C.J. Lawrence Weekly – The Stumble-Prone Equity Market Remains on Solid Footing
2017’s prize-fighter equity market now looks like it may have a glass jaw. In 2017, the S&P 500 posted a positive return in each month of the year, and shrugged off negative news at nearly every turn. But already in 2018, the market has experienced two 6+% corrections. Events that would have slid off the market’s teflon coating last year are now sticking and causing stumbles. A myriad of issues cropped up last week sending the S&P 500 index down almost 6%. As of Friday, the Index is in negative territory for the year, down 2.8%. The abdication of leadership from the Technology sector worries market participants who have relied on the sector as an important prop for the broader market. Episodes like index heavyweight Facebook’s fall from grace are disruptive. But in previous markets, that disruption might have been off-set by strong performance by new leaders. In last week’s action the leadership void was left empty.
A much hoped-for rally in financial shares did not materialize, as the 2-to-10-year treasury bond yield spread tightened to its lowest level since January. As a result, bank profitability was questioned and investors sold shares of financial stocks. As a result, the Financials Sector Index was the second worst performing sector in the S&P 500 last week, down 7.2%. But interestingly, the market’s correction, and crisis of confidence, comes at a time when corporate earnings forecasts are climbing, and the underlying economic data is trending positive. At the beginning of 2018, bottoms-up forecasts for current year S&P 500 Index earnings per share were $146. That figure now stands at $157, an 8% increase. At the same time, the multiple on those earnings has fallen from 18.3x to 16.5x 2018 estimates, all while forecasted returns on equity (ROE) and EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) margins reach 20-year highs.
Underneath the market, global and domestic economic growth remains supportive, and domestic manufacturing is improving. Global trade activity warrants increased attention as trade barbs are exchanged between the world’s largest economies. But to date, most trade metrics look steady. The Baltic Freight Index, which acts as a good measure of demand for bulk commodities, is down for the year but is off its February lows. Domestically, freight shipments have been a mixed bag, but skew positive in the areas of chemicals, petroleum, and petroleum products. According to the American Association of Railroads, shipments of chemicals are up 2.7% year-to-date, versus last year, and petroleum and petroleum products shipments are up 4.8%. Conversely, shipments of autos and grain are lower on a year-to-date basis. Total intermodal loads (container shipments that are often used in import/export) are up a meaningful 6.2% from year ago levels. Data from the American Trucking Association (ATA) confirms positive domestic freight shipping trends. The ATA’s truck tonnage index dipped in February, versus January, but is up 7.1% year-to-date over last year’s level. Thus, our outlook for the stock market remains constructive, based on improving economic and equity market fundamentals, but recognizes that the market is prone to stumbles. For long-term investors willing to wade into the market’s volatile waters, the risk-reward ratio remains favorable.
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