Modest Pullback Or Something Bigger? | Weekly Market Commentary | March 11, 2019

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KEY TAKEAWAYS

  • Following such a strong rally since the December 24 lows, a pullback is reasonable to expect.
  • We expect additional stock market weakness beyond last week’s more than 2% decline to be modest.
  • Fundamentals remain sound, valuations are reasonable, and most technical indicators we follow point to further potential gains ahead.

Click here to download a PDF of this report.
Following the strong 2019 rally, we ask if stocks are overdue for a pullback. The S&P 500 Index rallied 17% in 2019 and 9.4% since the December 24, 2018, low. The strength of the rally has been a surprise to many given widespread concerns about slower global growth, trade uncertainty, and the age of the bull market—which turned 10 last weekend, as we discussed here last week. Following that strong rally, a pullback is to be expected; but we don’t think it will get much worse than last week’s 2.1% drop, for reasons discussed below.

FUNDAMENTALS REMAIN SOUND

Although stocks may need a pause to digest recent gains, we continue to believe fundamentals support further gains for stocks this year. The economy is growing steadily and, despite Friday’s soft and likely weather-distorted payrolls report, is creating jobs at a solid pace for this point in the cycle. We don’t think it’s widely understood that fiscal stimulus (tax cuts and government spending) will add more to gross domestic product (GDP) in 2019 on a percentage basis than it did in 2018.
Though earnings growth is slowing, economic growth supported by fiscal stimulus, expansionary manufacturing surveys, and solid labor markets point to another year of record profits in 2019. Historically, corporate revenue is correlated with GDP plus inflation (or nominal GDP), which could approach 5% this year, if our forecasts are accurate. History also reveals that peaks in earnings growth—as we experienced in the third quarter of 2018—have tended to be followed by several years of economic growth and stock market appreciation, which should be reassuring to those who think a now 10-year-old bull market is getting fatigued.
Though nothing has been signed, a trade deal with China over the next month or two appears likely. Key players in the negotiations have expressed increasing optimism, and it’s clear President Trump wants a deal. Any agreement is probably good news for stocks at this point, but a potential rollback of tariffs put in place last year presents a possible upside surprise.
Finally, keep in mind that the post-midterm election period has historically produced strong gains—Since WWII, the S&P 500 has never been down over the 12-month period following midterm elections (18 for 18), having produced an average 14.5% gain during those periods. President Trump sees a strong stock market as part of his path to reelection, suggesting this historical pattern may hold.

MIXED TECHNICAL PICTURE

Most of our favorite technical indicators, such as market breadth, are flashing positive signals and there are a number of historical analogues pointing to more gains ahead:

  • The S&P 500 is above its upward sloping 50-day moving average (MA), suggesting an improving trend, and at support in the form of its 200-day moving average.
  • March has been the second strongest month for the stock market over the past 20 years.
  • Stocks tend to go up in the final 10 months of a year (25 out of the last 27 years) after experiencing gains during January and February.
  • Market breadth is favorable, with a high proportion of stocks participating in this year’s advance.
  • Investor flows have been negative in 2019—evidence of caution, not euphoria.
  • Investor sentiment surveys suggest bulls are not in overabundance.

At the same time, however, some indicators suggest the S&P 500 may be due for a pullback.

  • The percentage of stocks above their 50-day moving averages is still high at 84%, though down from the recent peak of 92%.
  • Put/call ratios suggest investors are complacent; more nervousness is typical ahead of rallies.
  • The S&P 500 has failed to sustain levels above the 2,800 level four times since mid-October, making a breakout more difficult.
  • Support for the S&P 500 below the 50-day moving average is at 2,650, 3.4% below Friday’s closing level.
  • The average peak-to-trough pullback after a positive January and February is 9%.

RISKS

While we do think the macro environment sets up well for stocks, we are mindful of several risks. Earnings growth has slowed quite a bit and could slow further. A potential first quarter earnings decline may fuel investor concerns about another earnings recession (not our expectation) and weigh on investor sentiment.
Though unlikely, a disorderly Brexit that creates instability in Europe is possible. The European Central Bank reminded us last week how much European economies have slowed; risk of spillover into the U.S. remains.
The latest trade headlines have been positive, but President Trump could still walk away. Even if a deal is reached, it may already be priced in and markets may sell the news.
Finally, although the Fed is on hold now, the central bank may feel the need to respond with tighter policies should economic growth improve later this year.

CONCLUSION

Putting all of that together, a 5% or so pullback may be in order. With fundamentals still sound, valuations quite reasonable (discussed here two weeks ago), and the potential catalyst of a U.S.- China trade deal, we would expect additional stock market declines beyond last week’s 2% dip to be fairly modest. Keep in mind that pullbacks of this
magnitude are typical—we tend to see three or four of them each year. Weakness may provide opportunities for suitable investors to add equities based on what we see as a generally favorable macroeconomic environment.
The possibility of a pullback does not scare us off of our 2019 year-end forecast for further stock gains from here. Although it’s reasonable to expect a pickup in volatility following the strong bounce off December lows, we maintain our 2019 year-end S&P 500 target of 3,000, or 9% above Friday’s closing level.
 
IMPORTANT DISCLOSURES
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. The economic forecasts set forth in this material may not develop as predicted.
Investing involves risk including loss of principal. No investment strategy or risk management technique can guarantee return or eliminate risk in all market environments.
All indexes are unmanaged and cannot be invested into directly. Unmanaged index returns do not reflect fees, expenses, or sales charges. Index performance is not indicative of the performance of any investment.
All information is believed to be from reliable sources; however, LPL Financial makes no representation as to its completeness or accuracy.
INDEX DESCRIPTIONS
The Standard & Poor’s 500 Index is a capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.
This research material has been prepared by LPL Financial LLC.
To the extent you are receiving investment advice from a separately registered independent investment advisor, please note that LPL Financial LLC is not an affiliate of and makes no representation with respect to such entity.
Not FDIC or NCUA/NCUSIF Insured | No Bank or Credit Union Guarantee | May Lose Value | Not Guaranteed by Any Government Agency | Not a Bank/Credit Union Deposit
Tracking #1-830608 (Exp. 03/20)
]]>

The Bull Turns 10 | Weekly Market Commentary | March 4, 2019

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KEY TAKEAWAYS

  • During the 10-year bull market, the S&P 500 Index has more than quadrupled in value.
  • It might be the longest bull market, but the 1990s bull market saw substantially higher returns.
  • Market breadth continues to support higher equity prices and eventual new highs.

Click here to download a PDF of this report.
The bull market will celebrate its tenth birthday on March 9, 2019. During that period, the S&P 500 Index has increased more than fourfold in value, producing a total return of 410% (17.7% annualized) while rising 314% in price. Concerns over the global economy, along with a potential policy mistake by the Federal Reserve (Fed) and the trade dispute with China, all have many wondering just how much the longest bull market ever could have left in the tank. This week, we’ll show why this bull market is indeed alive and well and could make it to 11 next year.

