Positive Surprises In Productivity And Wage Growth, A Big Deal

May 3, 5:00 pm EST

If you are a regular reader of my daily notes, you’ll know we’ve been discussing the setup for positive surprises all year.

As we’re near the end of Q1 earnings season, clearly we’re getting it. With 78% of the companies in the S&P 500 now reported on Q1 earnings, 76% have beat earnings estimates.

And we’re getting positive surprises in the economic data.  We had a huge positive surprise for Q1 GDP this week.  And today we had a blow out jobs report.

There were 263k jobs added in April.  The market was expecting just 185k.  That gives us a 12-month average of 218k, well above pre-financial crisis average monthly job growth!  The unemployment number was 3.6% — the lowest since 1969.

Remember, we’ve been told all year long that we were headed for both earnings and economic recession.  It’s not happening.

Moreover, the two missing pieces of the economic recovery puzzle, have been productivity and wage growth.  And these pieces are emerging. Wage growth has been on the move for the past 18 months, now sustaining above 3%.   And we had a huge positive surprise in productivity this week.

With the above in mind, given the contrast of media narrative and reality, how are people getting it so wrong?   I suspect we are seeing plenty of people make the mistake of letting politics cloud their judgement on the economy and the outlook for stocks.

Can Stocks Force The Hand Of The Fed … Again

May 2, 5:00 pm EST

We talked about the technical reversal signal in stocks that developed yesterday, following the Fed press conference.

Stocks continued lower today.  We’ve now had a quick 2% decline from the top.

And now we have this technical breakdown in oil as well (the break of the yellow trendline from the Dec lows). 

 

In the post-financial crisis world we live in, oil prices going down is generally representing a gloomier outlook on global growth and global demand.  Oil prices going up is good news — representing a hotter demand/hotter growth outlook.  And as you can see below, oil prices and stock prices have tended to move together. 

The recovery in oil prices has been almost in lock-step with the recovery in stocks (aggressively bouncing).  Crude is up 57% in four months.

Now, yesterday I asked the question:  Can stocks force the hand of the Fed, again (i.e. can lower stocks force a rate cut from the Fed)?

If oil prices were to fall hard from here, then maybe.  Why?  The Fed is afraid of deflationary pressures.  And while they like to talk about their assessment of inflation, excluding the effects of volatile oil prices, they have a record of acting on monetary policy when oil prices are falling quickly — especially in this post-crisis environment where deflation has been a persistent threat throughout.  They acted in 2016, and they’ve acted in early 2019 — in both cases taking projected interest rate hikes off of the table.

But the case for another crash in oil prices isn’t there.  We continue to have supply cuts outside of the U.S. (OPEC and non-OPEC countries).  Trump has recently stepped up sanctions against Iran, with the goal of taking Iranian oil exports to zero.  That takes supply out of the market.  And the political crisis in Venezuela has created supply disruptions for the oil market.

The shale industry is expected to plug the supply gap.  As it stands, the shale industry may or may not be able to.  But keep in mind, oil demand has been estimated on what is (and has been) low expectations for the global economy.  If we’ve seen a bottom in China, it would set up for positive surprises in the global economy. And that means the supply necessary to meet global oil demand, would be underestimated.  With that, higher (if not much higher) oil prices  from here remain the higher probability scenario.

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Stocks Flashing A Technical Reversal Warning

May 1, 5:00 pm EST

As we discussed yesterday, the interest rate market has been signaling that the Fed made a mistake in December, when it hiked rates one last time, into a stock market that was in a steep decline.

In today’s post-Fed meeting press conference with the Fed Chairman, markets were expecting signals from Jay Powell that they might be looking to take that hike back, if the current subdued inflation levels persisted.  But Powell was reluctant to give much of a leaning toward a cut.  In fact, he said the risks that precipitated their “pause” on the rate path (China and European growth, Brexit risks, and trade negoations), have been largely improving.  He’s right.  He said the economy was solid.  He’s right.

Still, stocks came off sharply into the close.

After today, you have to ask the question:  Can stocks force the hand of the Fed, again?  Remember, stocks fell 8% in just four trading days after the Fed’s December hike – penalizing a tone deaf Fed.  In a market that was already down 9% on the month, the slide was exacerbated by the further Fed tightening. 

