Mike Gibbs, Managing Director of Equity Portfolio & Technical Strategy, discusses fourth quarter earnings and the early February pullback.

February 27, 2018
 Over the past month, volatility returned to the equity markets. The S&P 500 experienced an 11.8% correction from its closing high on January 26 to its intraday low ten days later on February 9. This sharp pullback was the first one of its magnitude in roughly two years, making it feel much worse to investors that had grown accustomed to the exceptionally low volatility experienced throughout 2017. As a reminder, since 1980, the S&P 500 has experienced a pullback of -14.9% on average each year. Additionally, ~25% of days since 1980 have had an intraday move of at least 1% (in either direction). We believe that volatility is likely to return to more normal levels this year.

Following the correction, the S&P 500 has been able to rally back to its 50 Displaced Moving Average (up 7.6% from the low and back to positive territory on the year). We view this as a healthy beginning to the rebuilding phase. It is very common following sharp selloffs for the market to be choppy in the short term, as technical resistance and support levels are tested (and retested), and consolidation occurs to build a base for renewed upside.

The volatility was sparked by a couple of economic reports showing “hotter” than expected wage growth and inflationary pressures. The U.S. 10-year Treasury yield rose to a high of 2.94% (2.88% currently) from 2.43% at the end of 2017, and investors became concerned over the potential pace of wage growth, its impact on inflation and interest rates, and in turn its influence on future monetary policy. The concern is that rising inflationary pressures could cause the Federal Reserve to tighten too quickly, and potentially upset economic conditions. Inflation and interest rates remain low, but as they rear their head up over the course of the year, volatility could ensue. However, given the strong economic and earnings backdrop, pullbacks should be normal in nature and viewed opportunistically.

According to FactSet, 4Q17 earnings season was very strong (90% of S&P 500 companies have reported thus far) as earnings grew 14.9% on sales growth of 8.2%. This takes full year 2017 earnings growth up to 10.8% on sales growth of 6.3% – the strongest levels since 2011. Additionally, estimates have been revised sharply higher for 2018. Earnings for the first, second, third and fourth quarters and for 2018 as a whole now reflect estimated growth of 17.4%, 19.2%, 21.1%, 16.1%, and 18.2% respectively. Full year 2018 earnings growth has been upwardly revised by 7.9% since the start of the year, with the strongest upward revisions coming from Energy, Telecom, Financials, Industrials, and Consumer Discretionary. Furthermore, the strongest earnings growth is expected from Energy, Financials, Materials, Industrials and Technology.

Through the volatility, Technology outperformed, Financials and Consumer Discretionary held up very well, and the interest-rate sensitive sectors (Utilities, Telecom, Real Estate, and Consumer Staples) continued their poor relative strength trends. Energy also continued to be the worst-performing cyclical sector and broke to new relative strength lows despite crude oil prices back to $63/barrel currently.

Sources: FactSet, Raymond James Equity Portfolio & Technical Strategy

The S&P 500 is an unmanaged index of 500 widely held stocks. It is not possible to invest directly in an index. All expressions of opinion reflect the judgment of the Research Department of Raymond James & Associates, Inc. and are subject to change. There is no assurance any of the trends mentioned will continue or that any of the forecasts mentioned will occur. Economic and market conditions are subject to change. Past performance may not be indicative of future results. Displaced Moving Average (DMA) is a moving average that has been adjusted forward or back in time to forecast trends. U.S. Treasury securities are guaranteed by the U.S. government and, if held to maturity, offer a fixed rate of return and guaranteed principal value. Every investor’s situation is unique and you should consider your investment goals, risk tolerance and time horizon before making any investment. Investing involves risk and you may incur a profit or loss regardless of strategy selected. The forgoing is not a recommendation to buy or sell any individual security or any combination of securities.

By | 2018-03-07T10:50:54+00:00 March 7th, 2018|Latest Articles|