Highlights
• Equity markets remain stuck between the positives of improving economic growth and strong corporate earnings and the negatives of rising trade issues.
• We are growing more concerned about protectionism, but still expect tensions to ease.
• Over the next 6 to 12 months, we believe stock prices will move unevenly higher and government bond markets will struggle.
Investors focused on a mix of positive and negative developments last week. On the plus side, second quarter corporate earnings have been coming in strong. However, trade worries continued to dominate the investment narrative and concerns grew over additional interest rate hikes. U.S. equities were largely unchanged for the week, which is not surprising in this environment.1 Financials and industrials exhibited strong performance, with energy being the largest decliner.1 U.S. Treasury prices fell last week, while the yield curve steepened slightly.1
Weekly Top Themes
1. Aided by tax law changes, corporate earnings have been coming in strong. With 24 percent of S&P 500 companies reporting, results have beaten estimates by an average of 4.4 percent.2 78 percent of reporting companies have surpassed bottom-line expectations.2 At this point, estimates for growth in second quarter revenues, earnings and earnings-per-share stand at 8 percent, 19 percent and 21 percent, respectively.2
2. Strong earnings results are coming more from revenue gains than bottom-line margins. Since 2010, 90 percent of positive earnings surprises have come from margins.2 This quarter, 75 percent of surprises are from better revenues.2 This is a healthy sign for future earnings results, and hence for stock prices.
3. The Federal Reserve appears likely to continue raising interest rates, but is acknowledging downside risks. In his congressional testimony, Fed Chair Powell noted improving labor market conditions and rising inflation. He also pointed out, however, that rising trade problems may be weighing on capital expenditure levels and could cause broader economic problems.
4. The long-term U.S. fiscal outlook is growing more troublesome. The combination of tax cuts and more federal spending is likely to cause long-term problems. Over the next 5 to 10 years, interest costs are likely to rise and government bond yields should move higher as investors demand a higher premium given soaring debt levels. Over the longer-term, taxes will likely need to rise to service government debt and capital spending may fall, both of which could undermine economic growth potential. Additionally, the dollar is likely to weaken, which would make imports more expensive.