Summary: Mid-way through September, US equities are flat to lower for the month. The longer term trend is positive but the near-term outlook is unfavorable. It seems unlikely that any equity weakness will be substantial or long lived, but investors should remain on alert to heightened risk over the next several weeks. We believe that will be a good set up for gains into year end.
* * *
Mid-way through September, US equities are flat to lower for the month (table from alphatrends.net). Enlarge any chart by clicking on it.
Summary: The macro data from the past month continues to mostly point to positive growth. On balance, the evidence suggests the imminent onset of a recession is unlikely. The largest risk to the economy is the escalation in trade war rhetoric.
The bond market agrees with the macro data. The yield curve has 'inverted' (10 year yields less than 2-year yields) ahead of every recession in the past 40 years (arrows). The lag between inversion and the start of the next recession has been long: at least 10 months and in several instances as long as 2-3 years. On this basis, the current expansion will likely last into mid-2019 at a minimum. Enlarge any image by clicking on it.
Summary: SPX, NDX, small caps as well as broad measures like the Russell 3000 - which equals 98% of total US market capitalization - made new all-time highs (ATHs) last week. Even when indices are adjusted for the dominant FAAMNG companies, the remaining 99% of stocks also at new ATHs. The trend is clearly higher, and several new momentum studies suggest that equities are likely to gain more before year-end.
If there is a reason for caution, the risk is mostly short-term (within the next month) and probably not very significant, as explained in this post.
* * *
US equities rose for a 5th month in a row in August, gaining 4-6%. Through the first 8 months of the year, SPX is up 9% while the Nasdaq-100 is up 20% (table from alphatrends.net). Enlarge any chart by clicking on it.
Summary: US equities have returned to, and in some cases exceeded, their January all-time highs. The trend is clearly higher and several new momentum studies suggest that equities are likely to gain more into year-end. Recent macro and corporate results data also support the ongoing equity bull market. Despite the gains over the past 5 months, investor sentiment is not frothy.
What's new is that US equities now have a topping pattern in place: the momentum high in January has been followed a price high in August. This is how every major top in the past 40 years has started. On it's own, this doesn't suggest a major top is near. But in January, not even a topping pattern was visible in US stocks. That's no longer true.
Trade war rhetoric continues to provide sharp, interim market volatility. This week, the US and China resume trade talks for the first time in two months.
* * *
Halfway through August, US equities are on pace for a monthly gain of 2-4% (table from alphatrends.net). Enlarge any chart by clicking on it.
Summary: Overall, corporate results in the second quarter were excellent. S&P sales grew 11%, earnings rose 27% and profit margins expanded to a new all-time high of 11.4%.
Fundamentals are driving the stock market higher, not valuations: earnings during the past 1 year and 2 years have risen faster than the S&P index itself. The strong growth in company profits is not due to the net reduction in shares through, for example, corporate buybacks.
The outlook in 2018 looks solid: the consensus expects earnings to grow 21% this year. Rising energy prices and the tax reform law are tailwinds.
Expectations for 10% earnings growth in 2019 looks too optimistic and will likely be revised downward; the substantial jump in margins this year is unlikely to be sustained, especially with labor and interest expenses rising.
Valuations are back to their 25-year average. They are not cheap, but the excess from 2017 and early 2018 has been worked off. If investors once again become ebullient, there is room for valuations to expand.
* * *
90% of the companies in the S&P 500 have released their second quarter (2Q18) financial reports. The headline numbers are very good. Here are the details:
Sales Quarterly sales reached a new all-time high, growing 11% over the past year, the best sales growth in 7 years (since 2011). On a trailing 12-month basis (TTM), sales are 9% higher yoy (all financial data in this post is from S&P). Enlarge any image by clicking on it.