Canadian and U.S. stocks were higher, while the price of oil fell by almost 7%, as the beginning of the first-quarter earnings season and political headlines led to a choppy week for the markets. While aggregate index earnings are expected to rise, not all companies will meet analysts' projections. That's why we recommend monitoring your portfolio's exposure to any single investment. By owning several stocks within each market sector, you may be able to reduce your portfolio's volatility – especially through the earnings season.
First-quarter earnings season is under way, with about 10% of S&P 500 companies reporting results so far. As usual, many industrial and financial services companies have been the first to report, and results to date have been encouraging.
Investors are looking for signs of improving business investment and manufacturing activity as leading indicators for industrial companies. While only a fraction of the sector has reported at this stage, some firms have provided upbeat commentary that activity levels have in fact begun to improve following a difficult 2016. While plenty of uncertainty exists, especially regarding regulation, it is encouraging to see the industrial economy improving in the United States.
Financial services companies in the U.S. benefited from higher interest rates earlier in the year as profitability on traditional borrowing and lending is showing early signs of improvement. Additionally, many of the large banks benefited from higher trading activity in the first quarter, which was largely driven by more active monetary policy (namely, the U.S. Fed's consecutive rate increases). However, lending growth is beginning to slow, which could offset some of the positive momentum from rising rates. Additionally, the timing and magnitude of any potential easing on the regulatory front still remain highly uncertain.
The overall market, while down slightly from recent highs, remains at rather lofty valuations. On a price-to-earnings basis, the S&P 500 and TSX trade above 17 times estimated 2017 earnings, reflecting a high level of optimism. Consequently, we believe further gains would need to be supported by earnings growth as opposed to higher valuations. Investors were anticipating about 9% earnings growth in the first quarter, so anything less than that may prove disappointing.
Another key support to higher stock prices is optimism about the Trump administration's pro-growth policy changes. Stock markets initially reacted positively to U.S. President Trump's agenda after the election, posting all-time highs at the prospects of more business-friendly regulatory, tax and economic policies. However, more recently markets have retreated, as concerns about global political tensions and growth have weighed on investor sentiment. Also, investors appear to be less convinced the new administration can push through desired changes. The initial agenda consisted of many initiatives, but investors focused primarily on several key items, a few of which could help corporate America and, in turn, support the stock market's valuation:
1) Infrastructure spending – This is viewed as a bipartisan way to create jobs and spur the economy by improving roads, bridges, etc. Companies that supply the materials, labor and machinery involved should benefit, but many of these stocks have already risen on expectations of future spending.
2) Lower taxes – A lower corporate tax rate would help boost corporate profits, which would support higher valuations.
3) Faster GDP growth in the U.S. leading to higher interest rates – This specifically would help the beleaguered financial services sector. These companies have suffered since the Great Recession from historically low interest rates. Their profitability would benefit from a wider spread between short- and long-term rates. Additionally, less government regulation could enable these companies to return more cash to shareholders, potentially boosting valuations.
|S&P 500 Index||2,349
|10-yr GoC Yield||1.47%||-0.03%||-0.26%|
Next week, we'll get a look at home sales on Tuesday and inflation data on Friday. In the U.S., we'll get housing and manufacturing data.
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Diversification does not guarantee a profit or protect against loss.
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