Key Points
• Investor attention has been focused on the negatives surrounding geopolitical tensions and White House drama.
• Yet, fundamentals such as economic growth and corporate earnings offer good news for equity markets.
• Although we acknowledge there are risks, we believe this equity bull market should persist.
As last week began, attention was focused on attempts to dial back tensions between the United States and North Korea. As the week progressed, investor focus turned to the backlash over President Trump’s comments in the wake of the violence in Charlottesville. Despite good economic and earnings news, the negatives won out and stock prices fell for a second week, with the S&P 500 Index dropping -0.6%.1
Weekly Top Themes
1. Economic data remains solid. Retail sales rebounded more than expected in July.2 And in August, the Empire Manufacturing Index soared to its highest level since September 2014.3
2. Second quarter earnings growth was quite strong. With the reporting season essentially completed, second quarter operating earnings were up 12% year-over-year.4 Revenue growth was particularly strong, up 5% with the highest percentage of companies beating revenue expectations in six years.4
3. The Federal Reserve should continue tightening policy, but is watching inflation carefully. The July meeting minutes showed Fed officials are puzzled by persistent inflation weakness. We still believe the Fed will begin normalizing its balance sheet in September. The earliest we expect to see another rate hike would be December, and inflation data may need to move higher before that happens.
4. The political climate continues to darken for Republicans. It was another head-spinning week for the Trump administration: The president was broadly criticized for his remarks about Charlottesville, Steve Bannon exited the White House and observers speculated about who would be next. Additionally, the disbanding of two advisory business councils highlighted the widening split between the establishment and populist wings of President Trump’s supporters. Should this type of turmoil persist, it could lead to a wave election against Republicans in next year’s midterms.
5. The strongest returns for the bull market may be behind us, but we expect stock market gains will continue. We believe the setback in stock prices that occurred over the last couple of weeks should prove to be temporary, as it has been based more on sentiment and political concerns rather than fundamentals. We don’t expect investors will experience the pace of gains they enjoyed during the last eight years, but we believe fundamentals should continue to provide tailwinds for equity markets.
Despite Risks, the Equity Bull Market Has Legs
Global financial markets are enduring a bumpy phase, largely due to rising geopolitical tensions and domestic political uncertainty. While the damage to equity markets and other risk assets has so far been minor, investors are focusing on potential downside risks that could trigger additional damage.
The political backdrop is fragile, but we believe that fundamentals will ultimately prove to be stronger determinants of market performance. In any case, tensions between North Korea and the United States appear to be easing. And while the drama surrounding President Trump is unlikely to go away, investors would welcome any hints of progress on the pro-growth agenda.
Outside of politics, the relentless decline in the value of the dollar has some concerned. Souring political sentiment in the United States means this trend will probably persist. But we expect improving U.S. economic growth and a slow shift toward tightening stances by global central banks should limit the downside.
Likewise, although investors are highly focused on Fed policy, we don’t believe the Fed will be overly aggressive about raising rates. If inflation were to start surprising to the upside, the Fed would be in a more difficult position. However, as things stand, policymakers should be able to continue to increase rates slowly and gradually as the economy continues to improve.
On balance, we believe fundamentals suggest this equity bull market is not approaching an end. Economic growth remains decent, earnings are improving and we see no signs of the speculative froth that typically mark the imminent ends of bull markets. We do think volatility is likely to climb in the coming months, but also believe equity prices are likely to advance unevenly over the coming year.