Give Me Fuel, Give Me Fire

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by Jason Norris, CFA
Executive Vice President of Research

Equities continue their grind harder and higher this week as optimism for economic growth remains. The S&P 500 finished the week up three quarters of a percent resulting in year-to-date gains of over 14 percent. Yields also ticked up resulting in the 10-year Treasury yielding 2.32 percent.

As September closes, we continue to be surprised by the strength in the equity market, even though it is at odds with both current events and past market trends. Turmoil in Washington D.C. does not lend the market confidence and, while we finally learned some details on the tax bill this week, fiscal policy has not been one of the catalysts for these robust returns. However, for the third quarter of 2017, the S&P 500 has rallied roughly 4 percent. On top of the headline volatility, there is the seasonal pattern of the third quarter being the worst quarter of the year. On average, stocks post negative returns in the third quarter.

This mysterious bolstering strength comes from corporate earnings, not just in the U.S. but also abroad. The chart below highlights the robust year-over-year growth in earnings in the U.S. as well as outside the U.S.

Source: Bloomberg

Source: Bloomberg

The snapback from the earnings recession of 2015 and 2016 has been meaningful, especially in international markets. This positive momentum should continue into 2018, and any fiscal stimulus out of Washington would just add to this earnings growth.

Because stocks don’t go up in a continuous, straight line, investors shouldn’t be surprised if we get some sort of a sell off after recent market strength. Since 1980, the average annual return for the S&P 500 is roughly 10 percent. However, at any given time during a year the market will have a drawdown of 14 percent (see below).

Source: Factset

Source: Factset

We have not had a 5 percent drawdown since the Brexit vote in June 2016, and the CBOE Volatility Index is at historic lows. While we currently do not see a catalyst for a market downturn, as Venus Williams said, “You can never get complacent because a loss is around the corner.”

Takeaways for the Week

  • Global earnings growth continues to fuel equity gains

  • Double digit sell offs are the norm, not the anomaly

Disclosures