Elections and Market Reactions

By Ketu Desai

In September, the equity markets remained robust behind strong earnings, economic fundamentals, and progress on trade negotiations. Earnings reports during the month continued to validate domestic economic strength. Most notably, retail earnings from some of the largest retailers in the country were quite strong, and a positive sign for consumer spending which makes up approximately two-thirds of GDP. Walmart for instance, had its strongest growth in more than a decade, and raised its sales and earnings guidance for the year.

Similarly, Target posted its best results in more than a decade. The CEO of Target said, “there's no doubt that, like others, we're currently benefiting from a very strong consumer environment — perhaps the strongest I've seen in my career." The consumer is not just spending income gains, as the savings rate has increased this year, indicating a more sustainable consumer environment. The market is taking notice. In recent weeks, the market rally has broadened out, many investors have been rotating out of popular tech names into various other parts of the market, most notably retail and healthcare.

The rotation underneath the market has allowed the broader market to climb to levels above what we saw in January. One of the notable differences between January's highs and currently, is in January, certain technical indicators were significantly overbought, while currently those indicators are below overbought territory. Further, with the strong earnings growth the forward P/E has actually declined since January from 18.7x to 17.9x Earnings are expected to continue to grow in 2019 by 10.5%, according to Yardeni Research.

In recent weeks the dollar has weakened, which has allowed the equity market rally to broaden out to sectors such as industrials and materials. The weaker dollar has also allowed certain international markets and commodities to stabilize. The economic data out of foreign economies has been mixed. Some of the economic data out of Europe is showing improvement, such as the Citi Economic Surprise Index climbing above the US.

Earnings growth in India continues to be strong, earnings are expected to grow 25 percent this year, and 20 percent next year. That said, the Indian Rupee hit an all-time low versus the dollar during the month. Many other emerging market currencies have also taken significant losses including in Argentina, South Africa, Turkey, and Indonesia. Data out of China has been weak, including retail sales, fixed investment spending, and industrial output. The weakness can be witnessed in the performance of the Chinese equity markets. The Chinese have taken steps to counter the weak fundamentals, such as reducing the reserve requirement ratio three times, ramping up spending and stimulus. With the mixed picture internationally, investors have continued to focus on domestic markets.

The two main risks that the markets are concerned with are trade and the shape of the yield curve. An agreement in principal with Mexico, accelerated the rally late in the month. Some investors appear to be extrapolating that a deal with Mexico will lead to a deal with China. However, that remains uncertain, as talks during the month yielded little results. We are moving closer to having $200 billion in tariffs go into effect. The market does not appear to be reflecting the second-order impact if these are put in place and remain for a while, such as supply-chain disruptions, reduced investment, and negative sentiment. September is already a historically volatile month, and this year we will not only have trade, but also the Fed will likely raise rates. The yield curve is now the flattest it's been post-crisis, with just a 20bps spread between 10s and 2s.

At the moment, the New York Fed's yield-curve based recession predictor indicates just a 13.6 percent chance of recession for the next twelve months, which is higher than its been, but not nearly at levels during prior recessions. Despite the fundamental strength, these concerns could derail this rally. Looking ahead, the market will continue to monitor economic and trade developments. The market will also turn its attention to the mid-term elections, and the potential impact on markets.


Ketu Desai is the Principal of i-squared Wealth Management Inc. (www.isquaredwealth.com), an investment management firm based in New Jersey. ketu@isquaredwealth.com