US Stock Market: Will Rally Be Able to Continue without Earnings Support?

The major U.S. equity indexes continued their recent gains, hitting record levels while finishing higher for the fifth straight week. Signs of progress in the U.S.-China trade talks, along with better-than-expected earnings reports, helped dampen recession fears, boosting investor sentiment. Stabilizing domestic and global growth, helped drive Treasury yields to their highest levels since early August.

Last week, the benchmark S&P 500 Index settled at 3093.00, up 0.90%. It is up 23.4% for the year. The blue chip Dow Jones Industrial Average finished at 27684.00, up 1.2% for the week and 18.7% for the year. The technology-based NASDAQ Composite Index closed at 8475.00, up 1.1% for the week and 27.7% in 2019.

Uncertainties over a trade deal still remain, however, the third quarter results suggest earnings may have bottomed, or are very close to bottoming out, and may even be in a position to reaccelerate next year to a mid-single-digit pace, according to analysts at Edward Jones.

Corporate Earnings Results Leading the Charge

Given the ongoing trade issues, the political drama in Washington, the Fed’s multiple moves and geopolitical uncertainties, the one constant this year underpinning stocks has been corporate earnings results. One can even build a case for earnings contributing the most to the market’s rise to record highs.

With close to 90% of S&P 500 companies having reported results since roughly October 15, the third quarter earnings season is nearing completion.

According to Bloomberg, corporate profits are on track to register a small decline (-1% as of 11/18/19) compared with a year ago. However, results have been better than expected (or feared), joining forces with the latest signs of progress on trade negotiations to help push the stock market to a fresh record last week.

The analysts at Edward Jones found three takeaways from the recent corporate earnings results:

1. Better-than-expected earnings reflect a resilient economy.
2. Still caution, even as market has rallied.
3. Earnings are still a pillar of support, albeit a shorter one.

Better-Than-Expected Earnings Reflect a Resilient Economy

78% of companies have exceeded consensus earnings expectations, which is due in part to depressed estimates. But remember, it was only three months ago that economists were predicting a recession. The third quarter earnings may be a sign that the economy is on stronger footing than previously thought.

Overall earnings for 2019 are expected to grow only 2%, but it’s unfair to compare this to last year’s 21% growth that was fueled by a tax cut. This year’s tepid growth could be attributed to lower GDP and weak business investment, fueled by caution over the escalating trade war.

Still Caution, Even as Market Has Rallied

Defensive sectors like health care and utilities are seeing the fastest earnings growth this quarter, while cyclical sectors like energy, materials and consumer discretionary are lagging.

The outlook for global growth will remain an important driver for stocks. The slowdown in global growth has taken its toll on demand for commodities, however, weakness in cyclical sectors may be turning a bit.

And importantly, the strength of the defensive sectors, relative to cyclicals, as the market has moved to new highs signals that there is still a fair bit of caution (if not pessimism) in the market.

Earnings are Still a Pillar of Support, Albeit a Shorter One

The direction of corporate profits is a powerful driver of the direction of the stock market over time. The earnings growth rate is expected to bottom out this year and reaccelerate next year to a mid-single-digit pace. Given current reasonable valuations, Edward Jones analysts think this sets the stage for moderate returns as we advance in this bull market. Over the last 60 years, when earnings rose at a mid-single-digit pace (4%-9%), the stock market delivered an average annual return of 9.5%, according to Morningstar Direct and Edward Jones calculations.

Conclusion

How will the markets be supported until the next earnings season in mid-January? What if the trade talks hit a snag? Will the Fed’s three rate cuts be enough to sustain the upside momentum in the economy? These are the questions that investors will be asking as 2019 comes to an end. The fact that investors are still supporting the defensive sectors suggests investors are still concerned about the possibility of a misstep in the trade talks. Furthermore, the political turmoil in Washington, a stronger U.S. Dollar and a weakening Chinese economy are all reasons why traders should look for value and not be too concerned about missing the rally by chasing the indexes higher.