THE LONGEST BULL, BUT…

On March 9, 2009, the S&P 500 closed at 676.53, marking the low point for the worst bear market in stocks since the Great Depression. Few believed it possible at the time, but that marked the beginning of the longest bull market, at 120 months, since World War II [Figure 1].

But while this might be the longest bull market ever, it isn’t the strongest. Stock prices in the 1990s bull market increased by 417% at the peak, morethan 100 percentage points above the current bull market. This comparison is reassuring, as it shows this bull might not be as extended as many think.
Although it may feel like this bull market has done nothing but go up for 10 straight years, that couldn’t be further from the truth. In fact, this bull market is the only one ever with two 20% or more declines based on intraday prices. In October 2011 and again in December 2018, the S&P 500 fell 20% from prior highs, only to rally by the daily close to narrowly avoid entering a bear market.
It’s worth noting that the S&P 500 hasn’t made a new high since September 20, 2018, so one could argue this bull market may have ended then. We can’t disagree, but with the S&P 500 only 5% away from making new highs, for the sake of argument, we’re going to assume this bull market is still alive and that the S&P 500 can make new highs later this year.

THREE DEVELOPMENTS

Near term, from a technical analysis perspective the stock market is clearly overbought, suggesting a break may be warranted and could come at any time. Additionally, we see potential warnings signs from put/call ratios becoming too complacent (market participants are not doing a lot of hedging against potential stock market losses) and investor sentiment polls revealing too many bulls, which makes sense after the 19% rally since December 24. Here’s the catch though: These are short-term sentiment measures—in the bigger picture, we have identified three signs that we could still be a long way from the euphoria we tend to see at major market peaks.

  • According to the Commodity Futures Trading Commission, speculators have their largest short position against the S&P 500 since November 2016.
  • According to Emerging Portfolio Fund Research, $30 billion has been pulled out of global mutual funds in 2019, even as many global stock markets have risen by double digits.
  • According to Bloomberg, 6% of all analyst ratings are sells, which is the highest level in nearly two years.

MARKET BREADTH STILL STRONG

As we discussed here last week, the underlying fundamental backdrop remains quite positive, we’re looking for earnings to potentially surprise to the upside in 2019, and we think stock valuations are still attractive relative to bonds despite this year’s gains.
Turning to market technicals, market breadth measures how many stocks are participating in moves in broader indexes. One of the easiest ways to measure this is via advance/decline (A/D) lines [Figure 2].An A/D line is a ratio of how many stocks go up versus down each day for a stock exchange or index. The thinking is, if many stocks drive broad market gains, then there are plenty of buyers and the upward trend should likely continue, all else being equal. On the other hand, if an upward move in a broad market gauge is driven by relatively few stocks, this can be a warning sign of cracks in the bull’s armor.

One sign that market breadth continues to suggest higher overall equity prices is that various A/D lines have broken out to new all-time highs this month. In fact, the NYSE Common Stock Only A/D line has a good history of leading equities higher.With that indicator making new highs currently, new highs in equity markets might not be too far away.

CONCLUSION

Despite its old age, we believe the 10-year-old bull market has quite a bit left in its tank. The ongoing benefits of fiscal policy, coupled with a more patient Fed, lead us to believe the economy may surprise to the upside in the second half of 2019. We don’t think it will be an easy ride, but we continue to expect eventual new highs in equity markets and reiterate our fair value target of 3,000 for the S&P 500, about 7% above Friday’s closing index price of 2,804.
 
IMPORTANT DISCLOSURES
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. The economic forecasts set forth in this material may not develop as predicted.
Investing involves risk including loss of principal. No investment strategy or risk management technique can guarantee return or eliminate risk in all market environments.
All indexes are unmanaged and cannot be invested into directly. Unmanaged index returns do not reflect fees, expenses, or sales charges. Index performance is not indicative of the performance of any investment.
All information is believed to be from reliable sources; however, LPL Financial makes no representation as to its completeness or accuracy.
INDEX DESCRIPTIONS
The Standard & Poor’s 500 Index is a capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.
The NYSE Composite Index is a float-adjusted market-capitalization weighted index which includes all common stocks listed on the NYSE, including ADRs, REITs, and tracking stocks and listings of foreign companies. The index was recalculated to reflect a base value of 5,000 as of December 31, 2002.
This research material has been prepared by LPL Financial LLC.
To the extent you are receiving investment advice from a separately registered independent investment advisor, please note that LPL Financial LLC is not an affiliate of and makes no representation with respect to such entity.
Not FDIC or NCUA/NCUSIF Insured | No Bank or Credit Union Guarantee | May Lose Value | Not Guaranteed by Any Government Agency | Not a Bank/Credit Union Deposit
Tracking #1-828249 (Exp. 03/20)

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Five Key Questions | Weekly Market Commentary | February 25, 2019

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KEY TAKEAWAYS

  • Stocks may keep going higher, but the easy gains likely have been made.
  • Stock valuations, when compared with bond yields, are actually historically cheap.
  • The overall technical backdrop supports a continuation of the bull market.

Click here to download a PDF of this report.
This week we reassess the stock market landscape following the latest rally. Specifically, we answer five of the most common questions we’ve received recently. We use multiple lenses to assess the stock market, including fundamentals, valuations, and technical analysis.

CAN STOCKS KEEP GOING HIGHER?

Since its low on December 24, 2018, the S&P 500 Index is up 18.8% as of February 22. Gains have been driven by progress in trade negotiations and a shift in the Federal Reserve’s (Fed) communication strategy; however, extreme oversold conditions and low valuations following the worst fourth quarter for stocks since the Great Depression provided an extra boost.
Recent gains eliminated oversold conditions and pushed valuations higher, raising the bar for further gains and making the next leg higher more difficult to achieve. We still see potential for some valuation expansion should the trade dispute be resolved and steady U.S. economic growth continue, but earnings may have to do the heavy lifting to push the S&P 500 to our year-end fair value target of 3000 by December 31, 2019.

IS EARNINGS GROWTH STRONG ENOUGH TO PROPEL STOCKS HIGHER?

We believe stock performance over the rest of the year can at least match the mid-single-digit earnings growth that we expect for the S&P 500 in 2019. A little bit of valuation expansion may help, but we think earnings will be enough to get stocks back to prior highs this year (2930 on the S&P 500) and potentially to our year-end S&P 500 fair value target of 3000.
Though a lot of attention has been paid to cuts in 2019 earnings estimates due to tariffs and slower global economic growth, the U.S. economic backdrop remains solid, manufacturing activity continues to expand (based on the latest Institute for Supply Management [ISM] survey), and the consumer spending outlook is well supported by a healthy labor market.
Tariffs are the primary risk to earnings. Other risks include possible margin pressures from higher wages or another potential leg down for European economies.

HAVE STOCKS GOT TEN TOO EXPENSIVE?

