We’re getting into the heart of earnings season now, with Q4 earnings rolling in. Remember, earnings guidance is set by management to be beat. And estimates are set by Wall Street to be beat. That’s the way Wall Street works. And it’s a built-in bullish force for the stock market.
With that, for the better part of the second half of last year, I said “we were set up for a big run for stocks into the year end given that expectations had been ratcheted down on earnings and the economic data. That creates opportunities for positive surprises, which is fuel for higher stocks.”
The dynamic continues.
Last quarter, 71% of earnings beat estimates for the quarter. And despite the analyst expectations that there would be an overall decline in S&P 500 earnings, the overall earnings reported by companies grew by 3%. Sounds positive, right?
Still, management, on whole, was downbeat on their guidance for what the fourth quarter would bring. They set the bar low. And with that, the early Wall Street expectations for earnings growth on the quarter has been dialed back, setting up for positive surprises.
As I’ve said, historically, about 68% of S&P 500 companies earnings beat estimates. Let’s assume the positive surprises will be even higher for Q4 numbers, especially given the rise of optimism following the November election. That’s more fuel for stocks.
We’ve heard from some of the biggest banks in the country today. JP Morgan stole the show, beating on earnings by 20%. PNC beat by 6%. Bank of America beat by 5%. Wells Fargo earnings came in lower, but deposits and loans grew despite its PR nightmare.
This is all positive for the trajectory of banks. Especially when you consider that we are in the very early innings of one of the tailwinds (rising interest rates) and the first inning is coming for the second tailwind (de-DoddFranking the banking business).
Fed raising rates is a money printing recipe for banks. Bank of America has said that a point higher on Fed Funds will add more than $5 billion of core earnings for the bank.
But the story here for the bank stocks is even more exciting when you consider that many of the regulations, that have turned banks into utility companies since the financial crisis, will be reversed by the Trump administration. To what extent will banks return to the business of risk-taking? Probably not to pre-crisis levels. But will it be dramatically different than the business of the post-crisis era? Highly likely, given the contingent of Wall Street bankers entering government in the Trump administration. With this, banks still look cheap.
Even last year, the health of the banks was looking as good as it has been in a long time. Loan balances were growing at the fastest 12-month rate since 2008, the share of unprofitable banks had fallen to an 18-year low, and the number of ‘problem banks’ continued to decline.
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Jobs, jobs everywhere there’s jobs. The President-elect yesterday said he will be the “greatest job creator God ever created.”
Since December, when the President-elect announced that Carrier, an air conditioner manufacturer in Michigan, would keep 1,000 jobs in the U.S. instead of moving them to Mexico, other companies have been lining up to announce big, bold hiring plans.
It was immediately clear that Carrier won priceless exposure and good-will. From that point, the Japanese billionaire Masayoshi Son took a visit to Trump Tower and followed with an announcement that his Softbank technology holdings company would invest $50 billion in U.S. businesses and create 50,000 new jobs. Softbank owns more than 80% of Sprint, and Sprint has followed with an announcement of 5,000 jobs to come.
Alibaba’s founder Jack Ma visited Trump Tower yesterday and left saying he would create 1 million jobs in the U.S.
Amazon, who’s CEO Jeff Bezos had a visit to Trump Tower last month, said today they plan to add 100k jobs.
Not to be outdone, Taco Bell (part of YUM Brands), said today it would add 1.6 million jobs in the U.S. Does this mean Taco Bell is about to go on a massive expansion increasing their store count by 5x — putting a Taco Bell on every corner in America?
Or, is this all just a public relations ploy? Are they all hoping to gain favor with the administration? Yes and yes. But it’s also all self-reinforcing. A better outlook for jobs is driving confidence. Confidence can drive a better outlook for jobs. More employed, more confident consumers can drive economic growth. And better growth drives more jobs.
Now, all of this said, the headline unemployment number is already down to 4.7% (near what is considered “normal”). The number that measures underemployed and those that have stopped looking is down to 9.2%. It’s much higher than the headline rate, but relative to history, it’s returning close to normal levels too. With the prospects of hotter growth coming, and new job creation, we could be headed for a very tight labor market. What does that mean? Higher wages are coming, to finally begin making up for two decades of wage stagnation.
