Global and U.S. equities continue to recover, while emerging markets struggle. The Midterm elections result in a split Congress, and Democrats consider their legislative priorities. Find out more in this edition of “The Week in Review.”
Last Week Review
Global equities climb higher for second week following 10% correction. Despite losses in emerging markets, global equities (1.0%)1 moved higher for the second week in a row. U.S. equities led the way with a 1.8% return2, followed by non-U.S. developed markets (0.2%) 3 and emerging markets (-1.9%)4. Global equities are still down for the year given the drag from emerging markets (-14.2%)5 and non-U.S. developed market equities (-7.9%)6. The U.S. leads all regions year-to-date with its 5.1% gain7.
Expected Fed rate hike path unchanged after November meeting. At last Thursday’s meeting, the Federal Reserve (Fed) maintained guidance for gradual rate hikes over the next year with a meeting statement expressing a positive view on the U.S. economy given low unemployment, strong household spending, higher wage growth and near-target inflation. We believe the recent equity market downturn has had little effect on expectations for Fed policy as markets continue to anticipate about a 75% probability of a December rate hike8. A December hike would be the ninth rate hike of the current cycle and place the Fed funds rate in the 2.25%-2.50% channel. Going forward, each Fed meeting will feature a press conference by Fed Chair Jerome Powell, meaning that an interest rate change is possible in any given meeting.
Democrats take control of the House; Republicans retain Senate majority. Last Tuesday’s midterm election resulted in a split Congress, with Democrats gaining control of the House of Representatives and a continued Republican majority in the Senate. The split Congress increases the odds of a struggle to find common ground on issues like health care, taxes, and infrastructure. However, the election results are unlikely to have a major impact on trade relations with China as the executive branch has taken the lead on that issue. In her election night speech, House Minority Leader Nancy Pelosi focused on drug price controls, infrastructure and campaign finance reform. Drug price legislation is likely to interest President Donald Trump but may have difficulty gaining traction in Congress. In the day following the election, the S&P 500 Index was up 2.1%9, with the consumer discretionary (+3.1%)10, health care (+2.9%)11, and information technology sectors (+2.9%)12 saw the largest gains on that day.
Earnings growth continues to surpass expectations. With earnings in from 90% of S&P 500 companies, aggregate year-over-year (y/y) earnings growth (26.8%) and revenue growth (8.4%) continue to exceed expectations13. Year-to-date, the health care sector (14.0%)14 has taken the place of information technology (11.9%)15 as the top performing sector.
This Week Preview
Third quarter earnings continue with a focus on consumer companies. With a few weeks left to report earnings for the third quarter, many of the remaining companies will come from the consumer discretionary sector including Home Depot (HD) on Tuesday. So far, earnings in the consumer discretionary sector have grown by 23.9% y/y16. Walmart (WMT), a consumer staples company, will release earnings on Thursday.
Global inflation readings set to remain close to prior levels. Germany kicks off the week with final October headline Consumer Price Index (CPI) readings expected to come in line with the 2.5% y/y flash reading. Surveys show UK’s core CPI (1.9% y/y) staying close to previous levels while headline CPI (2.5% y/y) increases slightly. Similarly, U.S. core CPI is expected to remain at 2.2% y/y, while headline CPI is expected to move higher(2.5% y/y). Investors continue to follow U.S. inflation closely to see the impact trade tensions will have on inflation metrics. Finally, Europe’s inflation readings will conclude the week with no expectations for a change from October’s flash readings for headline (2.2% y/y) and core CPI (1.1% y/y).
Italy’s revised budget due to the European Commission. The European Commission rejected Italy’s original budget as it exceeded the allowable deficit and requested a revised version due this Tuesday. Italy is unlikely to make major changes and further disagreement could affect Italy government debt yields. Italy’s 10-year yield has spiked higher during previous periods of heightened budget tensions earlier this year16.
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Unless otherwise noted, all opinions expressed in this post are those of the author and do not necessarily represent the views of Northern Trust. Information contained herein is current as of the date appearing only and is subject to change without notice.
1) Bloomberg, MSCI World Index return 05Nov2018 – 09Nov2018.
2) Bloomberg, MSCI U.S. Equities IMI Index return 05Nov2018 – 09Nov2018.
3) Bloomberg, MSCI ex-U.S. Equities IMI Index return 05Nov2018 – 09Nov2018.
4) Bloomberg, MSCI Emerging Market Equities Index return 05Nov2018 – 09Nov2018.
5) Bloomberg, MSCI Emerging Market Equities Index return 02Jan2018 – 09Nov2018
6) Bloomberg, MSCI ex-U.S. Equities IMI Index return 02Jan2018 – 09Nov2018.
7) Bloomberg, MSCI U.S. Equities IMI Index return 02Jan2018 – 09Nov2018.
8) Bloomberg, Fed Funds Futures Index 09Nov2018. Fed funds futures are used by banks and fixed-income portfolio managers to hedge against fluctuations in the short-term interest rate market. They are also a common tool traders use to take speculative positions on future Federal Reserve monetary policy.
9) Bloomberg, S&P 500 Index return 07Nov2018.
10) Bloomberg. S&P 500® Consumer Discretionary Index performance 07Nov2018. Comprising those companies included in the S&P 500 that are classified as members of the GICS® consumer discretionary sector. The Global Industry Classification Standard (GICS) is an industry taxonomy developed in 1999 by MSCI and Standard & Poor's (S&P) for use by the global financial community. The GICS structure consists of 11 sectors, 24 industry groups, 68 industries and 157 sub-industries into which S&P has categorized all major public companies. GICS is used as a basis for S&P and MSCI financial market indexes in which each company is assigned to a sub-industry, and to a corresponding industry, industry group and sector, according to the definition of its principal business activity.
11) Bloomberg. S&P 500® Health Care Index performance 07Nov2018. Comprising those companies included in the S&P 500 that are classified as members of the GICS® health care sector.
12) Bloomberg. S&P 500® Information Technology Index performance 07Nov2018. Comprising those companies included in the S&P 500 that are classified as members of the GICS® information technology sector.
13) Thomson Reuters. S&P 500 Earnings Dashboard. Retrieved 09Nov2018 from http://lipperalpha.financial.thomsonreuters.com/2018/11/this-week-in-earnings-9/.
14) Bloomberg. S&P 500® Health Care Index performance 02Jan2018 - 07Nov2018.
15) Bloomberg. S&P 500® Information Technology Index performance 02Jan2018 - 07Nov2018.
16) Bloomberg. S&P 500® Consumer Discretionary Index performance year over year comparison 09Nove2017 – 09Nov2018.
Past performance is no guarantee of future results. It is not possible to invest directly in any index and index performance returns do not reflect any management fees, transaction costs or expenses.