Stocks were down big today. The media will have fun touting the Dow’s 700-point loss. But while 700 points has good shock value, on a Dow at 24,000, it’s not what it used to be.
Still, as we’ve discussed, the media and Wall Street are programmed to fit a story to the price. And there are no shortages of potential risks to point to when stocks fall. We have trade posturing in Washington. We have a Fed that’s in a tough position, trying to balance a bullish view on growth with the perception that rising rates could choke off that growth. And we have more regulatory scrutiny growing against the tech giants — with Facebook being the latest in the hot seat.
All of that sounds like bad news. But we also have corporate earnings on pace to grow at nearly 20% this year. And that could be an undershoot, given the inability of Wall Street to calibrate the effects of tax cuts on demand. And we have a big trillion-dollar plus infrastructure plan coming down the pike too. This is all as consumers are in as healthy a position as we’ve seen in more than a decade.
But what about a trade war? Doesn’t that threaten the earnings and growth outlook. Not more than nuclear war. And that was, in the public perception, probably as much of a risk last year, as a trade war is now. Stocks went up 20% last year.
Most importantly, we’ve discussed the merits of fighting China’s currency manipulation. If we don’t, we (and the rest of the world) are destined to repeat the cycles of credit booms and busts, with a persistent wealth drain along the way.
It has to be done. And it’s best done when there is leverage. And there is leverage now, as our economic recovery has the chance to lift the global economy out of the rut of the post-crisis stagnation (i.e. everyone needs our fiscal stimulus-driven recovery to work, including China).
Now, as we’ve discussed for quite some time: Markets will correct, as they have. And corrections are a gift to buy stocks on sale. But we won’t likely see a resumption of the long-term trend higher in stocks (and likely new highs by year end) until we start seeing hard evidence that fiscal stimulus is working. And we’ll see that in earnings and growth data, much of which is still a month out.
With all of this said, we pointed last week to the signals that predicted this latest down-leg. It was the big technical reversal signals across the tech heavyweights: Amazon, Apple and Microsoft. Those three stocks led the bounce from the February lows. And those three stocks have predicted this slide and maybe retest back toward the February lows.
What may be the real casualty left from this correction in stocks, when it’s all said and done? It may be those tech giants. As we’ve discussed, the heyday of crushing competition with the advantage of little-to-no regulation, are probably coming to an end. That will change the way these companies (Facebook, Amazon, Google, Uber, Airbnb, etc) operate.
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We talked yesterday about the important inflation data. That was in line this morning. And with that, the big 3% level on the benchmark 10-year government bond yield remains well preserved.
But stocks soured anyway on the day, and it was led by the Nasdaq.
Let’s take a closer look at the Nasdaq.
This is where the big tech giants, Apple, Microsoft and Amazon have led the charge back in the index back to new record highs over the past couple of days. Those three stocks represent about a third of the index (and contribute heavily to the S&P 500 too).
But as the three tech giants led the way up, they cracked today, and we now have some very compelling signals that another down leg for stocks may be here.
First, as the broader financial markets are still licking the wounds of the sharp correction, and still jittery, Apple hit a record high valuation of $925 billion this week (sniffing near the trillion dollar valuation mark). And then it did this today…
As you can see in this chart above, Apple put in a huge bearish reversal signal (an outside day).
So did Microsoft (a huge bearish reversal signal).
So did Amazon, after breaching record levels of $1600 over the past two days …
And, not surprisingly, same is said for the Nasdaq – a big reversal signal…
The S&P 500 had the same reversal pattern.
For perspective, if we avoided the distraction of the big cap weighted indices, the Dow chart tells us the downtrend in stocks from the late January highs remains well intact.
We talked this past week about the prospects that a correction was underway in stocks. Stocks in China, Japan, Germany and the UK were already leading the way. And with earnings from the big tech giants, I thought any cracks in the armor might give people reason to accelerate the profit taking.
That was the case. Google (NASDAQ:GOOG) missed on earnings. And Apple (NASDAQ:AAPL) disappointed on guidance. And the global stock markets were a sea of red on Friday.
Now, markets don’t go in a straight line, there are corrections along the way. Remember, since 1946, the S&P 500 has had a 10% decline about once a year. And we haven’t had one in a while. Since the election (in November of 2016), the worst decline in stocks from peak to trough has been only 3.4%. We’ve matched that now.
Now, it should be noted that this decline isn’t driven by a negative turn in fundamentals, rather it’s driven by profit taking, and (more importantly) the increasing likelihood that a higher growth environment will ultimately allow the central banks in Europe and Japan to exit QE — the remaining instruments of life support for a global economy that has been brought back to life by fiscal stimulus.
