The S&P 500 has been in a holding pattern since the June Brexit vote, trading within a narrow band. Will U.S. earnings reports be the catalyst to trigger an upward breakout in the months ahead? We don’t think so.
Chart of the week
Earnings revisions ratio, 2002-2016
Analysts earlier this year expected the earnings headwinds of falling oil prices and a stronger U.S. dollar would diminish, driving better earnings-per-share growth in the U.S. by the end of 2016. This is evident in the upward trajectory of the chart’s blue line during the second quarter of 2016, as oil prices rallied and the U.S. dollar weakened.
But this year seems to be no exception to the annual pattern of analysts steadily lowering expectations. See the most recent downward shift in the chart’s blue line. In fact, analysts have cut third-quarter U.S. earnings expectations by 8% since the start of the year – bigger than the downward revisions in the first two quarters.
Early third-quarter earnings have beaten these reduced expectations at a higher-than-average rate. Yet fewer companies are raising their future guidance than in a typical quarter. Political uncertainty in the U.S. gives companies more reason to hold off on investment. Firms are likely to express similar caution this week when more than one-third of the S&P 500 reports earnings.
Ultimately, we believe earnings beats in this environment won’t be enough to spur a sustained rally, especially given how elevated U.S. valuations are relative to history. We see greater clarity on future Fed policy and the political outlook as more likely to drive risk appetite and stock performance in the months ahead. Against this backdrop, we like U.S. companies able to increase revenues and earnings in a low-growth world, such as selected technology stocks. We’re cautious of traditional dividend payers and prefer dividend growers instead. Outside the U.S., we prefer Asia ex-Japan stocks whose earnings momentum is improving.
|Oct. 24||October U.S. PMI manufacturing index flash; eurozone composite PMI flash|
|Oct. 27||UK Q3 gross domestic product (GDP)|
|Oct. 28||Advance estimates for U.S. Q3 GDP, including core personal consumption expenditure (PCE) index|
The GDP report will provide clues about consumer spending and the next monthly core PCE, the Fed's preferred inflation measure. Markets expect inflation to rise as headwinds such as low oil prices start to dissipate, giving the Fed more confidence inflation is nearing its 2% target.
Weekly and 12-month performance of selected assets
|Equities||Week||YTD||12 Months||Div. Yield|
|U.S. Large Caps||0.4%||4.8%||6.1%||2.2%|
|U.S. Small Caps||0.5%||8.5%||8.0%||1.4%|
|U.S. Investment Grade||0.5%||9.1%||7.5%||2.9%|
|U.S. High Yield||0.6%||16.4%||11.1%||6.0%|
|Emerging Market $ Bonds||0.6%||14.4%||12.9%||5.1%|
|Brent Crude Oil||-0.3%||38.9%||8.2%||$51.78|
Source: Bloomberg. As of October 21, 2016. Notes: Weekly data through Friday. Equity and bond performance are measured in total index returns in U.S. dollars. U.S. large caps are represented by the S&P 500 Index; U.S. small caps are represented by the Russell 2000 Index; Non-U.S. world equity by the MSCI ACWI ex U.S.; non-U.S. developed equity by the MSCI EAFE Index; Japan, Emerging and Asia ex-Japan by their respective MSCI Indexes; U.S. Treasuries by the Barclays U.S. Treasury Index; U.S. TIPS by the U.S. Treasury Inflation Notes Total Return Index; U.S. investment grade by the Barclays U.S. Corporate Index; U.S. high yield by the Barclays U.S. Corporate High Yield 2% Issuer Capped Index; U.S. municipals by the Barclays Municipal Bond Index; non-U.S. developed bonds by the Barclays Global Aggregate ex USD; and emerging market $ bonds by the JP Morgan EMBI Global Diversified Index. Brent crude oil prices are in U.S. dollars per barrel, gold prices are in U.S. dollar per troy ounce and copper prices are in U.S. dollar per metric ton. The Euro/USD level is represented by U.S. dollar per euro, USD/JPY by yen per U.S. dollar and Pound/USD by U.S. dollar per pound. Index performance is shown for illustrative purposes only. It is not possible to invest directly in an index. Past performance is not indicative of future results.
Views from a U.S. dollar perspective over a three-month horizon
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