We don’t think so. With the S&P 500 at a forward price-to-earnings ratio of about 16, valuations are roughly in line with the average over the past few decades. Factor in still-low interest rates and inflation, which increase equities’ attractiveness versus other asset classes like fixed income, and we would argue stocks are still attractively valued and modest valuation expansion this year is likely.
An easy way to make this point is to compare the earnings generated by stocks with bond yields, which are essentially earnings generated by bonds. We do this by comparing the earnings yield for the S&P 500 Index (S&P 500 earnings per share divided by the index price level) with the yield on the 10-year Treasury.
This statistic, referred to as the equity risk premium (ERP), is currently over 3% after averaging about 0.5% over the past six decades. Historically, a higher ERP has pointed to better future stock market performance. Since 1960, when the gap between the earnings yield and 10-year Treasury yield has been above 3% (as it is now), the S&P 500 has gained 12.4% on average over the following 12 months [Figure 1].

DO WE NEED A RETEST?

We believe a retest of the December 24, 2018, low for the S&P 500, near 2350, is unlikely. As we wrote here last week, with more than 70% of S&P 500 components recently hitting 20-day highs, we believe pullbacks in the near term will be modest.
Market breadth, which measures how many stocks are participating in the movement of broader indexes, is another positive sign. The NYSE Common Stock Only Advance/Decline line recently broke out to new all-time highs. We’ve seen time and time again that new highs in market breadth has led to eventual new highs in price.
Lastly, more than 90% of the components in the S&P 500 recently were trading above their 50-day moving average. While it may seem like stocks are overbought based on this metric, as Figure 2 shows, being overbought by this measure is actually quite bullish.

IS SENTIMENT NOW OVERLY BULLISH?

We don’t think so. As discussed last week, the overall technical backdrop continues to look strong, but one other substantial positive is that investor sentiment is still not near levels of optimism that we would consider to be a major warning sign. We use several surveys to gauge sentiment, including the AAII bull-bear survey and the CNN Money Fear and Greed Index, as well as investor flows.
History has shown that the crowd can actually be right during trends, but it also tends to be wrong at extremes. This is why sentiment can be an important contrarian indicator. If everyone who might become bearish has already sold, only buyers are left. The reverse also applies. We see this contained optimism as healthy and, in fact, are surprised there isn’t more excitement after such a powerful rally.

CONCLUSION

The questions are mounting after the significant gains since the December 24 lows. The good news is that our expectation for steady earnings growth, solid technicals, and nice valuations amid a healthy economic backdrop support further gains for stocks throughout 2019. We reiterate our year-end fair value range of 3000 for the S&P 500 from our Outlook 2019 publication.
 
IMPORTANT DISCLOSURES
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. Any economic forecasts set forth in the presentation may not develop as predicted.
Investing involves risk including loss of principal. No investment strategy or risk management technique can guarantee return or eliminate risk in all market environments.
All indexes are unmanaged and cannot be invested into directly. Unmanaged index returns do not reflect fees, expenses, or sales charges. Index performance is not indicative of the performance of any investment.
Because of its narrow focus, specialty sector investing, such as healthcare, financials, or energy, will be subject to greater volatility than investing more broadly across many sectors and companies.
All information is believed to be from reliable sources; however, LPL Financial makes no representation as to its completeness or accuracy.
INDEX DESCRIPTIONS
The Standard & Poor’s 500 Index is a capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.
The Institute for Supply Management (ISM) Manufacturing Index is an economic indicator derived from monthly surveys of private sector companies, and is intended to show the economic health of the U.S. manufacturing sector. A PMI of more than 50 indicates expansion in the manufacturing sector, a reading below 50 indicates contraction, and a reading of 50 indicates no change.
This research material has been prepared by LPL Financial LLC.
To the extent you are receiving investment advice from a separately registered independent investment advisor, please note that LPL Financial LLC is not an affiliate of and makes no representation with respect to such entity.
Not FDIC or NCUA/NCUSIF Insured | No Bank or Credit Union Guarantee | May Lose Value | Not Guaranteed by Any Government Agency | Not a Bank/Credit Union Deposit
Tracking #1-825770 (Exp. 02/20
]]>

The Rally Continues | Weekly Market Commentary | February 19, 2019

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KEY TAKEAWAYS

  • The market rally continues, with stocks off to their best year’s start since 1991.
  • Near-term stocks are quite overbought and a pullback could be warranted.
  • Yet, from a sentiment perspective, we still aren’t seeing signs of the over-the-top optimism that is consistent with major peaks.

Click here to download a PDF of this report.
The rally continues, as the S&P 500 Index gained for the seventh week out of the past eight, while the Dow Jones Industrial Average, Russell 2000 Index, and Nasdaq all closed higher for the eighth consecutive week. Sparking the rally this week were Washington striking a deal to avoid another government shutdown and hopes that President Trump might push back the March 1 deadline on higher tariffs on Chinese goods. With the S&P 500 off to its best year’s start since 1991, how much further can things go? This week we’re going to take a look at market sentiment, which can play an important part in determining how long the bull will run.

ABOVE THE 200-DAY

As Figure 1 shows, the S&P 500 finally closed above its 200-day moving average for the first time since early December 2018. Since October, the index hasn’t stayed above this long-term trend line for more than a few days. Given the S&P 500 has now bounced more than 18% from the December 24 lows, some type of consolidation or maybe another pullback would be normal.

As we discussed in That Was The Easy Part, a retest of the December 24 lows likely won’t happen. Historically, you see retests at major market lows, but this could be one of those rare times that we don’t. Two main reasons are:

  • On January 18, 2019, more than 70% of the S&P 500 components made a new 4-week high, and the returns after such a rare blast of strength have been quite impressive 3, 6, and 12 months later.
  • We saw two 90% up days coming off the December lows, on December 26 and January 3. This means that 90% of all stocks on the New York Stock Exchange were higher and 90% of the volume was also higher on those days. When we
    see two strong days like that so close together coming off a low, continued future gains without a rest is likely, in our view.

CHECKING IN ON SENTIMENT

The overall technical backdrop continues to look strong, but one other substantial positive is that investor sentiment is still not near areas we would consider to be a major warning sign.
History has shown that the crowd can be right during trends, but it also tends to be wrong at extremes. This is why sentiment can be an important contrarian indicator. If everyone who might become bearish has already sold, only buyers are left. The reverse also applies.
On multiple levels, we see increasing optimism— but not at levels that have shown it paid to be contrarian. In fact, with a more than 18% bounce off the December lows, we are quite surprised there isn’t more excitement.

  • The Bank of America/Merrill Lynch Global Fund
    Manager Survey had the highest number of investors “overweight cash” since early 2009. Additionally, investors with an “overweight global equities allocation” sank to the lowest level since September 2016. This shows managers aren’t giddy over the good start to the year and suggests there could be potential cash on the sidelines waiting to come in.
  • The CNN Money Fear and Greed Index hit single digits back in December, but has bounced to only 64 recently (on a 0–100 scale), again suggesting overall optimism isn’t near previous warning signs.
  • The National Association of Active Investment Managers (NAAIM) Exposure Index was recently over 80 for the first time since October, but again this has peaked much higher in the past.
  • The number of bulls in the weekly American Association of Individual Investors (AAII) Investor Sentiment Survey has been beneath 40% for 14 consecutive weeks, the longest such streak since last spring, when the first 10% correction in nearly 18 months occurred. What is so interesting about it this time around is bulls aren’t springing into the picture even after week after week of gains.
  • Investors continue to pull money out of equity mutual funds and equity exchange-traded funds (ETF). In fact, according to weekly data from the Investment Company Institute (ICI), only seven weeks over the past year have seen inflows into U.S. domestic mutual funds and ETFs. Additionally, the week of the December 24 lows saw the largest weekly outflows of funds since February 2018. We would expect to see more inflows and optimism before an ultimate market peak could take place.