With that, as I’ve said, it’s fair to expect a correction until the data begins to prove out the benefits of fiscal stimulus (i.e. when we see first quarter corporate earnings and GDP growth – both of which should be very strong).
Now, as they do, the media wrings their hands over a slide in stocks and tries to find a story of trouble to fit the price. The reality is, most investors should see a decline in the U.S. stock market as an exciting opportunity. The best investors in the world do. If you are not leveraged, dips in stocks (particularly U.S. stocks – the largest economy in the world, with the deepest financial markets) should be bought, because in the simplest terms, over time, the broad stock market has an upward sloping trajectory.
And when better earnings from tax cuts start coming in for Q1, a lower stock market would amplify the impact of a higher denominator in the P/E ratio — that means stocks could become cheap (er) – maybe something closer to 15 times forward earnings, in a world of (still) low rates.
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For the first time in a decade, the mood at the World Economic Forum in Davos was of optimism and opportunity. And Trump economic policies have had a lot to do with it.
That optimism has continued to drive markets higher this year: global stocks, global interest rates, global commodities – practically everything.
The S&P 500 is up nearly 7% on the year now — just a little less than a month into the New Year. And we’ve yet to see the real impact of tax incentives hit earnings and investment.
But, with the rising price of oil (now above $65), and improving consumption (on the better outlook), we will likely start seeing the inflation numbers tick up.
Now, what will be the catalyst to cap this very sharp run higher in stocks to start the year? It will probably be the first “hotter than expected” inflation number.
That would start the speculation that the Fed might need to move rates faster, and it might speed-up the exit talks from QE in Europe and Japan.
If the inflation outlook triggers a correction (which would be healthy), that would set the table for hotter earnings and hotter economic growth (coming down the pike) to ultimately drive the remainder of stock returns for the year.
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We talked last week about the prospects of a government shutdown and the little-to-no impact it would likely have on markets.
Here we are, with a shutdown as we open the week, and stocks are on to new record highs. Oil continues to trade at the highest levels of the past three years. And benchmark global interest rates continue to tick higher.
As we look ahead for the week, fourth quarter earnings will start rolling in this week. But the big events of the week will be the Bank of Japan and European Central Bank meetings. The Bank of Japan (the most important of the two) meets tonight.
Remember, we’ve talked about the disconnect we’ve had in government bond yields, relative to the recovering global economy and strong asset price growth (led by stocks). And despite five Fed rate hikes, bond yields haven’t been tracking the moves made by the Fed either. The U.S. 10-year government bond yield finished virtually unchanged for the year in 2017.
That’s because the monetary policy in Japan has been acting as an anchor to global interest rates. Their policy of pegging their 10-year yield at zero, has created an open ended, unlimited QE program in Japan. That means, as the forces on global interest rates pulls Japanese rates higher, away from zero, they will, and have been buying unlimited amounts of Japanese Government Bonds (JGBs) to force the yield back toward zero. And they do it with freshly printed yen, which continues to prime the global economy with fresh liquidity.
So, as we’ve discussed, when the Bank of Japan finally signals a change to that policy, that’s when rates will finally move–and maybe very quickly.
If they choose, tonight, to signal an end of QE could be coming, even if it’s a year from now, the global interest rate picture will change immediately. With that in mind, here’s a look at the U.S. ten year yields going in …
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While the President’s pro-growth plan had some wins this year, it was a slow start.
Going after healthcare first was a mistake. Fortunately, a pivot was made, and we now have a big tax bill delivered. And we have what will likely exceed a couple hundred billion dollars in government spending on hurricane/natural disaster aid underway (the early stages of a big government spending/ infrastructure package).
Last year this time, I predicted that Trump’s corporate tax cut would cause stocks to rise 39%. That’s a big number, that’s only been done a handful of times since the 1920s. We got a little better than half way there.
But, here’s the good news: We got there on earnings growth, ultra-low rates and an improving economy. All of that still stands for next year, PLUS we will have the addition of an aggressive tax cut that will be live day one of 2018.
With that, my analysis from last year still stands! Let’s walk through it (yet) again.
S&P 500 earnings grew by 10% this year. S&P 500 earnings are expected to grow at about the same rate next year. And that’s before the impact of a huge cut in the corporate tax rate. The corporate tax rate now goes from 35% to 21% – and for every percentage point cut in that rate, we should expect it to add at least a dollar to S&P 500 earnings.
With that, the forecast on S&P 500 earnings for next year is $144. If we add $14 to that (for 14 percentage points in the corporate tax rate) we get $158. That would value stocks on next year’s earnings, at today’s closing price on the S&P 500, at just 17 times earnings (just a touch higher than the long-term average). BUT, the Fed has told us that rates will continue to be ultra-low next year (relative to history). When we look back at ultra–low interest rate periods, the valuation on stocks runs higher than average—usually north of 20 times earnings.
