During October, the S&P 500 Stock Index rose 2.0% to a level of 3037.56, which represents a year-to-date gain of 21.2%. The principal driver of the October gain has been better-than-expected corporate revenues and earnings. At this writing, with 68% of the 500’s constituent companies having reported, 79% have exceeded consensus earnings estimates. Management’s guidance has generally been restrained, but this does not lead us to change our 2020 earnings forecast of a 6% gain to $175 per share. This suggests a forward P/E ratio of a bit over 17, equivalent to a forward earnings yield of 5.8%, still substantially above BBB bond yields. Although the manufacturing sector remains in a mild recession and exports are weak, residential construction is picking up as household formations, employment, consumer incomes and household net worth are all rising, while mortgage rates have declined significantly. Inflation remains restrained in the U.S. and abroad, due to globalization, technological advances and intense competition, as well as demographic factors.
Financial system liquidity remains plentiful. The inversion in the Treasury Yield curve has now been reversed as the 10/2 spread is positive by 17 basis points. Credit spreads have tightened since June. Broad money supply (M2) is still growing at a 6% rate, substantially above nominal GDP growth. The FOMC has just reduced the Federal Funds rate by a quarter point to a new range of 1.50%-1.75%. Monetary stimulus globally is well-underway, and there are some early signs that business conditions in Europe are bottoming out.
On the political front, there seems to be some progress toward a watered-down deal with China, though recent history suggests one should not get too far out in front until a deal is actually signed. Our own view is that China will take a very hardline stance on the most critical issues, especially intellectual property, joint ventures, and tariff reduction. Nevertheless, Trump needs a win to counter the very real impeachment threat that he faces.
The earnings reporting season began in mid-October, and although many of our portfolio companies have yet to report third quarter results, those that have reported have universally exceeded Wall Street consensus estimates of revenues and earnings. We have reduced our cash position modestly to reflect these results, and the favorable seasonality from November through April. As always, we will be alert to any deterioration in the economic and corporate fundamentals, and we will take appropriate action should circumstances warrant it. Needless to say, we will also carefully monitor the stated policies and plans of the various presidential candidates.
