Each week, we tap the insight of Sam Stovall, Chief Investment Strategist, CFRA, for his perspective on the current market.
Q: Shares of cannabis companies have skyrocketed in recent months, most notably Tilray (
Stovall: Well, we’ve seen this recently with the cryptocurrencies, and we also had similar kinds of activities in the late-1990s with the dotcom stocks. But I think that is a fairly traditional type of investor reaction as an embryonic industry gains credibility. We now have more blue-chip companies willing to invest in cannabis companies for recreational purposes and medicinal purposes, and I think it therefore bolsters the confidence of investors who were early players in many of these stocks.
EQ: In a broader context, considering where we are on the market cycle, does this suggest that investors are willing to go further out on the risk curve?
Stovall: I don’t think you can look upon that as a good indication that it’s a signal of the top. Some people look to such indicators as a pickup in M&A activity, for example, especially if it’s purchased by overvalued shares versus cash. But because this is an industry that is relatively new, is gaining in the legislatures in states around the country and has nothing to do with the economic or stock market cycle, I think it’s more coincident that some people would be saying that these stocks are heating up toward the latter stages of this bull market.
I would tend to say that it is more industry specific, driven by its own fundamental dynamics, and not really tied too closely to the sector to which it will end up being assigned. It really is more of a pure specialty play that investors are focusing on right now.
EQ: Next week, the Fed is widely expected to hike rates once again. While expectations are still favoring a fourth hike in December, there is growing concern that the Fed will slow or perhaps even pause in 2019. Do you think this is just normal market noise, or could this be a sign that the period of investor complacency toward the Fed is nearing an end?
Stovall: I think it is more normal noise because the Fed has been very transparent with the pace as well as the magnitude of their rate increases. I think they still would like to add as many arrows to their quiver in terms of interest rate increases—so long as it will not likely throw the economy into a tailspin—so that they do have some ammunition to fight the next recession.
Our belief still is two additional rate hikes in 2018, and then possibly three rate hikes in 2019. That could bring the Fed funds rate to about 3.2% by the end of next year and put us a little closer to the more normal relationship between CPI and the Fed funds rate.
EQ: In this week’s Sector Watch, you pointed out that investors have keyed in on fundamentals, largely shrugging off the economic implications of Hurricane Florence and trade tension headwinds. With Q3 earnings season looking very promising, what are the expectations currently?
Stovall: Where they currently stand is almost a 22% year-on-year increase in operating earnings for the S&P 500. All 11 sectors are expected to post earnings gains and the cyclical sectors, like Energy, Financials and Materials, are expected to post the highest double-digit increases. Meanwhile, the more defensive groups, like Consumer Staples and Utilities, are expected to rise by the lowest amount.
I think the biggest challenge is that investors have been very used to having actual results exceed end-of-quarter estimates. We just experienced our 26th consecutive quarter in which the earnings that were reported outpaced the earnings that were expected. The average beat rate has been about 3.8 percentage points. So, I think investors are going to have a whisper number in the back of their heads telling them that not only should these stocks outperform the 22% earnings gain currently anticipated, but they probably need to do so by a nice cushion.
EQ: In terms of the trade war with China, it’s largely been viewed as gamesmanship to this point. What are some indicators or guidance that you’d be watching to see when it actually starts impacting economic growth?
Stovall: Well, to paraphrase the old joke, “How do you find out if somebody went to an Ivy League college?” The answer is, “Don’t worry. They’ll tell you.”
I think the same will apply to economic data as it relates to the trade wars. We won’t have to look very far because it will be plastered along the headlines. So, looking at cargo shipments to and from the particular markets, the decline in prices for agricultural products, and so forth, I think the financial media will be monitoring this very closely, and they’ll be smacking investors between the eyes with this data on a daily basis.
Right now, the market seems to be brushing it aside. If there is a worry, they’re focusing on the midterm elections. I think that most investors believe this is just the negotiating strategy by the President, and like the arrangement made with Mexico, because the other parties have more to lose, the belief is that there will be some sort of agreement that will come to pass before things get out of hand.