CONCLUSION

The rally continues, and although we see many signs potentially indicating new highs for equities later this year, some type of market consolidation or pullback could be due. We have an improving technical backdrop that should support any pullback as a buying opportunity, and overall sentiment is still a long way away from what we’d call over-the-top and troublesome from a contrarian point of view. We believe the combination of fiscal policy,
optimism over a potential U.S.-China trade deal, and our expectation for steady earnings growth is strong enough to support further gains for stocks throughout 2019. We reiterate our year-end fair value range of 3000 for the S&P 500 from our Outlook 2019 publication.
IMPORTANT DISCLOSURES
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. Any economic forecasts set forth in the presentation may not develop as predicted.
Investing involves risk including loss of principal. No investment strategy or risk management technique can guarantee return or eliminate risk in all market environments.
All indexes are unmanaged and cannot be invested into directly. Unmanaged index returns do not reflect fees, expenses, or sales charges. Index performance is not indicative of the performance of any investment.
Because of its narrow focus, specialty sector investing, such as healthcare, financials, or energy, will be subject to greater volatility than investing more broadly across many sectors and companies.
All information is believed to be from reliable sources; however, LPL Financial makes no representation as to its completeness or accuracy.
INDEX DESCRIPTIONS
The Standard & Poor’s 500 Index is a capitalization-weighted index of 500 stocks designed to measure performance of he broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.
This research material has been prepared by LPL Financial LLC.
To the extent you are receiving investment advice from a separately registered independent investment advisor, please note that LPL Financial LLC is not an affiliate of and makes no representation with respect to such entity.
Not FDIC or NCUA/NCUSIF Insured | No Bank or Credit Union Guarantee | May Lose Value | Not Guaranteed by Any Government Agency | Not a Bank/Credit Union Deposit
Tracking #1-823073 (Exp. 02/20)]]>

Key Takeaways from Fourth Quarter Earnings | Weekly Market Commentary | February 11, 2019

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KEY TAKEAWAYS

  • Earnings growth for the fourth quarter is tracking to a solid 17%, above prior estimates but below the pace of the previous three quarters.
  • The bar has been substantially lowered for the first quarter, setting up potential upside surprises, particularly if trade uncertainty is diminished.
  • We expect S&P 500 companies will be able to at least deliver mid-single-digit earnings growth in 2019, driven by solid economic growth, fiscal stimulus, and share buybacks.

Click here to download a PDF of this report.
Earnings growth slowed in the fourth quarter but was still solid.
With two-thirds of S&P 500 Index companies having reported results so far, corporate America has delivered solid earnings growth—in the mid-to-high teens—for the quarter. However, slowing global growth and trade tensions have challenged the outlook, setting up slower earnings gains in the coming year. This week we provide key takeaways from fourth quarter earnings season, and update our 2019 earnings outlook.

THE NUMBERS

Year-over-year earnings growth for the fourth quarter is tracking near 17%, one percentage point above the growth rate reflected in year-end estimates (source: Refinitiv, formerly Thomson Reuters). This is solid growth, but below the 25% pace of the prior three quarters [Figure 1]. Tax cuts boosted earnings growth by 7–8 percentage points. Revenues (which are not impacted by the tax cuts) are tracking to a healthy 6% increase, similar to prior expectations.

Companies in the communication services, energy, and industrials sectors produced the most upside to prior estimates. Energy and communication services, in that order, made the biggest contributions to earnings growth. Upside was limited by the financials and technology sectors, which came up short.
Forward-looking guidance has been tepid overall during reporting season, mostly because of the uncertainty surrounding the U.S.-China trade dispute and slower growth overseas. U.S.-focused companies have delivered stronger revenue and earnings growth than more global companies, according to analysis by FactSet, while consensus S&P 500 earnings estimates for the first quarter were cut by an above-average 4.6% in January, as shown in Figure 2. Excluding energy, though, the reduction has been typical.

KEY TAKEAWAYS

Our key takeaways from the quarterly results received so far are:
1. Upside is tougher to come by
At this late stage of the economic cycle, it is tougher for companies to produce big upside surprises. Slower growth overseas, particularly in Europe, makes it even more difficult, which means we should probably expect 2–3% upside, rather than the recent 3–6% range, to be the norm going forward.
2. The bar for 2019 has been lowered substantially
The more-than-4% cut to consensus first quarter earnings estimates—to near flat with the prior-year quarter—sets companies up to surprise on the upside when first quarter results start being reported in April.The more-than-4% cut to consensus first quarter earnings estimates—to near flat with the prior-year quarter—sets companies up to
surprise on the upside when first quarter results start being reported in April.
3. Trade uncertainty is a headwind.
Based on management commentary this quarter, most companies are feeling an impact from the China trade dispute, either through tariff costs, supply chain disruptions, dampened consumer and business confidence, or simply less demand for U.S. goods in China. Until this uncertainty is lifted and tariffs are reduced or eliminated, current estimates may be difficult to achieve.

THE OUTLOOK

Earnings growth will likely slow in 2019 as the one-year anniversary of the tax cuts passes. Still, we think that S&P 500 companies will be able to at least deliver mid-single-digit earnings growth in 2019 due to the following:

  • Solid domestic economic growth. Our forecast is for U.S. GDP growth of 2.5–2.75% in 2019, supported by increased consumer spending, business investment, and government spending. The booming January jobs report, including steadily rising wages, reaffirms the strength of the consumer. January readings of the Institute for Supply Management (ISM) surveys on manufacturing and services, both in the 56–57 range, signal near-term earnings gains.
  • Fiscal stimulus. The tax reform boost will be smaller in 2019 than in 2018, but tax cuts and increased
    government spending could still provide an incremental fiscal policy boost to economic growth this year. Policy uncertainty has clouded capital investment decisions, but capital investment incentives enacted in December 2017
    remain in place, and a trade deal is a potential catalyst for more business spending.
  • Share buybacks. Healthy corporate balance sheets, still-low borrowing costs, and repatriation of overseas profits at low tax rates (part of the December 2017 tax reform) all support another year of robust share buyback activity. We expect S&P 500 earnings per share to get at least a 2% boost in 2019 from buybacks, despite being somewhat politically unpopular.

There are risks to the downside, most notably from tariffs and trade. Other risks include further deterioration of the European economy, a jump in labor costs, or a surging U.S. dollar. A potential sharp drop in oil prices poses another risk, though the potential energy cost savings for consumers and businesses would help offset the drag on energy sector profits.