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For two full months the Trump rally has consisted of higher stocks, higher yields, a higher dollar and higher commodity prices — all on the prospects of hotter growth and a sustainable period of prosperity ahead.
Since the night of November 8th, it’s been “buy it now, prove it to me later” market. But people are expecting there will be a period of time where the markets begin trading in “prove it to me” mode.
Often we see a “buy the rumor, sell the fact” phenomenon in markets — it’s a reflection of investors pricing new information in anticipation of an event, and then selling into the event on the notion that the market has already valued the new information. With that, the period surrounding the January 20th inauguration could be the “sell the rumor” moment (in fact, we may be working on it now).
Many are hoping it could be the second chance given to those that have been left behind in the great Trump reflation rally. The question is, how deep or shallow that correction might be, and how long or short-lived it might me.
I would argue, it’s going to short-lived and shallow (maybe very shallow), for all of the reasons I’ve discussed in this daily note, not the least of which, is a world starving for a return to meaningful and sustainable growth, and the perception that this is the best chance we’ve had and might have, to get the global economy back on track. Trump’s tone today, in his press conference, indeed, indicated that he would waste no time executing on his plan. That favors a short-and-shallow correction scenario for the Trump rally. And shallow corrections are typical of strong trending markets.
With that said, since the election, here’s a view of key markets (taking the last price before the election night whipsaw):
The yield on the 10-year has gone from 1.85% to over 2.64% on the Trump effect. But despite a surprisingly hawkish Fed on December 14th, and even more hawkish fundamental data since, the high in yields, thus far, was marked the day after the Fed meeting last month. And today yields traded just below 2.33%, the lowest since November 30th! For technicians, the 38.2% (Fibonacci) retracement of the entire move is 2.34%. That would be considered a shallow retracement.
The dollar (index) has gone from 97.68 to 103.82, and today trades at 101.28 which is the lowest level since December 14. Commodities (the broad commodity index) have gone from 183 to 193, and today trades at 191. Both have room for another 1% or so lower. The dollar looks very strong.
What about stocks? The S&P 500 has gone from 2,138 to 2,278, and now trades at 2,262. A shallow retracement for stocks of the Trump rally would be about 2,225 (which is about 2% lower from here). Given the policy outlook, those wishing for something deeper may not get the chance – a couple of percentage points from here may be the gift.
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This morning we got a report that small business optimism hit the highest level since 2004, on the biggest jump since 1980. This follows a big jump in December, which obviously follows the November elections.
Small business owners that have survived the storm over the past nine years, most likely have had credit lines pulled, demand for their products and services crushed, and have slashed their workforce. If they were able to piece it together to continue on, they’ve operated as lean as possible, and they’ve slowly seen it all recover. And finally, over the past couple of years, they’ve likely had banks calling offering them money again. But, given the scars of the financial crisis, taking on debt again (or more debt) in an uncertain world, many have turned it down.
But if you’re going to dip a toe in the water again, take on some risk to grow your business (to expand, to hire, to build inventories), small business owners are saying now is the time. They are buying into what the Trump agenda is promising–a “dynamic booming economy.”
You can see that reflected in this chart…
The survey shows that 50% of small business owners expect the economy to improve. That’s the most in 15 years. With that, they think it’s a good time to expand. And they expect higher sales coming down the pike, so they’ve been building inventories.
As we know, in the recovery that was manufactured by the Fed (and other central banks), Main Street didn’t participate–trillions of dollars spent and little impact on the real economy. But this survey shows that the Trump effect is already doing what nine years, and trillions of dollars of monetary stimulus and intervention, couldn’t do. Most of the small business sentiment data has now returned to pre-crisis levels, just on the pent up demand that has been unleashed by the prospects of a return to prosperity.
This number tends to correlate highly with consumer confidence numbers. Consumer confidence numbers drive consumption. And consumption contributes about two-thirds of GDP. By restoring confidence, the Trump effect on growth can be self-fulfilling.
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Over the past year we’ve had a wild ride in global yields. Today I want to take a look at the dramatic swing in yields and talk about what it means for the inflation picture, and the Fed’s stance on rates.
When oil prices made the final leg lower early last year, the Japanese central bank responded to the growing deflationary forces with a surprise cut of their benchmark interest rate into negative territory.
