Corporate Earnings and Margins Holding Relatively Firm…For Now
Sources: Sources for data in tables: Equity Market and Fixed Income returns are from JP Morgan as of 08/30/19. Rates and Economic Calendar Data from Bloomberg as of 08/30/19. International developed markets measured by the MSCI EAFE Index, emerging markets measured by the MSCI EM Index. Sector performance is measured using GICS methodology.
Global capital markets were mostly higher for the week as investors enjoyed a lull in the U.S./China trade saga. In the U.S., the S&P 500 Index propelled to a level of 2926, representing a gain of 2.83%, while the Russell Midcap Index increased 2.44% for the week. The Russell 2000 Index, a measure of the Nation’s smallest publicly traded firms, did not disappoint, swelling 2.46%. On the international equities front, developed markets moved 0.91% higher, while emerging markets followed suit growing 1.16%. Finally, the 10 year U.S. Treasury yield continued to give-up ground, finishing out the week at just 1.50%.
As the economy continues to show signs of “Slowing but Growing”, investors are naturally paying more attention to the bottom-line, corporate earnings and profit margins. We’ve discussed the importance of corporate earnings and profit margins to stock investors at length in the past as it is our general, overarching view that any appreciation in stock price should be considered pure speculation if that appreciation isn’t underpinned by positive earnings or an encouraging trend toward positive earnings.
On a year-over-year basis, net profit margin has steadily increased,peaking at 10.20% in 2018, and currently sitting slightly lower at 10.18%. If investors hope to see further stock market appreciation at this point in the cycle, the net profit figure must hold relatively firm, and for that to happen corporations must put their efforts not only into trying to further grow their earnings (which may prove challenging at this late state in the current economic expansion) but also into controlling costs.
The following chart highlights the three key expenses incurred by constituents of the S&P 500 (corporations): Corporate taxes, interest payments, and employee compensation.
You’ll notice that employee compensation has gradually moved higher, as it’s expected to do throughout an economic recovery. This has led to increased consumption, which has prolonged this economic expansion. You’ll also notice that this steady increase in employee compensation hasn’t led to a contraction in profit margins because it’s been balanced by lower interest and tax expenses. If this trend were to continue, and we currently believe that it should, it is reasonable to expect U.S. equities to experience some degree of upward movement.
Of course, markets don’t also move according to plan which is why we encourage investors to stay disciplined and work with experienced financial professionals to help manage their portfolios through various market cycles within an appropriately diversified framework that is consistent with their objectives, time-frame, and tolerance for risk.
Investing in foreign securities presents certain risks not associated with domestic investments, such as currency fluctuation, political and economic instability, and different accounting standards. This may result in greater share price volatility. These risks are heightened in emerging markets.
There are special risks associated with an investment in real estate, including credit risk, interest rate fluctuations and the impact of varied economic conditions. Distributions from REIT investments are taxed at the owner’s tax bracket.
The prices of small company and mid cap stocks are generally more volatile than large company stocks. They often involve higher risks because smaller companies may lack the management expertise, financial resources, product diversification and competitive strengths to endure adverse economic conditions.
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Products that invest in commodities may employ more complex strategies which may expose investors to additional risks.
Investing in fixed income securities involves certain risks such as market risk if sold prior to maturity and credit risk especially if investing in high yield bonds, which have lower ratings and are subject to greater volatility. All fixed income investments may be worth less than original cost upon redemption or maturity. Bond Prices fluctuate inversely to changes in interest rates. Therefore, a general rise in interest rates can result in the decline of the value of your investment.
MSCI- EAFE: The Morgan Stanley Capital International Europe, Australasia and Far East Index, a free float-adjusted market capitalization index that is designed to measure developed-market equity performance, excluding the United States and Canada.
MSCI-Emerging Markets: The Morgan Stanley Capital International Emerging Market Index, is a free float-adjusted market capitalization index that is designed to measure the performance of global emerging markets of about 25 emerging economies.
Russell 3000: The Russell 3000 measures the performance of the 3000 largest US companies based on total market capitalization and represents about 98% of the investible US Equity market.
ML BOFA US Corp Mstr [Merill Lynch US Corporate Master]: The Merrill Lynch Corporate Master Market Index is a statistical composite tracking the performance of the entire US corporate bond market over time.
ML Muni Master [Merill Lynch US Corporate Master]: The Merrill Lynch Municipal Bond Master Index is a broad measure of the municipal fixed income market.
Investors cannot directly purchase any index.
LIBOR, London Interbank Offered Rate, is the rate of interest at which banks offer to lend money to one another in the wholesale money markets in London.
The Dow Jones Industrial Average is an unweighted index of 30 “blue-chip” industrial U.S. stocks.
The S&P Midcap 400 Index is a capitalization-weighted index measuring the performance of the mid-range sector of the U.S. stock market, and represents approximately 7% of the total market value of U.S. equities. Companies in the Index fall between S&P 500 Index and the S&P SmallCap 600 Index in size: between $1-4 billion.
DJ Equity REIT Index represents all publicly traded real estate investment trusts in the Dow Jones U.S. stock universe classified as Equity REITs according to the S&P Dow Jones Indices REIT Industry Classification Hierarchy. These companies are REITs that primarily own and operate income-producing real estate.