Stocks continue to print new record highs. Let’s talk about why.
First, as we know, the most powerful underlying force for stocks right now is prospects of a massive corporate tax cut, deregulation, a huge infrastructure spend and trillions of dollars of corporate repatriation coming. But quietly, among all of the Trump attention, earnings are also driving stocks. More than 70% of S&P 500 companies have reported. About 2/3rds of the companies have beat Wall Street estimates. And most importantly, earnings in Q4 have grown at 3.1% year-over-year. That’s the first consecutive positive growth reading since Q4 2014/ Q1 2015.
Meanwhile, yields have remained quiet. And oil prices have remained quiet. That’s positive for stocks. Take a look at the graphic below …
You can see, stocks and most commodities continue to rise on the growth outlook. Yields and energy should be rising too. But the 10 year yield has barely budged all year — same for oil. Of course, higher rates, too fast, are a countervailing force to the pro-growth policies. Same can be said for higher oil too fast. With that, both are adding more “fuel” to stocks.
On the rate front, we’ll hear from Janet Yellen this week, as she gives prepared remarks on the economy to Congress, and takes questions.
She’s been a communications disaster for the Fed. Most recently, following the Fed’s December rate hike, she backtracked on her comments made a few months prior, when she said the Fed would let the economy run hot. She denied that in December. Still, the 10-year yield is about 10 basis points lower than where it closed following that December press conference. I wouldn’t be surprised to see a more dovish tone from Yellen this time around, in effort to walk market rates a little lower, to take the pressure off of the Fed and to continue stimulating optimism about the economy.
On Friday we looked at four important charts for markets as we head into this week: the dollar/yen exchange rate, the Nikkei (Japanese stocks), the DAX (German Stocks), and the Shanghai Composite (Chinese stocks).
With U.S. stocks printing new record highs by the day, these three stock markets are ready to make a big catch-up run. It’s just a matter of when. And I argued that a positive tone coming from the meeting of U.S. and Japanese leadership, under the scrutiny of trade tensions, could be the greenlight to get these markets going. That includes a stronger dollar vs. the yen. All are moving in the right direction today.
On the China front, we looked at this chart on Friday.
As I said, “Copper has made a run (up 10% ytd). That typically correlates well with expectations of global growth. Global growth is typically good for China. Of course, they are in the crosshairs of Trump’s fair trade movement, but if you think there’s a chance that more fair trade terms can be a win for the U.S. and a win for China, then Chinese stocks are a bargain here.”
Copper is surged again today on a supply disruption and has technically broken out.
This should continue to spark a move in the Chinese stock market.
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Stocks finished the week on record highs. We talked earlier in the week about Trump’s meeting with Japan’s Prime Minister and his economic and finance advisors.
I suspect that Trump will come away, after a weekend in Palm Beach with Abe, learning that Abenomics is good for the U.S., and good global growth and stability (in the current global economic environment).
And one of the keys to success in Abenomics is a weaker yen, which translates to a stronger dollar. As I’ve said, the weak yen has been pulled into the fray with Trump’s tough talk on trade imbalances, but his beef on currency advantage is really directed toward China – not Japan, not Mexico, not even Europe.
With that, and with the assumption that the yen may be pardoned for a while, the dollar bouncing against the yen as we head into the weekend. And it looks like we may see a technical breakout and an even higher dollar, lower yen in our future.
And Japanese stocks look set to break out too, to catch up to the strength of U.S. stocks. The Nikkei is 8% off of the 2015 highs, while U.S. stocks are on record highs, and 8% ABOVE its 2015 highs.
Another catch up trade: German stocks. Despite the growing attention given to the French nationalist candidate, Le Pen, who has been anti-euro and anti-European Union, right or wrong the bond market isn’t showing any new interest in disaster insurance in Europe, nor is the euro.
With that, German stocks look very good, still about 8% from the 2015 highs, and the technical correction clearly ended last summer.
