The S&P 500 Index has climbed 1.2% during the third quarter as optimism about a China trade deal and the increased probability of a more accommodative Federal Reserve has investors convinced that the economic expansion will continue. The second-quarter earnings reports were generally better than anticipated with 2-4% growth year over year, so overall valuations look reasonable.
While the equity market is trading near a record high, any tweet or news on the China trade agreement or U.S. interest rates will determine the market’s daily direction. The trade negotiations may continue for a long time or the two sides may reach an agreement sufficient to reduce trade tensions. The likelihood is that before the election in 13 months, a negotiated settlement will occur and the economy and the markets will continue to strengthen. In the meantime, Washington’s bad political theater will stall any legislation, so we should not expect any pharmaceutical drug-pricing legislation, infrastructure rebuilding program or information technology regulation.
|Index||September 30, 2019|
|S&P 500 Index||18.7%|
|S&P Mid-Cap 400 Index||16.4%|
|MSCI All World Cap Index||14.2%|
The overall market rise has had inconclusive daily rotations from more aggressive growth stocks to conservative high-dividend-paying stocks. Recently staples, utilities and REITs have outperformed the more cyclical information technology and industrial stocks. Overall, the information technology and consumer discretionary sectors remain the market leaders this year as U.S. corporate technology expenditures and consumer spending have both remained strong. The S&P 500 Index Price to Earnings ratio, which historically averages 17x, is now a slightly elevated 19x, but with strong cash flows, earnings and stocks buybacks, most companies should achieve their targeted third-quarter earnings.
The fixed income market has rallied and yields have dropped amidst international uncertainties and lower global inflation. Despite moderate growth in the U.S. economy, the yield curve remains flat and the 10-year U.S. Treasury bond has declined to 1.66%. Weakening European and slowing Chinese economic growth are suppressing U.S. interest rates, but allowing most multinational corporations to refinance debt at lower rates. Mortgage interest rates have also declined, with the 30-year fixed rate at 3.64%, providing refinancing opportunities to households. The Federal Reserve has remained accommodative by providing credit and liquidity to the markets and it would be highly unusual for the U.S. economy to enter a recession in these circumstances. The Federal Reserve is also adding to its balance sheet and actively supplying overnight funds for large institutional lenders in the market. Overall, conditions are healthy for continued U.S. economic expansion and higher equity valuations.
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