Neil George explains even more reasons why the markets are poised for additional gains
As I write Thursday morning, the Dow is down 267 points, dragged down by disappointing earnings from 3M, while the S&P and NASDAQ are modestly down.
Of course, today’s pullback comes on the heels of Tuesday’s record closing highs for the S&P and the NASDAQ. Markets have surged in 2019, fueled by an increasingly dovish Federal Reserve, the hope of the U.S.-China trade war resolution, and earnings that are surpassing lowered expectations.
In Monday’s Digest, we featured John Jagerson and Wade Hansen, editors of Strategic Trader. We looked at three reasons why investors were likely to keep pouring money into U.S. stocks — a low VIX, a downtrend in gold prices, and a steepening yield curve.
On Tuesday, Neil George, editor of Profitable Investing, added additional color on why more gains could be coming. So, in today’s Digest, let’s track what Neil is looking at.
***He starts by discussing investor sentiment
There are plenty of reasons for the market to be merry. Fear of missing out (FOMO) continues to run rampant throughout the financial media as investors keep piling into stocks.
Others are citing another term, “melt-up,” as the stock market seems to just keep climbing, despite many concerns over the fundamentals of the underlying stocks.
On this note, FOMO from professional money managers might be the fuel that intensifies the melt-up. You see, while retail investors like you and me have FOMO about missing out on market gains, professional investors have even more to fear — if their performance looks bad compared to competing money managers, their clients could jump ship. So, it’s not just an issue of missing out on gains, it’s about job security.
This puts professional money managers who have a more defensive mindset in a tough position — maintain that defensive stance and risk underperforming the competition, or put money to work to chase performance … possibly at the wrong time.
A Financial Times article from last week puts it this way:
Any substantial shift in underweight investment portfolios likely entails further gains across equities, credit and emerging markets, setting the stage for one of Wall Street’s favourite outcomes, a “melt-up”, a steady climb in prices that sets new records and carries other markets along for the ride.
Given that many professional investors follow benchmarks and are judged on quarterly performance, there’s clearly pressure on those that have favoured cash and focused on a defensive posture in recent months.
If the markets continue higher, it could easily draw more “reluctant” money. Yet, reluctant or not, those new dollars would serve as a self-reinforcing feedback loop, driving markets even higher.
***Next, Neil points toward fair earnings this quarter, and potentially improving earnings in the quarters to come
Back to Neil:
So far this earnings season, 104 out of the 505 stocks in the S&P have reported. And out of those in the varied industry groups, revenue growth is up on average by 3.94% and earnings growth is running at 1.72%. Not staggering to be sure.
Perhaps what’s helping is the number of companies that are looking at projected gains in revenue and earnings for the subsequent quarters of 2019 and into 2020, which are currently more optimistic.
On this note, as of Tuesday morning, almost 80% of S&P 500 companies that have reported earnings so far have beaten analyst estimates, according to FactSet.
But as Neil pointed out, perhaps investors are already looking beyond this quarter’s performance to what’s down the road.
We discussed this future earnings performance in our April 3rd Digest:
… what are analysts saying for the rest of 2019?
According to FactSet, earnings growth will swing back into the black in Q2 with growth of 0.1%. For Q3, growth climbs to 4.3%. And to round out 2019 in Q4, earnings estimates are projected to rise to 8.3%.
Given this, “good enough” earnings-performance this time around might be all that’s required for investors to hang in there, waiting on renewed earnings growth in the quarters to come.
***But companies that aren’t measuring up are being punished harshly
From yesterday’s Wall Street Journal:
On average this earnings season, shares of companies whose results have fallen short of analysts’ estimates have declined 3.5% from two trading days ahead of earnings to two sessions after the report, FactSet data through Tuesday morning show. That is more than the 2.5% average decline over the past five years.
A possible cause for the underperformance is that companies have been giving guidance either in line with or below analysts’ expectations, according to Bank of America Merrill Lynch. BAML analysts say mentions of “better” or “stronger” versus “worse” or “weaker” are tracking at their lowest since the first quarter of 2016.
The article referenced Intuitive Surgical falling 7% after a small earnings miss, a 10% drop from Bank of New York Mellon, and a 13% fall from Walgreens Boots Alliance.
Nearly a third of S&P companies will be posting earnings this week, so we’ll continue to monitor how this trend plays out.
***Neil finishes up by touching on a handful of other indicators
Back to Neil:
… despite some mixed retail sales data, consumer comfort levels, as measured by the Bloomberg “Comfy” Index, are very positive. And major capital expenditure plans remain in the works, as evidenced by the Federal Reserve Bank of New York’s Business Leaders Survey, which is nearly triple the level the survey was at in 2016.
Meanwhile, we have a docile Fed, low inflation and a good U.S. dollar driving foreign investment demand.
Putting all this together, despite a possible short-term breather, we’re looking at a market that appears poised for more gains — even after an incredible run so far in 2019.
But it’s equally important to pull back, and remember where we are in a broader sense. As we pointed out in yesterday’s Digest, there’s a correlation between a stock market’s valuation and its subsequent 10-year returns.
Even though U.S. stocks are currently enjoying strong positive momentum — and it’s appropriate to capitalize on that — history shows us that 10-year returns, based on today’s valuation, are likely to be underwhelming. But for now, the good times keep rolling, so we remain cautiously optimistic.
We’ll continue to keep you up to speed. And if you’d like to read more from Neil, click here. Have a good evening,