We recently hosted a video call to share our latest thinking about the markets globally and to take questions from our audience. Moderated by Chief Investment Officer Craig Metrick, the team shared our outlook for equities (Michael Geraghty), fixed income (Shahnawaz Malik) and alternatives (Jennifer Leonard).

We also had the pleasure of welcoming Larry Hatheway for this call. Larry is co-founder of Jackson Hole Economics, an ‘action tank’ designed to “provide context for the world we inhabit.” Prior to this new initiative, Larry was Group Chief Economist and Global Head of Investment Solutions at GAM Investments from 2015-19. This position followed more than 20 years at UBS Investment Bank serving in roles such as Chief Economist, Head of Global Asset Allocation, and Global Head of Fixed Income and Currency Strategy.

Larry’s macro backdrop set the scene for our dialogue, focusing on the impact of the pandemic-driven economic downturn on GDP both domestically and abroad, the hurdles to overcome in a recovery, and the longer-term risk posed by mounting debt.

Read our Quarterly Update and Outlook here.

Third Quarter 2020 Executive Summary:

Download Cornerstone’s Third Quarter 2020 Market Update and Outlook

Please join us on Tuesday August 4 at 11 am ET to join a panel discussion on our outlook in this uncertain environment. Chief Investment Officer Craig Metrick, CAIA, and Market Strategist Michael Geraghty will be joined by Larry Hatheway of Jackson Hole Economics. Larry will bring his 25+ years of experience as a strategist and economist, and now as leader of a “think/action tank”, Larry will share his insights. Register for our Market Outlook Webinar here.

 

The COVID-19 pandemic and the corresponding uncertainty in the financial markets necessitate a different approach to our Quarterly Market Update and Outlook. Importantly, COVID-19 is a health issue first and an economic issue second. In this report we highlight:

In Cornerstone’s view, following these principles will reward the long-term investor.

While we expect more evidence to emerge, we cite a few examples here that underscore the importance of investing with an impact lens:

Download Quarter Market Update and Outlook, Second Quarter 2020.

 

[1] https://www.npr.org/2020/04/09/831174878/racial-disparities-in-covid-19-impact-emerge-as-data-is-slowly-released

[2] https://www.aamc.org/news-insights/new-coronavirus-affects-us-all-some-groups-may-suffer-more

There has been tremendous volatility in the price of most asset classes since the onset of the coronavirus-related financial crisis.  That includes the price of sustainable equity funds.  Given that much of the growth of sustainable investing has taken place in the past five years, many environmental, social, and governance (ESG) strategies have experienced relatively few periods of market volatility.  What can we expect in terms of the performance of ESG funds in this period of extreme volatility?

The Benefits of ESG Discipline in Times of Market Volatility

In theory, the performance of ESG funds should hold up well in times of market volatility.  At the company level, the managers of a sustainable business will likely have given plenty of thought to contingencies.  They will focus on risk issues and make business continuity plans.  While even the best-governed companies likely wouldn’t have prepared sufficiently for a pandemic of this scale, they are still in a relatively strong position to act decisively given their strong leadership.

Risk management is an important factor at the portfolio level, and here too ESG provides an edge.  When the CFA Institute conducted a survey[1] of portfolio managers and asked, “why do you take ESG issues into consideration in your investment analysis/decisions?” the vast majority replied, “to help manage investment risks.”

In addition, many ESG funds completely avoid or limit their exposure to fossil fuels and other industries heavily reliant on oil and gas (e.g., airlines and cruise ships), which has insulated them from the recent volatility associated with the collapse in the price of oil.

ESG and Market Volatility: Some Studies

There have been several studies of the performance of ESG funds in times of market volatility.

