▪ Third-quarter earnings started strong. Should this persist, it may mark the end of the earnings recession.
▪ It looks likely that Hillary Clinton will win the presidency while the House remains in GOP hands.
▪ Equity markets face near-term pressures, but the economic and earnings environment should provide tailwinds.
U.S. equities moved slightly higher last week, with the S&P 500 Index climbing 0.4%.1 Corporate earnings results were solid, while data showed economic stabilization in China. Investors also reacted positively to high-profile mergerand-acquisition news. For the week, the materials, financials, consumer discretionary and technology sectors advanced while telecommunications, industrials and consumer staples lagged.1
Weekly Top Themes
1. Third quarter earnings results have been surprisingly strong. With more than 25% of S&P 500 companies reporting, earnings are beating expectations by 7% and revenues by 1%.2 Should these patterns hold, it will mark the end of the earnings recession largely caused by the rising dollar/falling oil trends.
2. Investors appear overly complacent about inflation. Economic growth is accelerating modestly, major central banks are becoming less accommodative and government spending is rising. These trends suggest we should see an uptick in inflation. A continued increase could put more pressure on the Federal Reserve and act as a headwind for bonds and equity valuations.
3. Defensive, yield-oriented equity sectors appear unattractive. Sectors such as utilities and telecommunications sharply underperformed in the third quarter as bond yields started to rise.1 We think these sort of bond-market proxies continue to look expensive and expect a continued shift toward economically sensitive cyclical sectors.
4. Infrastructure spending will likely increase in 2017. It appears increasingly likely that Hillary Clinton will be elected president, and we think she will soon focus on a fiscal stimulus plan that emphasizes infrastructure. Republicans in Congress may support this effort, especially if it is packaged with corporate tax reform centered on repatriated earnings.
5. Rising bond yields may limit prospects for a year-end equity rally. We do not expect a notable drop in prices over the next couple of months, but we believe any significant upside might be limited. Interest Rates and Bond Yields May Advance Modestly The presidential debates are over and election season is hitting the home stretch. Barring a massive shock, we think Hillary Clinton will likely be elected president, while the House remains in Republican hands. The Senate appears up for grabs. This environment would represent a more-or-less continuation of the status quo. Such a political backdrop would likely allow the economy to maintain momentum and the Fed to slowly raise rates. In the financial markets, this would represent a modest headwind for bonds and a tailwind for the U.S. dollar. If the Democratic party’s momentum accelerates and results in a complete change of control over Congress, this could raise uncertainty and create a more difficult environment for the economy and markets.