Lastly, let’s take a look at another big sleeper stock market, China…
You can see how Copper is on a big run (up 10% ytd). That typically correlates well with expectations of global growth. Global growth is typically good for China. Of course, China is in the crosshairs of Trump’s fair trade movement, but if you think there’s a chance that more fair trade terms can be a win for the U.S. and a win for China, then Chinese stocks are a bargain here.
Have a great weekend!
For help building a high potential portfolio for 2017, follow me in our Billionaire’s Portfolio, where you look over my shoulder as I follow the world’s best investors into their best stocks. Our portfolio more than doubled the return of the S&P 500 in 2016. You can join me here and get positioned for a big 2017.
Stocks are hitting new record highs today. That includes the Dow, the S&P 500 and the Nasdaq.
We’ve now seen about 60% of the earnings for Q4, and earnings are very good. As we’ve discussed, earnings guidance and consensus views are made to be beaten. Factset says that, on average, about 67% of S&P 500 companies beat the consensus view on earnings. For Q4, that number, as of last Friday, was 65%.
More importantly, the earnings growth rate for Q4 is +4.6% thus far. That’s better than the 3.1% that was predicted, coming into the earnings season. And that’s the first two consecutive quarters of year-over-year positive EPS growth in a couple of years.
So we have positive earnings surprises driving stocks higher. And finally, revenue growth is coming. After six consecutive quarters of revenue contraction, earnings for U.S. companies had a second consecutive quarter of growth. And the quarters ahead should be much better.
Clearly, in the weak growth environment, the focus has clearly been cutting costs, refinancing debt, selling non-core assets, and buying back shares. That’s all a recipe for juicing EPS, even though revenue growth is sluggish, if existent.
So for all of the people that are constantly hand wringing about the levels of the stock market, ask them this: What happens when you take these companies that are growing earnings by optimizing margins in a 1% growth world, and you give them 3%-4% economic growth? Earnings go up. What happens when you take a profitable company and cut the tax burden by 15 to 20 percentage points? Earnings go up.
When earnings go up, price to earnings goes down. And valuations can become very, very cheap.
We have companies that have been forced to streamline to survive. And now we’re in the early days of a regime shift, where tax cuts will work for them, deregulation will work for them, and a big infrastructure spend will pop demand, to actually fuel some revenue growth.
Below is a nice chart from Yardeni. You can see the flattish revenue growth, but earnings divergence over the past five years.
On the right hand axis, next year’s earnings on the S&P 500 are expected around $133. That doesn’t take into account the impact of a corporate tax cut, which Standard & Poors research has suggested could bump that number up to the mid $150s ($1.31 added for every 1% cut in the corporate tax rate). That would dramatically widen the revenue, earnings divergence — or make the closing of this gap that much more aggressive.
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We’ve talked about the drift (now slide) lower in interest rates over the past couple of days. This is a big deal and something to keep a close eye on. Remember, this move lower comes in the face of a strong jobs number on Friday. Following that number, the yield on the 10-year traded up to 2.50%. Today we’re looking at 2.35% (low of 2.32%).
In contrast to this move in rates, stocks are sitting on record highs, if not making new record highs. Oil has been stable in a $50-$55 range. The dollar isn’t doing much. Implied volatility on the stock market is dead. And commodities are relatively quiet, except for gold.
On that note, yesterday we looked at the tight correlation of the inverse price of gold and yields since the election (i.e. gold goes up, yields go down). And in recent weeks, yields have been lagging the strength in gold, making the case for even lower yields to come.
We looked at the below trendline on the 10-year yesterday that was testing… that gave way today.
This move lower in yields puts both the Trump administration and the Fed in a much more comfortable spot.
