Now that the midterms are over, investors can put behind them an event that had been circled on the calendar as the year’s biggest political catalyst for markets.
The initial aftermath was positive for investors on Wednesday — U.S. stocks staged a huge rally with the Dow gaining more than 500 points to move back above 26,000 and the S&P 500 once again trading over 2,800 after a 2% gain for the benchmark index.
But for investors who perhaps saw the midterms as an event that could change the economic and earnings story for markets, the market’s internal struggle between great corporate results and higher interest rates will once again be the biggest story driving market action.
In February, and then again in March, and then again in October, higher interest rates were seen as a central part of the story about why the stock market came under quick, acute stress. Interest rates are not expected to be lower in 2019.
On Thursday, the Federal Reserve’s latest policy statement will see the central bank keep interest rates unchanged in a band of 2%-2.25%. In December, the Fed will raise rates for a fourth time this year. In 2019, then, it gets interesting, with Fed officials and Wall Street economists split on whether two, or three, or four (or more) rate hikes will be warranted next year.
But higher rates, a key part of the market story so far in 2018, are not going to go away in 2019 and could further stress markets going forward. Indeed, they already have.
Higher rates, however, come against the backdrop of a corporate sector that has seen blockbuster earnings growth and is outperforming expectations in the third quarter. Earnings growth is up 26% over last year through the end of last week, according to data from Credit Suisse. The firm also notes that fourth quarter and year-ahead revisions for earnings are outpacing their historical trends.
And although corporate earnings growth is expected to slow down in 2019 as the one-time profit boost from Trump’s tax cut is lapped, earnings growth of 10% still suggests a corporate sector that is holding up quite well. Even amid talk of tariff and inflation pressures.
“Many have characterized corporate guidance as problematic and the source of market weakness,” Credit Suisse’s Jonathan Golub wrote in a note last week. “This appears inconsistent with the data.”
And so it is this tension — between higher rates investors see as a headwind for stocks and corporate earnings that provide the underpinning of strong returns — that has defined markets this year will define them going forward.
Even if the election, for a time, made it seem like that might not be the case.
Myles Udland is a writer at Yahoo Finance. Follow him on Twitter @MylesUdland