Mike Gibbs, Managing Director of Equity Portfolio & Technical Strategy, discusses the recent S&P 500 rally and the importance of possible tax cuts for future earnings growth.
Over the past 30 days, the S&P 500 recovered from a 2.9% pullback to move to a new all‐time high. During the rally, participation broadened as the small and mid‐cap indexes posted relative strength gains vs. the S&P 500. The small caps moved to a new high (S&P 600) while the S&P 400 mid‐caps are just below the highs. The broader participation reinforces the health of the technical trend of U.S. equities.
During the rally, sector performance was generally as expected. Risk-on cyclical sectors such as Energy, Industrial, and Materials outperformed. A higher yield on the 10-year influenced outperformance by the Financials and underperformance of the Utilities, Real Estate, and Telecom sectors. Challenging earnings caused Consumer Staples to lag, while negative sentiment resulted in underperformance in the Consumer Discretionary stocks. Healthcare stabilized from a month long pullback and returned to a new high. Technology held on to gains as relative strength was flat.
The all‐important tax reform debate should move into high gear with the introduction of the Republican plan soon. Whether or not the polarized party will be able finally pull it together on the reform front is important for the next phase of the equity market. In our opinion, tax reform (cuts) and the resulting boost to U.S. earnings makes it the most important item on the political agenda as it relates to the stock market. If no compromise can be struck, equities may finally succumb to a deeper pullback in the coming months than has been seen in a while.
3Q earnings season will commence the second week of October and join the political debate as a key equity market influence. Earnings growth is expected to slow from double digit year-over-year gains as mid‐to‐upper single digit growth is likely in 3Q. We think the slowing of the robust growth of recent quarters should not deter equities if revision trends continue to move higher.
In sum: We find favorable technical and fundamental tailwinds remain in place and supportive for the U.S. equity market. Unless earnings disappoint (not expected) or tax reform fails to develop, we think the favorable tailwinds suggest equities will generally trend higher in the months ahead.
Source: FactSet, Raymond James Equity Portfolio & Technical Strategy
All expressions of opinion reflect the judgment of Raymond James & Associates, Inc. and are subject to change. Past performance may not be indicative of future results. There is no assurance any of the trends mentioned will continue or forecasts will occur. Investing involves risk including the possible loss of capital. Investing in certain sectors may involve additional risks and may not be appropriate for all investors. The S&P 500 is an unmanaged index of 500 widely held stocks. The S&P SmallCap 600 Index is an unmanaged index of 600 small-cap stocks. The S&P MidCap 400 provides investors with a benchmark for mid-sized companies. Small and mid-cap securities generally involve greater risks. It is not possible to invest directly in an index.