Conclusion

The evidence strongly suggests that ESG funds are performing relatively well during the current period of market volatility, and this is consistent with their performance in prior periods of volatility. As Cornerstone’s CEO Erika Karp notes, “In the final analysis, when considering ESG factors, ‘Governance’ is first among equals.  It is a proxy for quality, a proxy for innovation, and a proxy for resilience. In times of volatility, when there is a vacuum of information, those companies that consistently embrace their principles, their workforces, and their unique competitive advantages will outperform.”

[1] https://www.cfainstitute.org/-/media/documents/survey/esg-survey-report-2017.ashx

[2] https://www.morningstar.com/articles/976361/sustainable-funds-weather-the-first-quarter-better-than-conventional-funds

[3] https://www.fundfire.com/c/2691413/328003

[4] https://www.bloomberg.com/news/articles/2020-03-13/older-esg-funds-outperform-their-newer-rivals-in-market-tumult?sref=wINQCNXe

[5] https://fortune.com/2018/08/22/stocks-esg-arabesque-ti-cummins/

[6] https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2555863

On March 19, 2020, Cornerstone Capital Group held a conference call addressing concerns about the current coronavirus pandemic and its impact on the markets, the economy, and importantly, the changes in how we think about the infrastructure of our society over the longer term. Cornerstone’s Erika Karp, Craig Metrick and Michael Geraghty were joined by two equity managers on the Cornerstone platform: Cathie Wood of Ark Investment Management, and Garvin Jabusch of Green Alpha Advisors. The full call replay can be accessed here.

Managing Portfolio Risk Through Integrated Analysis

The participants on the call focused on the benefits of integrating environmental, social and governance (ESG) factors into the investment process in an effort to de-risk long term portfolios and identify critical growth opportunities.  Both Ark and Green Alpha look at multiple risk factors at a systemic level to minimize exposure to threats such as climate change. This extends to investing in methods to address risk — such as pandemic crisis. In their view, by focusing on innovation and the future while considering all stakeholders instead of only shareholders, investors may experience better long-term returns with lower volatility.

Kicking off the discussion, Erika highlighted that “sustainable investing is a proxy for quality. It’s a proxy for innovation and a proxy for resilience. And that is precisely what we need right now.” She asked whether, when we emerge from this current crisis, we would be forever changed:

“We have to think about issues like distance learning, telecommuting, distributed health systems. We have to think about supply chain logistics. We have to think about surge capacity. We have to think about virtual entertainment, emergency service centralization, obviously food safety, water quality, hygiene standards. We have to think about mental health provision. We have to think more proactively and in an innovative way about investing. Going forward to attack these challenges, we remind everyone that impact and sustainable investing is just investing.  But a more conscious, predictive way to invest.  Impact investing is the new cornerstone of capitalism.”

Michael Geraghty, Cornerstone’s market strategist, discussed the volatility of the markets under the current coronavirus situation. He doesn’t believe the markets will stabilize until the virus is either contained or a vaccination is developed and made available to the public. Michael notes, however, that this is a short-term shock to the system and not a structural one. That’s not to say that this pandemic won’t have a profound effect on the economy or the markets near term.  The consumer accounts for 70% of U.S. Gross Domestic Product (GDP). If consumers are staying home and hunkering down, a cut in rates by the Federal Reserve and a payroll tax cut by the Federal government won’t have a strong impact on consumer behavior.

Craig Metrick noted that Cornerstone focuses on long term investment objectives while creating an investment plan which is designed to achieve social and environmental impact. He then interviewed Cathie and Garvin as to their views on the longer-term implications of the current crisis.

Investing in Disruptive Innovation and Strong Governance

Ark Investment Management focuses on investing in disruptive innovation over a five-year time frame.  Its five core themes are: DNA sequencing, robotics, artificial intelligence, energy storage and blockchain technologies. Cathie Wood noted that the companies her firm invest in are not typically in any indices. Other managers are selling these names while buying names in the indices, such as the S&P 500, giving firms like hers an opportunity to buy these innovative company stocks at lower valuations. Over the long haul, she believes these investments should outperform older economy names that still dominate the indices.

