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U.S. equities hit record highs in light pre-holiday trading


November 22, 2017

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Quote of the week

“You say you want a real solution/Well, you know/We’d all love to see the plan.”– from The Beatles’ “White Album,” released November 22, 1968

The Lead Story: Equity investors celebrate even before they sample the stuffing

As the Thanksgiving holiday approached, U.S. equities climbed in light trading. Buoyed by technology stocks, the S&P 500 Index notched a fresh record high on November 21 before treading water the following day. Year to date, the index has returned a stellar 18.2%. Europe’s STOXX 600 Index retreated on November 22 after posting back-to-back gains.

While this environment has been friendly to shareholders, it’s been less kind to U.S. companies that have failed to meet earnings expectations. According to Factset, S&P 500 companies that reported below-forecast third-quarter earnings saw their shares fall an average of 3.5% in the two days before and two days after releasing earnings reports. That’s harsher than the 2.4% penalty that companies have endured over the past five years for missing forecasts. On the other hand, companies that topped forecasts received barely any boost at all. Their reward, in many cases, has been simply maintaining a higher-than-normal valuation.

Brian Nick - 140px

Brian Nick, Chief Investment Strategist, TIAA Investments

Article Highlights

Because global economic fundamentals seem likely to strengthen further in 2018, earnings expectations continue to rise. In fact, analysts are still making positive revisions to both their fourth-quarter 2017 and full-year 2018 corporate earnings outlooks. This has allowed stocks to glide higher without rising significantly from their historically elevated levels—the S&P 500’s 12-month forward price-to-earnings ratio has remained between 17.5x-18.0x since March 1.

We expect earnings to grow 8%-10% in 2018, which should support equity markets in the near to medium term. This assumes, of course, that investors remain willing to pay some of the highest prices for those earnings since the early 2000s. With yields on cash and fixed income still low, demand for owning equities is not likely to fade anytime soon.

In other news: With December fully baked, March goes into the oven

While equities headed higher during the week, the yield curve continued to flatten. This trend has been driven by stable longer-term Treasury yields combined with sharply higher short-term rates. To illustrate, the yield on the bellwether 10-year note has barely budged since closing at 2.31% on September 27. Meanwhile, the yield on the 2-year security has surged 50 basis points (0.50%) since September 7, to a nine-year high of 1.77% on November 21. This jump reflects improving U.S. economic data, the rising likelihood of government stimulus through tax cuts, and a Fed that’s poised to tighten.

Markets are fully expecting the Fed to raise rates when it meets on December 12-13. Additionally, the odds that the Fed will tighten in March 2018 under newly minted Fed Chair Jay Powell have risen from under 5% on September 7 to over 55% on November 21. It’s possible that the “median dot” in the Fed’s forecasts—where the Fed expects interest rates to be at various points in the future—could reflect as many as four 25 basis-point rate increases in 2018, up from three such moves in September’s forecast.

A March hike could be at least partly contingent upon the passage of tax reform, particularly if the final bill seems likely to expand the federal budget deficit in the near term. Introducing fiscal stimulus into an economy that appears close to full employment would likely produce a modest but significant bounce in GDP growth, but at the risk of higher inflation. This would undoubtedly get the Fed’s attention as it looks for any sign that the risks to the economy have shifted from low growth to high inflation. Stimulating the economy could also produce a sustained rise in longer-term U.S. interest rates, which we’ve been expecting since 2009 but have seen little evidence of except for some brief periods in 2013 and 2016.

Below the fold: A mixed week for U.S. economic data

Both housing data and leading economic indicators improved in October as effects from the late-summer hurricanes receded. Among the reports:

  • Existing home sales topped forecasts by rising 2%. However, sales are still 0.9% below their year-ago levels because low inventory is pushing prices higher, keeping would-be buyers on the sidelines.
  • The Conference Board’s index of leading economic indicators (LEI) increased sharply. The LEI’s strengthening suggests that the U.S. economy’s solid growth will continue through the holiday season and into 2018.
  • Orders for durable goods (e.g., aircraft, machinery, computer equipment, and other big-ticket items) declined 1.2% in October after three straight months of hefty gains. Core capital goods, a key measure of business investment, fell 0.5% last month but were still 8.1% higher over the past 12 months.
  • Consumer sentiment dipped slightly from October’s 13-year high, according to November’s final reading of the University of Michigan’s index.

The Back Page: “Please pass the cranberry sauce. No, not that cranberry sauce.”

In the classic Marx Brothers film, “Animal Crackers,” Groucho Marx said, “If you take cranberries and stew them like apple sauce, it tastes much more like prunes than rhubarb does.” Groucho made that wisecrack 11 years before a cooperative of growers that would become Ocean Spray started offering the gelatinous version from a can in 1941. Across the U.S., cranberry sauce has become a holiday staple, with over five million cans consumed each Thanksgiving.

Ocean Spray can thank my grandmother for purchasing approximately 150 of those cans over the many Thanksgiving dinners she hosted. Instead of serving simple mixed greens, though, her favorite side dish was a layered “salad” composed of one folded leaf of iceberg lettuce, a slice of canned pineapple, and a thick slice of canned cranberry sauce. For that dish, I was always a little less than thankful.

The 26% of Americans who make their own sauce know it’s delicious, more nutritious, and easy to prepare. For those who don’t and are looking for a simple “go-to" recipe, try this:

  • Gently mix two pounds of washed cranberries, ¼ cup of water, 11/2 cups of sugar, and 1/2 cup of white wine in a 2-quart saucepan
  • Simmer until the berries begin to pop
  • Reduce the heat and simmer for five more minutes
  • Pour the sauce into a bowl and chill until set
Have a wonderful Thanksgiving.

The next Weekly Market Update will be published on Friday, December 1.