VIA NOVA UPDATE: Optimism for renewed China negotiations helped lift markets.

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  • Relative performance suggests market laggards may be making a comeback.
  • Economic momentum remains strong so far in Q3.
  • Third quarter S&P 500 profits growth estimated above 20%.
  • Markets cheered the scheduled resumption of U.S. / China trade talks.
  • The Week Ahead: FOMC minutes should receive considerable scrutiny.

Relative performance suggests market laggards may be making a comeback.

The market’s early fears related to the potential negatives associated with the U.S./Turkey standoff were replaced by optimism surrounding renewed U.S./China trade negotiations by the end of the week.  The S&P 500 rose 0.66% and is up over 5% so far in the third quarter.  Small cap stocks increased a respectable though more modest 0.4%, but international stocks continued to struggle losing -1.10%.  Emerging market stocks suffered most, falling -3.68%.

Within domestic stocks, there may be early signs that market leadership is shifting away from the long dominant technology sector, at least over the near term.  The export-oriented industrials predictably outperformed the overall S&P 500 for the week, as might be expected with news of fresh trade talks, but technology stocks fell.  Moreover, the most impressive gains came from consumer staples, utilities, telecom and health care.  The net effect of the performance shift was a clear win for the value style, which has been lagging the growth style by over 18% during the past three years.  It is too early to tell if the performance shift will last, but it bears watching, as technology stocks have outperformed the market for quite some time and may be due for a breather.

In other markets, inflation-sensitive commodity prices remained soft.  Oil prices fell following news of higher than expected inventories, though the cost of a barrel is still up 9% year to date and 40% over the past twelve months.  That being said, oil companies are still earning profits.  Gold prices also fell, closing below the psychologically important $1,200/ounce level, and Treasury Inflation Protection Securities (TIPS) also edged lower.  The yield on the 10-year Treasury note moved slightly higher.

Q3 economic momentum remains strong.

The economy is humming along in the third quarter based on available reports.  Small business optimism is at the second highest level in 35 years, retail sales are up 6% year over year, and initial jobless claims are hovering around a 50-year low.  The Leading Economic Indicators index rose more than expected in its latest reading, suggesting that the current expansion has more room to run.  The Atlanta Fed’s GDPNow model currently estimates third quarter real GDP growth tracking at a 4.3% rate compared with the 2.3% rate of growth so far in this expansion.  This data suggests the U.S. economy is on solid footing and provides a constructive backdrop for earnings.

Third quarter S&P 500 profits growth estimated above 20%.

With second quarter earnings season winding down, market attention is turning to the third quarter, and expectations are for another quarter of 20+% profits growth.  Third quarter earnings are currently estimated to increase 22.4%, following the 24.6% gain in the second, and fourth quarter profits are forecast to rise 20.3%.  Calendar year 2018 earnings are expected to increase 23.3% but should slow to 10.1% in 2019%, as the initial impact of tax reform begins to fade.

Markets cheered the scheduled resumption of U.S. / China trade talks.

Markets cheered a surprise announcement that U.S. and Chinese negotiators are mapping out talks to try to end their trade standoff ahead of planned meetings between President Trump and Chinese leader Xi Jinping at multilateral summits in November.  A delegation from Beijing, led by Vice Commerce Minister Wang Shouwen, will meet with U.S. officials led by the Treasury undersecretary, David Malpass, on August 22-23.  The negotiations are aimed at finding a way for both sides to address the trade disputes, and could lead to more rounds of talks.  The iShares China ETF is down over -10% so far this year in contrast to the 8% increase in the S&P 500, suggesting that the Chinese markets have bourne most of the brunt of the trade tensions.

Via Nova belives both sides are interested in reaching a deal, and that neither side wants an all-out trade war.  A negotiated deal would be positive for both the U.S. and China markets.  Initially, the Shainghai Composite might enjoy a near term relief rally, but if a pact leads to a persistently lower trade deficit with China, the U.S. economy and the stock markets will likely receive a noticable and sustained boost.

The Week Ahead: FOMC minutes should receive considerable scrutiny.

With the good news from second quarter earnings season winding down, the market focus will likely turn to the minutes of the Federal Reserve’s July 31-August 1 Federal Open Market Committee (FOMC) meeting.  Since there was no press conference following that meeting, the minutes may provide some useful details on the conversation about the economy, inflation and the impact and potential risks from a trade war on near term Fed policy moves.  The August 22-23 trade discussions with mid-level Chinese negotiators could also yield possible market-moving news.