CONCLUSION

Corporate America has delivered solid earnings growth in the fourth quarter, though the pace of growth has slowed and is poised to slip further. Limited upside to prior estimates reflects the late-cycle economic environment, slower growth overseas, and trade tensions, but the lower bar for first quarter expectations should lead to more
upside surprises.
We continue to expect mid-single-digit earnings growth for S&P 500 companies in 2019, driven by solid economic growth, fiscal stimulus, modest inflation, and steady share buybacks. Although the peak earnings growth rate for this economic expansion is almost certainly behind us, profit growth peaks have historically been followed by several years of economic growth and stock market gains.
We believe the earnings outlook is strong enough to support solid gains for stocks over the balance of 2019, and we reiterate our year-end fair value range for the S&P 500 of 3000 from our 2019 Outlook publication.
 
IMPORTANT DISCLOSURES
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. Any economic forecasts set forth in the presentation may not develop as predicted.
Investing involves risk including loss of principal. No investment strategy or risk management technique can
guarantee return or eliminate risk in all market environments.
All indexes are unmanaged and cannot be invested into directly. Unmanaged index returns do not reflect fees, expenses, or sales charges. Index performance is not indicative of the performance of any investment.
Because of its narrow focus, specialty sector investing, such as healthcare, financials, or energy, will be subject to greater volatility than investing more broadly across many sectors and companies.
All information is believed to be from reliable sources; however, LPL Financial makes no representation as to its completeness or accuracy.
INDEX DESCRIPTIONS
The Standard & Poor’s 500 Index is a capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major
industries.
The Institute for Supply Management (ISM) Manufacturing Index is an economic indicator derived from monthly surveys of private sector companies, and is intended to show the economic health of the U.S. manufacturing sector. A PMI of more than 50 indicates expansion in the manufacturing sector, a reading below 50 indicates contraction, and a reading of 50 indicates no change.

This research material has been prepared by LPL Financial LLC.
To the extent you are receiving investment advice from a separately registered independent investment advisor, please note that LPL Financial LLC is not an affiliate of and makes no representation with respect to such entity.
Not FDIC or NCUA/NCUSIF Insured | No Bank or Credit Union Guarantee | May Lose Value | Not Guaranteed by Any
Government Agency | Not a Bank/Credit Union Deposit
Tracking #1-821145 (Exp. 02/20)
]]>

That Was the Easy Part | Weekly Market Commentary | February 4, 2019

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KEY TAKEAWAYS

  • Stocks posted their best January in more than 30 years after a historically bad December.
  • Stocks’ bounce was the easy part; the next 10% will likely be much harder.
  • There are technical signs that suggest December marked a major low and potentially higher prices are ahead.

Click here to download a PDF of this report.
2019 is off to a roaring start, as the S&P 500 Index gained 7.9% for its best January since 1987. Stocks’ strong January comes on the heels of the worst December in 87 years. What happens now? This week we will discuss why we see signs that point to higher prices, why the easy gains have likely already occurred, and what several key hurdles lie ahead.
IMPRESSIVE RALLY OFF THE LOWS
Since its low on December 24, 2018, the S&P 500 is up 15% (through 02/01/19) after investors bargain shopped. With the focus now shifting to trade, corporate profits, and clarity on Federal Reserve (Fed) policy, this was the easy part of the bounce; the next 10% will likely be harder.After the worst fourth quarter since the Great Depression, which included a nearly 20% drop leading to December 24 and a 9% drop in December alone, equities were extremely oversold, so a healthy bounce wasn’t a big surprise. Importantly, we’ve recently learned that much of the selling during the second half of December was hedge fund driven. Once the S&P 500 broke the triple bottom support near 2,600–2,625, we saw massive indiscriminate selling, which is often tied to hedge funds. In fact, hedge fund liquidations in December were the largest in any month this cycle, so much of the selling took place during a perfect storm of worry and computer-driven trading.
Can stocks gain another 10% this year and make new highs along the way? We think it’s possible, but it won’t be easy. Trade tensions continue to linger, although we do see the potential for some type of resolution between the United States and China over the coming months. Fourth-quarter corporate profits are once again very solid, albeit at a slower rate of growth than in the third quarter. The Fed announced last week that it would pause interest rate hikes and was open to slowing its balance sheet runoff. (The Fed has been slowly reducing the amount of Treasuries and mortgage-backed securities on its balance sheet following purchases made during the 2007–2009 financial crisis to stabilize the economy.) As we noted last here last week, stocks have tended to hold up well during Fed pauses.
We do think enough of these uncertainties will eventually resolve in a way that markets can discount and lead to higher prices.
W OR V BOTTOM?
The big question is: Will the S&P 500 retest the December 24 lows? History is littered with retests of previous lows, which is affectionately called a “W bottom,” as the shape of the price pattern resembles a W shape. Just look at the last few major corrections: There was a double bottom in August and October 2011, a double bottom in August and September 2015, a double bottom in January and February 2016, and a double bottom in February and April 2018. Recent history would say the December lows will likely be retested sometime soon.
The other type of bottom is a “V bottom,” which doesn’t include a retest and is shaped like the letter V. Here’s the catch: We do see growing evidence that we could be looking at a V type of bottom this time around. As Figure 1 shows, 71% of the components in the S&P 500 recently reached new 4-week highs. This type of extreme strength is very rare and is usually a sign the lows have been made and higher prices are yet to come. In fact, the last time we saw this many of the S&P 500 components make a new 20-day high was in October 2011, showing just how rare this is.

Since 1990, stocks have booked strong 3-, 6-, and 12-month returns after at least 60% of S&P 500 components made a new 4-week high, thus increasing the odds of a V bottom this time around, as shown in Figure 2. In fact, stocks have been higher a year later every single time.

Some other important considerations:

  • Stocks have risen during the third year (pre-election year) of every four-year presidential cycle since 1939.
  • The S&P 500 historically has gained an average of 32% in the 12 months following the midterm-year lows and has been higher every single time since World War II.
  • Stocks gained last Wednesday after the Fed meeting. This was the first time this has happened under Fed Chair Jerome Powell. Is this yet another clue the markets and the Fed are seeing more eye to eye?
  • You can have a bear market without a recession, and historically these bottom near a 20% correction—exactly where the recent correction ended

CONCLUSION
The easy gains are likely over, but we still think the S&P 500 can make its way to new highs before year end. History shows we typically see a W and not a V bottom, but given that the selling in December was likely hedge fund liquidations, coupled with 71% of stocks in the S&P 500 recently hitting 20-day highs (learn more in our Market Signals Podcast), the chances it is a V bottom have significantly increased in our view.
As we discussed in our Outlook 2019, focusing on improving fundamentals will be important throughout the year. We are encouraged by the improving technical backdrop along with steady U.S. economic growth, the ongoing effects of fiscal stimulus, midto-high-single digit earnings gains, and a potential (we think likely) U.S.-China trade agreement—all of which should support solid gains ahead in 2019.
 