A continued rise in market interest rates would force the Fed to be more aggressive, both of which would work against fiscal stimulus, dulling the contribution to growth, if not neutralizing it all together. Higher rates would slow the housing market and slow spending, especially in a fragile economy. Among the things to be worried about, higher rates, too soon, could be the biggest (bigger than protectionism, European elections…)
President Trump was said to be asking for advice on the administration’s view on the dollar overnight. I suspect the upcoming meeting with Japan’s Prime Minister (and co.) had something (a lot) to do with it. This is precisely what we’ve been talking about. The dollar and the yen are squarely in the crosshairs for this face-to-face meeting. But Trump may learn from the meeting that he would far prefer a stronger dollar and weaker yen, than a 4-4.5% ten year yield by the end of the year.
As I’ve said, Japan’s QE policies, which weaken the yen, also offer an anchor to U.S. interest rates, keeping them in check. I suspect the softening of U.S. yields, as all other markets are quiet, may have something to do with Chinese money leaving China (as we discussed yesterday). But it also may be influenced by Japan, finding the best, safest parking place for freshly printed money (i.e. buying U.S. Treasuries, which pushed down U.S. rates) – and showing that benefits of that influence to the new President.
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Yesterday we looked at the slide in yields (U.S. market interest rates — the 10-year Treasury yield). That continued today, in a relatively quiet market.
Let’s take a look at what may be driving it.
If you take a look at the chart below, you can see the moves in yields and gold have been tightly correlated since election night: gold down, yields up.
As markets began pricing in a wave of U.S. growth policies, in a world where negative interest rates were beginning to emerge, the benchmark market-interest-rate in the U.S. shot up and global interest rates followed. The German 10-year yield swung from negative territory back into positive territory. Even Japan, the leader of global negative interest rate policy early last year, had a big reversal back into positive territory.
And as growth prospects returned, people dumped gold. And as you can see in the chart above of the “inverted price of gold,” the rising line represents falling gold prices.
Interestingly, gold has been bouncing pretty aggressively since mid December. Why? To an extent, it’s pricing in some uncertainty surrounding Trump policies. And that would also explain the slow down and (somewhat) slide in U.S. yields. In fact, based on that chart above and the gold relationship, it looks like we could see yields back below 2.10%. That would mean a break of the technical support (the yellow line) in this next chart …
Another reason for higher gold, lower yields (i.e. higher bond prices), might be the capital flight in China. Where do you move money if you’re able to get it out in China? The dollar, U.S. Treasuries, U.S. stocks, Gold.
The data overnight showed the lowest levels reached in the countries $3 trillion currency reserve stash in 6 years. That, in large part, comes from the Chinese central banks use of reserves to slow the decline of their currency, the yuan. Of course a weakening yuan only inflames U.S. trade rhetoric.
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We ended last week with a very strong jobs report, yet the measure of wage pressure was soft. That, for the near term, reduces expectations on how aggressive the Fed might be (but not a lot).
Still, the 10-year yield has drifted lower to start the week. It was 2.50% Friday afternoon. Today it’s closer to 2.40%. When the 10-year yield drifts lower, mortgage rates drift a little lower, back very close to 4% today. This all helps two of the most important tools the Fed has been focused on for the past eight years to drive economic recovery: stocks and housing.
The Trump administration, like the Fed, will need both stocks and housing to continue higher to maintain confidence in the economy, and in the agenda.
Now, on Friday I said Trump was hosting Japan’s Prime Minister Abe in Florida over the weekend for a round of golf at Mar-a-Lago. It looks like it’s this coming weekend, instead.
Interestingly, this comes as the Trump administration made a conscious effort on Friday to refocus the messaging from a protectionist narrative to an economic growth narrative.
Abe will be entering this meeting with President Trump under some peripheral scrutiny about trade imbalances. Japan runs about a $60 billion surplus with the United States. That’s about on par with Mexico, which has become a target for Trump in recent weeks. Still, as I said last week, it’s peanuts compared to China, and that’s where the Trump administration’s real attention lies.
