Stocks At Record Highs: What Next?
Yesterday, both the Nasdaq and the broader S&P 500 closed at record high levels, buoyed by yet more strong earnings data and reports that the U.S. are sending a high-level delegation to China, and announcement that has led traders to conclude that a much-anticipated trade deal is imminent.
If you read Market Musings on Monday or, to be honest, even if you are just aware of what is going on, the breach of the previous high close will come as no surprise. There was very little doubt that we would get to these levels before too long; the question is what does it mean going forward?
The answer is that simply finishing yesterday above the previous high close means very little, but for investors that is a good thing. As significant as highs and lows, or chart points of any kind for that matter, are in the short term, they are always trumped by fundamental factors, and this is a move based on fundamentals.
More accurately, it is a move based on the market’s perception of those fundamentals. That is enough to push on through the highs, but there is some doubt as to how long the bull run can be sustained.
As of the end of last week, according to FactSet, 78% of S&P 500 companies that had reported beat expectations for Earnings per Share (EPS). On average, roughly two-thirds of companies beat Wall Street’s best guesses every quarter, but even in that context, this has been a good earnings season so far. That is always welcome news, but particularly so this quarter.
Going in, there was a fear that Q1 would be the period during which a slowdown became evident, but that doesn’t seem to be the case. At least, not in terms of the bottom line. Relief that things aren’t as bad as thought can continue to drive stocks higher for a while but dig a bit deeper into the numbers, there are still reasons to be somewhat cautious.
The FactSet report mentioned above also indicates that fewer companies than average are beating estimates of sales, and the average size of those beats is also smaller than in previous quarters. In addition, while overall EPS is better than expected, the numbers still represent an expected decline of 3.9% as compared to the same quarter last year.
For now, that doesn’t matter much given the negative vibes that preceded earnings season, but “not as bad as it could have been” is never a good basis for a sustained rally.
The trade news will also help in the short-term, but there too, the long-term outlook is less certain. After such an extended period of tariffs, any deal will be welcomed, but the market has been working on the assumption that a deal will be reached for quite some time. When one is announced, there will inevitably be an initial positive effect, but any deal involves concessions on both sides, so a “buy the rumor, sell the fact” dynamic would be no surprise at all.
Those consideration may well be partly why, despite the good news, the yield curve remains either flat or inverted, depending on which time periods you are looking at. That is typically a sign of trouble ahead, although once again, it is a long-term rather than immediate concern. In the past, when inversion has preceded a recession, it has been by 9-24 months and if that were to be the case this time, we can go a lot higher before we see any reversal in stocks.
I don’t want to sound too negative, however. The fact is that U.S. corporations are once again showing that they can adapt to changing conditions and can maximize profits, even when sales are a little weaker than in the past. That and the feeling that there is an end in sight to the trade war will support stocks for quite some time, and with the psychological barrier of the all-time high being broken, we could see significant gains in the near future.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.