Garvin Jabusch noted that a recession is already priced into the markets and his firm is looking for companies that will perform well out of the downturn.  Bottom-up analysis is key, in his view. He looks for companies that are good stewards of capital, are innovative and create solutions that will make the economy more productive. Green Alpha is a long term buy and hold manager. The firm focuses on innovative companies that can help de-risk the economy such as those engaged in decarbonization, biotech and electrification.

Summing up the discussion, which included a very lively Q&A, Erika noted: “When it comes to ESG analysis, the “G,” governance, is first among equals. Because if we’re talking about a well-governed company, then by definition it is looking at environmental and social issues. And if a company is not looking at environmental and social issues, it is by definition not well-governed. It’s tautological.”

Ark Investment Management and Green Alpha are two of the strategies included in the Cornerstone Capital Access Impact Fund. Click the link to view standardized performance and the Fund’s top ten holdings:  https://cornerstonecapitalfunds.com/quarterly-commentary

You should carefully consider the investment objectives, risks, and charges and expenses of the Fund before investing. The prospectus contains this and other information about the Fund, and it should be read carefully before investing. You may obtain a copy of the prospectus by calling 800.986.6187. The Fund is distributed by Ultimus Fund Distributors, LLC. Cornerstone Capital Group is the adviser to the Fund. Investing involves risk, including loss of principal. Applying ESG and sustainability criteria to the investment process may exclude securities of certain issuers for both investment and non-investment reasons and therefore the Fund may forgo some market opportunities available to funds that do not use ESG or sustainability criteria. Securities of companies with certain focused ESG practices may shift into and out of favor depending on market and economic conditions, and the Fund’s performance may at times be better or worse than the performance of funds that do not use ESG or sustainability criteria.

9827671-UFD-3/23/2020

COVID-19, more commonly known as the coronavirus, emerged in late 2019.  It was first identified in Wuhan, the capital of Hubei, China.  Infection is primarily through human-to-human transmission via exhalation, such as sneezing or coughing.  Symptoms may include flu-like symptoms, such as fever, coughing, breathing difficulties, fatigue, and muscle pain.  No vaccine currently exists.  Thus far, the fatality rate has been estimated at around 2–3% of cases, with older people particularly vulnerable.

In this note we assess the coronavirus in terms of its impact on humans, economic activity, corporations, and financial markets.

Coronavirus: The Human Impact

Thus far there have been close to 3,000 deaths caused by the coronavirus — the majority of those in China — in addition to around 80,000 officially recorded cases globally.  Worryingly, pockets of the virus have popped up in a range of geographically dispersed countries, most notably Japan, Italy, Iran and South Korea.  As of now, some of the infections in those countries have no known connection to China.  The World Health Organization (WHO) has said the increase in the number of cases in Italy, Iran and South Korea is “deeply concerning.”  However, the WHO has not yet declared the spread of the virus to be a pandemic, which is defined as an uncontrollable geographical spread.

Restriction of movement is the primary method authorities are using to control the spread of the virus.  In China, tens of millions of people are under some form of quarantine, curfew, or lockdown.  Italy’s government recently imposed a lockdown on an area of 50,000 people near Milan, which is the epicenter of the virus in Italy.  It has been reported that South Korean officials are drawing up plans for a quarantine in affected areas.

Coronavirus: The Economic Impact

Quarantines, curfews, and lockdowns don’t just impact day-to-day activities, they also limit the number of workers able to get to work.  So, for example, reflecting restrictions in China, Bloomberg Economics has estimated that the country’s economy is running at just 50-60% of its normal capacity.  That was underscored by the fact that domestic car sales plunged by 92% in the first half of February.

The coronavirus outbreak in Italy centered around Milan is threatening to shut down the richest segment of the economy.  Milan alone accounts for 10% of the Italian economy, and the Lombardy region more than double that.  The New York Times recently reported that “Milan is not a closed city, but it is a drastically slowed one, after a spike of cases in the region, raising anxiety about a broader slowdown.”

