The S&P 500 continued its steady advance higher over the past week, as 3Q earnings season kicked off and tax policy remains at the forefront of the Congressional agenda. The Senate is expected to vote on the budget today, which will let the House begin the budget reconciliation process (and start the discussion on tax changes).
On the earnings front, 15% of the S&P 500 have reported 3Q earnings thus far. As is common, S&P 500 earnings estimates were revised lower into the quarter (-3% over the past two months), only for actual earnings to come in better than expected. For example, reported earnings growth so far has been 8.44% vs expectations of 2.2% growth. Reported sales growth for the companies that have reported so far has been 6.51%, bringing up aggregate expected S&P 500 sales growth for the quarter to 4.85%.
Technical: Over the past two weeks, the S&P 500 has traded within a very narrow 25 point range. Large Cap Growth is the only S&P style that has gained relative performance during this period. We believe that this was due to positioning ahead of 3Q earnings reports, as Technology (largest weighting within Growth) was the only sector with positive estimate revisions heading into the quarter. Also, small cap relative performance has consolidated following its sharp performance previously. If tax cuts come to fruition, small caps will have an outsized benefit (relative to large caps) due to their greater leverage to the domestic economy, higher percentage of U.S. sales, and higher effective tax rates on average. As such, the recent consolidation could be an attractive buying opportunity.
The S&P 500 is pausing near various technical price targets in the mid-2560s, and we would not be surprised to see the market pull back in the near term. With plenty of support levels nearby, we believe downside is likely limited. Initial levels of support include 2540, 2508, and 2495.
In sum: Investors remain focused on earnings and the potential for fiscal stimulus (i.e., tax cuts). Both their paths will continue to have a significant influence on equity markets moving forward. As long as the pillars of this market remain in place (a healthy global economy, earnings growth, low interest rates, and fairly loose monetary policy around the world), pullbacks should be normal in nature; and we would use them as buying opportunities.
Core inflation grew less than expected, remaining at 1.7% y/y, in September. The odds of another Fed rate hike in 2017 ticked slightly lower on the report but have since rebounded to ~80% currently. Wage pressures have risen recently, and there will be many more inflationary readings by the December 13th FOMC meeting. Also, September retail sales bounced back from August’s hurricane-affected data, with headline sales growing 1.7% m/m and control sales growing 0.5% m/m. Furthermore, housing data continues to soften (housing starts and building permits down over 4% in September- probably some hurricane effects), and survey data remains strong (empire manufacturing and U of Michigan sentiment both sharply higher). Overseas, China released 3Q GDP in line with estimates at 6.8% y/y, but slightly below the 6.9% growth in the second quarter. China’s retail sales and industrial production both rose above expectations, up 10.3% and 6.6% (from 10.1% and 6.0%) respectively. PBOC Governor Zhou Xiaochuan spooked markets a little when he commented on China’s high corporate debt levels and growing household debt. This has been a concern for years, and will continue to be monitored by investors. Overall, domestic and global economic activity remain supportive of equity markets.
Economic data reported in the past week (actual vs estimate):
CPI m/m (Sep): 0.5% vs 0.6%, 0.4% prior
CPI Ex Food and Energy m/m (Sep): 0.1% vs 0.2%, 0.2% prior
CPI y/y (Sep): 2.2% vs 2.3%, 1.9% prior
CPI Ex Food and Energy y/y (Sep): 1.7% vs 1.8%, 1.7% prior
Retail Sales Advance m/m (Sep): 1.6% vs 1.7%, -0.1% prior
Retail Sales ex Auto m/m (Sep): 1.0% vs 0.9%, 0.5% prior
Retail Sales ex Auto and Gas (Sep): 0.5% vs 0.4%, 0.0% prior
U of Michigan Sentiment (Oct P): 101.1 vs 95.0, 95.1 prior
Business Inventories (Aug): 0.7% vs 0.7%, 0.3% prior
Empire Manufacturing (Oct): 30.2 vs 20.4, 24.4 prior
Import Price Index m/m (Sep): 0.7% vs 0.6%, 0.6% prior
Industrial Production m/m (Sep): 0.3% vs 0.3%, -0.7% prior
NAHB Housing Market Index (Oct): 68 vs 64, 64 prior
Housing Starts (Sep): 1127k vs 1175k, 1183k prior
Housing Starts m/m (Sep): -4.7% vs -0.4%, -0.2% prior
Building Permits (Sep): 1215k vs 1245k, 1272k prior
Building Permits m/m (Sep): -4.5% vs -2.1%, 3.4% prior
Initial Jobless Claims (Week): 222k vs 240k, 244k prior
Philly Fed Business Outlook (Oct): 27.9 vs 22.0, 23.8 prior
Leading Index (Sep): -0.2% vs 0.1%, 0.4% prior
GDP y/y (3Q): 6.8% vs 6.8%, 6.9% prior
Retail Sales y/y (Sep): 10.3% vs 10.2%, 10.1% prior
Industrial Production y/y (Sep): 6.6% vs 6.5%, 6.0% prior
Source: Bloomberg, FactSet, RJ Equity Portfolio & Technical Strategy
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