October 25, 2019
The S&P 500 inched closer to its all-time closing high this week, driven by another round of better than expected Q3 2019 earnings reports. As of today, 80% of companies that have reported earnings have topped analyst expectations. The figure remains firmly above the long-term average of 65%. The strong earnings momentum continued as U.S. economic data remained light with existing and new home sales being the highlights of the week. In international news, the European Central Bank (ECB) bid farewell to President Mario Draghi after eight years of service. Draghi’s tenure will be remembered for its ultraloose monetary policies with the ECB electing to hold rates steady at -0.5% on Thursday – its lowest rate in history. Absent trade and political flare ups, and with earnings leading the way, the S&P 500 managed to rise 1.22% for the week.
Housing Market Sputters in September
A strong jobs market and low mortgage rates were not enough to spur homebuyers off the sidelines. In September, existing home sales fell -2.20% to a seasonally adjusted annual rate of 5.38 million units. The decline in sales was driven by a -2.70% year-over-year (yoy) drop in the supply of homes on the market to 1.83 million. That served to push median home prices up 5.9% yoy to $272,100, the strongest price appreciation since January 2018. For the time being it looks like home prices are expected to remain elevated with the stock of homes on the market at only 4.1 months, substantially below the six to seven months supply seen as a healthy balance between supply and demand. New home sales also struggled in September, falling -0.70% to a seasonally adjusted annual rate of 701,000 units. On a positive note, the median price of new homes fell -8.80% yoy to $299,400, as homebuilders are beginning to build more homes for entry level buyers. Although home prices remain high, homebuyers should see improved home affordability as the Federal Reserve is set to cut interest rates another 0.25% next week.
ECB Changes the Guard…Christine Lagarde
ECB President Mario Draghi presided over his last ECB meeting this week as he handed the reins to former International Monetary Fund chief Christine Lagarde who is set to begin her term in November. Draghi leaves after eight years of leading the ECB’s fight to spur eurozone economic growth. His term brought mixed success for the euro bloc with the Eurozone facing anemic growth once again. Lagarde now assumes the mantle of leading the ECB as it implements an aggressive monetary policy to once again jumpstart the eurozone economy. Beginning in November, the ECB will reinitiate its bond-buying program, purchasing bonds at a $22 billion a month pace. The bond-buying program comes on the heels of the decision to hold interest rates steady at this week’s ECB meeting. The ECB also reiterated its commitment to keep interest rates at “present or lower levels” until inflation hits its target of 2.00%. Given that the ECB also expects the Eurozone to expand by only 1.1-1.2% next year, it is unlikely rates are going to rise in Europe anytime soon.
Once again it was a light week for economic news, but this time it was coupled by a lack of negative developments on the U.S.-China trade front and better than expected Q3 2019 earnings news. Surprisingly strong reports from chipmakers Lam Research and Intel helped ease concerns over slowing demand from China trade tariffs, propelling the semiconductor sector and the S&P 500 higher. Now, all eyes turn to next week’s Fed meeting where the central bank is widely expected to cut interest rates by 0.25% and bring the total number of Fed rate cuts this year to three. Traders will also be closely tuned into the Fed’s post-meeting conference where Fed Chairman Jay Powell will seek to lay out the future path of interest rates as the U.S. economy continues to expand at a modest pace despite slow global growth.
The Week Ahead
It’s a big week for markets as the Fed holds its FOMC Meeting. In economic news, we’ll have the latest on nonfarm payrolls and manufacturing.
Clients Get Boost From New Zero Trading Fees
The brokerage battles have heated up again, with Charles Schwab announcing on October 1st that it would drop trading fees to zero. The change went into effect on October 7th. The move was countered by TD Ameritrade and Fidelity — Probity’s primary custodians — who made similar announcements earlier this month.
While the announcements took many by surprise, the move is a reaction to a broader shift in the economics of the industry which is indeed good news to our clients. Historically, brokerage firms have relied on commissions or ticket charges as the primary source of their revenue, covering everything from the cost of a seat on an exchange to the effort involved in clearing and accounting for the trade, as well as providing the reporting and necessary statements. In the past when Probity has made an equity trade on behalf of a client, Fidelity and TD Ameritrade would charge $4.95 or $6.95 respectively for their part in effecting that trade. As a consequence of this, Probity would set minimum trade sizes for the positions we would buy for any particular client so that the cost of the trade was not disproportionate to the overall value of the trade, and, under certain circumstances, we would reduce the total number of names in a portfolio that we might otherwise have desired to hold. With the newly announced zero commission structure, portfolios can now afford to be more robust.
The implications for our clients are very positive. “Every nickel counts when we’re talking about retirement savings, and we’d expect a client to save $175 on average per year now that equity trading is free. From a research standpoint, we’re really pleased that we’ll have better representation for some of our highly rated but lower weighted names in our models,” said Christopher Sorrow, one of Probity’s portfolio managers. “We’ve gone back and tested our client portfolios’ variance relative to their targets in light of the new commission-free announcement, and I think what is most encouraging is that we found that the absence of free trading in the past has had very little impact on the ability to maintain tight tracking to our models in our clients’ accounts.” Chris added, “That is somewhat counterintuitive, but put simply, it means that the algorithms we rely upon to keep portfolios on track have worked extremely well, and with the introduction of free trading, we now have the opportunity to express opinions more actively. It’s a win-win.”
As you might expect, neither Fidelity nor TD Ameritrade are offering free trading out of the goodness of their heart and some minor stipulations apply. The economics of the industry have shifted in recent years. Trading and clearing costs have plummeted with new technology and automation, while at the same time brokerage firms have found new, more profitable lines of business, namely banking, securities lending, order flow, and retail advisory services. Free trading is an inducement for clients to transfer their assets and idle cash away from traditional brokerage firms, which the likes of Fidelity and TD would then lend out to earn interest. It looks like free trades have become the new toaster of online brokerages.