When is good news bad news: when interest rates surge on strong economic reports.

Fears won the battle over facts in the latest week.  After closing out August at a record high, the S&P 500 fell nearly 1% in the holiday-shortened week.

Powell contends that, in the absence of precision surrounding the monetary policy objectives, a more gradual approach to raising interest rates is the most appropriate strategy.  His comments are consistent with Via Nova’s view that the Fed will not raise rates too rapidly and short-circuit the expansion.

The week started off in a positive fashion, and stock indexes continued to edge up closer to the January market highs.  Likewise, the yield on the 10-year Treasury note looked ready to break up above 3%. Then came the news that President Trump planned even steeper tariffs on Turkey. The market reaction was predictable and reminiscent of the second quarter.

Perhaps the most favorable factor influencing the markets in the week was a surprisingly good meeting on trade between President Trump and European Commission President Juncker. Via Nova’s take on the Trump/Junker meeting is that it helped defuse some of the escalating concerns surrounding trade, a welcomed positive, but it offered few immediate tangibles.

Facts vs. Fears: The second quarter earnings season is off to a great start.  84% of reporting S&P 500 companies beat analyst expectations compared to a long-term average of 64%, according to Thomson Reuters.  Second quarter earnings are now expected to increase a very healthy 22.0% from Q2 2017.  Almost three-quarters of companies also beat revenue estimates which is above the long-term average.  Profit margins are at record highs, according to FactSet, thanks in large part to the cut in the corporate tax rate.  The strong increase in earnings so far in 2018 combined with sluggish stock prices lowered stock market valuations.  The forward four-quarter (3Q18 – 2Q19) P/E ratio for the S&P 500 is 16.5X, down from over 18.5X early in the year.

From a stock market perspective, however, Via Nova believes rising interest rates are not currently a threat to the bull market.  Historically, in periods when the 10-year yield is below 5% but rising (as it is now), the S&P 500 is higher one year later 89% of the time with a median return of 10.67%, according to research from Chaikin Analytics.  The conclusion is that interest rising rates, on their own, are not a cause for concern for the equity market.  We continue to favor stocks over bonds.

Facts continue to beat fears, but trade tensions were felt in the more export-oriented Dow Jones Industrial Average (DJIA) which added only half that of the S&P 500 in the latest week.  Indeed, the DJIA is essentially flat so far in 2018, compared to a 4.25% increase in the broader S&P 500.

Blame it on trade tensions.

Happy Memorial Day.  While we enjoy a beautiful long weekend with friends and family, we know we are able to do so because of those who made the ultimate sacrifice for our nation.  Today, we remember them.

HIGHLIGHTS:

A mixed week for stocks.  The large cap S&P 500 slipped, but the small cap Russell 2000 hit a record.

We believe that the strength in small cap stocks is more reflective of the underlying market trend, which remains positive.

HIGHLIGHTS:

• Lots of information, but not much market movement.  Stocks edged lower.  Bonds mostly flat.

• The moderate employment report is consistent with FOMC’s “gradual” approach.

• Q1 earnings growth is 80% complete and 79% of companies have beaten profit estimates.

• Policy: More trade talks.  Fewer trade threats.  The negotiation phase appears to be underway.

• Coming Week: More earnings.  More negotiations. The CPI is the only notable economic report.

The 3% level, while not high, is psychologically and technically significant for investors, because it is something of a tipping point between the extended period of ultra-low yields associated with easy monetary policy in recent years, and the gradual return to a more “normal” interest rate environment.

Lately, equity investors have been hesitant to hold trading positions over the weekend for fear of some adverse tweet or policy announcement from the U.S., China, Russia or the EU.  The S&P 500 sold off on Friday, again, but managed to hang onto a moderate gain for the week lifting the index back into slightly positive territory year-to-date.  The S&P 500 remains in a trading range this year as investors sort through the many positives (economic and earnings) and negatives (trade and monetary policy).