Eventful Week, But US Equities Add to Month’s Gains – Week Ended 7/27/18

In many respects, it is hard to recall a week in recent memory as eventful or bifurcated as the one just completed.  For all the noteworthy data points, earnings releases, and developments, performance at broad index-level was perceptibly average.  The Dow and S&P logged gains of roughly +0.5% each, but beneath the surface, performance among sectors and individual stocks was extraordinarily diverse.  The technology sector for example was negatively impacted by the pummeling of heavyweights such as Facebook and Twitter following release of those companies’ respective quarterly earnings and can be blamed for the tech-heavy Nasdaq concluding the week down -1.1%.  At the same time, the more tangible and traditional economy enjoyed a positive bump with the headline that the US and key international trading partners in Europe reached verbal agreements in principal to back away from tariffs and restrictive trade policies in what is one of the most globally integrated industries of automobile manufacture.  Amid all the trade-war talk, might it be that when all is said and done we actually end up “free-er” trade than before any of the hostile rhetoric began 6 months ago?  That is one non-consensus perspective that is beginning to gain some traction following the positive surprise last week.

In deeper review of the notable developments last week, the most anticipated point was the initial estimate of 2Q GDP growth.  US real (after effects of inflation are subtracted) GDP grew at a +4.1% annualized pace.  For as good as that number is, it came in slightly below consensus expectations.  However, nominal GDP (the raw pace of growth including effects of inflation) was up more than 7% annualized.  Taken together, there are important implications: first, nominal GDP is growing at a pace that is historically encouraging to business owners and stimulates confidence (and more spending/investment); second, however is that there is inflation of roughly 3% suggesting the Federal reserve is more than justified in their pursuit of additional interest rate increases.  For those who are most concerned about the flattening yield curve the notion that the Fed has no reason to hold off on additional hikes for now is unwelcome news.  But, the stronger inflation reading also had the effect of actually provoking the long-end of the yield curve higher, and as a result caused the yield curve to modestly steepen for a change last week.  That said, it would appear that rising interest rates and/or other factors are slowing housing-related activity.  New home sales were weaker than anticipated last week, as were mortgage applications and home price appreciation.  These sluggish housing sector readings are creating concern for some when considering that housing drives roughly 15% of the US economy.  Beyond these macro-economic considerations, it was also the biggest week for corporate earnings releases with 40% of the S&P500 reporting.  So far 263 of the 500 S&P constituents are reported; 81% are beating the street’s estimates on earnings and 72% on revenues.  Those are impressive metrics considering how long is the current cycle – clearly Wall Street still under-appreciates the effects of the recent tax-reform passed into law at the end of 2017.  More interesting and lesser expected however is that those companies deriving a more significant portion of their sales internationally are the ones logging the best revenue growth; this is a sharp contrast to what many might expect given all the negative trade-related headlines.

Putting it all together, the fundamental backdrop supports the idea we are headed for the longest US economic expansion on record.  And the encouraging development between the US and European economic leaders last week provides hope that all the negative trade and tariff rhetoric might still carry the potential to be a positive for not just the US but trading partners around the globe.  And China is again pressing their foot to the gas in pursuit of local economic stimulus.  These two developments may give the synchronized global growth story new life after an 8 month hiatus.  At the same time however, last week serves as an important lesson that even seemingly “perfect” investments like the FAANG stocks are not without risk, nor are they immune to disappointment.  Facebook reported strong earnings, but indicated in its forward-looking guidance that it believes its growth trajectory will slow – that sent the stock down 19% on the day following the announcement and resulted in what is being reported as the single-biggest daily loss of market value for a publicly traded stock… ever.  More broadly however, examples like these reveal a particularly strong case in which active investment can add value vs. passive, market-cap weighted, own-everything strategies at this stage of the cycle.

Posted in Blog Post.