Fed, Earnings Are Meaty Filling Between Slices Of Job, Price Data

The coming week looks a little like a sandwich, with the bread consisting of key inflation and jobs data and the meat coming in the middle with a host of earnings from every sector along with a Fed meeting presided over for the last time by Chair Janet Yellen.

The next sessions bring earnings from bellwether companies across almost every sector, starting with McDonald's Corporation MCD and Pfizer Inc. PFE on Tuesday; Boeing Co BA, Eli Lilly and Co LLY, AT&T Inc. T, Microsoft Corporation MSFT and Facebook Inc. FB on Wednesday; and the four “Big A’s” of Amazon.com, Inc. AMZN, Alibaba Group Holding Ltd BABA, Alphabet Inc GOOG GOOGL, and Apple Inc, AAPL on Thursday. The week ends with energy giants ExxonMobil Corporation XOM and Chevron Corporation CVX and big-pharma Merck & Co., Inc. MRK on Friday.

Let’s just say earnings data could be a bit overwhelming, probably making it hard to keep up with every bit of news. Still, the reports above are some of the most important to watch, and investors might want to consider jumping on a few of the calls to get a better sense of how things are going beyond just the numbers.

By the end of next week, we’ll be through the heaviest part of the earnings schedule and investors should have a much better sense of how the info tech, industrial, health care, energy, and consumer discretionary sectors performed in the final quarter of 2017. We already know consumer spending and business investment both boomed in Q4, something the government’s first estimate of Q4 gross domestic product (GDP) revealed on Friday (see below).

So far this earnings season, a greater percentage of companies than usual have exceeded Wall Street’s expectations, and company leaders have generally painted a sunny picture for the rest of the year amid tailwinds from tax reform and recovery abroad. The weak dollar could also be especially helpful for some of the multi-nationals reporting this week, including BA, AAPL, MSFT, and some of the energy firms. The slumping greenback could make U.S. products more attractive to consumers overseas, but that said, last week brought some rumblings on the trade front that could mean a rockier road ahead.

Namely, European Central Bank (ECB) President Mario Draghi complained that the U.S. might be trying to push down the dollar to promote its own economy, and China lashed out at the Trump administration for placing new tariffs on some goods. President Trump’s speech at Davos last week revealed an openness to trade, but arguably with more of an “America First” approach than we saw with past administrations. There also continues to be concern about the foundations of the North American Free Trade Agreement (NAFTA), which Trump has complained is unfair and again said last week the U.S. could exit. Any move by the U.S. to leave NAFTA could give certain industries, especially agriculture, a headache.

Overall, however, the markets seemed to interpret Trump’s speech as a positive, and stocks rallied in the aftermath. Both the Dow Jones Industrial Average ($DJI) and the S&P 500 (SPX) continued setting new records as the old week ended, and 10-year U.S. Treasury yields also marched toward new one-year highs above 2.66%. The strong dollar language in Trump’s speech might have given bond yields a lift despite lower than expected Q4 GDP growth, but it didn’t seem to help the dollar index much. The dollar fell against competing currencies and remained near three-year lows around 89 as the week approached an end. The weak dollar could be one reason why commodity prices — including crude oil — keep heading higher. Gold also reached new highs for its current rally last week.

We talked about the week being a sandwich with earnings representing the meat in the middle. What about the bread? On top of the meat is Monday’s Personal Consumption Expenditure (PCE) prices report for December. This is an inflation index the Fed watches very closely, and it’s been trailing other inflation monitors over the last months. In November, overall PCE prices rose just 0.2%, while core PCE rose even less at 0.1%. PCE prices were up 1.8% year-over-year, vs. 1.6% in October, while core PCE prices rose 1.5%. Remember, the Fed’s inflation goal is 2% growth in PCE prices.

It seems rather appropriate, then, that the Fed gathers on Tuesday for its next meeting, the final one with current Chair Janet Yellen. It’s certainly possible that the Fed might discuss the PCE data and issue some new thoughts on inflation after the meeting ends Wednesday, but few expect a rate move. Chances of a hike moved up just a little by the end of the week, but stayed under 5%.