That stock fallout soon led to a response from the U.S. Treasury, as Mnuchin called out to major banks and the President’s Working Group on Financial Markets (which includes the Fed) to “assure normal market operations.”  That put a bottom in stocks.  And within days of that, the three most powerful central bankers of the past ten years (Bernanke, Yellen and Powell) were backtracking on the Fed’s rate path — signaling a pause.  The Fed’s pivot has fueled a V-shaped recovery in stocks.

So, we’ve just come off of a four-month run in stocks that gave us a full recovery of the late 2018 losses — and a new record high in the S&P 500.  That was the best four month gain since 2010.  Now we enter May with this chart …

 
As you can see, with the decline this afternoon, the S&P 500 put in a key reversal signal — a bearish outside day.  That’s tough to ignore, given that we’ve had a 16% gain in stocks to open the first four months of the year. This signal may be enough to stop the momentum, for now, as we wait for the word on a China deal — which is now said to ‘possibly’ come by next Friday.

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Why A Fed Rate Cut Would Steepen The Yield Curve

April 30, 5:00 pm EST

As we head into a Fed decision tomorrow, we’ve talked about the prospects of a Fed rate cut.  It’s highly unlikely.

It’s even more unlikely today, after Trump pushed for, not just a cut, but a full point cut …

 

Unfortunately, the influence Trump tried to wield late last year, is probably why the Fed hiked in December — just to prove to the world that they (the Fed) wouldn’t be politically influenced.

With that, we now have an economy growing at 3%+, stocks near record highs and subdued inflation.  And yet we have a ten-year yield at 2.5%.  It doesn’t fit.  The interest rate market is still sending the message that the December rate hike was a mistake.

With that, if we did get a cut by this summer, I suspect the interest rate market would adjust to reflect a more optimistic economic outlook.  By that, I mean, with a cut in the Fed funds rate, the long end of the yield curve (specifically, 10-year yields) would probably go UP not down –steepening the yield curve.

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A Rational View Of S&P 3,500+

April 29, 5:00 pm EST

We ended last week with a positive surprise for Q1 GDP.  Today, we had more soft inflation data.

The Fed’s favored inflation gauge, core PCE, continues to fall away from it’s target of 2%.

Here’s a look at the chart …

 

With a Fed meeting this week, they remain in the sweet spot.  They have trend economic growth, subdued inflation and a 10-year yield at 2.5%.  They can sit and watch. They could cut!   That’s highly unlikely, but less unlikely by the summer, if current conditions persist.

The market is pricing in about a 60% chance that we’ll see a rate cut by year-end.  It doesn’t sound so crazy, if you consider that it would underpin/if not ensure the continuation of the economic expansion — perhaps even fueling an economic boom period.

Remember, we’ve talked about the 1994-1995 parallels. In 1994, an overly aggressive Fed raised rates into a recovering, low inflation economy.  By 1995, they were cutting.  That led to a 36% rise in stocks in 1995.  And it led to 4% growth in the economy through late 2000 — 18 consecutive quarters of 4%+ growth.  Stocks tripled over the five-year period.

This, as the S&P 500 is already sitting on new record highs?  As I said earlier this year, with yields back (well) under 3%, we should see multiples on stocks expand back toward 20x in this environment.

The forward 12-month P/E on the S&P 500 is currently 16.8.  If we multiply Wall Street’s earnings estimate on the S&P 500 ($175) times a P/E of 20, we get 3,500 in the S&P 500. That’s 19% higher than current levels.

But keep in mind, the earnings estimate bar has been set low.  And already 77% of companies are beating estimates on Q1 earnings.  I suspect, we’ll see higher earnings over the next twelve months than Wall Street has estimated, AND a higher multiple paid on those earnings (i.e. an outlook for an S&P 500 > 3,500).

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Bar Has Been Set Low To Manufacture Positive Surprises … And They Are Rolling In

April 26, 5:00 pm EST

The first reading on first quarter U.S. GDP came in this morning at 3.2%— much better than expected.  This is a huge positive surprise, for what many expected to be a terrible quarter.

Just a month ago, the consensus view was something closer to 1%.  Goldman was looking for 0.7% going into the end of the quarter.

With that, we’ve been talking about this set-up for positive surprises all year.

Remember, the economy added on average 173,000 jobs a month in Q1.  Both manufacturing and services PMIs expanded in the quarter, and stocks fully recovered the losses from December.  Add to that, just days into the first quarter, the Fed told us they were done raising rates.  Whatever headwinds the Fed was stirring up, quickly became tailwinds.
Yet we’ve been told an economic recession was coming and an earnings recession upon us.  The above is a recipe for growth, not contraction.

