Notes on the week aheadContributor Dr. David Kelly
The grizzled coach, scowling under his hoodie, paced the sideline with photos and sharpie. This wasn’t going to be an easy game. His star tight-end had retired and his wide receivers were banged up. His kicker was injured and his replacement was unreliable. The team was working on four days rest and strong winds swirled around the stadium. Still, he needed a game plan and so he probed the defense for any signs of weakness. Winning ugly would still be winning.
Entering the fourth quarter of the year, nothing seems easy for investors either and there are a number of issues that are making it difficult for markets to move higher from here. However, it is important to recognize any softening in these impediments to progress.
Last week, there seemed to be a little movement on two issues that have dogged financial markets for some time. First, on trade talks with China, the Administration announced a deal by which China would buy more U.S. agricultural products and agree to some guidelines around the management of its exchange rates. In return, the U.S. would postpone plans to raise tariffs on $250 billion in Chinese goods from 25% to 30% on October 15th.
As a practical matter these are only small concessions on both sides and a comprehensive deal between China and the U.S. may well have to wait until after next November’s U.S. elections. However, the fact that the negotiators were so anxious to announce a deal suggests that both sides now appreciate the damage being done to their economies by the conflict. This probably reduces the risk of a re-escalation of the war in the months ahead.
There are also some hopeful signs in the interminable Brexit standoff. Last Thursday’s meeting between the British Prime Minister, Boris Johnson, and the Irish Taoiseach, Leo Varadkar seemed to go well, setting off a whirlwind of diplomacy between the British Government and the Europeans to try to come up with an agreement this week.
While it is by no means certain that the UK and Europe can agree to a deal or that such a deal can make it through the UK parliament, there does appear to be recognition from the British side that any Brexit deal will have to treat Northern Ireland very differently from the rest of the UK. In the multiple permutations of Brexit end games, this has reduced the risk of a damaging “no deal” Brexit.
A slight reduction of risk in these two areas should be a positive for equity markets. However, elsewhere the landscape remains difficult. In the week ahead, investors will be focused on Wednesday’s September Retail Sales report to see if consumer momentum is holding up in an otherwise slowing U.S. economy. Numbers on Housing Starts and Industrial Production for September along with early indications on manufacturing for October should be downbeat.
52 S&P 500 companies are set to report this week as earnings season gets underway. Regardless of positive or negative surprises, the overall year-over-year growth rate in earnings per share should be low single digits at best, even with some continued help from stock buybacks. Also this week it is likely that the Treasury Department will release numbers for the budget deficit for the fiscal year just ended, with the red ink likely to exceed $980 billion.
Finally, in the week ahead, a number of Fed officials will be speaking ahead of the Fed’s October 30th meeting. As of right now, markets are pricing in a rate cut in October followed by a pause in rate moves until 2020. However, it would not take much more economic weakness to push the Fed into further rates cuts, sending long-term yields even lower than their current levels.
For investors, a slow-growing, low interest rate U.S. economy with low earnings growth should continue to limit the upside for domestic equity and fixed income markets. However, there are still some areas of mispricing within U.S. markets that offer opportunities to investors. In addition, any reduction in international uncertainty, such as recent moves on Chinese trade and Brexit could be a positive for equities outside the U.S., highlighting the potential for international diversification to boost performance in what remains a difficult investment environment.