We’re getting into the heart of Q1 earnings now, with about a quarter of the companies in the S&P 500 now in, and many more reporting this week. And we’ll get the first look at Q1 GDP this Friday.
Remember, as we went through the price correction in stocks, we’ve been waiting for the data to “prove it” to the market that fiscal stimulus and structural reform are indeed fueling a return to trend growth.
On that note, the performance of companies in Q1 have NOT disappointed. As of Friday, 80% of the S&P 500 companies that have reported have beat earnings estimates. And 72% have beat revenue estimates.
Now we have the build up to the big Q1 GDP number at the end of this week. We were already heading into the first quarter, with the economy growing at better than 3% for the second half of 2017. And then the fire was fed with the tax bill.
So what are the expectations going into the GDP report?
The Atlanta Fed attempts to mimic the model used by the BEA on their GDP forecast. They are looking for 2% for Q1 growth. And as you can see in their chart above, the forecasted number has been on a dramatic slide as we’ve seen more and more economic data through the period. More importantly, Reuters has the consensus view of economists at 2%.
The New York Fed’s model is predicting 2.9% growth (closer to that important trend growth level).
As with earnings, a low bar to hop over tends to be very good for stocks. And at a 2% consensus, we’re setting up for a positive surprise on GDP.
As we’ve discussed, despite the move higher in global rates over the past week, and the coming break of the 3% barrier in the 10-year yield, it will be hard to dispute the signal of economic strength and robustness from the combination of a huge earnings season and a positive surprise in GDP. If we get it, that should kick the stock market recovery into another gear.
We talked last week about the correction underway in stocks. As I said, 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 November 2016 election, the worst decline in stocks from peak to trough had been only 3.4%.
So we were due. And we’ve gotten it.
Today we’ve seen it accelerate. With the steep slide in stocks today, for a brief moment, the Dow futures were down 11% from the peak of just 7 days ago.
Now, let’s add a little perspective on this …
First, as I’ve said, when you are a hedge fund or trader and you’re leveraged 10, 20, 50, 100 times, then avoiding corrections or trend changes is critical to your survival. Getting it wrong, can mean your portfolio blows up and maybe goes to zero. That’s the mentality the media is speaking to, and frankly much of Wall Street is speaking to, when addressing any market decline.
The bottom line is that 99.9% of investors aren’t leveraged and should have no concern about U.S. stock market declines, other than saying to themselves: “What a gift! Do I have cash I can put to work at these cheaper prices? And, where should I put that cash to work?” As the great Warren Buffett has said, “be greedy when others are fearful.”
So, for the average investor, dips are an opportunity to buy stocks at a discount. Don’t let the noise distract you.
Remember, we’ve talked about the transition that is underway, with a global economy that now has the potential to officially exit the economic slog of the past decade, driven by pro-growth policies in the U.S. And those economic tailwinds have introduced the likelihood that the world will finally be able to exit central bank life support (i.e. QE). That’s all very positive.
But it has also been the trigger of the correction in stocks–this transition. QE has promoted higher stock prices. Now we get a correction, and a new catalyst (earnings and the growth picture) to justify the next leg of the global economic recovery (and stock bull market).
With that in mind, the fundamentals for stocks are very strong. As stocks tick down, the better valuation on stocks will only be amplified, when we get hot first quarter earnings hitting in a few months (thanks to the big corporate tax cut). For the S&P 500 P/E: We have the “P” going down, and the “E” going up.
How long could this correction last?
Remember when we were discussing the probability of a correction back in November, we looked at this chart …
In September 2014, with no significant one event or catalyst prompting it, the S&P 500 went on a slide. Stocks closed on a record high on Friday, September 19 (2014). On Monday, stocks gapped lower and over the next 18 days fell 10%. But over the following 12 days it all came back–a sharp V-shaped recovery. It was a textbook technical correction–right at 10%, right into the prevailing trend. You can see it in the chart above: the v-shaped move in stocks, and the bounce right off of the big trendline.
What’s happened in the markets the last few days reminds me of that correction. The moves can be fast, and the recovery can be fast, in this (post-crisis) environment. 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.
With the above dynamic, we’ve seen a fair share of quick declines and quick recoveries in the post-financial crisis era.
How do things look now?
In the chart above, this big trend line represents the move off of the oil crash lows of 2016. This 2560 area would give us a 10.8% correction in the S&P 500. I wouldn’t be surprised if we got there over a few days, and a recovery began. And I expect to stocks to end the year up double digits (still).