Rate hike odds for the Fed’s March meeting now stand at 71%, which, if history is any guide, represents a pretty good chance for action at that time. The Fed continues to guide toward three rate hikes this year, but some economists see the rate hikes slowing in 2019, and the latest Fed “Dot Plot” shows the majority of Fed members predicting rates to level out near 3% or just above that by 2020. Remember that Yellen has spoken about a new reality in which “normal” rates won’t necessarily be as high as in the past.

The bottom slice of bread this week comes Friday with January non-farm payrolls. We’ll study this subject more as the week advances, but remember a couple of things: First, with unemployment near 20-year lows, it gets harder and harder for companies to find new workers, which means that huge jumps in monthly job gains might be less common. That’s not necessarily a bad thing, but the market might misinterpret lower job gains as bearish. Last month’s rise of 148,000 was below expectations, but perhaps people need to adjust their expectations to the current reality.

Second, the wage component grows more and more important as inflation concerns come into play. Wages rose 0.3% in December, and many economists saw that as a solid number but not necessarily high enough to put pressure on companies to pass along bigger costs to consumers. If wage growth stays at that level, it’s probably no cause for alarm. If wage growth jumps a lot more than that, however, it could send Treasury yields higher and weigh on some sectors of the stock market.

FIGURE 1: A RISING TIDE? NOT FOR ALL. While a rising tide is said to lift all boats, the strong S&P 500 (SPX) performance this year (top line of year-to-date chart above) hasn’t helped sectors like utilities (candlestick), telecom (purple line), or real estate (blue line). These so-called “defensive” sectors continue to lag. Data source: Chart source: The thinkorswim^® platform from TD Ameritrade. For illustrative purposes only. Past performance does not guarantee future results.

Did Goldilocks Pay GDP A Visit?

Arguably, you could say last Friday’s Q4 gross domestic product (GDP) report from the government fell into “Goldilocks” territory, meaning not too hot or too cold. The headline 2.6% growth estimate was a few basis points below Wall Street analysts’ expectations, and below the 3% growth of the previous two quarters. One argument, though, is that the somewhat weak reading might counter arguments about an overheating economy and push back on worries that the Fed might get more aggressive.

Underneath the headline there was a lot to like, especially on the consumer and business demand sides. As Briefing.com noted, the key takeaway from the report is that consumer spending is alive and well, rising 3.8% in Q4. That was the best reading since Q1 2015, and consumer spending makes up 70% of GDP. Another good sign: Business spending on equipment rose more than 11%.

Coffee Klatch

Looking back at Starbucks Corporation SBUX earnings last week could offer a lesson for other retailers as earnings season advances: Mainly that it’s not helpful from a stock market perspective for a retailer to miss Wall Street’s expectations in the current environment. SBUX beat on earnings per share, but missed analysts’ estimates for top-line revenue and on same store sales in the U.S. and Europe. That was a negative sign and perhaps helps explain why the stock fell steeply on Friday. Missing on top-line revenue and on same store sales overall in this type of healthy economy is very difficult to overcome right now. In this type of growing economy, a company’s stock is likely to get punished for any missed expectations.

50,000 Foot View

With nearly a month of 2018 under the market’s belt, sector performance is shaping up a little differently from what we saw in 2017. While info tech — last year’s leader by a long shot — continues to do well, some other sectors have surpassed it year-to-date. The leading sector through midday Friday was consumer discretionary, up more than 9%. That was followed by health care (up 8.4%) and financials (up 7.2%) with info tech in fourth place with a 7.1% rise. Real estate, utilities, and telecom are the only three sectors to lose ground in 2018.

So what does all this tell us? You never want to make any sweeping judgments based on a few weeks of trading, but it seems fair to say there hasn’t been much flagging of investor confidence. Three of the top-four performing sectors are traditionally among the sectors that lead during times of economic vigor, and there’s little evidence of investors abandoning their bullish stance for traditionally defensive stocks. Still, investors should keep in mind that stock valuations remain near record highs, interest rates are rising, and this bull run has been going on a very long time. Keep a close eye on your portfolio to make sure this long rally hasn’t gotten your allocations out of whack.

Information from TDA is not intended to be investment advice or construed as a recommendation or endorsement of any particular investment or investment strategy, and is for illustrative purposes only. Be sure to understand all risks involved with each strategy, including commission costs, before attempting to place any trade.