IMPORTANT DISCLOSURES
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results.
The economic forecasts set forth in the presentation may not develop as predicted.
Investing involves risks including possible loss of principal. No investment strategy or risk management technique can guarantee return or eliminate risk in all market environments.
All indexes are unmanaged and cannot be invested into directly. Unmanaged index returns do not reflect fees, expenses, or sales charges. Index performance is not indicative of the performance of any investment.
All information is believed to be from reliable sources; however LPL Financial makes no representation as to its completeness or accuracy.
INDEX DESCRIPTIONS
The Standard & Poor’s 500 Index is a capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.
This research material has been prepared by LPL Financial LLC.
To the extent you are receiving investment advice from a separately registered independent investment advisor, please note that LPL Financial LLC is not an affiliate of and makes no representation with respect to such entity.
Not FDIC or NCUA/NCUSIF Insured | No Bank or Credit Union Guarantee | May Lose Value | Not Guaranteed by Any Government Agency | Not a Bank/Credit Union Deposit
Tracking #1-818383 (Exp. 02/20)]]>

Is the Fed Almost Done? | Weekly Market Commentary | January 28, 2019

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KEY TAKEAWAYS

  • We expect the Fed to pause interest rate hikes this week.
  • While the market environment has been challenging, we think recent weakness increases the chances of a positive market response post-tightening cycle.
  • Whether the Fed’s rate hike campaign is already over, or will end fairly soon, history indicates that doesn’t suggest a recession is right around the corner.

Click here to download a PDF of this report.
The Fed will likely pause interest rate hikes at its policy meeting this week. The Federal Reserve (Fed) meets this week, culminating in its rate decision on Wednesday, January 30. We expect the Fed to pause in response to slower global growth, trade tensions, and market volatility, although we believe at least one and possibly two more rate hikes are likely before the end of the cycle. At the same time, we recognize the possibility that the Fed’s December hike may have been its last.
Below, we’ll discuss potential stock market implications if the Fed is done, or nearly done, hiking interest rates. For more of our thoughts on the upcoming Fed meeting, please see this week’s Weekly Economic Commentary.
WILL THE FED PAUSE?
Financial markets and the Fed were at odds through the end of last year. U.S. stocks’ sharp decline during the fourth quarter was driven in large part by the disconnect between the Fed’s and the market’s economic outlooks. Fed Chair Jerome Powell spooked markets in October by communicating that the Fed was a long way from a neutral rate, which the markets interpreted to mean several more hikes were yet to come. However, Powell has since adjusted his narrative. The latest commentary from Powell and other Fed officials has emphasized the central bank’s flexibility, data dependency, and increasing willingness to factor financial market volatility and overseas developments into rate decisions. Just the message the market wanted to hear, and a nod to the growing possibility that the Fed may pause its gradual rate hikes.
The Fed’s shrinking balance sheet has also been of concern to market participants looking for a pause in tightening. Though different from a rate hike, borrowing costs can rise when bonds that the Fed purchased through its quantitative easing program mature and proceeds are not reinvested (referred to as balance sheet runoff or unwind, or quantitative tightening). Here, the change in the Fed’s message, from a balance sheet “normalization” on autopilot to one that is more flexible, has helped market sentiment and increased speculation around the Fed’s short-term policy plans. Friday’s Wall Street Journal report that the Fed was considering slowing its balance sheet runoff and holding more Treasuries for longer was another positive sign for the doves.
Markets have increasingly positioned for a pause. Fed funds futures are now pricing in about a 70% probability that rates remain unchanged throughout 2019. So where does that leave us? While we think another hike this year is likely (possibly two), the Fed’s soft exit from accommodative policy is on the horizon.
HOW MIGHT STOCKS REACT?
The Fed’s current tightening cycle is slightly more than three years old. So how might stocks react to a long-term pause? With the help of research provider Ned Davis Research (NDR), we can see that stocks have generally responded favorably. NDR defined a pause as at least five months between rate hikes within a rate hike cycle. They found that in six such occurrences since 1963, stocks have been up an average of 1% in the three and six months after pauses. The 6% gain in the S&P 500 Index since the Fed’s rate hike on December 19 would be by far the best post-pause performance if the gains hold and the next hike is at least five months away.
Regardless of what the Fed does this week, we recognize the possibility that they may be finished or nearly so, so we looked at what stocks have done around the end of Fed rate hike campaigns. Not surprisingly, we found that stocks tend to react positively [Figure 1]. Looking at the 6 and 12 months following the final hike in the last seven rate hike cycles, the S&P 500 has risen by an average of 9% and 12%.

Stocks have historically fared well in the 12 months leading up to the last hike. However, the S&P 500 fell 4% during the 12 months ending December 19. While the market environment has been challenging, we think recent weakness increases the chances of a positive market response post-tightening cycle. Recent stock gains suggest that investors probably recognized rate hike fears were overdone. Though we don’t think the Fed is done, that scenario is worth considering given the market is pricing it in.
If the Fed’s last hike comes this year, which we see as likely, that doesn’t necessarily mean a U.S. recession is near. Every cycle is different, but over the past 40 years, the average time from the last hike to recession has been nearly three years. In 1984 and 1995, it was over six years. Bottom line, we think recession within the next year or two is unlikely.
CONCLUSION
The Fed will likely pause this week and stocks are likely to respond favorably as a result. Whether the Fed’s rate hike campaign is already over, or will end fairly soon, history indicates that doesn’t suggest a recession is right around the corner.
We are encouraged by the latest stock market rebound off the December 24, 2018, lows and see more solid gains ahead in 2019, driven by steady U.S. economic growth, the ongoing effects of fiscal stimulus, mid-to-high-single digit earnings gains, and a potential (we think likely) U.S.-China trade agreement. Our year end fair value target for the S&P 500 is 3000.
 
IMPORTANT DISCLOSURES
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results.
The economic forecasts set forth in the presentation may not develop as predicted.
Investing involves risks including possible loss of principal. No investment strategy or risk management technique can guarantee return or eliminate risk in all market environments.
All indexes are unmanaged and cannot be invested into directly. Unmanaged index returns do not reflect fees, expenses, or sales charges. Index performance is not indicative of the performance of any investment. All information is believed to be from reliable sources; however LPL Financial makes no representation as to its completeness or accuracy.
INDEX DESCRIPTIONS
The Standard & Poor’s 500 Index is a capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.
This research material has been prepared by LPL Financial LLC.
To the extent you are receiving investment advice from a separately registered independent investment advisor, please note that LPL Financial LLC is not an affiliate of and makes no representation with respect to such entity.
Not FDIC or NCUA/NCUSIF Insured | No Bank or Credit Union Guarantee | May Lose Value | Not Guaranteed by Any Government Agency | Not a Bank/Credit Union Deposit
Tracking #1-816029 (Exp. 01/20)
]]>

Brexit Clouds Linger | Weekly Market Commentary | January 22, 2019

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KEY TAKEAWAYS

  • Following last week’s rejection of Theresa May’s Brexit plan, we discuss what’s next for the United Kingdom and possible market implications.
  • We maintain a cautious tactical view on European equities, given lackluster economic growth, increased political risk, and only fair valuations.
  • A better economic and earnings growth outlook and a possible pause in Federal Reserve rate hikes underpin our preference for emerging market equities.