Nonetheless, Abe is expected to come in with a plan to balance trade with the U.S., which includes working together on a big U.S. infrastructure program. And there is still considerable sensitivity surrounding the value of the yen (the Japanese currency).
As we know, under Abenomics, the yen has devalued by about 40% against the dollar. But as China has done often over the past decade, as they have headed into big meetings with global leaders, Japan seems to be walking its currency up in the days heading into the Abe/Trump meeting.
You can see in the chart above, the dollar has been in decline against the yen this year (the orange line falling represents a weaker dollar, stronger yen). The top in the USD/JPY exchange rate this year came when Trump’s chief trade negotiator was named on January 3rd. Robert Lighthizer worked in the Reagan administration and happened to be behind stiff tariffs imposed on Japan during that era on electronics.
Trump’s tough talk on trade, and the market’s continued focus on upcoming elections in Europe (that threaten to continue the trend of nationalism and protectionism) have stocks in Japan and Europe diverging from the strength we’re seeing in U.S. stocks. The Dow is above 20k. Meanwhile, Japanese stocks are still 10% off of the 2015 highs. German stocks are 7% off of 2015 highs.
But as I’ve said, growth solves a lot of problems. In addition to the underlying current of a better performing U.S. economy (with the pro-growth agenda in the pipeline), the data is already improving in both Germany and Japan. I suspect that Europe and Japan will soon be cleared from the fray of the trade protectionist rhetoric, and we’ll start seeing major European stock markets and the Japanese stock market climbing, and ultimately putting up a big number in 2017.
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The dollar has come into the crosshairs of the new president in recent weeks.
Let’s talk about what’s happening and why it matters.
First, it’s highly unusual for the U.S. President to comment on the dollar. The Fed doesn’t even comment. If they do it’s in an indirect way. It has always been a topic deferred to the Treasury Secretary. And the consistent message there has been, for a long time, that we are for a strong dollar.
Things have changed. Or have they? In mid-January, President Trump told the Wall Street Journal that the dollar was “too strong.”
The markets have had a hard time trying to reconcile this comment and stance taken by the administration. But we have to keep in mind: The new president has been a bit less than measured in his words.
When the Fed is in a hiking cycle and other major central banks are still in QE mode, capital will continue to flow into the U.S., and you’re going to get a stronger dollar. When you incentivize U.S. corporates to repatriate a couple trillion dollars they have offshore, you’re going to get a stronger dollar. When/if you pop growth to 4%, you’re going to get higher rates, faster, and you’re going to get a stronger dollar (especially when that growth will lead the rest of the world).
So what is this jawboning on the dollar all about?
As we know, Trump has had an early focus on trade. And he’s used displeasure with trade deficits with countries as a bargaining chip to start conversations about more fair trade terms. But while many have been pulled into the fray over the past few weeks (like Canada, Mexico, the euro zone, etc), this is all about China. My guess is he’s using Mexico as an example for China.
We’ve heard a lot about the $60 billion trade deficit Mexico. It is our third largest trading partner. But that deficit is peanuts when compared to China. Same can be said for Japan, Germany and Canada, three of our other largest trading partners. With China, however, we buy about $483 billion worth of goods. And we sell them only about $116 billion. That’s a $367 billion deficit.
The problem is, it never corrects. It continues, and will continue, unless dealt with. Currencies are the natural trade rebalancer. And with China, it doesn’t happen because they outright dictate the exchange rate. The cheap currency has been/and continues to be its economic driver–and it’s the unfair competitive advantage that has crippled the global economy over time.
Consider this: Over the past 20 years, China’s economy has grown more than fourteen-fold! … to $10 trillion. It’s now the second largest economy in the world. During the same period, the U.S. economy has grown just 2.5x in size. And in the process a global credit bubble was formed. China sells us goods. We give them dollars. China takes our dollars and buys U.S. Treasuries, which suppresses U.S. interest rates and incentivizes borrowing, which fuels more consumption. And the cycle continues.
