Market Recap

Posted on July 27, 2018 by Gemmer Asset

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Corporate Earnings – A Solid Foundation


If you are a Facebook investor, it was a tough week. The stock opened Thursday morning 20% lower than where it closed on Wednesday. As part of its second quarter earnings report it predicted slower growth in future quarters.



For all the wailing, we shouldn’t lose sight of the fact that the shares had been on a tear going into this week. Before the earnings release the stock was up over 23%. Thursday’s decline basically erased all the gains for the year.


All very entertaining, but we shouldn’t extrapolate Facebook’s woes. The broad earnings picture is actually solid based on second quarter earnings reports so far. As you can see below, only about a quarter of the S&P has reported earnings so far, but the results are good.



Key points:


  • At 93%, the proportion of S&P 500 companies beating earnings estimates is the highest since records started in 1993 (see below).



  • Earnings per share growth of 24% is 5 points higher than expected just a couple weeks ago.


  • 74% of firms are also beating sales growth estimates. This is the highest rate since 2009 by a wide margin.


  • What is also encouraging is that earnings guidance for the rest of the year is increasing. About 55% of reporting firms have increased estimates for the rest of 2018. While not a record, still a solid trend.



All of this means the S&P is on track to earn roughly $160 this year and possibly $175 next year. This would mean earnings growth as follows


– 2018 estimated earnings growth = +28.5%


– 2019 estimates earnings growth = +9.4%


Could we be at peak growth this quarter? That’s quite possible, but the combination of robust growth and positive surprises goes a long way towards explaining how the market can grind higher in the face of some notable headwinds such as trade (see below) or a softening in the housing market (see our blog post ).


Might the Trade War Talk be Topping Out?


Trade policy at the moment seems to be working at cross purposes. Take the three following examples:


Washing Machines


The administration slapped tariffs on imported washing machines back in January 2018 to support domestic manufacturers such as Whirlpool. Despite this, Whirlpool’s stock is off -26% this year (-33% from its high) because the company is struggling with higher input cost thanks to the steel and aluminum tariffs. The stock fell as much as 14% on Tuesday alone after a weak earnings report. This was the biggest drop in almost 10 years.





So we slap tariffs on things like imported washing machines, steel, and aluminum, but our trade partners retaliate with tariffs on our exports of motorbikes and farm commodities. Soybean prices, for example, have fallen over -16% this year as they have been specifically targeted for retaliation.



Needless to say, this is tough on business if you grow soybeans for a living. So to try and ease the pain the administration has floated the idea of spending $12 billion to support farmers hit by retaliatory tariffs. Of course, the retaliatory tariffs are only in place because we fired a salvo against Chinese and European imports. Ummm, ok.


Car Manufacturers


Finally, take the domestic automakers. All three big U.S. manufacturers issued downward earnings revisions on Wednesday. Each highlighted a problem with rising commodity costs that stem in large part from the steel and aluminum tariffs. The chart below shows the costs of higher inputs dwarfs whatever tax savings the big three hoped for from the recent tax cuts.



Is an auto bailout part 2 next? Of course, the administration has talked about levying tariffs on all imported European cars to protect domestic manufacturers.


Not So Fast


On Wednesday the rhetoric took a more, shall we say, rational, turn. The White House and European Commission President Jean-Claude Juncker struck a much more conciliatory tone after their meeting on possible auto tariffs. There was even talk about eliminating all tariffs between the two trading blocs.


Not to rain on anyone’s parade, but we probably shouldn’t get too far ahead of ourselves. Comments from Greg Valliere neatly summarize the hurdles facing policy makers and investors after Wednesday’s meeting:


“FIRST, U.S. TARIFFS ON STEEL AND ALUMINUM are still in place; yesterday’s statement did not lift the tariffs – it just pledged not to expand them.


SECOND, THE COMMERCE DEPARTMENT IS STILL INVESTIGATING a dubious threat to U.S. security because of auto imports – and the prospect of new U.S. tariffs on European cars has not been eliminated.


THIRD, A KEY FEATURE OF YESTERDAY’S STATEMENT is a pledge by Europe to purchase vastly more liquefied natural gas, which will take years to actually implement – all while Western Europe enjoys an LNG supply glut.


FOURTH, YESTERDAY’S VOWS TO WORK TOWARD ZERO TARIFFS AND SUBSIDIES seemingly ignore huge divisions within the European Union. Let’s see how French farmers will react to the prospect of no tariffs or subsidies.


FIFTH, TRUMP HAS SHIFTED REPEATEDLY ON TRADE, first imposing steel and aluminum tariffs on European countries, then exempting them, then imposing them. As a skeptical piece in the Washington Post points out, there have been similar reversals with China and Canada, with all U.S. trading partners unsure what Washington really wants.


SIXTH, AS WE’VE SEEN WITH NAFTA, trade talks are incredibly complicated, and require months and months of negotiations. Yesterday’s “deal” will now lead to extensive negotiations, which could be scuttled by Trump or the Europeans.


THE MOST ENCOURAGING SIGNAL YESTERDAY was an apparent willingness by Trump to listen to congressional Republicans.”


Will the Fed Point Towards a December Hike?


Finally, the Fed meets again next Tuesday and Wednesday to talk about monetary policy. The broad-based expectation is they don’t move rates next week but will set the stage for a rate hike on September 26th.


The other thing analysts will be watching is the tone of the statement and what it might mean for a December rate hike. At the moment, the market is placing the odds of a December hike at 55%, as you can see below.



However, a statement that stresses the solid U.S. growth data and low unemployment should bump these odds up materially.


We think it is a decent bet that the market will start to fully price in a December hike over the next couple months.


Have a good weekend.





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