Stocks are at record highs this week, as the S&P 500 and Nasdaq finally broke through their September zenith on the back of remarkably strong earnings from major firms. Fears surrounding a potential growth slowdown and even recession have been surmounted by near term data encouraging a resurgence of optimism in equity markets. Meanwhile, sending ongoing signs of confusion, mixed signals from the bond market continue to show worries about underlying growth as bond yields remain lower despite the equity rally. In economic news, unemployment claims surged higher, but US business equipment orders rebounded the most in eight months. New US home sales also showed strength, and oil prices spiked as the US ended waivers on Iranian oil buying, constraining supply. Other confusing signs included declining global trade data while consumer comfort rose. All in all, it’s a very murky picture out there, but growth simply appears to be stuck in slower gear as expected. On the international front, US and Chinese negotiators will meet in Beijing next week as both sides work to draft an agreement by next month. Focusing on the Chinese domestic economy, the government’s stimulus efforts have worked extraordinarily well in reviving the beaten down stock market, but leaders have begun to send mixed messages on continuing efforts and volatility ticked up dramatically this week.
This earnings season’s results have caught many off guard, though stocks look to have already priced in a positive surprise. While always a jumble of good and bad, almost 80% of S&P 500 companies have exceeded earnings estimates thus far. The largest US banks reports provided some guidance on the health of the economy, with mostly positive data on loan growth, credit markets, and encouraging manager commentary. Big tech companies thus far have shown ongoing gangbuster growth, with investors stoking prices to record highs for the Nasdaq this week. The web services and advertising revenues within this sector continue to outperform as long-term secular trends remain favorable for the industry. Meanwhile, health care stocks have taken a serious beating year-to-date, as talks of universal healthcare for all scares off investors, despite attractive valuations, innovation, and supportive demographic trends. We continue to find this area of the market very compelling at this time despite recent setbacks, as the political will for broad healthcare changes is likely lacking.
Our tactical allocation remains neutral, given the recent rise in valuations. The current market environment seems largely due to the Federal Reserve’s accommodative actions this year. As has been the case for almost all of the current bull market, the Fed appears to be firmly in the driver’s seat for determining the direction of most asset classes. The power of the Fed should not be understated – their actions strongly influence the basis for most asset pricing models, essentially setting the risk-free rate. Their accommodative pivot in January sent powerful signals to markets that they are willing to take action to avoid deflation and keep the economic engine of the last decade intact. While earnings have been positive this year, the slowing growth cannot be overlooked, and other economic variables portend potential trouble ahead. We will continue to ride out the recent rise in asset prices but remain vigilant and cautious over becoming exuberant. As always, we continue to remain extremely focused on monitoring unfolding market dynamics and reacting only when appropriate.