphoria where risks are ignored in favor of surging market gains.

Glimmer of hope in the trade war – Thursday's market rally was fueled in part by news that U.S. and Chinese officials would resume trade talks later this month. Following several rounds of implemented and proposed tariffs between the world's two largest economies, markets cheered the sign of potential progress.

Our read-through:

• An agreement to meet later in August is far from an official compromise, but we believe it offers some comfort that the two sides remain open to negotiation and that perhaps the bite of recent tariffs has been effective in raising the urgency for a deal. 
• Our view remains that an all-out global trade war is not the most probable outcome. That said, just as the markets rallied on this news, volatility is likely to return on any news of a delay, setback or additional tariffs involving China.

Strong earnings results: details reveal budding trends - Second-quarter earnings season is nearly complete, with many retail companies reporting last week, rounding out a strong quarter for corporate America. Eighty percent of S&P 500 companies have reported earnings above expectations with profits rising 25% versus the prior year, the second consecutive quarter above 20%.² With earnings, in our view, being one of the most powerful drivers of longer-term market performance, the surge in corporate profits has offered solid support to stocks this year, with U.S. equities up 8% and Canadian equities up 4% year-to-date. ³

Our read-through: 

• A look under the surface of the healthy rise in profits shows an encouraging 10% lift in sales growth – the strongest since the third quarter of 2011. Earnings can be aided by cost controls, but the rebound in sales growth reflects a more robust economic foundation, including improving consumer and business demand. 
• While we expect U.S. GDP growth to moderate a bit from last quarter's 4% pace, we think the U.S. economy is on sound footing, offering ongoing support for corporate profits ahead. This is increasingly important because rising cost pressures were an emerging theme in this quarter's earnings announcements. Rising transportation costs, supply constraints, tariffs and higher wages are leading many companies to announce price increases that will go into effect in the months ahead. 
• We expect profits to rise again next year, but the rate of growth will, in our view, peak in 2018. We think the bull market will extend next year, but slower earnings growth suggests stock market gains may be more moderate in the final stages of the expansion.

^{Sources: 1. FactSet, 7/23/2018 – 8/17/2018. 2. FactSet Earnings Insight. 3. U.S. equities represented by the total return of the S&P 500 Index. Canadian equities represented by the total return of the TSX Index.}

Index	Close	Week	YTD
TSX	16,324	0.0%	0.7%
S&P 500 Index	2,850	0.6%	6.6%
MSCI EAFE	1,928	-1.2%	-6.0%
10-yr GoC Yield	2.27%	-0.04%	0.22%
Oil ($/bbl)	$65.86	-2.6%	9.0%
Canadian	US $0.77	0.6%	-3.7%

Source: Bloomberg, 08/17/18. Bonds represented by the iShares Core U.S. Aggregate Bond ETF. Past performance does not guarantee future results.

The only notable economic report coming next week is retail sales on Wednesday.