The S&P 500 now sits 2 percent below its peak. Financial stocks in particular have conceded some of their recent gains in the absence of definitive progress on tax reform and deregulation. Nonetheless, the ability of equities to hold onto most of their post-election gains suggests that investors are still hopeful on the policy front, and willing to wait. But with equity valuations as elevated as they are, the market may be vulnerable to disappointment in the meantime if market fundamentals are not supportive. Most immediately that means earnings. And we are about to find out, as the big banks will begin reporting later this week and good results are expected.
Factset now estimates that first quarter earnings are expected to grow by 8.9 percent, a total which has followed the typical historical pattern of decline from the original 12.5 percent estimate at the start of the quarter.[i] If we do get 8.9 percent growth, it will be the best quarterly gain in over three years. Aside from the energy sector, for which no earnings growth rate is being estimated because of year-ago losses, financials are expected to deliver the strongest earnings at the sector level, followed by materials and technology. At the opposite end of the spectrum, industrials, telecom, and consumer discretionary stocks are all expected to see year-over-year declines in the quarter.
Mixed signals on the strength of the economy
Beyond the immediate focus on first quarter earnings, investors are wrestling with conflicting evidence as to the relative strength of the economy. And Friday’s weaker than expected March payroll report only added to the confusion, as non-farm payrolls reportedly grew at just half of the expected pace. But there was apparently enough weather-related distortion to render the report suspect. Both investors and the Fed are likely, therefore, to look beyond the report. But it does raise the bar for the April report to deliver better than expected results.
On Friday of this week, despite markets being closed, we will get the latest readings on both retail sales and inflation. Consumers in particular are being counted on to support the economy. Personal consumption in the fourth quarter was revised higher to a healthy 3.5 percent pace, but first quarter data has been a little soft, and real average hourly earnings growth year-over-year in February was flat. At the same time, business activity as measured by purchasing managers indices remains solidly in growth mode, albeit off their recent peaks. On balance, the first quarter is likely to be once again on the soft side, as it has been historically. But, we do expect activity to accelerate through the middle of the year, supporting the level of anticipated earnings growth.
Apparently the Federal Reserve is becoming increasingly confident that its policies have achieved sufficient and lasting progress toward its goals of full employment and stable prices, as it has begun to actively discuss how best to begin the long process of winding down its balance sheet. While the details are still being debated, this discussion injects a new degree of uncertainty as to the future path of interest rates and the degree of accommodation the Fed wants to provide, and for how long.
Geopolitical unrest at the fore
With the U.S. military response in Syria last week, geopolitical risk has elbowed its way back into the forefront of investor concerns. But what this means for investors remains to be seen, and may even turn out to be something of a positive for markets. The U.S. has said publicly that the attack on the Syrian airbase, from which it is believed the recent chemical attack was launched, was a one-off event. It is intended to send a message that we will, as some of our adversaries had begun to doubt, respond appropriately when provoked. If that message is received, it may change the calculus of those intent on testing the new administration in Washington, and be reflected in a modest boost to investor confidence. If, however, it turns out to be the first step toward deeper entanglement in the region, any boost to investor confidence might just as easily erode.
Important Disclosures:   

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[i]  Factset Earnings Insights, https://insight.factset.com/