Click here to download a PDF of this report.
Brexit uncertainty continues to cloud Europe’s economy. On January 15, more than two-thirds of the U.K. Parliament voted against British Prime Minister Theresa May’s European Union (EU) separation deal, another bump in the road for “Brexit.” That outcome had been anticipated, though the wide margin underscored the tough road ahead. Even though May survived a no-confidence vote the next day, the margin was narrow, and the path forward remains unclear.
Here we discuss potential market implications of the United Kingdom’s ongoing effort to leave the EU. We also share our updated views on European equities and reiterate our preference for emerging market (EM) equities over developed international equities.
BREXIT: NOW WHAT?
As we write this, May is negotiating with opposition and coalition parties, and will attempt to strike an amended deal. At this point, we find it difficult to envision a cross-party agreement—a so-called “soft Brexit”—and are skeptical that any deal will be struck by the March 29 deadline. As a result, the odds have increased that the U.K. may end up staying in the European Union, potentially via a second referendum. Our best guess at this point is that a negotiated “soft Brexit” deal eventually may be reached, but it may take beyond March. Still, a second referendum, a hard Brexit (leaving without any deal), or regime change remain on the table.
Should the U.K. go down the hard Brexit path, the U.K. economy would likely slow further as EU trade uncertainty weighs on consumer sentiment and business investment. Over the past year, economic growth expectations for the U.K. have fallen only marginally (Bloomberg consensus is calling for lackluster 1.3% gross domestic product [GDP] growth in 2018), while forecasts for 2019 have held steady at 1.5%. Manufacturing activity has held steady throughout the more than two-year ordeal, in part because of the weakness in the British pound.
Should the U.K. go down the hard Brexit path, the U.K. economy would likely slow further as EU trade uncertainty weighs on consumer sentiment and business investment.
Recent strength in the British currency [Figure 1], which has been sensitive to Brexit headlines, is somewhat reassuring.

The U.K. constitutes only about 2% of the global economy and 4% of world goods trade, so global ramifications of all realistic scenarios are likely to be manageable. Economic forecasting firm Capital Economics thinks a disorderly exit could cause a 1–2% hit to British GDP growth, spread over two years.
BROADER INTERNATIONAL OUTLOOK
Lackluster economic growth, heightened political risk, and—despite weakness—only fair valuations drive our cautious tactical view of European equities. Europe, including the U.K., represents the bulk of the international developed markets, and is wrestling with some of the globe’s biggest policy issues. A tighter regulatory environment, labor laws that restrict business growth, and the rise of populism throughout Europe remain structural concerns.
Beyond Brexit, which has clearly hurt the U.K. stock market [Figure 2], Italy still has a debt and spending problem that will likely flare up again for the world’s third-largest bond market. Even Europe stalwart Germany appears to have narrowly avoided slipping into an economic recession in the fourth quarter (defined as two consecutive quarters of contraction in GDP) and grew only 1% over the past year.

More broadly, in developed international equity markets (including Japan and other major nonEuropean markets), the picture improves some. Still, even with the lift from faster-growing Asian economies, we do not expect GDP growth in international developed economies to reach 2% in 2019, supporting our cautious tactical stance toward developed international markets.
We believe the outlook for EM is better. Economic growth in emerging market economies may approach 5% in 2019, based on Bloomberg’s consensus forecast, while high-single-digit earnings growth is achievable in our view. Other potential catalysts include a likely first-half pause in the Federal Reserve’s rate hike campaign, U.S. dollar weakness, and a U.S.-China trade agreement. In the meantime, China will likely launch more stimulus programs to help stabilize growth. More flare-ups in fiscally challenged EM countries and escalating trade tensions are possible, but we’re comfortable with these risks, particularly given attractive EM valuations.
Please see our Outlook 2019: FUNDAMENTAL: Howto Focus on What Really Matters in the Markets for more details on our global equity views.
CONCLUSION
Brexit uncertainty continues to cloud the growth outlook for the U.K. and has the potential to weigh on consumer sentiment and business investment throughout Europe. We continue to favor U.S. and EM equities over their developed international counterparts for tactical global equity allocations.
Among developed markets, the United States remains the standout in terms of economic and earnings growth, while we continue to see solid upside potential in EM.
 
IMPORTANT DISCLOSURES
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results.
The economic forecasts set forth in the presentation may not develop as predicted and there can be no guarantee that strategies promoted will be successful.
Investing in stock includes numerous specific risks including: the fluctuation of dividend, loss of principal, and potential liquidity of the investment in a falling market.
Investing in foreign securities involves special additional risks. These risks include, but are not limited to, currency risk, political risk, and risk associated with varying accounting standards. Investing in emerging markets may accentuate these risks.
All investing involves risk including loss of principal.
DEFINITIONS
Gross domestic product (GDP) is the monetary value of all the finished goods and services produced within a country’s borders in a specific time period, though GDP is usually calculated on an annual basis. It includes all of private and public consumption, government outlays, investments, and exports less imports that occur within a defined territory.
INDEX DESCRIPTIONS
The MSCI Emerging Markets Index is a free float-adjusted market capitalization index that is designed to measure equity market performance of emerging markets.
The MSCI Emerging Markets Index consists of the following 21 emerging market country indices: Brazil, Chile, China, Colombia, Czech Republic, Egypt, Hungary, India, Indonesia, Korea, Malaysia, Mexico, Morocco, Peru, Philippines, Poland, Russia, South Africa, Taiwan, Thailand, and Turkey.
The MSCI All Country World Index is an unmanaged, free float-adjusted, market capitalization-weighted index composed of stocks of companies located in countries throughout the world. It is designed to measure equity market performance in global developed and emerging markets. The index includes reinvestment of dividends, net of foreign withholding taxes.
The MSCI EAFE Index is made up of approximately 1,045 equity securities issued by companies located in 19 countries and listed on the stock exchanges of Europe, Australia, and the Far East. All values are expressed in U.S. dollars. Past performance is no guarantee of future results.
This research material has been prepared by LPL Financial LLC.
To the extent you are receiving investment advice from a separately registered independent investment advisor, please note that LPL Financial LLC is not an affiliate of and makes no representation with respect to such entity.
Not FDIC or NCUA/NCUSIF Insured | No Bank or Credit Union Guarantee | May Lose Value | Not Guaranteed by Any Government Agency | Not a Bank/Credit Union Deposit
Tracking #1-814053 (Exp. 01/20)
]]>

Fourth Quarter Earnings Preview: From Great to Good | Weekly Market Commentary | January 14, 2019

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KEY TAKEAWAYS

  • S&P 500 earnings growth will slow in the fourth quarter but is still expected to be strong.
  • U.S. economic growth, tax cuts, higher oil prices, and corporate stock buybacks are among the positive drivers.
  • However, earnings may be capped by trade tensions, slower economic growth abroad, and a rising U.S. dollar.

