(13 JULY 2019)DAILY MARKET BRIEF 1：Earnings lull may temper rate-driven enthusiasm
Driven by expectations for rate cuts following dovish testimony to Congress from Federal Reserve Chair Jay Powell, the S&P 500 is at a record high. The Fed appears willing to cut rates preemptively, even though the economy is growing close to trend and looks to be at full employment – a potentially favorable combination for stocks.
But while we expect modest upside for equities in our base case, stronger equity market gains may not materialize until earnings growth picks up.
Aggregate 2Q S&P 500 EPS growth should be similar to 1Q, with earnings up 1–2% versus a year ago. This period of stagnant—but not shrinking—profit growth will likely persist into 3Q, before growth begins to pick up. More encouragingly, 2Q growth for the average company should be stronger, around 5%.
Profit drivers have weakened: Business sentiment has fallen, tariffs have risen, and overseas growth has slowed. Our outlook is lower for oil prices and interest rates, which affect energy and financial stocks, respectively. We have reduced our full-year estimate for S&P 500 EPS growth to 1%, but we expect these headwinds to ease and for EPS to grow by 7% next year.
Two of the best leading indicators of profit growth are the ISM survey of manufacturing sentiment, which has been falling but remains in expansion territory (above 50), and the Fed's Senior Loan Officer Opinion Survey, which suggests that banks are extending credit on generally favorable terms, but not as favorable as they were a year ago. Both of these leading indicators are suggesting that annual profit growth will be modest in 2019.
This backdrop argues in favor of maintaining equity exposure, but suggests that second-half returns will be lower than in the first half. Over our six- to 12-month tactical time horizon, we continue to overweight equities with a regionally selective approach. In addition, in the near term, given downside risks, we would also recommend countercyclical positions.
BY UBS