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I talked yesterday about the Fed. As I said, I think we’ll find that the Fed will shift gears again to stay behind the curve on inflation, to let the economy run a little hot. They met today and it was a non-event. They said nothing to build momentum on their rate hike from December.
The news of the day has been Apple (NASDAQ:AAPL) earnings. People over the past couple of years have been calling for the decline in Apple. They’ve said it’s topped. They can’t innovate in the post-Steve Jobs era. The iPhone was magic. But reproducing magic isn’t easy. Once you put a computer in everyone’s pocket, there’s not much more they can do to it with it. These are all of the quips about Apple’s peak. They may be right. But Apple’s peak, at least as a stock, is greatly exaggerated.
They reported a huge positive surprise on earnings yesterday after the close. The stock was up 6% on the day. But even before that, I suspect it has become a much loved stock in the past two months in the “smart money” investor community.
We should see in the coming weeks, as big investors disclose their positioning for the end of Q4, Apple will have returned to a lot of portfolios again. Warren Buffett, an investor that has made his fortune buying when others are selling, built a big stake at the lows of the year last year. And it’s a perfect Buffett stock.
It’s incredibly cheap compared to the market.
The stock still trades at 15x earnings. Much cheaper than the market. Apple trades at 13x next year’s projected earnings. The S&P 500 trades at 16.5x. What about Apple’s monster cash position? Apple has even more cash now — a record $246 billion. If we excluded the cash from the valuation, Apple market cap goes down from $675 billion to $429 billion. That would equate to Apple trading at closer to 9x earnings. Though not an “apples to apples” that valuation would group Apple with the likes of these S&P 500 components that trade around 9 times earnings, like: Dow Chemical, Prudential Financial, Bed Bath & Beyond, a Norwegian chemical company (LBY), and Hewlett Packard Enterprise. It’s safe to say no one is debating whether or not Hewlett Packard is at the pinnacle of its business. Yet, if we strip out the cash in Apple, AAPL shares are trading closer to an HPE valuation.
Add to that, Apple now has a fresh catalyst coming in, Trump policies. The new President Trump is incentivizing Apple (and others) to bring offshore cash hoards back home with a flat 10% tax. And Apple makes money – a lot of it. A cut in the corporate tax rate will be a boon for earnings. Two years ago, Carl Icahn argued that Apple should use (a lot more of) their cash to buyback shares – and, with that, valued the stock at double its current levels.
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Remember, it wasn’t too long ago that the world was sitting on every word uttered by a central banker. Those days are likely over — at least to the extreme extent of the past decade. For now, Trump has supplanted central bankers as the most powerful policy maker in the world.
Still, the Fed will meet following their rate hike last month, the second in their very slow hiking cycle – 1/4 point hike twelve months apart. They’ll do nothing this week, but the data tends to be going as desired by the Fed, and other major central banks for that matter (aside from Japan) — meaning, inflation has recovered and is nearing the target zone.
Remember, this time last year, the world was staring down the barrel of DE-flation again. Inflation, central bankers have tools to combat. Deflation is far more difficult, and far less predictable. It can spiral and grind economies to a halt. When consumers are convinced prices will be cheaper in the future, they wait. When they wait, economic activity stalls. With that, deflation tends to create more deflation. The fear of that scenario, and the potential of an irreversible spiral, is why central bankers were cutting rates to negative territory last year.
Where was the imminent deflationary threat coming from? Slow economic activity, but mostly a crash in oil prices.
Central bankers have the tendency to change the rules of the game when it suits them. When inflation is running hot, they may hold off on tightening money by pointing to hot “food and energy” prices. These are temporary influences, as they say. Interestingly, they are much more aggressive, though, when oil prices are creating a deflationary threat – as they did last year.
With that, oil prices have doubled from the lows of last February. So it shouldn’t be too surprising that inflation numbers are rising, and getting close to the desired targets (around 2%) of the central bankers of the U.S., Europe and England.
