Happiness = Reality – Expectations

In the short to intermediate term, financial markets are directed by much the same formula: Market Direction equals Actual Results minus Consensus Expectations. The market closed at all-time highs this week as reality has exceeded expectations.

As of two weeks ago, we expected overall earnings for S&P 500 companies to decline over 3% in the second quarter, but the low bar could set up for positive for stock reactions. According to Factset, 44% of the companies in the S&P 500 have reported actual results for Q2 2019. 77% of companies reported actual earnings per share (EPS) above estimates. In aggregate, companies are reporting earnings that are 5.4% above their estimates. Sales figures are also coming in 1.2% above expectations.

Earnings are lower year-over-year, and revenue is set to grow at the slowest rate since Q3 2016. But it is not as bad as expected and stocks are responding accordingly. The companies in Haverford’s portfolios have also fared quite well so far this earnings season. From technology to consumer, results have been strong. But we are seeing weakness in sectors most exposed to trade (i.e Industrials and Materials.) According to Factset, companies with more than 50% of their sales in the U.S. have reported earnings growth of 3.2%, while companies with less than 50% domestic revenues have reported earnings decline of 13.6%.

Preliminary 2Q Gross Domestic Production (GDP) also exceeded expectations on Friday, 7/26 – growth of 2.1% vs. 1.8%, down from the Q1 growth of 3.1%. Consumption growth accelerated to 4.3%, from 1.1% in the prior quarter, while business investment declined by 0.6% as non-residential investment contracted by 10.6%. The strong consumption number aligns with the results coming out of companies these last couple weeks, with Starbucks and McDonalds reporting same store sales growth above 6% driven by strong pricing and mix benefits.

The budget deal, approved by the House of Representatives this past week, also exceeded our expectations of a more contentious partisan brawl. We are of two minds to say we find it refreshing that Republicans and Democrats have finally agreed on something – government spending should have no limit.

A true test of expectations will come this week when the Federal Open Market Committee (FOMC) is widely expected to announce a 25 basis point rate cut. Global central banks continue to signal the move towards easing as the global economy slows. Last Thursday, the European Central Bank (ECB) met expectations, with rates left unchanged and Mario Draghi laying the groundwork for rate cuts and a new round of asset purchases. If the Fed announces 25 bps cut as expected, speculation will immediately turn to what’s next. At Haverford, we currently expect a second 25 bps cut by year-end, likely at the September meeting.