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24 Apr 2018
Micro meets macro
The S&P 500 fell 1.3% on Tuesday. By sector, industrials (–2.8%) and materials (–2.7%) bore the brunt of the selling. But tech (–2%) was also weak. Defensive segments of the market—telecom and utilities—rose.
Ten-year Treasury yields rose only 2 basis points to finish at 3%, but this is the highest level in over four years.
What triggered it?
Some company-specific earnings results seemed to raise concerns: 3M missed revenue expectations, while Caterpillar suggested that 1Q earnings would be the high watermark for the year. A few industrials also highlighted higher raw materials costs. Separately, spending on growth initiatives was higher than expected for Alphabet.
The 10-year US Treasury yield hit 3% for the first time in over four years, perhaps raising concerns that higher interest rates will either lead to slower economic growth or make stocks less attractive relative to bonds.
What are the key takeaways?
While earnings results from a couple of large companies were slightly disappointing in the last 24 hours, overall earnings are quite strong, in the UBS Chief Investment Office's (CIO's) view. Aggregative revenues and profits are beating expectations by a larger-than-normal amount.
Forward-looking profit expectations are also solid. Both earnings and revenue estimate revisions continue to be quite robust. CIO remains very comfortable with its S&P 500 EPS growth estimates for 2018 (+16%) and 2019 (+5%).
While interest rates have risen in 2018, CIO doesn't believe 3%yield on the 10-year Treasury represents a tipping point. Valuations still favor stocks over bonds and higher interest rates have not dented growth or sentiment in housing, one of the most interest-rate-sensitive segments of the economy.
Tuesday's action may reflect frustration that solid earnings don’t seem to be enough to propel markets higher in the near term. But bear in mind that the sell-off began in early February on a hotter-than-expected inflation reading. So until investors get more comfort that inflation will not prompt the Fed to raise rates aggressively, markets may remain unsettled.
Still, CIO doesn't expect inflation to materially overshoot the Fed's target in the next several quarters. Therefore, the Fed should be able to continue to raise rates gradually, and solid earnings growth will eventually drive equities higher.
CIO is overweight equities in its tactical asset allocation and views the risk-reward for US stocks as attractive.
Thoughts on Tuesday's market performance
Gain perspective on the performance drivers behind Tuesday's market activity, as well as insights on portfolio positioning in light of the current economic environment.
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