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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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Yesterday we talked about the commodities bull market and the move underway in natural gas.
That all continued today, thanks in part to a comment by the U.S. Treasury Secretary, saying “obviously a weaker dollar is good for us.” When the dollar goes down, commodities prices tend to go up, since they are largely priced in dollars. As such, commodities were the top performers of the day – beginning to gain more momentum at multi-year highs.
But as we’ve seen from this chart, this recovery in commodities, which has dramatically lagged in the reflation trade, has a long way to go.
While the markets reacted as if Mnuchin, the Treasury Secretary, was talking down the dollar, the dollar is already in a long-term bear market cycle.
Remember, we looked at this chart (below) of the long-term dollar cycles back in June…
And I said, “if we mark the top of the most recent cycle in early January, this bull cycle has matched the longest cycle in duration (at 8.8 years) and comes in just shy of the long-term average performance of the five complete cycles. The most recent bull cycle added 47%. The average change over a long-term cycle has been 56%. This all argues that the dollar bull cycle is over. And a weaker dollar is ahead. That should go over very well with the Trump administration.”
The dollar is down about 8% since then and is breaking down technically now.
The dollar index is now down 14% in this new bear cycle. And these are the early innings. Based on the dollar cycle, it has a long way to go, and should last for another 5 to 7 years.
So, this dollar outlook is further support for the case for a big run in commodities we’ve been discussing. And as we observed yesterday, in the case of Chesapeake Energy (CHK), the second largest producer of natural gas in the country, the commodities stocks are still extremely underpriced if this scenario for commodities plays out.
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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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With a government shutdown over the weekend, today I want to revisit my note from last month (the last time we were facing a potential government shutdown) on the significance of the government debt load.
The debt load is an easy tool for politicians to use. And it’s never discussed in context. So the absolute number of $19 trillion is a guarantee to conjure up fear in people – fear that foreigners may dump our bonds, fear that we may have runaway inflation, fear that the economy is a house of cards. So that fear is used to gain negotiating leverage by whatever party is in a position of weakness. For the better part of the past decade, it was used by the Republican party to block policies. And now it’s being used by the Democratic party to try to block policies.
Now, the federal debt is a big number. But so is the size of our economy – both about $19 trillion. And while our debt/GDP has grown over the past decade, the increase in sovereign debtrelativetoGDP, has been a global phenomenon, following the financial crisis. Much of it has to do with the contraction in growth and the subsequent sluggish growth throughout the recovery (i.e. the GDP side of the ratio hasn’t been carrying its weight).
You can see in the chart below, the increasing debt situation isn’t specific to the U.S.
Now, we could choose to cut spending, suck it up, and pay down the debt. That’s called austerity. The choice of austerity in this environment, where the economy is fragile, and growth has been sluggish for the better part of ten years, would send the U.S. economy back into recession. Just ask Europe. After the depths of the financial crisis, they went the path of tax hikes and spending cuts, and by 2012 found themselves back in recession and a near deflationary spiral – they crushed the weak recovery that the European Central Banks (and global central banks) had spent, backstopped and/or guaranteed trillions of dollars to create.
The problem, in this post-financial crisis environment: if the major economies in the world sunk back into recession (especially the U.S.), it would certainly draw emerging markets (and the global economy, in general) back into recession. And following a long period of unprecedented emergency monetary policies, the global central banks would have limited-to-no ammunition to fight a deflationary spiral this time around.
Now, all of this is precisely why the outlook for the U.S. and global economy changed on election night in 2016. We now have an administration that is focused on growth, and an aligned Congress to overwhelm the political blocking. That means we truly have the opportunity to improve our relative debt-load through growth.
In the meantime, despite all of the talk, our ability to service the debt load is as strong as it’s been in forty years (as you can see in the chart below). And our ability to refinance debt is as strong as it’s been in sixty years.
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government shutdown, washington, wall street, economy
Last week we talked about the big adjustment we should expect to come in the inflation picture. With oil above $60 and looking like much higher prices are coming, and with corporate tax cuts set to fuel the first material growth in wages we’ve seen in a long time (if not three decades), this chart (inflation expectations) should start moving higher…
And with that, market interest rates should finally make a move. As we discussed last week, we will likely have a 10-year yield with a “3” in front of it before long.
Yields have already popped nearly a quarter point since the beginning of the year. But that’s just (finally) reflecting the December Fed rate hike. What hasn’t been reflected in rates, as it has in stocks, is the different growth and wage pressure outlook this year, thanks to the tax cut. Last year, people could argue it wasn’t going to happen. This year, it’s in motion. And the impact is already showing up. We should expect it to show in the inflation data, sooner rather than later.