Coronavirus: The Corporate Impact

The day after President’s Day, Apple warned it would not meet its first quarter 2020 revenue guidance because of the effects of the coronavirus.  The company pointed to demand and supply issues in China.  On the demand side, all its retail stores were closed at some point, although some are now open.  The stores that have reopened are operating in a limited way, and with very low customer traffic.  On the supply side, Apple said all its manufacturing facilities have reopened in China but were “ramping up more slowly than we had anticipated,” leading to iPhone supply shortages.

Supply chain disruptions because of the coronavirus in China have been impacting companies across the globe.  China is a supplier of key components essential to a range of industries, particularly electronics and automobiles.  However, as noted above, it’s estimated that China’s economy is only running at 50‑60% of its normal capacity.

It’s likely that supply-chain disruptions associated with past crises — such as the 2003 outbreak of severe acute respiratory syndrome (SARS) that swept across Asia, or the 2011 Fukushima nuclear disaster — are not good benchmarks for the current epidemic.  For a start, today’s supply chains are global and more complex than they were in 2003, which was before China established itself as a manufacturing powerhouse.  And during that period China’s growth represented a much smaller portion of global GDP growth than it does now.  Second, the Fukushima nuclear disaster greatly impacted the global supply chain for auto parts, but not many other sectors were affected.  Moreover, the damage to the supply chain was relatively short term.

In terms of market reaction to these events, in the six months after the first occurrence of SARS, the S&P 500 posted a gain of 15% (using April 2003 as a base); after 12 months, it was up 21%.  In 2011, the year of the Fukushima nuclear disaster, the S&P 500 ended flat for the year.

For the moment, U.S. corporations remain sanguine.  A recent Bloomberg study of corporate transcripts of S&P 500 companies revealed that about half said it was too early to gauge how the virus might play out, about a third said the virus would have some impact, and only 5% anticipated a severe blow from the virus.

Coronavirus: The Financial Markets Impact

Financial markets dislike uncertainty.  So far, the cases of the virus in the U.S. have all been traceable to overseas travel.  However, if cases not linked to travel start to emerge, that could lead to quarantines in the U.S., business shutdowns, and negative earnings estimate revisions.  These factors would undoubtedly weigh on financial markets.  Even with the recent selloff, U.S. stocks still remain at the high end of the historical range in terms of valuations.

At this time Cornerstone is not recommending tactical shifts in asset allocation resulting from the virus, because it’s still too early to gauge the impact.  However, we are closely monitoring potential economic impacts related to the spread of the virus.

 

 

 

 

The combination of (i) a phase one trade agreement with China, (ii) the enactment of the USMCA trade agreement, (iii) an accommodative Fed, and (iv) possible fiscal stimulus ahead of the 2020 election has the potential to boost U.S. growth.

Has global economic growth troughed? Signs of a possible rebound in global economic activity include improvements in global Purchasing Managers Indices, as well as increases in the prices of copper and oil. Around half the earnings of the S&P 500 companies come from overseas.

Have net earnings estimate revisions troughed? There has been a sharp improvement in net earnings estimate revisions by analysts for the S&P 500 companies.

Although stocks will likely provide more muted gains in 2020, equities will probably offer the best returns among major asset classes. That said, a real shooting war with Iran would drastically change the outlook.

Read our full report: First Quarter 2020 Market Update and Outlook.

Global GDP growth continues to slow, with trade and tariff issues being a major contributory factor. The deteriorating macroeconomic outlook has been impacting investors’ decisions. The prices of perceived “safe haven” assets, such as gold and government-issued securities, have soared in recent months. The dollar, which is often perceived as a “global fear index,” has also been strong.

Stock prices have remained resilient. Even in an environment of falling earnings estimates (which are declining at a much faster rate than the historical average), equities remain close to record highs.

