Making hay while the sun shines

Throughout the weeks of warm weather, the phrase most used seemed to be “This is great, but it won’t last forever…” And they were right – the weather naturally returned to a colder and wetter snap, although there is talk of us seeing some more sun in September.

However, while the sensation might be similar to conversations about stock markets, the accompanying behaviours are quite different. Another day of sun and warmth is greeted with plans as to how to make the most of the weather. Notably absent (at least in my experience), are suggestions that we should get inside and layer up NOW because, at some point, it will get cold again.

Yet, in the equity markets, that’s the prevailing mood. Every gain in the S&P 500 is greeted by a sort of gloomy acknowledgement of success, followed by a reminder that markets will fall eventually, and this sort of thing can’t go on forever. These views are often highlighted as part of a legacy of the Financial Crisis with investors remaining nervous and afraid. It’s as if one extremely cold winter ten years ago is still keeping us from fully enjoying the sun, and we descend into a panic every time it goes behind a cloud.

7IM continues to believe though that there are a number of reasons to believe that we aren’t about to enter into a bleaker period – if only for equity markets.

Our first reason is a familiar one. Companies are still making money – particularly in the United States. The results period for the second quarter of 2018 has lent unambiguous support for this view. Reported earnings in the US have been on average 25% higher than the same period in 2017. In addition, (and which is possibly more important), sales growth is nearly 10% higher than in 2017. This is significant, as the reported sales figure is less susceptible to artificial inflation from one-off events, such as the tax cuts – it is largely just a reflection of how many units of product or service a company is managing to shift in any given period. So, bluntly, customers are buying more things, and we see similar strong sales figures around the rest of the world. Historically, that’s been a reasonably solid grounding for equity markets to continue to rise in the medium term.

Our other reason is that these earnings and sales figures continue to surprise in a positive way, despite analysts doing their best to revise their estimates higher and play catch up. This is true across every sector in the US, whether tech, energy or consumer (unless of course Amazon has just taken aim at your business…). In fact, nearly 80% of businesses in the US have exceeded analysts’ forecasts this quarter. Really, this is close to an ideal situation – expecting things to turn out well, and having them turn out picture-perfect is very good for confidence, and in the short term, equity markets need confidence.

Of course, all good things eventually come to an end – we certainly aren’t suggesting that the sun will shine on investors forever. Ultimately, expectations will go too far, and the reality will fall too short. At the minute though, we seem to be some way off from the state of euphoria that prompts this kind of overshoot. What could change that? Another few earnings seasons such as this one, coupled with a disappearance of the worries about trade wars could be such a catalyst – although that seems somewhat unlikely at the moment.

An occasionally erratic grind higher for risk assets, propelled by fundamentals, in the face of geopolitical tensions is a reasonably good base case for the next few months. After that? We’ll have to assess the weather forecast, and see whether we should be preparing portfolios for an Indian summer, a gentle autumn or a long winter. The multi asset wardrobe should have enough clothes for any and all of these – in the meantime, enjoy any sun!

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