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What to know in markets Tuesday

Stocks jumped on Monday as trade tensions eased between the U.S. and China.

The Dow (^DJI) soared more than 400 points at the open, but ultimately closed 287.97 points higher. The S&P 500 (^GSPC) was up 1.09% and the Nasdaq (^IXIC) rose 1.51%.

President Donald Trump and President Xi Jinping’s meeting at the G20 summit ended on better terms than were expected on Wall Street. “The better-than-expected outcome should help reduce near-term
uncertainty and improve market sentiment,” UBS said in a note.

However, this doesn’t signal an all-clear ahead just yet, according to Citi. “We believe the risk of further escalation of the trade war has been contained for now, leaving the markets some breathing space and then worrying about the uncertainties after February next year,” the bank said in a note.

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Crude oil (CL=F) also got a boost after Saudi Arabia and Russia agreed to extend their pact to manage the market and surged 4.24%, closing at $53.09 per barrel on Monday. The commodity’s just closed out its worst month since 2008. Oil’s bounce comes as OPEC and Russia prepare to gather at a meeting in Vienna on Thursday to discuss output. Alberta, Canada announced plans to impose oil production cuts, and many believe that OPEC will be next to tighten supply.

Earnings reports remain light on Tuesday. Auto parts retailer AutoZone (AZO) will report before the market open, and homebuilder Toll Brothers (TOL) is set to report before the bell. Analysts polled by Bloomberg are expecting AutoZone to report earnings of $12.25 per share on $2.64 billion of revenue. Toll Brothers is expected to earn $1.83 per share on $2.35 billion of revenue.

There is no notable economic data to be released on Tuesday.

And here’s what caught Yahoo Finance’s markets correspondent Myles Udland’s eye:

Earnings are still great, and that’s what matters for stocks

Third-quarter earnings season is over, and corporate results haven’t been this strong in eight years.

With 97% of the S&P 500 having reported results through the end of last week, the blended earnings growth rate for the S&P 500 is 25.9%, according to data from FactSet.

If this growth rate holds after 100% of reports are in, the third quarter of 2018 will mark the best earnings growth rate for a single quarter since the third quarter of 2010, a period when results were snapping back from the post-crisis collapse in profits.

To say earnings have been anything other than stellar of late is to misrepresent what is happening in corporate America. The stock market, on the other hand, has clearly been expressing concerns about a downturn in the economy. In the last six trading sessions, however, the S&P 500 has been up nearly 5% amid an abrupt shift in sentiment.

The earnings multiple on the S&P 500 this year — which most simply stated measures the amount investors will pay for $1 of corporate earnings — declined to a roughly five-year low as the price of the index advanced just 4%, according to data from Deutsche Bank. In a note to clients published last Friday, Deutsche Bank chief strategist Binky Chadha said that 2018 will mark the “year of the great de-rating.”

“2018 will mark the year of strongest earnings growth in this cycle, excluding the early years off of a low base,” Chadha writes. “S&P 500 EPS are on track to rise by 25%, boosted by the cut in the corporate tax rate (+10pp), but even adjusted for it, growth (15%) would have been the best of this cycle. Yet, with the S&P 500 up only modestly year to date, equity multiples de-rated severely.”

The last time the market’s trailing 12-month P/E ratio stood at current levels (around 16.5x the last 12 months of earnings), markets were bracing for midterm elections in 2014, grappling with a major currency adjustment from the world’s second-largest economy in 2015, and concerned about the global economy tipping into recession in early 2016.

The stock market’s earnings multiple has dropped sharply this year, falling to near the lowest levels in five years and implying elevated investor fears about a recession. (Source: Yahoo Finance)
The stock market’s earnings multiple has dropped sharply this year, falling to near the lowest levels in five years and implying elevated investor fears about a recession. (Source: Yahoo Finance)

Recent trading action, however, suggests that the sharp fall in multiples on various fears over higher rates and a slowing global economy may have been enough to snap at least some investors out of their sour moods.

As Chadha notes, during the average recession since World War II, the S&P 500 has seen a median decline of 21%. The 10% drop in stocks seen from early October through late November got investors about halfway to a market fully reacting to a recession.

“The extent of the multiple de-rating suggests a high (68%) probability of recession priced in,” Chadha writes. “The decline in equities has occurred in the context of strong growth in earnings, with the year to date decline (17%) in the multiple compared to a median decline around recessions (25%), suggesting a high probability of recession priced in.”

And with investors currently enjoying a U.S. economy adding more than 200,000 jobs per month, manufacturing data that continues to point to a solidly expanding U.S. economy, and an apparent de-escalation in trade tensions — which leaves out a Federal Reserve that last week showed signs of softening its stance on the pace of interest rate increases — it seems a 68% chance of recession was judged too high for many investors.

So while the recent trading action has been to a large extent attributed to the headline factors of a new outlook on trade and a more dovish Fed, it seems that investors had simply priced in more bad news than was available to harvest from either economic or corporate data.

And though markets are always trying to place a discounted value on future growth, the best corporate performance of the post-crisis economic cycle, at that price, simply became too much to ignore.

Heidi Chung is a reporter at Yahoo Finance. Follow her on Twitter: @heidi_chung.

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More from Heidi:

The U.S. has a secret weapon in the trade war: Nomura

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Trump slams Fed Chair Powell, says he’s ‘not even a little bit happy’ with him

Trade uncertainty is ‘squelching business investments,’ JPMorgan strategist says