Wrapping Up a Solid Quarter, Markets Digest Inflation Data, Tax Plan

Hurricanes, missile threats, and Washington drama all dominated the quarter, but didn’t prevent strong market gains. Major indices start the last session of Q3 near record highs after advancing around 5% over the last three months.

Energy, info tech, financials, and materials led the sector race in Q3, and only consumer staples and real estate posted quarterly losses. With two more record closes, the S&P 500 Index (SPX) would have 40 for the year. Barring a disaster, it will be a very good month for stocks, and a good quarter.

Stocks ticked a little lower in pre-market trading Friday, with the exception of light gains for the Nasdaq. A fresh batch of inflation data and continued buzz about the Republican tax plan could dominate discussion today.

Because today is the last trading session of the quarter, investors might want to be more prudent than usual if they participate in the markets. The final day of the quarter often sees some position squaring by the big financial firms, a process known on Wall Street as “window dressing.” That means we could see some rotation out of certain sectors and into others. Sectors that might be vulnerable include energy and financials, due to their strong performances during the quarter.

European and Asian stocks traded mostly higher early Friday, while the dollar was mixed vs. the euro and yen. The dollar has been on a bit of a run lately, helped in part by a more hawkish tone from the Fed and rising bond yields. The Republican tax plan presented earlier this week might also be giving the dollar a boost, but as far as that’s concerned, it’s way too early to predict how taxes might ultimately shape out. There’s a lot of negotiating to come. Listen to any noise that comes out over the weekend about the plan, as the first shots might be fired on those Sunday morning television programs.

On the economic calendar, we saw Personal Consumption Expenditure (PCE) prices and personal income this morning, with Michigan Sentiment and Chicago PMI coming up. Personal income rose 0.2%, in line with Wall Street’s estimates. Core PCE prices ticked up a scant 0.1%, a little below expectations and another sign that inflation remains tame.

Thursday’s trading was on the ho-hum side, though small caps hit another record high amid hopes that the Republicans’ tax plan might benefit smaller companies. Remember, smaller companies tend to do more of their business domestically, and also tend to have a higher tax load than larger firms.

Arguably, stocks might also have gotten a small boost from the better-than-expected final Q2 gross domestic product (GDP) estimate by the government, which rose to 3.1%, from the prior 3% and from just 1.2% in Q1 (see below). Materials and real estate led the sector race Thursday, and just two of 11 sectors fell. On the other hand, no sector climbed 1% or more, and the S&P 500 Index (SPX) really hasn’t made much of an advance since first piercing the 2500 mark earlier this month.

The oil market fell yesterday and retreated further early Friday. Keep an eye on the weekly U.S. oil rig count later today for signs of any producer response to higher prices. The rig count fell by one last time out. Barring some sort of major collapse today, it looks like oil is going to have a very good month, up nearly 7%.5 by the end of the day Thursday took it back down toward all-time lows posted earlier this year.

Volatility waned on Thursday and VIX fell well below 10, but there could be some last-minute volatility as the quarter comes to a close, so be on the lookout. The decline in VIX to 9.55 by the end of the day Thursday took it back down toward all-time lows posted earlier this year.

GDP Rehash

We touched on gross domestic product (GDP) yesterday, as the government raised its Q2 estimate to 3.1%. That’s the first time a quarter has seen 3% growth in more than two years, though there’s no guarantee these high levels can continue. It also might heighten suspicions that something has gone out of whack in the government measurements, as Q1 growth was a mediocre 1.2%. This year continues a pattern we’ve seen of growth dwindling in Q4 and Q1 before showing strength in the middle of the year, leading some economists to wonder if the government might need to adjust how it calculates GDP to take into account seasonal variations in Q1. That said, Q2 showed improved consumer and business spending, which, as Briefing.com noted, is typically a good mix for accelerating economic growth.

Running in Place

It’s hard to find a pattern in the stock market this week, with the major indices mostly standing still. At one point on Thursday, the Dow Jones Industrial Average ($DJI) was down 0.1% for the week while the S&P 500 (SPX) and Nasdaq (COMP) were both up 0.1%. The market is looking a little tired here after scampering to new record highs, and might need a fresh catalyst to rise from current levels. The remainder of this week doesn’t provide much in the way of news, but payrolls data wait in the wings at the end of next week followed by the start of Q3 earnings. One exception among indices is the Russell 2000 (RUT), which has risen sharply since the start of the week. Small stocks have really caught a wave here.

Speaking of Earnings

The curtain opens on Q3 earnings season in just over a week, and it’s time to look at forecasts. Research firm CFRA expects S&P 500 earnings to rise 5.3%, with year-over-year improvements expected in eight of the 11 sectors. CFRA projects leading performances from energy (up 129%), info tech (up 10.3%) and financials (up 5.3%). Understudies could include utilities (down 1.3%), consumer discretionary (down 2.2%), and materials (down 6.8%). The firm looks for full-year earnings per share growth of 10.6% this year and 10.4% in 2018. It also looks for S&P 500 revenues to rise 5.7% in Q3. While the projections for Q3 EPS and revenue are down somewhat from Q2, keep in mind that the pattern in recent quarters has been for actual earnings and revenue to surpass many analysts’ expectations. Let’s see if that trend continues.