Still, as we’ve discussed, never underestimate the appetite of Wall Street and corporate America to dial down expectations when given the opportunity.  That sets the table for positive surprises.  And positive surprises are fuel for stocks.   Stocks are fuel for confidence.  Confidence is fuel for the economy.

Last week we looked at the early signals on Q1 economic activity.  The positive surprises started with what looks like the bottom in Chinese industrial output and retail sales (two key indicators of economic health). This is important because the global slowdown fears have been centered around the weak Chinese economy.

Then both UK retail sales and the U.S. retail sales came in better.  And yesterday, we had a hot durable goods orders number in the U.S for March.

So, despite the negative picture that has been painted, the trajectory of U.S. economic growth seems to be well intact.

This is just the first reading on the Q1 number, but it gives us an average annualized growth rate of three percent even.  The average annualized growth coming out of the Great Recession (pre-Trumponomics) was just 2.2%.

And keep in mind, the next big pillar of Trumponomics is a trillion-dollar-plus infrastructure spend (with bipartisan support).

Just as expectations have been dialed down, this is where we could see a real economic boom kick in, especially if we get a deal on China (clearing that drag on sentiment).  As we’ve discussed, we are well overdue for an economic boom period.  We’ve yet to have the bounce-back in growth that is typical of a post-recession, if not post-depression environment.  You can see in the table below, the six years that followed the Great Depression, relative to the growth coming out of the Great Recession …

 

Have a great weekend!

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Bidding War For Anadarko May Signal The Beginning Of Takeovers In Energy

April 24, 5:00 pm EST

Among the big news of the day is the bidding war that is underway for the Permian Basin oil producer Anadarko.  This fits right in with my daily notes of the past two days.

Anadarko received a bid from Chevron two weeks ago for $65 a share.  Today, Occidental Petroleum offered $75 a share for the company.  Prior to the takeover bids, the stock was trading $47.  So, Occidental’s bid is a 60% premium to where Anadarko shares were trading on April 11.

Now we have this chart ….

 

We’ve talked about the opportunity to see a big comeback in the energy sector.  The S&P energy ETF (XLE) is the only sector ETF with a negative five-year return.

It’s common to see M&A activity ramp up in sectors that have been beaten down and misvalued.  This may be the beginning.

With that in mind, yesterday we drilled into the constituents of the XLE and highlighted the four stocks in the ETF that have been vetted and are owned by big influential activist investors.

What will these activists likely do, in light of this takeover activity?  I suspect they will push to put the companies they own on the selling block.

Let’s revisit the four stocks and the billionaire investor involved in each, and then we’ll take a look at how these companies stack up, relative to Anadarko, in output in the Permian Basin.

Devon Energy (DVN)

Billionaire Paul Singer of Elliott Management is one of the best activist investors in the world.  He has one of the longest tenures in the business, dating back to the 70s.  And he’s had one of the hottest hands on Wall Street over the past few years. Singer’s fund, Elliott Management, owns 4% of Devon.  It’s the eighth biggest long position.  Devon is down 52% over the past five years.

Hess Corp. (HES)

Singer and his team are the fourth largest shareholder in Hess.  They have a 7% stake in Hess.  And it’s a big position in the Elliott portfolio — a top five position representing over 7% of the portfolio.   Hess is down 25% over the past five years.

Pioneer Natural Resources (PXD)

Billionaire Seth Klarman has been called the next Warren Buffett.  His fund, Baupost Group, is the sixth largest shareholder of Pioneer.  Klarman has 5% of his portfolio invested in Pioneer.  Pioneer is down 14% over the past five years.

Diamondback Energy (FANG)

Billionaire Carl Icahn owns 6% of Diamondback.  It’s a half a billion dollar stake in his $20 billion portfolio.  Diamondback is up 46% — and already up 22% from when Icahn entered in the fourth quarter. 

Now, here’s how they look, ranked by annual production in Texas.
With the above in mind, and considering the $38 billion bid for Anadarko, Pioneer is the second largest producer in the state, and has a market cap of $29 billion.  Diamondback is the fourth largest producer in the state, with a market cap of $18 billion.  And Devon Energy is the 15th largest producer in Texas, with a market cap of $15 billion.  Icahn may be sitting on the biggest opportunity stock.

If you haven’t signed up for my Billionaire’s Portfolio, don’t delay … we’ve just had another big exit in our portfolio, and we’ve replaced it with the favorite stock of the most revered investor in corporate America — it’s a stock with double potential.