Click here to download a PDF of this report.
Fourth quarter earnings reporting begins this week. Over the next five days (January 14–18), 35 companies in the S&P 500 Index will report quarterly results, highlighted by several big banks. Here we preview fourth quarter earnings, discuss several key drivers, and share some thoughts on the outlook for 2019. We expect a mid-to-high teens increase in earnings for the quarter, driven primarily by the solid economic backdrop.
THE NUMBERS
Consensus estimates from Thomson Reuters are for a 14.5% year-over-year increase in S&P 500 earnings for the quarter, which is slower than the 25% pace of the past three quarters, but still quite strong [Figure 1 . Should results come in ahead of expectations, as we anticipate, it would mark the 39th consecutive quarter that earnings have exceeded estimates. We believe the reduction in fourth quarter estimates has lowered the bar enough that corporate America will clear it, as it typically does. Although several high-profile companies, including Apple, have warned about weaker results, overall preannouncements have been consistent with recent trends. Profit margin trends remain positive [Figure 2].


THE DRIVERS
We see several positive drivers for earnings this quarter:
U.S. economic growth. U.S. economic activity should support further, though slower, earnings growth in the fourth quarter. U.S. gross domestic product (GDP) rose more than 3% year over year in the quarter, and 5% including inflation, based on Bloomberg consensus forecasts. Manufacturing activity, which is important because it is tied to earnings, remains quite healthy—the Institute for Supply Management (ISM) Manufacturing Purchasing Managers’ Index (PMI) remains firmly in expansion territory at 54.1, despite a large drop in December (over 50 is considered expansionary). Consumer spending is on a solid trajectory, supported by steady job growth and rising wages. Impact: Positive
Tax cuts. S&P 500 profits will get another strong (perhaps 7–8%) boost from corporate tax cuts in the fourth quarter. Consumer spending may also get a boost from individual tax cuts. Impact: Positive
Higher oil prices. Though oil fell sharply late last year into the low $40s, West Texas Intermediate (WTI) crude still averaged $59–60 per barrel during the fourth quarter, 8% above the year-ago average. Those gains along with firming natural gas prices in November and December will help energy sector earnings grow 60% year over year, based on Thomson Reuters estimates. Impact: Slight Positive
Share buybacks. Stock buybacks (companies repurchasing their own shares) are expected to boost S&P 500 earnings per share by about 2% by reducing the number of shares in the earnings per-share calculation. Low interest rates and repatriation of overseas profits at lower tax rates help. Impact: Positive
At the same time, several factors may cap the fourth quarter earnings gain:
Trade tensions, slower growth in China. Clearly, tariffs are impacting corporate profits. The uncertainty has weighed on business confidence, dampening “animal spirits,” while economic growth in China was already slowing. Apple’s revenue warning brought this risk to the forefront of investors’ minds earlier this month. Impact: Negative
Slower growth in Europe. Europe’s growth outlook has weakened considerably over the past nine months, which may hurt demand for U.S. goods and services sold abroad. Consensus forecasts for GDP growth in 2018 and 2019 have been reduced by about one half of a percentage point during that time (source: Bloomberg). Impact: Negative
Currency. The U.S. dollar rose 3% during the fourth quarter of 2018 compared with the year-ago quarter, presenting a slight drag on overseas earnings for U.S. multinationals. Impact: Slight Negative
THE OUTLOOK
After the big tax reform boost at the start of 2018, which propelled S&P 500 earnings to a stellar 20%- plus increase for the year, earnings growth will slow in 2019. Still, we expect support from the following:

  • Solid U.S. economic growth. Our forecast is calling for U.S. GDP growth of 2.5-2.75% in 2019, supported by consumer spending, business investment, and government spending.
  • Fiscal stimulus. Even though the tax reform boost will be smaller, tax cuts and increased government spending still add incremental economic growth in 2019 relative to 2018. Manufacturing activity will likely remain healthy amid existing policy incentives.
  • Slightly higher and manageable inflation. Some inflation is good for corporations by providing pricing power.
  • More buybacks. Corporate balance sheets remain quite healthy and borrowing costs are low, supporting another year of robust share buyback activity.

Primary risks include: 1) tariffs and trade, which add risk to the economic picture in the U.S. and China; 2) a more pronounced slowdown in Europe; 3) higher wages, which could weigh on companies’ profit margins; and 4) a possible surging U.S. dollar.
CONCLUSION
We believe a mid-to-high-teens increase in earnings for the fourth quarter is achievable, supported by a solid U.S. economic backdrop, tax cuts, strong energy sector profit gains, and share buybacks. Recent cuts to estimates likely already factor in the drags from tariffs and slower overseas growth during the quarter.
Looking ahead, we believe a mid-to-high single digit increase in S&P 500 earnings in 2019 is achievable, based on slower but still solid U.S. economic growth and fiscal policy support, alongside manageable inflation and continuing share buybacks. Though earnings growth is slowing, our forecast is near long-term averages. While the peak earnings growth rate for this bull market may be behind us (it almost certainly came in the third quarter of 2018), growth peaks have historically been followed by several years of economic growth and stock market gains.
We believe the earnings outlook is strong enough to support solid potential gains for stocks over the coming year. We forecast a year-end fair value range for the S&P 500 of 3000, as cited in our Outlook2019 publication, representing a solid double-digit return for 2019. That target is derived from a priceto-earnings multiple of 17.5 and our 2019 S&P 500 earnings forecast of $172.50 per share.
 
IMPORTANT DISCLOSURES
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results.
The economic forecasts set forth in the presentation may not develop as predicted and there can be no guarantee that strategies promoted will be successful.
Investing involves risks including possible loss of principal. No investment strategy or risk management technique can guarantee return or eliminate risk in all market environments.
All indexes are unmanaged and cannot be invested into directly. Unmanaged index returns do not reflect fees, expenses, or sales charges. Index performance is not indicative of the performance of any investment.
All company names noted herein are for educational purposes only and not an indication of trading intent or a solicitation of their products or services. LPL Financial doesn’t provide research on individual equities.
INDEX DESCRIPTIONS
The Standard & Poor’s 500 Index is a capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.
The Institute for Supply Management (ISM) Manufacturing Index is an economic indicator derived from monthly surveys of private sector companies, and is intended to show the economic health of the U.S. manufacturing sector. A PMI of more than 50 indicates expansion in the manufacturing sector, a reading below 50 indicates contraction, and a reading of 50 indicates no change.

This research material has been prepared by LPL Financial LLC.
To the extent you are receiving investment advice from a separately registered independent investment advisor, please note that LPL Financial LLC is not an affiliate of and makes no representation with respect to such entity.
Not FDIC or NCUA/NCUSIF Insured | No Bank or Credit Union Guarantee | May Lose Value | Not Guaranteed by Any Government Agency | Not a Bank/Credit Union Deposit
Tracking #1-811412 (Exp. 01/20)
]]>