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March Madness? The stock market’s Cinderella story

by Giorgio Carlino | 08/04/2019

Summary

Much like last year's underdog, the stock markets faced some obstacles going into 2019—plenty that would give them reason to extend their end-of-2018 slide. But also like the Cinderella team, stock markets overcame adversity and rallied last month, continuing to build on their impressive gains since the start of the year.

With US men’s basketball NCAA March Madness underway, I’m reminded of an historic moment from last year’s tournament, where the University of Maryland, Baltimore County (UMBC) pulled off a stunning upset victory over the University of Virginia (UVA). It was the very first time in tournament history that a team with the lowest-ranking seed (no. 16) beat a highest-ranking seed (no. 1)—a true Cinderella story by all accounts.

Going into the historic game, it was clear UMBC had the odds stacked against them. UVA was a better team on all measurable fronts, boasting a nearly undefeated record and a notably strong defense. UMBC was a little-known school that had only made the tournament by the skin of their teeth, ranked 63 out of a field of 68 teams. But in a situation where defeat was all but a foregone conclusion, UMBC emerged from the game victorious by a wide margin, out-strategizing UVA’s defense with speed and agility.

Much like UMBC last year, the stock markets faced some obstacles going into 2019—plenty that would give them reason to extend their end-of-2018 slide. But also like the Cinderella team, stock markets overcame adversity and rallied last month, continuing to build on their impressive gains since the start of the year.

If the face of adversity for UMBC was a stronger, more accomplished team, what did the face of adversity for the stock markets look like? If I had to put it in one word, it would be this: earnings.

A company’s earnings don’t necessarily tell the whole story of financial health (or lack thereof), but they give the market something to react to—and the recent news hasn’t been encouraging. Earnings surprises—the degree by which earnings beat estimates—came in considerably lower than the last two years, and also below the historical median.

And that’s just a look in the rearview—the look ahead also painted a dreary picture. Analyst expectations for earnings growth have more than halved since September, and less-than-stellar sales are at least in part to blame.

Increased risk of earnings recession in the US
In the last four months, earnings growth estimates have precipitously declined.

S&P 500 2019 consensus EPS growth continued to decline in February and consensus sales growth expectations also declined 

Source: Bloomberg. Data as at March 2019.

You might be thinking this gloomy news can’t possibly bode well for the stock markets, and if earnings were the only factor in play you’d be right. But we’ve watched two other trends unfold over the past couple of months, both of which you might have heard a few things about.

First, as tensions over the US/China trade deal continued to ease, renewed investor optimism gave stocks a boost. And the second boon for the stock market came from the Federal Reserve (the “Fed”)—that entity holding the reigns of monetary policy—which had previously been on a (potentially stock market-crushing) track to continue its interest rate hikes. The Fed instead declared a more patient stance on raising rates, bolstering overall confidence in markets.

If we again reflect on UMBC’s tournament run, we can try to glean some future learning. Just two days after their historic first round victory, UMBC lost steam and fell to Kansas State, putting an end to their historic March Madness run. If this turn of events tells us anything, it’s that past performance is truly not indicative of future results, and there’s a chance the same could also ring true for stock markets—particularly if earnings headwinds persist.

While consensus among analysts implies that we’ll see earnings growth pick up again in the second half of the year, we think this may still be lofty and maintain a neutral view on US stocks. We’ll continue to keep an eye on earnings expectations for later in the year, and see whether stocks can again make like UMBC—prevailing in the face of earnings adversity.




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About the author

Giorgio Carlino

Giorgio Carlino

Global CIO Multi Asset, CIO Multi Asset US

Mr. Carlino is a portfolio manager, a managing director, Global CIO Multi Asset and CIO Multi Asset US with Allianz Global Investors, which he joined in 2001. As the chief investment officer of the Multi Asset team, he is responsible for all multi-asset investment functions. He is also a member of the firm’s Global Investment Management Committee and US Executive Committee.

The Fed has found the right balance

by Franck Dixmier | 29/04/2019
Building facade

Summary

With the US economy slowing and inflation low, we expect the Fed to confirm a pause in its monetary policy normalisation. Given the controlled slowdown in the US economy and equity-market momentum, we believe the Fed has found the perfect balance.


Key takeaways

  • The Fed’s rate-hike plans are on pause, and we don’t expect any surprises from its 30 April/1 May meeting
  • Given US growth prospects and inflation expectations, there’s no reason for the Fed to change course: it has found the right balance to remain "behind the curve"
  • We expect the Fed’s stance to confirm the markets’ confidence; they are no longer expecting a rate hike