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Four Beaten Down, Activist-Owned Energy Stocks

April 23, 5:00 pm EST

Yesterday we talked about the big recovery in crude oil prices.  That continues today.

However, the energy sector remains the worst performing sector over one-year and five-years.  And it’s the only sector still in the red over the past five-years — down 27%.

Let’s take a look again at the how the constituents of the S&P’s energy ETF have performance over the past five years.  And then we’ll take a look at the stocks in this group that have been vetted and are now owned by the best billionaire activist investors…

 

Devon Energy (DVN)

Billionaire Paul Singer of Elliott Management is one of the best activist investors in the world.  He has one of the longest tenures in the business, dating back to the 70s.  And he’s had one of the hottest hands on Wall Street over the past few years.

Singer’s fund, Elliott Management, owns 4% of Devon.  It’s the eighth biggest long position in the portfolio.  Devon is down 52% over the past five years.

Hess Corp. (HES)

Singer and his team are the fourth largest shareholder in Hess.  They have a 7% stake in Hess.  And it’s a big position in the Elliott portfolio — a top five position representing over 7% of the portfolio.   Hess is down 25% over the past five years.

Pioneer Natural Resources (PXD)

Billionaire Seth Klarman has been called the next Warren Buffett.  His fund, Baupost Group, is the sixth largest shareholder of Pioneer.  Klarman has 5% of his portfolio invested in this stock.  Pioneer is down 14% over the past five years.

Diamondback Energy (FANG)

Billionaire Carl Icahn owns 6% of DiamondBack.  It’s a half a billion dollar stake in his $20 billion portfolio (all his money).  Diamondback is up 46% — and already up 22% from when Icahn entered in the fourth quarter.

These are the best value investors in the world, betting on a comeback in this sector and in these stocks.  No surprise, aside from Icahn’s stake, they like to hunt in some of the most beaten down names.

 If you haven’t signed up for my Billionaire’s Portfolio, don’t delay … we’ve just had another big exit in our portfolio, and we’ve replaced it with the favorite stock of the most revered investor in corporate America — it’s a stock with double potential.

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More Positive Surprises Hitting In The Economic Data

April 18, 5:00 pm EST

Yesterday we talked about the positive surprises in the Chinese data.  This is important because the global slowdown fears have been centered around the weak Chinese economy.

So, we now have what looks like a bounce off of the bottom in Chinese industrial output and Chinese retail sales (two key indicators of economic health).

Today we had more positive surprises for the global economic outlook picture.  The UK retail sales number came in better than expected.  And the U.S. retail sales came in better.

You can see in the chart below, this March U.S. retail sales is a bounce from the post-crisis lows of December.  

With this, the Q1 GDP estimate from the Atlanta Fed has bumped up to 2.8%.

We’ve talked about the set up for both earnings and the economic data to surprise to the upside for Q1, given the dialed down expectations following the December decline in stocks.

You can see how this is playing out in the chart below (see where the gold line is diverging from the “consensus estimate” blue line) …

If you haven’t signed up for my Billionaire’s Portfolio, don’t delay … we’ve just had another big exit in our portfolio, and we’ve replaced it with the favorite stock of the most revered investor in corporate America — it’s a stock with double potential.

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Bottoming in Chinese Data

April 17, 5:00 pm EST

Last month we talked about Chinese stocks has a key spot to watch for: 1) are they doing enough to stimulate the struggling economy, and 2) (more importantly) are they taking serious steps to get to an agreement on trade with the U.S.?

The signal has been good.  Chinese stocks are up 34% since January 4th.

As I said back in March, Chinese stocks are reflecting optimism that a bottom is in for the trade war and for Chinese economic fragility.  That’s a big signal for the global (and U.S.) economy.

Fast forward a month, and we’re starting to see it (the bottoming) in the Chinese data.  Overnight, we had a better than expected GDP report.  And industrial output in China climbed at the hottest rate since 2014.

For those that question the integrity of the Chinese GDP data, many will look at industrial output and retail sales.  Retail sales had a better than expected number too overnight.  And the chart (too) looks like a bottom is in. 

Remember, by the end of last year, much of the economic data in China was running at or worse than 2009 levels (the depths of the global economic crisis).

The signal in stocks turned on the day that the Fed put an end to its rate hiking path AND when the U.S. and China re-opened trade talks (both on January 4th).