That began the global yield slide. By mid-year, more than $12 trillion dollars with of government bond yields across the world had a negative interest rate. Even Janet Yellen didn’t close the door to the possibility of adopting NIRP (negative interest rate policies).
So investors were paying the government for the privilege of loaning it their money. You only do that when 1) you think interest rates will go even further negative, and/or 2) you think paying to park your money is the safest option available.
And when you’re a central banker, you go negative to force people out of savings. But when people think the world is dangerous and prices will keep falling, they tend to hold tight to their money, from the fear a destabilized world.
But this whole dynamic was very quickly flipped on its head with the election of a new U.S. President, entering with what many deem to be inflationary policies. But as you can see in the chart below, the U.S. inflation rate had already been recovering, and since November is now nudging closer to the Fed’s target of 2%.
Still, the expectations of much hotter U.S. inflation are probably over done. Why? Given the divergent monetary policies between the U.S. and the rest of the world, capital has continued to flow into the dollar (if not accelerated). That suppresses inflation. And that should keep the Fed in the sweet spot, with slow rate hikes.
Meanwhile, there’s more than enough room for inflation to run in other developed economies. You can see in Europe, inflation is now back above 1% for the first time in three years. That, too, is in large part because of its currency. In this case, a stronger dollar has meant a weaker euro. This (along with the UK and Japan) is where the real REflation trade is taking place. And it’s where it’s needed most, because it also means growth is coming with it, finally.
You can see, following Brexit, the chart looks similar in the UK – prices are coming back, again fueled by a sharp decline in the pound, which pumps up exports for the economy.
And, here’s Japan.
Japan’s deflation fight is the most noteworthy, following the administrations 2013 all-out assault to beat 2 decades of deflation. It hasn’t worked, but now, post-Trump, the stars may be aligning for a sharp recovery.
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With the Dow within a fraction of 20,000 today, and with the first week of 2017 in the books, I want to revisit my analysis from last month on why stocks are still cheap.
Despite what the media may tell you, the number 20,000 means very little. In fact, it’s amusing to watch interviewers constantly probe the experts on TV to get an anwer on why 20,000 for the Dow is meaningful. They demand an answer and they tend to get them when the lights and a camera are locked in on the interviewee.
Remember, if we step back and detach from the emotions of market chatter, speculation and perception, there are simple and objective reasons to believe the broader stock market can go much higher from current levels.
I want to walk through these reasons again for the new year.
Reason #1: To return to the long-term trajectory of 8% annualized returns for the S&P 500, the broad stock market would still need to recovery another 49% by the middle of next year. We’re still making up for the lost growth of the past decade.
Reason #2: In low-rate environments, the valuation on the broad market tends to run north of 20 times earnings. Adjusting for that multiple, we can see a reasonable path to a 16% return for the year.
Reason #3: We now have a clear, indisputable earnings catalyst to add to that story. The proposed corporate tax rate cut from 35% to 15% is estimated to drive S&P 500 earnings UP from an estimated $132 per share for next year, to as high as $157. Apply $157 to a 20x P/E and you get 3,140 in the S&P 500. That’s 38% higher.
Reason #4: What else is not factored into all of this simple analysis, nor the models of economists and Wall Street strategists? The prospects of a return of ‘animal spirits.’ This economic turbocharger has been dead for the past decade. The world has been deleveraging.
Reason #5: As billionaire Ray Dalio suggested, there is a clear shift in the environment, post President-elect Trump. The billionaire investor has determined the election to be a seminal moment. With that in mind, the most thorough study on historical debt crises (by Reinhardt and Rogoff) shows that the deleveraging of a credit bubble takes about as long as it took to build. They reckon the global credit bubble took about ten years to build. The top in housing was 2006. That means we’ve cleared ten years of deleveraging. That would argue that Trumponomics could be coming at the perfect time to amplify growth in a world that was already structurally turning. A pop in growth, means a pop in corporate earnings–and positive earnings surprises is a recipe for higher stock prices.
For these five simple reasons, even at Dow 20,000, stocks look extraordinarily cheap.
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We talked yesterday about the bad start for global markets in 2016. It was led by China. Today, it was a move in the Chinese currency that slowed the momentum in markets. Yields have fallen back. The dollar slid. And stocks took a breather.
