The 2019 rebound in risk assets continued over the past four weeks. The S&P/ASX 200 surged 4% and sits over 6,000, recouping most of the losses from the second half of 2018 despite the Royal Commission and weakening housing market. Meanwhile, the U.S. S&P 500 rallied 5% in the same period as reporting season is in full swing and is now 12% up on its early January low. Similarly, the Euro STOXX is up 5%.
In the same period, dovish comments from the U.S. Federal Reserve (Fed) have suppressed bond yields despite the rebounding sentiment. The U.S. 10-year yield fell nearly 10 basis points or 0.1% over the past four weeks to around 2.65%, whilst the Australian 10-year yield fell 15 basis points or 0.15% to around 2.12%.
Commodities also benefitted from the rebound in sentiment, with oil rising around 6.5% and metals rising strongly as well. Iron ore prices also received a boost following another tailings dam disaster in Brazil, owned by industry giant Vale.
The Australian Dollar remains around the 71.5 U.S. cents mark.
Markets have had cheery news on several fronts but the outlook for economic growth has weakened. The Fed had further dovish comments, with one speaker indicating that Quantitative Tightening may cease in late 2019. Meanwhile, Donald Trump tweeted that discussions with China were going well and raised the possibility of an extension to the March 1 deadline for the tariff freeze.
On the economic data front, the domestic picture was not pretty. Australia’s unemployment rate fell to 5% as employment figures surprised to the upside but the underlying picture was mixed, with full time employment falling. Inflation remains low at 1.8% and the housing market remains weak, with building approvals down 8.4% and home loans down 6.1% from December. Retail sales also fell 0.4%.
The U.S. economy remains robust as employment recorded another strong month, with 296,000 jobs added in January and the participation rate ticking up, meaning that despite the large number of jobs added, the unemployment rate rose to 4%. This continues a trend of strong jobs growth but rising unemployment rate as more people are tempted back to look for work with wages rising 3.2% over the past year. Activity indicators were also strong, showing that the U.S. economy continues to show robustness, though a very weak December retail sales print reined in optimism. A key point to watch is the inflation rate in the U.S. which picked up to 2.2%. This could push the Fed to turn more hawkish again if it continues to push higher.
Elsewhere, European and Japanese data remain weak. China showed a pick up in non-manufacturing activity despite the ongoing slowdown in the manufacturing sector, providing some hope. Chinese trade data was also much better than expected and a big boost in new loans showed that earlier stimulus measures could be starting to work through the economy. However, data around this time of year can be volatile due to the Lunar New Year celebrations.
On the earnings front, we are coming to the tail-end of what has been a good U.S. earnings season so far, and we are just about to get into the busy period for domestic earnings.
Back to the fundamentals
After a nosedive in December, markets came roaring back over the past eight weeks. This coincided with the start of earnings season in the U.S. and many other parts of the world. So far, given the rally, it looks like the market has liked companies’ reports of the past year and forecasts for this one.
We are still in the early stages of the domestic reporting season, with only about a quarter of the companies reporting so far. Results have been mixed, with about a third beating estimates, a third in-line and a third missing estimates. So it has been a fairly even spread, though the historical norm has been for more positive earnings surprises by the end of the season.
Most of the misses so far have come from the financial and auto sectors, with financials feeling pressure from the Royal Commission and slowing property markets, as well as the poor returns from equities hitting the asset managers.
Commodity companies were big contributors to the positive surprise side so far, and the retail side could potentially be one to watch as well, with the likes of JB Hi-fi and Nick Scali posting good results.
It is still early days for the domestic season so we will have to wait and see but the current P/E ratio of the S&P/ASX 200 of 15.3 is in-line with its longer term average of 15. However, with economic growth at risk, corporate earnings could take a hit and the risk may be skewed to the downside at these levels.
In the U.S., we are at the tail-end of the earnings season and over three-quarters of companies in the S&P 500 have reported. So far so good as about 70% have reported better than expected earnings and over 60% have reported better than expected revenue. This quarter will most likely mark the fifth quarter in a row for double digit earnings growth of the S&P 500. The earnings growth rate for the index is currently tracking at 13.1%, about 1% above the expected rate just prior to the start of the earnings season.
Given the poor sentiment at the start of the season, it should come as no shock that markets have been rewarding positive surprises more than average and punishing negative surprises less than average as the chart below shows:
On the other hand, expected earnings for 2019 has been on the decline, and guidance has been lower than expected. Analysts predict that moving forward, revenue growth will be lower and profit margins will no longer expand to help earnings growth. Rather, a mild contraction in profit margins is expected, with 2019 calendar year earnings expected to be 4.8% versus revenue growth of 4.9%. It is still early days and expectations can change quite significantly over the year, but history has told us that this is usually downwards. Based on a 4.8% growth in earnings, the S&P 500 would be on a forward P/E ratio of 16x, slightly over the long-term average so post the rebound, the S&P 500 looks around fair value.
Where the U.S. goes continues to hold a big weight in global markets given that the U.S. market generally leads sentiment in other markets despite the rise of China thus far. Though that might be changing as we saw last year.
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