There are many moving parts in the fixed income outlook. The yield curve is still inverted. Inflation remains stubbornly low. The Fed’s policy course is not entirely clear.

For investors, the current environment presents challenges. A large over- or underweight in equities or fixed income seems risky.

Download our Quarterly Market Update and Outlook for Q4 2019.

Global central banks have been key to supporting financial markets. The stimulus has offset weak economic growth and a poor corporate earnings environment. There is no reason to believe this monetary stimulus will end any time soon.

To be sure, there are risks. U.S. equity valuations are above historical average levels. The U.S. is engaged in tense trade negotiations with several countries (China, Mexico, Canada) and with the European Union; the focus of the U.S. could extend to other countries, e.g. Vietnam. A number of geopolitical issues also have the potential to worry investors, e.g. U.S. – Iran.

It remains to be seen how much longer expanding price to earnings multiples can offset falling earnings estimates, especially with the uncertainties outlined above. Net-net, it seems that U.S. stocks could stay at current levels or move a bit higher, but risks likely remain on the downside.

Bond yields seem likely to remain low. Unexpected economic weakness could be a catalyst to drive yields lower.

Download the full report here.

With the U.S. yield curve not far from inversion, global GDP growth slowing, and earnings estimates continuing to decline, it seems the risks to stocks are on the downside from current levels.  Progress on trade issues could give a boost to P/E multiples, although that would likely be short-lived if earnings estimates continue to fall.

In fixed income markets, a scenario where long yields move materially higher would likely involve a significant acceleration in economic growth and / or a shift to tightening by the Fed, with neither of these scenarios seeming likely any time soon.

In summary, the equity and fixed income markets are likely to be range-bound, with further data on the direction of the U.S. and global economies likely to move markets above and below current levels, although without a strong trend in either direction unless the data prove to be surprisingly weak or surprisingly strong.

Download our full report here.

Contents: 

Strategic Outlook …p. 2

Equity Outlook …p. 6

Fixed Income Outlook …p. 9

Alternatives/Commodities Outlook … p. 12

Tactical Asset Allocation…p. 14

Market and Global Sector Performance…p. 15

Key Economic Indicators…p. 17

In our last Quarterly Market Update and Outlook, we noted that “volatility in the capital markets was even more muted in the third quarter than it was in the prior quarter.”  The fourth quarter turned out to be markedly different.

It’s likely that the extreme volatility in the fourth quarter was driven by two factors occurring at the same time:

S&P 500 profit growth had been forecast to slow considerably in 2019, given tough comparisons (S&P 500 EPS growth increased an estimated 26% in 2018), and the benefits of the tax cuts wearing off for corporations and consumers.  More recently, however, estimate downgrades by companies including Apple and Fedex have highlighted the uncertainty about the 2019 outlook reflecting, in large part, the fragile state of the global economy.

At the same time, political issues have pressured P/E multiples, with the P/E of the S&P 500 (trailing EPS) plummeting from 22x in January to 16x in December.  Some of the issues likely behind that multiple contraction:

It likely that volatility in the equity market will continue in 2019, at least until investors become more comfortable with the outlook for 2019 earnings growth, and some of the macro concerns are alleviated.

Download our full report here.

Contents:

Strategy Overview…p. 2

Equities: Strong Headwinds in 2019…p. 6

Fixed Income: Yields Likely Range-Bound…p. 9

Alternative Assets: Caution Warranted… p. 11

Tactical Asset Allocation…p. 13

Market and Global Sector Performance…p. 14

Key Economic Indicators…p. 16

Summary: Tough Comparisons in 2019

2019 is shaping up to be a more challenging year for investors than 2018:

Overall, U.S. equities will likely post a single-digit gain in 2019, while bond prices will likely continue to move lower, although more bearish scenarios for both asset classes cannot be ruled out.

Download our fourth quarter outlook and update here.