So will we see a turning point for global central banks (not just the Fed) in the months ahead? The world has already been pricing in the likelihood that the pro-growth policies coming from the Trump administration will take the burden of manufacturing economic recovery off of the central banks.
But we may find that “transitory oil prices” will be the excuse for more inaction by the Fed, and continued QE from the ECB and BOE in the months ahead, which may result in a slower pace of rate hikes than both the Fed projected in December and the market has been anticipating.
Higher rates at this stage: 1) creates problems for the housing recovery, 2) promotes more capital flight from emerging markets like China (which means more dollar strength),and 3) threatens to neutralize the fiscal stimulus and reform coming down the pike for the U.S.
In December, the Fed dialed back their talk about letting the economy run hot (i.e. staying well behind the curve on inflation to make sure recovery is robust). We’ll see if they switch gears again and start explaining away the inflation numbers to oil prices.
For help building a high potential portfolio for 2017, follow me in our Billionaire’s Portfolio, where you look over my shoulder as I follow the world’s best investors into their best stocks. Our portfolio more than doubled the return of the S&P 500 in 2016. You can join me here and get positioned for a big 2017.
The Trump agenda continues to dominate the market focus as we entered the second week of Trumponomics.
To this point the market focus has been on the pro-growth agenda. With that, stocks have been higher, yields have been higher, the dollar has been higher, and global commodities have been broadly rising. Meanwhile, gold (the fear trade) has been falling and the VIX has been falling, toward ultra-low levels. The VIX, like gold, is a good market indicator of uncertainty and/or fear.
Let’s talk about the VIX…
The VIX measures the implied volatility of options on the S&P 500. This is a key component in the price investors pay for downside protection on their portfolios.
So what is implied volatility? Implied volatility measures both actual volatility and the options market maker community’s expectations (or perception of certainty) about future volatility. When market makers feel confident about the stability in markets, implied vol is lower, which makes the price of options cheaper. When they aren’t confident in stability, implied vol goes up, which makes the price of an option go up. To compensate those that are taking the other side of your trade, for the lack of predictability, you pay a premium.
With that in mind, on Friday, the VIX traded to the lowest levels since the days before the failure of Lehman Brothers. That indicates that the market had (or has) become a believer that pro-growth policies, combined with ultra-easy central bank policies have created a buffer against the downside in stocks. But that perception of downside risk is changing today, with the more vocal uprising against Trump social policies. You can see the spike (in the far right of the chart) today…
So as big money managers were closing the week last Friday, looking at Dow 20,000+ and a VIX sliding toward levels not too far from pre-crisis levels, buying downside protection was dirt cheap. This morning, they’re paying quite a bit more for that protection.
With that said, this pop in the VIX and the Dow trading off by more than 100 points today gets a lot of attention. But is there justification to think that market turbulence will begin to reflect the turbulence and division in public opinion toward Trump policies? Just gauging the extent of the market reaction from the VIX today, it’s unlikely. The chart below is the longer term view of the VIX.
My observations: The VIX has had a small bounce from very, very low levels. On an absolute basis, vol is still very cheap. When there is real fear in the air, real uncertainty about the future, you can see from the spikes in the longer term chart above, the premium for the unknown gets priced in quickly and aggressively. Given that there has been virtually no risk premium priced into the market for any falter in the Trump Presidency, or the execution of Trump policies, the moves today have been very modest. And gold (as I write) is barely changed on the day.
We are likely entering an incredible era for investing, which will be an opportunity for average investors to make up ground on the meager wealth creation and retirement savings opportunities of the past decade. For help building a high potential portfolio for 2017, follow me in our Billionaire’s Portfolio, where you look over my shoulder as I follow the world’s best investors into their best stocks. Our portfolio more than doubled the return of the S&P 500 in 2016. You can join me here and get positioned for a big 2017.
