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 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.
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.
We’re finishing the first full week under Trumponomics. And it’s been an active one.
It’s clear now that President Trump intends to follow through on his campaign promises. While that’s making waves with the media and with Washington types, it’s creating more certainty about the outlook for growth for the real economy and, therefore, for financial markets.
We close the week with the Dow above 20,000, on new record highs. And as we discussed yesterday, stock markets around the world are rallying too on the prospects of a stronger U.S. economy translating into a stronger global economy. We looked at the charts of Mexican and Canadian stocks yesterday–both of which are sitting on record highs. U.K. stocks are near record highs and German stocks are quickly closing in.
We already know that small business optimism in the U.S. has hit 12-year highs, jumping by the most in since 1980–on Trump’s pro-growth agenda. Today the consumer sentiment report showed sentiment is on the rise too–at 13-year highs.
Let’s talk about the data that we’re leaving behind. Fourth quarter GDP was reported today at just 1.9%. This, more than seven years removed from the failure of Lehman Brothers, an $800 billion stimulus package, seven years of zero interest rates and three rounds of quantitative easing, and the economy is running at about 60% of its normal pace. And even after taking the Fed’s balance sheet from $800 billion to $4.5 trillion, we have inflation running at less than 50% of its normal pace. This malaise is consistent throughout the world. And this is precisely why big, bold fiscal stimulus and structural change is desperately needed, and is being embraced by those that understand the dangers of the stall-speed global economy that has been kept alive by global central bank intervention. As I’ve said, at Dow 20,000, it’s just getting started.
Have a great weekend!
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.
We talked yesterday about the significance of Dow 20,000. Higher stock prices are fuel for higher stock prices. And higher stock prices are fuel for better economic growth. It’s all self-reinforcing, and we discussed the reasons why stocks can still go much, much higher from here.
As I said, this serves as a validation marker for some that have been waiting to see what the Trump effect might be on markets. If you’ve listened to the consensus voice on Trumponomics, they’ve told you over and over how disastrous the protectionist rhetoric would be the U.S. economy and for the world. I’ve said, given the position of the world, post-Great recession, that Trump’s tough talk is leverage that can be used to ultimately create a fair playing field on trade, which can ultimately lead toward a rebalancing of the global economy — something that has to take place to put the world back on a path of sustainable growth, and end the cycle of booms and busts. That’s a win-win for everyone.
We’ve seen it working with industry leaders (they’re playing ball). And expect a similar outcome on the geopolitical front. This approach doesn’t work in normal times, but we’re not in normal times, almost a decade after the onset of the global financial crisis — where global economies remain weak and vulnerable.
With this in mind, Mexico and Canada are in focus with the announcement this week of the NAFTA renegotiation, the wall and the Keystone pipeline. And the media is hot and heavy on the cancellation of a trip to the White House by the Mexican President.
Let’s take a look at how Trumponomics is working for our two biggest trading partners, thus far.
This is the chart of the dollar versus the Mexican Peso. The rising line represents the dollar strengthening and the peso weakening, and vice versa.
If we look at this exchange rate as a gauge of trade partner health, we’ve seen the peso hit hard through the campaigning period under the protectionist fears of a Trump administration – and post election. That has represented a negative-scenario message for Mexico. But since the inauguration, the peso has been strengthening (not weakening), even as President Trump signed an executive order to renegotiate NAFTA. The message behind that usually means: the U.S. does better, Mexico does better.
What about Mexican stocks? Similar story. As the U.S. stock market is on record highs, the Mexican stock market too, is sitting on record highs. When the prospects are better for U.S. growth, our trade partners do better.
What about Canada? The same story. The Canadian stock market is on record highs.
The worst-case scenarios are good fodder for attracting readers and viewers. That’s why the media is obsessively focused on the potential negatives. But with some perspective on the bigger picture, and with respect to the position of the world coming out of the crisis period, those worst-case scenarios have lower probabilities than they think, and would have you believe. That’s why reality is crafting a very different story.
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.
Remember, this (animal spirits) is the element that economists and analysts can’t predict, and can’t quantify. It’s not in the forecasts. 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 mistrust 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 mindsethas been underway since the night of the election. And that gives way to a return of animal spirits.
Higher stock prices tend to beget higher stock prices. Trust me, individual investors that haven’t been believers will be calling their financial advisors and logging in to their online brokerage accounts over the coming days. Institutional investors that haven’t been believers, that have been underweight stocks, will be beefing up exposure if they want to compete with their peers (and keep their jobs).
And not only do higher stock prices lead to higher stock prices, but higher stock prices tend to make people feel more confident about the economy, which begets a better economy.
Add to this, the psychological value of Dow 20,000 could finally be a turning point in the divergence of sentiment toward the Trump Presidency. It may serve as a validation marker for those that have been on the fence. And for those in opposition, as I’ve said before, growth solves a lot of problems! When the college grad that’s been relegated to a 10-year career as a barista begins to see signs of opportunity for a better career and a better future, in a stronger economy, the sands of Trump sentiment can shift quickly.
Cleary, Trump entered with a game plan that can pop economic growth. And he’s going 100 miles an hour at executing on that plan. For markets, what he’s doing is creating a sense of certainty for investors. They know what he’s promised, and now they know that he appears to intend on delivering on those promises. And the coordination of growth policies, along with ultra-easy monetary policy (even with tightening in view) serves as risk mitigators for markets. It should limit downside risk, which is what investors care most about. How?
Remember, even at Dow 20,000, stocks are still extremely cheap.
Here’s a review on why …
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 48% by the middle of this year. We’re still making up for the lost growth of the past decade. And there’s a lot of ground to make up.
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. That’s an S&P 500 earnings estimate of $133.64 times a P/E of 20 equals 2,672 on the S&P 500.
Reason #3: 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 37% higher.
With this in mind, 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.