If we take the corporate tax cut driven earnings of $158 and multiply it times 20, we get 3,160 on the S&P 500. That’s 18% higher than current levels. This analysis doesn’t incorporate the impact of a potentially hotter than expected economy next year (thanks to the many other areas of fiscal stimulus). So, as we’ve discussed throughout the year, the backdrop continues to get better and better for stocks.
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Last week we had the merger of Fox and Disney, and the repeal of the Net Neutrality rule. And the tax bill continues to inch toward the finish line.
That said, this would typically be the time of year when markets go quiet as money managers close the books on the year, decision makers at companies go on holiday and politicians do the same.
But that wasn’t the case last year, as President-elect Trump was holding meetings in Trump towers and telegraphing policy changes. And it may not be the case this year, as the tax plan may be approved before year end. The final votes are said to come next week, and the bill is tracking to be on the President’s desk by Christmas.
With that, and with the lack of market liquidity into the year end, we may get a further melt-up in last trading days of the year.
Yesterday we talked about the other side of the Net Neutrality story that doesn’t get much acknowledgement in the press. In short, the tech giants that have emerged over the past decade, to dominate, have done so because of regulatory favor. This favor has decimated industries and has dangerously consolidated power into the hands of few. The repeal of this rule is turning that regulatory tide.
It looks like the playing field might be leveling. That means a higher cost of doing business may be coming for Silicon Valley, with fewer advantages and more competition from the old-economy brands that have been investing to compete online. That means potentially slower earnings growth for the big internet giants, for those that are making money, and an even more uncertain future for those that aren’t (e.g. Tesla).
With this in mind, at the moment Amazon is valued at twice the size of Walmart. Uber is valued at almost 40 times the size of Hertz. And Tesla, which has lost$2.5 billion over the past five years is valued the same as General Motors, which has made$43billion over the same period.
Next year could be the year these valuation anomalies correct.
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We had a jobs report this past Friday. The unemployment rate is at 4.1%. We’re adding about 172k jobs a month on average, over the past twelve months. These are great looking numbers (and have been for quite some time). Yet employees, broadly speaking, still haven’t been able to command higher wages. Wage growth continues to be on the soft side.
With little leverage in the job market, consumers tend not to chase prices in goods and services higher — and they tend not to take much risk. This tells you something about the health of the job market (beneath the headline numbers) and about the robustness of the economy. And this lack of wage growth plays into the weak inflation surprise that has perplexed the Fed. And the weak growth that has perplexed all policy makers (post-crisis). That’s why fiscal stimulus is needed!
And this could all change with the impending corporate tax cut. The biggest winners in a corporate tax cut are workers. The Tax Foundation thinks a cut in the corporate tax rate would double the current annual change in wages.
As I’ve said, I think we’re in the cusp of an economic boom period — one that we’ve desperately needed, following a decade of global deleveraging. And today is the first time I’ve heard the talking heads in the financial media discuss this possibility — that we may be entering an economic boom.
Now, we’ve talked quite a bit about the run in the big tech giants through the post-crisis era — driven by a formula of favor from the Obama administration, which included regulatory advantages and outright government funding (in the case of Tesla). And we’ve talked about the risk that this run could be coming to an end, courtesy of tighter regulation.
Uber has already run into bans in key markets. We’ve had the repeal of “net neutrality” which may ultimate lead big platforms like Google, Twitter, Facebook and Uber, to transparency of their practices and accountability for the actions of its users (that would be a game changer). And we now know that Trump is considering that Amazon might be a monopoly and harmful to the economy.
With this in mind, and with fiscal stimulus in store for next year, 2018 may be the year of the bounce back in the industries that have been crushed by the “winner takes all” platform that these internet giants have benefited from over the past decade.
That’s probably not great for the FAANG stocks, but very good for beaten down survivors in retail, energy, media (to name a few).
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Stocks fell sharply this morning, but recovered nearly all the losses from the lows of the day.
Today we got a reminder of the impact that algorithmic trading can have on markets. When the headline hit today about Flynn, here’s what stocks did…
Big institutions have been trading stocks through computer programs for a long time, but the speed at which these algorithms can access markets and information have changed dramatically over the past decade – so has the massive amount of assets deployed through high frequency trading programs. They can remove liquidity very quickly. Combine that with the reduced liquidity in markets that has resulted from the global financial crisis (i.e. the shrinkage of the marketing making community and of hedge fund speculators, and the banning of bank prop trading) and you get markets that can go down very fast. And you get markets that can go up very fast too.
