Over the past couple of months – I’ve been trying to reconcile the following: (i) can the market achieve 12% EPS growth; and in parallel; (ii) see the Fed cut rates 5 or 6 times this year? I ask this question as that’s what the market is pricing in. It feels like a contradiction. Can we achieve both? For example, if the Fed is forced to cut rates aggressively – what does that tell us about the health of the economy? I would assume it signals an economy in need of emergency assistance.
Where Do We Go From Here?
Major averages pulled back this week on fears rates could remain higher for longer. Makes sense – with the US 10-year above 4.25% – that’s a reasonable assumption. But here’s the thing: get used to it. Whilst rates might feel ‘tighter’… rates are still not historically high. Not even close. What was not normal was rates being artificially suppressed to near zero for 15 years. And that might prove to be a difficult adjustment for some people. So where to from here? The honest answer is none of us know. What follows are some of the assumptions being made; and perhaps gaps in the market’s thinking… it starts by asking quality questions.
Half Way Through Earnings: 81% Beat on EPS
This week was the busiest week of earnings on the calendar. Half of all S&P 500 companies have now reported for Q2. So far so good! 81% of companies have beaten earnings per share (EPS) expectations – by an average of about 6.4%. By way of comparison – prior to COVID – the average EPS beat was in the realm of ~3%. What’s more, about 64% of all companies have also beaten top line expectations. The question is will this continue in the second half?
Fed Minutes Suggest More Hikes
Today the Fed released this statement from their latest minutes “The economy was facing headwinds from tighter credit conditions, including higher interest rates, for households and businesses, which would likely weigh on economic activity, hiring, and inflation, although the extent of these effect remained uncertain”. But here’s the thing: the market could be underestimating how long the lag effect is. Typically it’s between 12 and 24 months. However, with an extra $2+ Trillion in (perhaps wasteful) government handouts, that has softened the blow dealt from higher rates. But make no mistake – the lag effects from 500 bps of tightening will come – it’s just longer than expected.
For a full list of posts from 2017…