Shifting into Gear

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by Shawn Narancich, CFA
Executive Vice President Research

When the Seemingly Innocuous Becomes Consequential

Markets were inundated with a barrage of political, economic and stock-specific news this week, challenging investors to stay on top of it all. Wall Street has done a good job of ignoring the never-ending stream of provocative headlines out of Washington. However, as long-time geo-political alliances are strained and new tariff threats emerge, the results of trade policy are beginning to wash up on company income statements. For example, this week Alcoa lowered earnings guidance due in part to the added cost of tariffs imposed on its Canadian operations. Such multi-national companies are left to ponder what the end game is for scattershot attempts to even the scales of trade. The scope, magnitude and duration of tariffs is a big question companies are grappling with, and in the absence of clarity, we recognize the risk that this uncertainty poses for business confidence and investment. For now, the economy is strong, unemployment is low and the stock market stands within a couple good days of new all-time highs.

Economic Bliss

Fed Chairman Powell offered his upbeat assessment of the economy at the central banker’s semi-annual testimony to Congress this week. He imparted to lawmakers his expectation that the Federal Reserve will continue to gradually raise rates in the face of record employment and inflation that is finally at targeted levels. At the risk of becoming a Twitter target which some might observe he later became, Powell verbalized the economic risk that tariffs and trade wars pose – namely, higher prices and less output. Retail sales data out this week complemented the Fed’s testimony to Congress. Ahead of next week’s GDP release, we observed solid June data and upwardly revised retail sales growth for May that offer investors yet another input pointing to an accelerated pace of economic growth that many expect to exceed 4 percent in the second quarter.

A Quarterly Tradition

Turning to the earnings season now in full force, corporate America appears to have enjoyed robust fundamentals in the second quarter. With approximately 10 percent of the S&P 500 having delivered numbers, early reporters are averaging over 20 percent earnings per share (EPS) growth for the second consecutive quarter. Investors by now appreciate the contribution that lower tax rates are making it to the bottom line, but revenue growth is also surprisingly strong at 8.5 percent.

Puts & Takes

Contradicting the plurality of encouraging results so far, Netflix missed revenue estimates and lowered subscriber growth estimates by 17 percent. The company’s shortfall and management’s acknowledgement of competition for its subscription video on demand service put a dent in the stock, but we were surprised that a 9 percent share decline on the week wasn’t worse given the stock’s triple-digit earnings multiple.

For tech done right, we turn to Microsoft, which reported another strong showing driven by rapid growth in its cloud computing business. Investors increasingly appreciate the two-horse race here between Amazon Web Services and Microsoft Azure, with the latter scoring a notable victory this week in signing up Wal-Mart for its web computing service and in the process, shunning its e-commerce rival. Microsoft concluded its fiscal year ending June in fine fashion, logging better-than-expected double-digit top- and bottom-line growth, with its investors enjoying continued outperformance in the stock.

Takeaways for the Week: 

  • While digesting the latest U.S. trade policy news, stocks treaded water as earnings season kicked into high gear
  • Early reporters are providing evidence of continued strong profit growth