It was a great week for the stock market. The S&P 500 Index rallied 4.9% last week, leaving the index less than 6% from its record high, on September 20, 2018 (excluding today’s gains) [Figure 1]. Gains were driven by increasing optimism (now proven to be warranted) for progress on U.S.-China trade talks at the G20 summit over the weekend and a more dovish outlook from Federal Reserve Chair Jay Powell (see today’s Weekly Economic Commentary for more). This week we share our thoughts on these major market-moving events and reiterate our positive stock market outlook.
The market is focused primarily on two things right now: trade and the Federal Reserve (Fed). On trade, as we expected, the meeting between President Trump and Chinese President Xi at the G20 summit yielded positive results. The two powers agreed to a 90-day halt on fresh tariffs and increases in tariff rates, while they intensify negotiations. In addition, China agreed to purchase a “substantial” amount of U.S. agricultural and industrial goods to help narrow the trade deficit and, according to President Trump, will reduce or eliminate tariffs on imported American-made cars. Based on the immediate stock market reaction, it’s clear that the outcome landed at the high end of the market’s expectations.
Although this is progress, we’re not out of the woods. Future talks may stall, leading to higher and more tariffs. It will be difficult to reach an agreement on forced transfers of U.S. technology to Chinese companies and enforcement of intellectual property theft. But given how much both sides have to lose, we continue to expect an agreement early next year. Weakness in the Chinese stock market has added to the economic pressure China is under to strike a deal [Figure 2].
FED EASES CONCERNS
Powell certainly eased the other primary concern for markets last week with his more dovish ratehike outlook during a speech on Wednesday (November 28). The Dow Jones Industrial Average’s surge that day underscored the market angst around how far from the neutral rate the Fed’s target interest rate might be. The Dow’s 600-point climb on Wednesday is a testament to how much impact Powell’s word choices—“a long way from neutral” to “just below neutral”—can have. We are encouraged by the flexibility suggested by Powell’s latest comments. The risk that the Fed disrupts markets down the road still exists, but this clarification represents progress toward interest rate and currency stability, which is positive for stocks.
Amid the flurry of trade headlines over the weekend, we wanted to reiterate our view that stock market fundamentals remain positive.
First, the U.S. economy remains in excellent shape. Gross domestic product (GDP) grew at a very strong pace over the past two quarters, near 4%, and is expected to grow at a nearly 3% pace in the coming year, despite some drag from exports due to the ongoing trade dispute. Consumers and businesses remain quite confident. The job market is healthy, bolstering already healthy consumer finances. Our favorite leading indicators point to continued economic growth in the year ahead. We expect fiscal stimulus to offset the impact of tariffs
Corporate profits also provide fundamental support. S&P 500 Index earnings grew more than 28% year over year in the third quarter as results solidly outpaced expectations, supported by better economic growth, robust manufacturing activity, and tax cuts (more on earnings here). Companies generally provided upbeat guidance. Wage pressures may cap profit margin expansion, but we think the macroeconomic outlook is strong enough to support potential high-single-digit earnings growth for the S&P 500 in 2019 even if some tariffs remain in place.