The proliferation of ETFs exacerbates this dynamic. ETFs give average investors access to immediate execution, which turns investors into reactive traders. Selling begets selling. And buying begets buying.
Now, with the Flynn news, Wall Street and the financial media spend a lot of time trying to predict when the market will correct and what will cause it. But as the great billionaire investor, Howard Marks, has said: “It’s the surprises no one can anticipate that move markets. But most people can’t imagine them, and most of the time they don’t happen. That’s why they’re called surprises.”
Still, if you’re not a leveraged hedge fund, this tail-chasing game of trying to pick tops and reduce exposure at the perfect time shouldn’t apply.
More important is the observation that stocks remain cheap at current levels, when we consider valuations in historically low interest rate periods. And we continue to have very low interest rates. So the question is: Is it more likely that corporate earnings will get worse from here, or better from here?
There’s plenty of evidence to suggest the momentum and the fundamental backdrop supports “getting better” from here. And we add to that, the fuel of tax cuts, and earnings should continue to make stocks very attractive relative to a 2.3% ten-year yield.
Since the election, almost a year ago, we’ve talked about the great passing of the torch, from a monetary policy-driven global economic recovery (which proved dangerously weak and shallow) to a fiscal stimulus-driven recovery (which finally gives us a chance to return to trend growth).
Now, almost a year in, policy execution on the fiscal stimulus front is moving. The Fed has hiked rates three times. In the past week, the ECB has signaled the end of QE in Europe is coming. And this Thursday the Bank of England is expected to raise rates for the first time in a decade.
Again, if you can block out the day-to-day noise, this is all confirming the exit of the post-crisis deleveraging era of the past decade – it’s all playing out fairly close to script.
With that, I want to revisit my note from early January of this year, which argues the case for this “passing of the torch” and emphasizes the value of having some bigger picture perspective…
From my Market Perspectives piece: JANUARY 18, 2017
“Two weeks ago, in my daily Market Perspectives note, I talked about the five reasons, even at Dow 20,000, that stocks look extraordinarily cheap as we head into 2017.
Today I want to talk a bit more about the idea that the timing is right for a pop in economic growth.
For the past ten years, we’ve heard experts pontificate about ‘what inning we’re in,’ during the crisis era. I think there are good reasons to believe the game is over, and it was ended on election night–that was the catalyst.The policy responses and regime shift have more to do with the evolution of the global financial crisis and human psychology, than it does with the character behind it all.
I want to focus on a study from Carmen Reinhart and Kenneth Rogoff – the two economists that laid out the script, back in 2008, for precisely what the world has experienced over the past ten years. Fortunately, Bernanke was a believer in it. That’s why the Fed kept its foot on the gas, even in the face of a lot of scrutiny from people that blamed the Fed on extending the crisis.
Reinhart and Rogoff studied eight centuries of financial crises and they found striking commonalities in the aftermath. They found that financial crises tend to lead to sovereign debt crises. And sovereign debt crises tend to be contagious. Clearly, we’ve seen it.
Reinhart went on to look at the 15 severe financial crises since World War II and found that they were typically driven by credit bubbles. Check.
Importantly, they found that the credit bubble typically took as long to unwind (or de-lever) as it took to build. And the deleveraging period tends to mean ultra-slow economic activity as consumers, businesses and governments are paying down debt, not spending. And because of this, the research suggested that throughout this ten-year deleveraging period we should expect: 1) economic growth will trend at lower levels than pre-crisis growth, 2) housing prices will remain anywhere from 20% to 50% below peak levels and 3) unemployment will hover around 5% higher than pre-crisis levels. Check, check and check.
In the current case, Reinhart and Rogoff said the credit bubble was built over about a decade. That means we all should all have expected a decade long deleveraging period.
Now, with that, you can mark the top in the bubble as the 2006 housing top, or in 2007 when we the first big mortgage company and Bear Stearns hedge fund failed, or 2008, when consumer credit peaked. We’re somewhere in the middle of this window now and major turning points in markets tend to come with significant events. It’s a fair argument to make that the Trump election was a significant event for the world. With that, we may find that the crisis period officially ended with the election, when the history books look back on this current period of time.’
So that was my take back in January. It’s not easy to watch the process play out. It can be slow and ugly. But we’re seeing the reaction in stocks to this thesis – now at 23k in the DJIA. And we’re getting some momentum building on the policy making side that further supports this structural turning point is here (or has been here).
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Since the election, almost a year ago, we’ve talked about the great passing of the torch, from a monetary policy-driven global economic recovery (which proved dangerously weak and shallow) to a fiscal stimulus-driven recovery (which finally gives us a chance to return to trend growth).