Contents:

Asset Allocation: Strategic Outlook …p.2

Equity Outlook …p. 6

Fixed Income Outlook … p. 9

Alternatives/Commodities Outlook … p. 12

Tactical Asset Allocation…p.14

Market and Global Sector Performance…p. 15

Key Economic Indicators…17

Executive Summary

Access our full report here.

 

Summary: Strengthening Headwinds

While the global economic environment remains relatively healthy, strengthening headwinds that are largely policy-driven are creating challenges for major asset classes.  Governments in the U.S., Canada, Europe and China, among others, are engaged in trade hostilities.  Central banks are either tightening monetary policies, as in the U.S., or becoming less accommodative, as in Europe.

Overall, U.S. equities will likely post single-digit gains in H2 2018, while bond prices will likely trade in a range, although it may be a bumpy ride for both asset classes.

Download our third quarter update and outlook here.

Contents:

Asset Allocation: Strategic Outlook … p. 2

Equity Outlook —  Increasingly Challenging … p. 5

Fixed Income Outlook — Inversion Angst … p. 8

Alternatives/Commodities Outlook — Rangebound … p. 11

Tactical Asset Allocation … p. 13

Market and Global Sector Performance … p. 14

Key Economic Indicators … p. 16

A key issue for investors is that the business cycle is moving into an increasingly mature phase.  The U.S. economy is now in its ninth year of expansion, is one of the longest periods of growth on record.  At the same time, some of the world’s most important central banks are shifting away from an extraordinarily accommodative monetary policy.  Given these factors, risks are starting to rise, and are becoming more skewed to the downside, especially given asset price gains in recent years.

There has also been a notable increase in volatility.  In the first quarter, the high-to-low range of the S&P 500 was 10% (Figure 1), while the yield on the 10-year U.S. Treasury bond declined 18 basis points in just seven trading days in late March, falling from 2.91% to 2.73% (Figure 2).

Figure 1: S&P 500 Price: 2018 Year-to-Date

Source: Bloomberg

Figure 2: Yield on 10-Year U.S. Treasury Bond: 2018 Year-to-Date

Source: Bloomberg

Volatility is likely to continue for the foreseeable future.  As we discuss below:

Earnings and Valuations

Stock price volatility has increased in 2018, and equity valuations are high by historical standards.  All the same, the U.S. equity outlook remains fundamentally sound.  Corporate profitability is exceptionally strong — nine of the 11 sectors in the S&P 500 are currently forecast to post double-digit earnings gains this year.

Political and Market Risks

In the opinion of some observers, a major exogenous risk currently is a disconnect between the political environment and the performance of financial markets, which, despite increased volatility, have been relatively resilient.  These risks include (i) trade and tariffs, (ii) heightened regulatory scrutiny of tech companies, and (iii) the ongoing Russia investigation in the U.S.

Current U.S. foreign policy has been characterized as a “Doctrine of Withdrawal.”  Observers point to the U.S. leaving the Paris climate-change accord, exiting the Trans-Pacific Partnership free-trade agreement (although this may be under review), ending American membership in UNESCO, as well as threats to withdraw from NAFTA and the Iran nuclear deal.

In addition, the U.S. has imposed tariffs on certain Chinese products.  A first wave of U.S. tariffs, focused on steel and aluminum imports, was followed by a separate 25% tariff on $50 billion of specific Chinese imports.  That sparked a retaliatory response, in which China presented its own list of products worth an equal $50 billion that will be subject to a 25% tariff.  Steel and aluminum tariffs have already gone into effect for Chinese products, as have China’s retaliatory tariffs on U.S. pork, fruit, nuts, ethanol and other products.  On top of fears about an escalating trade war, another concern is that China’s large holdings of Treasuries could be used by the Chinese government as a tool to cause disruptions in U.S. financial markets.

Separately, the key technology sector was hit by regulatory investigations into Facebook, prompted by the revelation that personal data had been improperly accessed, as well as by a salvo of tweets by the U.S. president against Amazon.