China’s currency is a big deal to everyone. It’s the centerpiece of the tariff threats that have been levied from the U.S. President-elect. I’ve talked quite a bit about that posturing (you can see it again here: Why Trump’s Tough Talk On China May Work).
As we know, China, itself, sets the value of its currency every day. It’s called a managed float. They determine the value. And for the past two years, they’ve been walking it lower — weakening the yuan against the dollar. That’s an about face to the trend of the prior nine years. In 2005, in agreement with their major trading partners (primarily the U.S.), they began slowly appreciating their currency, in an effort to allay trade tensions, and threats of trade sanctions (tariffs).
So what happened today? The Chinese revalued its currency — pegged ithigher by a little more than a percent against the dollar. That doesn’t sound like a lot, but as you can see in the chart, it’s a big move, relative to the average daily volatility. That became big news and stoked a little bit of concern in markets, mostly because China was the sore spot at the open of last year, and the PBOC made a similar move around this time, when global marketswere spiraling.
Why did they do it? This time around, the Chinese have complained about the threat of capital flowing out of the country – it’s a huge threat to their economy in its current form. That’s where they’ve laid the blame, on the two year slide in the value of the yuan. With that, they’ve allegedly been fighting to keep the yuan stable and have been stepping up restrictions on money leaving the country. Today’s move, which included a spike in the overnight yuan borrowing rate, was a way to crush speculators that have been betting against the currency, putting further downward pressure on the currency. But it also likely Trump related – the beginning of a crawl higher in the currency as we head toward the inauguration of the new President Trump. It’s very typical for those under the gun for currency manipulation to make concessions before they meet with trade partners.
So, should we be concerned about the move today in China? No. It’s not another January 2016 moment. But the move did drive profit taking in twobig trends of the past two months: the dollar and U.S. Treasuries. With that, the first jobs report of the year comes tomorrow. It should provide more evidence that the Fed will hike a few times this year. And that should restore the climb in the dollar and in rates.
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Remember this time last year? The markets opened with a nosedive in Chinese stocks. By the time New York came in for trading, China was already down 7% and trading had been halted. That started, what turned out to be, the worst opening stretch of a New Year in the history of the U.S. stock market.
The sirens were sounding and people were gripping for what they thought was going to be a disastrous year. And then, later that month, oil slid from the mid $30s to the mid $20s and finally people began to realize it wasn’t China they should be worried about, it was oil. The oil price crash was a ticking time bomb, about to unleash mass bankruptcies on the energy industry and threaten a “round two” of global financial crisis.
What happened? Central banks stepped in. On February 11th, the Bank of Japan intervened in the currency markets, buying dollars/selling yen. What did they do with those dollars? They must have bought oil, in one form or another. Oil bottomed that day. China soon followed with a move to boost bank lending, relieving some fears of a global liquidity crunch. The ECB upped its QE program and cut rates. And then the Fed followed up by taking two of their projected four rate hikes off of the table (of which they ended up moving just once on the year).
What a difference a year makes.
There’s a clear shift in the environment, away from a world on liquidity-driven life support/ and toward structural, growth-oriented change.
With that, there’s a growing sense of optimism in the air that we haven’t seenin ten years. Even many of the pros that have constantly been waiting for the next “shoe to drop” (for years) have gone quiet.
Global markets have started the year behaving very well. And despite the near tripling from the 2009 bottom in the stock market, money is just in the early stages of moving out of bonds and cash, and back into stocks. Following the election in November, we are coming into the year with TWO consecutive record monthly inflows into the U.S. stock market based on ETF flows from November and December.
The tone has been set by U.S. markets, and we should see the rest of the world start to play catch up (including emerging markets). But this development was already underway before the election.
Remember, I talked about European stocks quite a bit back in October. While U.S. stocks have soared to new record highs, German stocks have lagged dramatically and have offered one of the more compelling opportunities.
Here’s the chart we looked at back in October, where I said “after being down more than 20% earlier this year, German stocks are within 1.5% of turning green on the year, and technically breaking to the upside“…
And here’s the latest chart…
You can see, as you look to the far right of the chart, it’s been on a tear. Adding fuel to that fire, the eurozone economic data is beginning to show signs that a big bounce may be coming. A pop in U.S. growth would only bolster that.
