Mike Gibbs, Managing Director of Equity Portfolio & Technical Strategy, discusses midterm elections and equity market conditions.
The S&P 500 has had a strong start to the third quarter (up 3.8%), exceeding the market’s return through the first half of the year (2.6%) and taking the year-to-date return to 6.6% (through July 27). In the process, the S&P 500 was able to move marginally above the top of what we feel is a potential trading range as the trade skirmishes play out.
Based on commentary from Raymond James Washington, D.C., policy analyst Ed Mills, the headlines may pick up between now and Labor Day before dying down ahead of the midterm elections. The Trump administration celebrated the “deal” with the EU, but the market accurately downplayed it due to a lack of details. There is a chance for success with NAFTA, as it appears the U.S. and Mexico are talking. Canada will still need to be swayed. China remains the biggest challenge. There does not appear to be any current exchange taking place. The non-approval of the QCOM/NXPI merger could increase the risk of the U.S. ramping up investment restrictions on China.
In the market’s advance to begin the quarter, volume has been light and participation has been narrow. In fact, the equal weight S&P 500 index gave up relative strength; and despite the index getting within 1% of new highs (on July 25), 17% of S&P 500 companies were in bear markets (down over 20% from their highs) and ~50% of companies were down over 10% from their highs. Sector rotation has continued to take place, as the transports, banks and pharma/biotech industry groups have had strong starts to 3Q (positively), while the interest-sensitives have underperformed. Moreover, technology has consolidated the past couple days. The small caps have consolidated some strength, but intermediate term trends remain solid. The opportunity for market volatility over the next 30 days is high. After a near 6% peak-to-trough rally off the June low, and with short-term technical indicators coming down from overbought areas, we believe the odds are high that equities may pull back short term. We expect the degree of the “news” will influence whether technical support (breakout near 2800; 50 DMA: 2763; short-term uptrend: 2720) will hold.
We also continue to view downside as limited (and believe potential pullbacks should be treated as buying opportunities) given the economic and fundamental backdrop. Economic momentum remains solid. 2Q GDP was reported in line with estimates at 4.1%, the strongest quarterly growth since 3Q14 and only the fifth time since the credit crisis that quarterly growth exceeded 4%. Furthermore, 2Q earnings have been stellar. Just over half of the S&P 500 has reported results at this point. According to Bloomberg, 88% of S&P 500 companies have beaten on the bottom line for an aggregate earnings surprise of 5.2%, and 73% of companies have beaten on the top line for an aggregate sales surprise of 1.1%. This takes estimates for the full quarter up to 21.4% earnings growth on 9.2% sales growth.
All expressions of opinion reflect the judgment of the Research Department of Raymond James & Associates, Inc. and are subject to change. There is no assurance any of the trends mentioned will continue or that any of the forecasts mentioned will occur. Economic and market conditions are subject to change. Legislative and regulatory agendas are subject to change at the discretion of leadership or as dictated by events. Investing involves risks including the possible loss of capital.
The S&P 500 is an unmanaged index of 500 widely held stocks. It is not possible to invest directly in an index. Sector investments are companies engaged in business related to a specific sector. They are subject to fierce competition and their products and services may be subject to rapid obsolescence. There are additional risks associated with investing in an individual sector, including limited diversification. Investing in small cap stocks generally involves greater risks, and therefore, may not be appropriate for every investor. The prices of small company stocks may be subject to more volatility than those of large company stocks.
Technical analysis does not attempt to measure a security’s intrinsic value, but instead use charts and other tools to identify patterns that can suggest future activity. A moving average (MA) is a trend-following or lagging indicator because it is based on past prices. Moving averages are commonly used to identify trend direction and to determine support and resistance levels. 50 DMA represents the securities average closing price over the last 50 days. Past performance may not be indicative of future results.