Interest Rates

Turning to the fixed income markets, a tightening of global monetary policies is expected to continue, with seven advanced economy central banks likely to raise policy rates this year, in addition to the European Central Bank (ECB).  75 basis points of hikes are expected in the U.S. and Canada, and 25 basis points each in the U.K., Norway, Sweden, New Zealand, and Australia.  Furthermore, central bank net asset purchases will likely continue to fall sharply, reflecting a gradual normalization of monetary policies after the global financial crisis of 2008-09.

International Economies

Central bank policies reflect that global growth remains solid.  For the first time since the 2007-08 financial crisis, all the world’s major economies are growing: Canada, U.S., Mexico, Brazil, U.K., Euro Area, Russia, Turkey, India, China, South Korea, Japan, Indonesia and Australia.

Cautious Outlook Amidst Volatility

The strength in global economies is a positive for equities, but will likely continue to put pressure on interest rates and, therefore, P/E multiples.  In addition, an unpredictable political environment could continue to cause volatility in asset prices.  Overall, U.S. equities will likely post gains of 5-10% in 2018 while bond prices will likely decline further (and interest rates rise), although it may be a bumpy ride for both asset classes.

In this report, which may be downloaded here:

Equity Outlook …p. 5

Fixed Income Outlook … p. 11

Alternatives/Commodities Outlook … p. 13

Tactical Asset Allocation…p.16

Market Recap…p.17

Market and Global Sector Performance…p. 18

Key Economic Indicators…20

Michael Geraghty is Executive Director, Equity Strategist for Cornerstone Capital Group.

Jennifer Leonard, CFA is Director, Asset Manager Due Diligence for Cornerstone Capital Group.

Summary

Even as stock price volatility has increased in 2018, the U.S. equity outlook remains fundamentally sound.  Strength in corporate profitability is broad-based, with nine of the eleven sectors in the S&P 500 currently forecast to post double-digit earnings gains this year.

There are risks to our outlook: potential interest rate increases; wage pressures; trade tensions; geopolitical conflicts; domestic political upheaval. We also consider risks that might arise from environmental, social or governance factors, particularly for the technology and finance sectors.

While acknowledging these risks, our 2018 equity outlook remains unchanged. We continue to believe that strength in corporate profits will offset any pressures on P/E multiples, so that stock prices are likely to end 2018 with gains of 5-10%.

Read our full analysis here.

Michael Geraghty is the Equity Strategist at Cornerstone Capital Group. He has over three decades of experience in the financial services industry.  Michael has worked as an investment strategist at a number of leading firms.  At PaineWebber (1988 – 2000), he was a Senior Vice President and member of an Institutional Investor ranked U.S. Portfolio Strategy team.  At UBS (2000 – 2003), he was an Executive Director and senior member of the global equity strategy team responsible for regional and sector allocations.  At Citi Investment Research & Analysis (2004 – 2012), Michael was the global themes strategist; Citi was ranked #1 for Thematic Research in the 2011 Extel survey.  Michael holds a Master’s degree in Economics and a Masters of Business Administration in Finance from Columbia University.

On January 26, 2018 the S&P 500 closed at a record high, and up 7% for the year to date. On February 5, the S&P 500 was down 1% for the year-to-date, reflecting a decline of 8% from its record high. Fundamentally, not much has changed. If anything, the earnings outlook has actually improved.

Download our update here.

 

Summary:

Robust Earnings Environment. The combination of favorable bottom-up factors (sales growth, margin expansion) and a solid economic environment (synchronized global growth) has created a healthy earnings environment. 2017 S&P 500 earnings growth is on track to have been the fastest since 2010.

Rising estimates. Earnings estimate upgrades have been outpacing earnings downgrades lately, in the most extended period of net estimate increases since 2010. Upward estimate revisions have been most significant in the Information Technology and Energy sectors.

