Stocks finished mixed with a bias to the downside yesterday amid mixed earnings news. So far this earnings season good news gets rewarded, but bad news gets slaughtered. With stocks within 1% of all-time highs and political headlines leaving investors jittery, there is little margin for error.
One stock making headlines yesterday with a somewhat disappointing earnings report was McDonald’s#. While earnings fell a bit short of expectations, revenues were about on target and same store sales growth was robust. Higher beef prices and G&A expenses associated with introducing new technology (e.g. ordering kiosks) pinch earnings and sent shares 5% lower, the biggest one-day drop in years. Fundamentally, the bullish story on McDonald’s is still in tact. However, the stock was richly priced going into the earnings season leaving little margin for error. On the flip slide, Procter & Gamble# was also richly priced. But the company blew away expectations with 7% organic sales growth and better than expected earnings. Still, the stock could only rally about 2% and remained below 52-week highs.
What we have learned about the economy from the earnings reports to date is that the consumer remains robust. Even the McDonald’s shortfall can’t be blamed on the consumer. Same store sales still grew by well over 5%. A strong consumer is insurance against any lingering thoughts of recession.
If the economy isn’t a concern to investors, the political environment certainly remains problematic. While President Trump retains his core support, virtually every day something new, whether from a Presidential tweet to testimony in Congress, raises concern. While Mr. Trump has never had much support from Democrats, Republicans have remained unified in their support. But recent events like the impetuous decision to remove troops from Syria and the decision to hold the next G-7 meeting at his Doral resort has begun to try the patience of many Republicans. So far, any dissent has been isolated to individual issues. But there are only so many of these faux pas that his supporters in government are going to be willing to ignore. More and more, Wall Street research firms are beginning to ask what if some of the leading Democrats win. What might the consequences be? For the most part, they are viewed as negative for the stock market. How negative depends on the observer, but no one suggests the election of one of the more progressive liberals will lift stock prices.
It is important, when doing this intellectual exercise, to separate possible executive orders from possible legislation. Even should Democrats win both chambers of Congress (still unlikely), 60 votes would be needed for legislation to pass the Senate. While it is possible to change the rules in ways that all legislation can be passed with 51 votes, getting all Democrats to vote for large tax increases, a ban on fracking or Medicare-for-all would be a stretch. What would be more likely would be Executive Orders to tighten banking regulations, bans on fracking on public lands, and tighter environmental legislation. While such changes would affect specific industries, the notion that a wholesale disruption of the American economy would be in store is probably an overstatement. While many might disagree with my thoughts, so far markets seem to agree. Bank stocks today are reacting far more to a steeper yield curve than they are to the thought of tighter regulation.
But that doesn’t suggest complacency is in order. Facebook’s# stock lost 3% yesterday as anti-trust pressures rose and the likelihood that its cryptocurrency, Libra, will get off the ground any time soon.
The bottom line is as follows:
- The economy worldwide is starting to grow a touch faster thanks to easy monetary policy. The Federal Reserve is almost certain to cut rates one more time next week.
- Stocks are fairly priced. In some cases, they are fully priced. Bad news won’t be tolerated. Witness McDonald’s yesterday or Texas Instruments last evening.
- Political noise is rising. So far, markets have ignored the news. Markets aren’t directly concerned with whether President Trump is impeached or not, but they are if Democrats nominate a progressive liberal and the nominee looks likely to win. That will become more apparent next summer but investors won’t wait until then to adjust portfolios.
- A changing yield curve that is steeping and rising suggests better times ahead for now. It also is good news for lenders such as the banks and credit card companies.
- Given the impetuous nature of President Trump and the fact that there are few if any left in the White House to challenge him, the risk of a wayward tweet is higher today than it has been. While the Syrian-Turkish affair or the decision to hold a conference at the Doral are not market moving, a sudden change in trade or tariffs could move markets quickly (in either direction).
For the rest of this week and next, earnings will dominate. The overall market shows little momentum. Stocks remain within spitting distance of all-time highs but without a surge from earnings, it seems premature for a significant upward push from here. Perhaps a modest increase past the July 2018 highs is the most likely outcome. The bond market suggests a slow recovery in interest rates, which will pressure any further P/E increases. Earnings remain flat as they have all year. That suggests there are not enough tailwinds at the moment to justify a big move higher. Conversely, solid earnings and a sign of some economic acceleration give stocks a floor. S&P dividend yields are still higher than yields on 10-year Treasuries.
We remain stuck in a trading range.
Today Ryan Reynolds is 43. “Weird Al” Yankovic is 60. Pele turns 79.
James M. Meyer, CFA 610-260-2220