Tax Reform: Driving Earnings Expectations Higher
The move in the dollar has created a headwind for developed overseas markets and their central banks’ efforts to generate sustainable inflationary pressure. The MSCI EAFE index rose 1.5 percent last week for dollar-based investors, but fell 0.4 percent in local currency terms. European Central Bank (ECB) President Draghi expressed his frustration with the dollar in remarks following the bank’s meeting last week. For commodity producing emerging economies, the dollar’s weakness was less of an issue. The MSCI Emerging Markets index rose 2.6 percent last week in local currency terms. In dollars, the move was even stronger, up 3.3 percent.
Equities Already Beating Year-End Targets
The surge in equities to start the year has already pushed several indices close to, and in some cases, beyond year-end targets. The S&P 500 closed last week within a fraction of our own target of 2875. Tax reform has proven to be an even stronger driver of earnings expectations and rising sentiment than first estimated. We will revisit our forecast at the conclusion of fourth quarter earnings season after hearing from corporate management teams.
Suddenly, however, it is not just equities that are bumping up against year-end targets. Treasury yields have been surging as well. The yield on the ten-year treasury note was flat last week at 2.66 percent. However, it began the year at 2.41 percent. And in early trading this week the yield is spiking higher to 2.72, its highest level in almost four years, and exceeding our year-end target of 2.70 percent. The two-year note rose five basis points last week to 2.11 percent, its highest level in more than nine years. In early trading this week it, too, has jumped higher to 2.15 percent. While that remains well below our year-end target of 2.40 percent, there is clear evidence that the bond market is waking up to evidence of stronger economic growth, nascent inflationary pressure, rising treasury supply, and central banks in transition. If this trend continues, eventually equity markets will take note.
This week’s economic calendar contains many reports that will clarify the near-term outlook for both inflation and the dollar, as well as the broader economy. On Monday, the Fed’s preferred inflation measure, the PCE deflator, for December will be released. It is expected to show only a modest increase. That report will be accompanied by personal income and spending. On Wednesday, the Fed meets in what will be Chair Yellen’s last meeting. And on Friday, the December jobs report is expected to show a rise in average hourly earnings. Also on the calendar is the ISM manufacturing report, pending home sales, consumer confidence and sentiment, construction spending, motor vehicle sales and factory orders. On Tuesday, the President delivers his state of the Union address in which he is expected to focus on the economy, including his plans for infrastructure spending.
Investors Watching Reports from the Eurozone and Corporate Earnings
Investors will also be watching scheduled reports from the Eurozone this week, including fourth quarter GDP, which is expected to show another quarter of solid growth, and both producer and consumer prices, which are expected to remain in check. Japan’s reports this week include retail sales, industrial production, the Purchasing Managers’ Index (PMI) for manufacturing and consumer confidence. China also reports its PMIs for manufacturing and services.
Not to be overlooked, earnings season continues this week. According to Factset, with approximately one-quarter of the S&P 500 having already reported, a higher than historical average percent of companies are exceeding both revenue and earnings estimates.
The views expressed are as of the date given, may change as market or other conditions change, and may differ from views expressed by other Ameriprise Financial associates or affiliates. Actual investments or investment decisions made by Ameriprise Financial and its affiliates, whether for its own account or on behalf of clients, will not necessarily reflect the views expressed. This information is not intended to provide investment advice and does not account for individual investor circumstances.
Past performance is not a guarantee of future results.
S&P 500 Index: Is an unmanaged capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.
The U.S. Dollar Index (DXY) measures the dollar's value against a trade-weighted basket of six major currencies.
Morgan Stanley Capital International EAFE Index (MSCI EAFE), an unmanaged index, is compiled from a composite of securities markets of Europe, Australasia and the Far East.
The MSCI Emerging Markets Index is a free float-adjusted market capitalization index that is designed to measure equity market performance in the global emerging markets.
Indexes are unmanaged and are not available for direct investment.
The information and opinions in this article are compiled from third party sources believed to be reliable, but accuracy and completeness cannot be guaranteed by Ameriprise Financial. The information is not intended to be used as the sole basis for investment decisions, nor should it be construed as advice designed to meet the particular needs of an individual investor.
Ameriprise Financial Services, Inc. Member FINRA and SIPC.
- Chief Market Strategist, Ameriprise Financial
- More than 30 years of experience in the investment management industry
- Frequent guest on CNBC, Bloomberg TV and Fox Business Network.