A week of crosswinds for stocks

Monday, 28th January 2019 16:34 - by Shant

While the macroeconomic backdrop will hinge significantly on the FOMC meeting this week, we have a number of earnings announcements released this week, which will serve to give the market a much greater insight into the sectoral performance as well as the well being of the real economy.  While the range of national data is showing a healthy economy on balance, there are signs that the pace of activity in the US has slowed down, with the pass-through of stimulus effects also a key measure in the outlook going forward.  

So far this morning, Caterpillar has reported a miss on their projected EPS of $2.99, coming in at $2.55, but revenue was closer to estimates at $14.3bln vs $14.36bln.  Their outlook on 2019 remains optimistic, however, though the market reaction suggests a degree of concern.  China is a major customer of the construction equipment maker and lower demand through Q4 of last year had a clear impact on bottom line profits.  Due to broader worries over a Chinese economic slowdown, this release could serve as a benchmark for the prospects for global growth and it is fair to say that the early signs are not encouraging.  

Looking ahead, the big name on the schedule tomorrow is Apple, and with demand from China again pointing to likely disappointment, equity markets are expected to remain downbeat after the results from Caterpillar and the key factor behind soft underbelly in the results.  

We also look to Amazon, Microsoft, and AT&T as major indicators on consumer demand in the US, and as noted above, tax cuts have now largely passed through.  Focus on the employment report - the latest of which comes at the end of this week - therefore takes on an added significance, in what has been an otherwise positive component in data reflecting strong economic performance over the last year.  As some may remember, I have been advocating a stronger reliance on differentiation in what has largely been a passive approach to investing in risk assets.  

This brings us onto the topic at hand, and arguably the biggest event risk this week - the FOMC meeting.  On Friday, a WSJ article suggested the Fed is ready to end its quantitative tightening program, where it has allowed maturing bonds to roll off without reinvestment.  This has played a significant part in the price adjustment in equities, which also received a jolt when long-end Treasury yields somewhat pushed stock market resilience to its limits.  In October-November last year we saw the benchmark 10yr Note hitting 3.25% and coming back hard in response to the reaction in the US equity indices.  This came about amid the backdrop of balance sheet reduction, which has been (ever so) slowly soaking up the mass of liquidity emanating from the series of bond buying programs amounted to some $4.5trln of assets, which ended in 2014.  

Now that the sensitivity to rate increases has been clearly defined, the Fed will no doubt consider the pace of balance sheet runoff as a further measure to try and stabilise the markets which as of Monday's price action, looks in need of some supportive measures.  We are now beyond the question of whether the Fed can hike in the current climate, and now more on whether stock market valuations can stand up on their own merits.  This is where the earnings season will have a much greater bearing on the indices as a whole.  Even if the Fed does end the QT measures early may be a case of too little too late.  If indeed stock markets are now ever more vulnerable to the factors affecting global growth remain to be seen, this week will also dictate whether looser financial conditions can actually save their fate.  Based on what we have seen in the aftermath of the Caterpillar results, we look set for an unstable week at best and by Wednesday evening, Fed chair Powell and the committee may have to be reactive more than anything else.