Why The Midterm Elections Have Me Worried…

As I began writing this Sunday evening, I’m still feeling confident about a few more weeks of upside here… with a few expected bumps along the way (as I’ve stated before).

While the few pullback days we’ve seen lately are unnerving to some, they’re still extremely moderate in the grand scheme of things. They are also a needed test to see just how “worried” investors feel about rising rates, slowing earnings growth, and the upcoming mid-term elections. (Of all the potential headwinds investors could be concerned with, I believe the mid-terms could be the biggest binary catalyst.)

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The Kavanaugh mess really revealed the huge amount of pent-up energy on both sides of the aisle… and just how polarized we are as a nation. From my perspective, it seems the drama is bringing more moderate Republicans to the table, while a good number of centrist, left-leaning voters are concerned with how Democrats seem to be moving to the far end of the scale. Several polls have shown that the charged up, left-leaning Dems are seeing their enthusiasm challenged by Republicans — in other words, the chances of the GOP losing the House and the Senate have declined. This is likely why the selling over the past few days hasn’t been more severe.

#-ad_banner-#While I hate to talk politics (especially in this climate), if the GOP loses one or both of these legislative bodies, it would likely send stocks plummeting in the short term. And even though the most recent polls are showing this is less likely than it was just a few weeks ago, it’s still a real possibility — one that investors shouldn’t be ignoring.

With Q3 earnings season already underway, investors will be watching not just the numbers, but the commentary and tone of earnings projections — looking for subtle hints on future growth.

I wanted to share with you some comments and research from my friends over at Zacks regarding earnings:

— For Q3 as a whole, total earnings are expected to be up +17.9% from the same period last year on +7.3% higher revenues, the 6th time in the last 7 quarters of double-digit earnings growth.

— Q3 earnings growth is expected to be in double-digit territory for 10 of the 16 Zacks sectors, with Energy, Finance, Construction, Basic Materials and Technology sectors with the strongest growth and Conglomerates and Autos expected to experience modest earnings declines.

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— For the Finance sector, total Q3 earnings are expected to be up +29.5% on +3.2% higher revenues. This would follow the sector’s +21.5% earnings growth on +7.6% higher revenues in 2018 Q2.

— For the small-cap S&P 600 index, total Q3 earnings are expected to be up +20.3% from the same period last year on +7.2% higher revenues. The Finance sector, which is an even bigger earnings contributor to the small-cap index compared to the S&P 500 index, is expected to see +57% higher earnings on +6.9% higher revenues.

— For full-year 2018, total earnings for the S&P 500 index are expected to be up +20.7% on +6.5% higher revenues. For full-year 2019, total earnings are expected to be up +9.8% on +5.1% higher revenues.

— Estimates for Q3 came down as the quarter got underway, in contrast to the positive revisions trend that we have been experiencing in the comparable periods of the last three earnings seasons. This revisions trend is in-line with the long-run historical trend (beyond the last three quarters).

— The implied ‘EPS’ for the index, calculated using current 2018 P/E of 18.5X and index close, as of October 2nd, is $157.72. Using the same methodology, the index ‘EPS’ works out to $173.18 for 2019 (P/E of 16.8X). The multiples for 2018 and 2019 have been calculated using the index’s total market cap and aggregate bottom-up earnings for each year.

Looking Ahead
As of now, multiples, while elevated, are not ungodly expensive. As long as investors aren’t spooked and/or consumers aren’t stifled by rising energy prices and higher borrowing (and savings) rates, we should continue to see more upside going into the end of the year.

And while rising bond yields are a real danger to stocks, their sheer volatility is keeping many would-be buyers away. When bond prices fall, (interest) yields rise. When yields get high and stable enough, investors can be lured away from a volatile and risky stock market into a much more stable investment.

If Democrats steal power away from Trump, lots of equity market money is likely to steer away from stocks and into bonds. Of course, all that buying will send bond yields lower as well, so it’s a catch-22 at this point.

For now, my Profit Amplifier subscribers and I plan to buy the dip and look to equalize the portfolio around November 1. When the mid-term elections start to dominate the headlines, I’m preparing my readers for what could be one of the most volatile times in the market we’ve seen in quite some time.

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