And a big bounce back in euro zone growth this year would be a very valuabledefense against another populist backlash against the establishment (first Grexit, then Brexit, then Trump). Nationalist movements in Germany and France are huge threats to the EU and euro (the common currency). Another round of potential break-up of the euro would be destabilizing for the global economy.
With that, as we enter the year with the ammunition to end the decade long economy rut, there are still hurdles to overcome. Along with Trump/China frictions, the French and German elections are the other clear and present dangers ahead that could dull the efficacy of Trumponomics.
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Happy New Year! We’re off to what will be a very exciting year for markets and the economy. And make no mistake, there will be profound differences in the world this year, with the inauguration of a new, pro-growth U.S. President, at a time where the world desperately needs growth.
I’ve talked a lot about the “Trump effect.” Clearly, when you come in slashing the corporate tax rate, creating incentives for trillions of dollars of capital to come home, and eliminating overhead and hurdles associated with regulation, you’ll get hiring, you’ll get spending, you’ll get investment and you’ll get growth.
But there’s more to it. Ray Dalio, one of the richest, best and brightest investors in the world has said, there is a clear shift in the environment, “from one that makes profit makers villains with limited power, to one that makes them heroes with significant power.”
The latter has been diminished over the past 10 years.
Clearly, we entered the past decade in an economic and structural mess. But while monetary policy makers were doing everything in their power (and then some) to avert the apocalypse and, later, fuel a recovery, it was being undone by law makers and a lack of fiscal support, swinging the pendulum too far in the direction of punishment and scapegoating.
With that, despite the continued wealth creation of the 1% over the past decade, and the widening of the inequality gap, the power of the wealth creators has been diminished in the crisis period – certainly, the public’s favor toward the rich has diminished. And most importantly, the incentives for creating value and creating wealth have been diminished.
With all of the nuances of change that are coming, and the many opinions on what it all means, that statement by billionaire Ray Dalio might be the most simple and clear point made.
Another good point that has been made by Dalio, as he’s reflected on the “Trump effect.” It’s the element that economists and analysts can’t predict, and can’t quantify. The prospects of the return of “animal spirits.” This is what has been destroyed over the past decade, driven primarily by the fear of indebtedness (which is typical of a debt crisis) and mis-trust of the system.
All along the way, throughout the recovery period, and throughout a tripling of the stock market off of the bottom, people have continually been waiting for another shoe to drop. The breaking of this emotional mindset appears to finally be underway. And that gives way to a return of animal spirits, which haven’t been calibrated in all of the forecasts for 2017 and beyond.
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Over the past two days, we’ve looked back at a couple of the six marketthemes I expected to dominate in 2016. Back in January, I said “central banks are in control, be long stocks.” That was theme number one. And I thought “China’s currency manipulation would come home to roost.” That was theme number six. Both have clearly materialized. As for China, its currency manipulation has become center stage with the incoming President Trump.
Among the six themes we discussed back in January, I also expected the dollar to continue on a big run. I said…
“The dollar is in a long term bull cycle—Be Long Dollars
When we look back at the long term cycles of the dollar over the past 40 years, we see five distinct cycles for the dollar. And these cycles have lasted, on average, about seven years. The most recent cycle is a bull cycle, started in March 2008, yet has underperformed the average of the past six cycles. While the bull cycle appears to be long–in–the–tooth, in terms of duration, the fundamentals for dollar strength have just recently swung massively in favor of the dollar. We have an historic divergence in the monetary policy path of the U.S. relative to Europe and Japan—a very rare occurrence to have the Fed going one direction (toward raising rates) and two major economic powers going the opposite direction, aggressively.
This huge monetary policy divergence dynamic creates the potential for a sharp extension in the dollar over the coming months.”
The dollar has indeed been strong, but only after a correction earlier in the year. In the past week, the dollar index has reached a 14–year high.
With the Fed projecting three hikes next year and Europe and Japan still going the opposite direction (full bore QE), the dollar trend doesn’t look like it will slow anytime soon. And despite what many are warning about what a stronger dollar might do to growth, a strong dollar tends to accompanystrong growth historically (and it doesn’t kill it). On the other hand, it should be fuel for the rest of the world, as cheaper foreign currencies give the weaker global economies a chance to export their way out of an economic rut.
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