Business capital expenditures (capex) have grown solidly over the past two years after an oil-related contraction in 2015 and 2016. Part of the turnaround has been a natural rebound from those two years of slowdown, but fiscal stimulus is also playing an increasingly important role. Tax and spending packages passed in late 2017 and early 2018 have provided the economy with a $350 billion windfall that has helped raise business confidence and boost firms’ earnings, leading them to focus more on investing in their businesses for future growth [Figure 1]. Changes in tax laws have also allowed businesses to expense capital purchases, making them less expensive, and to bring their overseas profits back to the United States (known as repatriation), providing an additional lift to business spending. As a result, some measures of capex, manufacturing, and business confidence climbed to their highest levels of the business cycle in 2018.
Corporate America produced another outstanding earnings season. We expected another quarter of strong earnings growth, and corporate America delivered even more than we anticipated. Third quarter numbers were excellent, even if the boost from the new tax law is excluded, as has been the case throughout this year. Revenue and earnings upside compared with expectations was particularly impressive, making prior assertions of an earnings growth peak premature. We’re also impressed by the resilience of companies’ outlooks in the face of tariffs and ongoing trade policy uncertainty.
The U.S.-China trade dispute has carried on for about eight months, with no agreement in sight. To date, the U.S. has imposed tariffs on about $250 billion in Chinese goods, representing about half of what the U.S. imported from China last year. In turn, China has retaliated with its own tariffs on $100 billion in imported U.S. goods.
So far, the global economy has avoided a trade breakdown, as exports and imports are growing steadily for both the U.S. and China. However, small cracks are forming in the global economy due to the indirect impact of trade tensions, and leading trends show a prolonged dispute or more severe tariffs could exacerbate these effects.
In last week’s midterm election, Republicans held onto the Senate and the Democrats claimed control of the House, bringing potential gridlock to Congress. This week we discuss some investment implications, including highlighting the positive seasonal tailwinds now in place for stocks. We also discuss potential winners and losers at the sector level post-election, and some risks that the leadership change in Washington may present. Most importantly, with the election out of the way, we welcome the opportunity to focus on fundamentals, which we believe remain quite positive.
U.S. wage growth has been one of the most highly scrutinized economic trends recently. Investors watch average hourly earnings and employment cost data to gauge inflationary pressures, as wages represent up to 70% of business costs, and the Federal Reserve’s (Fed) dual mandate includes achieving stable prices.
So far, wage growth has been contained, but recent reports show wage pressures are rising. The October jobs report showed average hourly earnings grew at a 3.1% pace year over year, the first time annual growth has eclipsed 3% since April 2009. Employment Cost Index (ECI) data for the third quarter confirmed that compensation costs are growing at their fastest pace of the cycle [Figure 1].
– “It is always darkest just before the day dawneth.” –
Thomas Fuller | English theologian and historian
The quote above is better known today as “It is always the darkest just before dawn.” Well, October was one of the worst months we’ve seen in years for stocks, but we see a much brighter future. The next two months could have a nice year-end rally thanks to historically bullish seasonal patterns during midterm years and the extreme buying strength we saw last week.
Yes, there is a potential bright side to what could happen next!