Highlights
• First quarter earnings results have been impressive, but equity markets have struggled to gain traction.
• We believe economic and earnings growth should remain solid for at least the next 18 months, which should provide a tailwind for equity prices.
• Nevertheless, given shaky investor confidence, we don’t expect stocks to break out of their trading range any time soon.
Investors focused their attention on first quarter-earnings results last week. Although the overall numbers continue to be strong, high-profile comments from Caterpillar’s management team forecasting that first quarter results would be the “high-water mark” for the year caused concern for the markets. Stocks were mixed for the week: The S&P 500 Index was flat while other indexes were down slightly.1 The biggest financial news story came from the bond markets, where the 10-year Treasury yield rose above 3 percent for the first time in four years before ending the week lower.1
Weekly Top Themes
1) First quarter economic growth was soft, but we expect a rebound. Real gross domestic product rose a modest 2.3 percent during the first quarter and was up 2.9 percent year-over-year.2 Consumer spending and housing were relatively weak, while capital expenditure levels were solid. Looking ahead, we believe growth should rebound to close to 3 percent for the year and expect inflation will move over 2 percent.2
2) Earnings results are at their best levels in years. With more than half of S&P 500 companies reporting, the blended earnings rate (including companies that have yet to announce) is on track for 23.2 percent growth for the quarter.3 Close to 80 percent of companies are ahead of earnings-per-share expectations by an average of 9 percent, the best results since 2010.3 And 74 percent have beaten revenue expectations by an average of 2 percent, the strongest results since 2008.3
3) Recession risks this year appear low, but should rise by 2020 or 2021. We think current growth momentum and fiscal stimulus should keep the economy growing for at least the next 18 months. But we see challenges ahead, as the Fed will need to calibrate interest rate policy given higher spending levels and the effects of tax cuts. Rising trade protectionism also adds to the possible risks.
4) Rising interest rates and higher debt levels are also a concern over the coming years. Higher levels of Treasury issuance from additional federal spending, combined with the Federal Reserve balance sheet wind down, are increasing Treasury supply. We estimate the net supply of Treasuries will double over the next 18 months. This is likely to put more upward pressure on interest rates.
5) Easing tensions on the Korean peninsula are a positive, but the road ahead remains uncertain. The prospective deal announced between North and South Korea could officially end a war that has lasted nearly 70 years and has the potential to lead to denuclearization. President Trump will have a chance to enhance these possibilities at an upcoming summit, but we caution that these issues have bedeviled heads of state and foreign policy pros for decades.