For several years we saw share prices rise without earnings growth, this led to a re-rating of equity valuations based on low-interest rates. Recently we have seen equity prices fall despite earnings growth as interest rates have been rising in the US. Corporate earnings of leading American companies are set to grow over 20% year on year in both the second and third quarter of 2018. This has led to some of the rerating to come out of US equity valuations. The S&P 500 has fallen 7% in October, the FTSE 100 a similar amount, the latter not really benefitting from the recent weakness in sterling.
There has been some questioning whether the recent correction in equity prices will lead the Fed to change its mind to raising interest rates in December, as they planned? The odds on the Fed holding fire in December have widened slightly, but the balance still seems to be they will go ahead. On Friday the latest GDP estimate for the US economy reported the economy grew ahead of expectations in the third quarter. Possibly of more significance, the Federal Reserves preferred measure of inflation, Personal Consumption Expenditure, came in below expectations and at 1.6% is back below the Fed target of 2%. This data point could encourage the Federal Reserve to slow the pace of interest rate rises and did encourage some buying in the bond market.
The Vix index finished the week just below 25, and despite the sell-off on Friday of US equities, the fear gauge remained largely unchanged. Possibly clutching at straws, but it may suggest a pause for breath on Monday for equity prices.
Looking to the week ahead, tomorrows Budget will be of interest to those in the UK. How will Phillip Hammond square the circle to meet Theresa May’s dual task of ending austerity and adding 20 billion to the National Health Service, will be interesting to hear? Brexit is bound to be discussed and may be used as an excuse for some of Mr Hammond’s initiatives. The Bank of England also release their latest announcement on UK interest rates, no change is expected. They will also release the latest inflation report.
The earnings season will continue this week, with companies such as Coca-Cola, Kellogg’s, GE ( a global company that has really fallen from grace) and Facebook reporting. Other events that will make headlines will be Italian GDP and we see whether the spat between the Italian Government and the European Commission has impacted economic growth.