5 June 2017
Solid Economic and Earnings Growth Should Help the U.S. Bull Market to Continue
Political instability is in play these days with regard to the markets, but there are times when they move front-and-center. That occurred recently as impeachment of President Trump was brought up on the floor of the House of Representatives, and concerns spiked that the business-friendly portion of the President's agenda would fail to get enacted. Pundits and politicians are quick to pull out the "unprecedented" phrase to describe multiple actions by the current President and his staff. We aren't here to debate the merits or wisdom of the actions in question; just to point out that investors shouldn’t get too caught up in the political wrangling's with respect to investing decisions. It would not be unprecedented for Congress to criticize the president, or for the president to have missteps; although clearly impeachment is much less common. The institutions of U.S. government are not threatened, and, in fact, are working as the founders intended them, with the legislative and judicial branches providing checks and balances to the executive branch and vice versa. So we suggest keeping an eye, or maybe a squinted eye, on the political issues, because they can impact investment decisions at some point; but remain focused on your longer term goals and the more market-influencing fundamentals of economic and earnings growth.
The recent sharp, but single-day pullback was not extraordinary based on history and in fact may have been a healthy move as it allowed some of the overly optimistic sentiment conditions and complacency to ease. Stocks will likely experience more bouts of volatility in the coming months due to both political surprises and Fed policy communications. But we believe the trend can continue to be higher and that we remain in a secular bull market.
Earnings were strong and economy looks good
Reasons for our continued optimism include the mostly-completed earnings season which, according to Bloomberg, saw close to 80% of companies in the S&P 500 beat consensus earnings estimates; while more than 60% beat on the revenue estimates, a high historical beat rate for top-line growth (which is harder to manipulate). And despite ongoing political uncertainty, corporate confidence is holding up for now. The Empire Manufacturing Index slipped into negative territory at -1.0, but the Philadelphia Fed Index surprisingly rose to 38.8 from 22.0. Homebuilders also remain optimistic as the National Association of Homebuilders (NAHB) Housing Market Index (HMI) rose to a robust 70 from 68.
We're starting to see that optimism filter through to actions. Industrial Production rose 1.0% in the most recent reading, the largest gain since August of 2014, while capacity utilization rose to 76.7, the highest level since August 2015. These data points can be volatile, but they are pointed in the right direction. In addition, the Index of Leading Economic Indicators (LEI) continues to show a growing economy, posting a gain of 0.3% in the most recent reading.
One of those leading indicators, and a potential indicator of both consumer and business confidence in action, is initial jobless claims, which continue to be remarkably low, indicating a continued tightening labor market.
This historically low claims level, combined with the historically low unemployment rate of 4.4%, appears to be pushing wages higher. This should help to support consumer spending and, as was from earnings season, hasn't yet begun to dent corporate profitability.
Fed likely still on track for June hike
Market odds of a June hike fell during the politically induced turmoil in the market but bounced back quickly (now close to 100%), and we remain confident that we’ll see another quarter point added to the fed funds rate. There are, of course, caveats, as escalation of political uncertainty or a sharp downturn in economic data could deter the Fed, but as of now it seems relatively intent on continuing their normalization process. Remember that the Fed has a dual mandate—full employment and contained inflation. Inflation doesn’t appear to be a problem at the moment so the Fed doesn't have to be overly aggressive. But we are at—or even below—"full" employment, allowing the Fed to continue to move toward policy normalization. For now the market appears comfortable with gradual hikes, and is now looking forward to more information with regard to the upcoming reduction in the Fed’s massive $4.5 trillion balance sheet. Information regarding the balance sheet, and the process itself, is another potential source of volatility for the market.
Both political uncertainty and Fed policy changes could contribute to increased volatility, but solid economic and earnings growth—both in the United States and globally—should help the bull market to continue. We suggest looking past the political rhetoric for the most part and focusing on economic developments and the long-term stability the United States provides.
This material is issued by Charles Schwab, Hong Kong, Ltd. The information provided here is for general informational purposes only and has not been reviewed by the Securities and Futures Commission in Hong Kong.