Abstract Background
Investment Commentary Banner
Posted on APR 29, 2019

Investment Commentary | Monday, April 29

This is part of an ongoing series of articles published by Johnson Financial Group. This issue is written by Brian Andrew, EVP, Chief Investment Officer.

Subscribe

Feeling Flush

Each year, companies pay out millions of bonuses to their employees. When those bonuses are received, people feel like they have an extra spring in their step, spend money on something they’ve been planning for, splurge on a vacation or put some of it into savings. These actions have a lasting effect on the economy―some longer than others.

If you buy a new couch, that’s good for the couch manufacturer, the retailer who sold it to you and the spouse who’s been eyeing it up for a year. If you put the bonus into savings, it becomes an investment in the economy. For example, if you buy a certificate of deposit, it is lent by a bank to a company that creates jobs and economic growth. If you buy a stock, it becomes capital for a multinational company to build its brand around the world. If you buy a bond, it might be part of a debt financing a company uses to get into a new business. The point is that savings have a lasting effect on how the economy grows.

We can think about the effects of corporate tax rate cuts this way. At the end of 2017, corporate tax rates were reduced and changing tax rules allowed companies to repatriate earnings from abroad. As a result, we saw corporate earnings grow nearly 25% in 2018. Of course we knew some of this growth was a one-time event related to those cuts, but some of it would have a lasting impact on those companies and the economy. One year later, as we look at how companies are reporting their earnings for the first quarter of 2019, we can see some of that impact.

YoY

Stock investors are making an investment in the future earnings of a company when they buy the stock; however, they can only look at the past for information regarding what the future holds. They follow growth trends over time, and since companies can only report earnings quarterly, the year-over-year (YoY) comparisons become very important. Of course, you can’t only look at earnings; revenue is also an important guide.

Through the end of last week, only 15% of the companies in the S&P 500 Index had reported their financial updates (mostly financial and industrial companies). Earnings declined by 3.9% YoY, while revenue grew by 5%! Wait, how did earnings decline if revenue went up? Earnings growth in the first quarter of 2018 was over 25%, about a third of which was a result of the tax law change. It isn’t surprising, then, that YoY earnings growth is down. That’s akin to the purchase of couches with bonus money. If bonuses are smaller the following year, there are fewer couches bought.

However, the 5% revenue growth belies the more negative view many had of the economy coming into 2019. Some of that growth comes from the benefits of companies investing in themselves with that “savings.” This is known as capital expenditures. These get reflected in durable goods orders which reflect the purchase of more expensive, long-lived assets like machines, cars, planes and semiconductors.

The recent durable goods order report showed a strong uptick of 2.7% last month and .5% without the transportation orders. These core orders are up 5% in the last year. The strong orders data suggests that the longer term effect of last year’s capital expenditure gains may sustain better economic growth throughout 2019, even if the first quarter shows some weakness.

Couple this with the effect of better revenue growth for companies and you could see a sustained rally in stock prices beyond the 16% we’ve already seen this year.

Interest Rates

As we know, the Federal Reserve has telegraphed to the market that its rate hike policy is on hold. We caution that this view is still “data dependent” and, if the improvement in financial conditions and strength in corporate revenue growth causes better economic growth, we could see the Fed change course in 2019.

In addition, we’ve seen an almost 50% increase in the price of energy, and that will make its way into the economy in the form of higher inflation. Add to that the fact that the labor market remains tighter, with unemployment below 4%, and we could argue that wages will continue their upward trajectory throughout the year.

Taken together, we still don’t think we’ll see a significant move higher in interest rates; however, we have to acknowledge that the data the Fed watches could change its view.

While feeling flush feels great, how you use the capital infusion of a bonus or tax benefit is what matters long-term.

Brian Andrew
As Chief Investment Officer, Brian Andrew leads Johnson Financial Group's investment strategy
to provide consistent, actionable investment solutions for our clients.
Subscribe

This information is for educational and illustrative purposes only and should not be used or construed as financial advice, an offer to sell, a solicitation, an offer to buy or a recommendation for any security. Opinions expressed herein are as of the date of this report and do not necessarily represent the views of Johnson Financial Group and/or its affiliates. Johnson Financial Group and/or its affiliates may issue reports or have opinions that are inconsistent with this report. Johnson Financial Group and/or its affiliates do not warrant the accuracy or completeness of information contained herein. Such information is subject to change without notice and is not intended to influence your investment decisions. Johnson Financial Group and/or its affiliates do not provide legal or tax advice to clients. You should review your particular circumstances with your independent legal and tax advisors. Whether any planned tax result is realized by you depends on the specific facts of your own situation at the time your taxes are prepared. Past performance is no guarantee of future results. All performance data, while deemed obtained from reliable sources, are not guaranteed for accuracy. Not for use as a primary basis of investment decisions. Not to be construed to meet the needs of any particular investor. Asset allocation and diversification do not assure or guarantee better performance and cannot eliminate the risk of investment losses. Certain investments, like real estate, equity investments and fixed income securities, carry a certain degree of risk and may not be suitable for all investors. An investor could lose all or a substantial amount of his or her investment. Johnson Financial Group is the parent company of Johnson Bank, Johnson Wealth Inc. and Johnson Insurance Services LLC. NOT FDIC INSURED * NO BANK GUARANTEE * MAY LOSE VALUE