U.S. Tax Reform: A Wildcard in 2018. Quite unusually, consensus estimates for 2018 S&P 500 EPS increased late in 2017; estimates typically decline steadily. Even a modest reduction in the effective corporate tax rate in 2018 could materially boost consensus estimates.

Market Outlook. A 5% increase in current 2018 EPS estimates combined with a two percentage point reduction in the P/E multiple (possibly driven by interest rate hikes) would suggest about a 10% gain in stock prices in 2018.

Figure 1: S&P 500 Operating EPS — Consensus Estimate for 2017 and 2018

Source: S&P

Download our full report here.

Michael Geraghty is the Equity Strategist at Cornerstone Capital Group. He has over three decades of experience in the financial services industry. Michael has worked as an investment strategist at a number of leading firms. At PaineWebber (1988 – 2000), he was a Senior Vice President and member of an Institutional Investor ranked U.S. Portfolio Strategy team. At UBS (2000 – 2003), he was an Executive Director and senior member of the global equity strategy team responsible for regional and sector allocations. At Citi Investment Research & Analysis (2004 – 2012), Michael was the global themes strategist; Citi was ranked #1 for Thematic Research in the 2011 Extel survey. Michael holds a Master’s degree in Economics and a Masters of Business Administration in Finance from Columbia University.

Executive Summary

Earnings Growth Set to Slow in 2018. S&P margins and earnings are now at record levels, while sales growth has accelerated in recent quarters. Likely reflecting tough comparisons, as well as anticipation of Federal Reserve interest rate hikes that could curb economic growth, the consensus expectation is for earnings growth to slow sharply in 2018.

A Risk of Earnings Disappointments. Even as profits moved to record levels, 2017 earnings expectations have continued to fall, albeit modestly, suggesting that analysts have been a little too optimistic. But, with earnings growth forecast to slow in 2018, that raises the risk of earnings disappointments if expectations remain too high.

Sector Forecasts. All sectors are currently forecast to experience earnings growth in 2018, which seems unrealistic. Energy, a key swing sector, is expected to see a 40% gain in profits, which is likely highly dependent on the direction of oil prices.

Market Outlook. Slower earnings growth and higher interest rates could well pressure stock prices in 2018, especially with valuation multiples still elevated.

ESG Matters. We have added a new section to this report, which recaps key Environmental, Social and Governance (ESG) developments during the month.

Figure 1: S&P 500 Operating EPS ̶ Consensus Estimates for 2018
Year-to-year percentage change in quarterly EPS

Source: S&P, Cornerstone Capital Group

Our full report is available here.

Michael Geraghty is the Equity Strategist for Cornerstone Capital Group. He has over three decades of experience in the financial services industry including working as an investment strategist at UBS and Citi.

 

Executive Summary

Accelerating Earnings Growth. With earnings reporting season about to begin, Q2 2017 S&P 500 operating earnings are forecast to rise 19% from year-ago levels, an acceleration from the 13% rate of growth in Q1 2017.

Stable Earnings Expectations. Consensus 2017 S&P 500 estimates have been relatively stable — in contrast to the trend in most years, in which earnings expectations are ratcheted down steadily — and have declined only 4% over the past year. A significant majority of companies have been exceeding earnings expectations.

A Decline in P/Es. Given steadily accelerating corporate profit growth, the Price to-Earnings multiple of the S&P 500 has actually declined, so that valuations are not as stretched as they were one year ago.

Revising Expectations Upward. Reflecting the highly favorable combination of accelerating profit growth and improved valuations, we are revising upward our expectations for 2017, and now expect a mid-teens gain in US stock prices, as compared to our previous expectation for a high-single-digit gain.

Figure 1:  A Declining S&P 500 P/E Multiple
Earnings Growth Has Been Exceeding Stock Price Gains

Source: S&P, Cornerstone Capital Group

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Michael Geraghty is the Equity Strategist for Cornerstone Capital Group. He has over three decades of experience in the financial services industry including working as an investment strategist at UBS and Citi.