With that, today we’re knocking on the door of a big breakout in rates (as you can see in the chart below) — which comes in at 2.65%…
As we’ve discussed, the anchor for the benchmark U.S. 10-year yield (and for global rates), even in the face of a more optimistic global economic growth outlook, has been Japan’s unlimited QE (driven by its policy to peg its 10-year at a yield of zero). On that note, last week, the former head of the central bank in India, Raghuram Rajan (a highly respected former central banker), said he thinks both Europe and Japan will exit emergency policies sooner than people think. That’s a positive statement on the global economy and a warning that global rates should finally start moving.
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Yesterday’s slide in stocks was all recovered today, despite the continued threat of a government shutdown. As we discussed yesterday, holding the government budget hostage to make gains on partisan demands hasn’t been enough to move the needle on the stock market the past three times we’ve seen it happen (2013, 1995-1996 and 1990).
Still, incredulously, the chatter about a “top” in stocks was heavy, yesterday afternoon and throughout this morning – given the 300 point move off of the top in the Dow (and accompanied by a sharp slide in bitcoin this morning).
The media and Wall Street experts must need to be reminded daily that we have a huge tax cut hitting this year, into extremely favorable economic conditions (low rates, cheap gas, record low unemployment, record high household net worth, record high consumer credit worthiness), with continued pro-business policies being executed, a major infrastructure spend pursued, and global growth expected to run as hot as we’ve seen since before the financial crisis.
With this in mind, Apple told us today that they plan to repatriate all of their offshore cash (about a quarter of a trillion dollars worth — thanks to a new, massive repatriation tax break), hire 20k people over the next five years and spend $30 billion in capex, to contribute $350 billion to the U.S. economy overall.
So, this is a direct result of incentives. And creating these incentives are the motivations behind the fiscal stimulus policies – all in an effort to achieve the behavior we’re seeing from Apple. Ultimately, it’s all about escaping the dangerously slow economic growth that was manufactured by central banks – so that the 10-year global economic slog doesn’t give way to a full-blown depression. So these incentives are working. Fiscal stimulus is working. And, as we’ve discussed, this should promote the big bounce back in growth that is typical of post-recession recoveries, but has been lacking in this post-financial crisis environment.
Still, people with the most influential voices continue to underestimate the outlook. The Fed is looking for just 2.5% U.S. GDP growth for the year (that’s likely less than what we’ll see for full year 2017). And Wall Street is looking for just 6% growth in stocks (according to this WSJ piece). The S&P 500 is already up 5%.
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Stocks reversed after a hot opening today. With a quiet data week ahead, the focus is on the prospects of a government shutdown.
If this sounds familiar to you, it should. Government debt is the, often played, go-to political football.
It was only last month that we were facing a similar threat. But with some policy-making tailwinds on one side of the aisle, the fight was politically less palatable in December. With that, Congress passed a temporary funding bill to kick the can to this month.
And just three months prior to that, in September, we had the same showdown, same result. The “government shutdown” card was being played aggressively until the hurricanes rolled through. From that point, politicians had major political risk in trying to fight hurricane aid. They kicked the can to December to approve that funding.
Now, the Democrats feel like they have some leverage, and their using the threat of a government shutdown to make gains on their policy agenda. So, how concerned should we be about a government shutdown (which could come on Friday)? Would it derail stocks?
If you recall, there was a lot of fuss and draconian warnings about an impending government shutdown back in 2013. The government was shutdown for 16 days. Stocks went up about 2%. Before that was 1995-1996 (stocks were flat), and 1990 (stocks were flat).
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Stocks have now opened the year up 4%. Global interest rates are on the move, with the U.S. 2-year Treasury trading above 2% for the first time since 2008. Oil is trading in the mid $60s. And base metals are trading toward the highest levels of the young, two-year bull market in commodities.
This all looks like a market that’s beginning to confirm a real, sustainable economic recovery – anticipating much better growth than what we’ve experienced over the past decade.
If that’s the case, we should expect a big adjustment coming in inflation readings. And with that, we should expect a big adjustment coming for global interest rates. We’ll likely have a 10-year yield with a “3” in front of it before long. And that will have a meaningful impact on key consumer borrowing rates (especially mortgages).
On the inflation note, we’ve talked this week about the impact of higher oil prices on inflation and the impact it may have on the path of central bank policies (most importantly, the speed at which QE may be coming to an end in Europe and Japan).
You can see in this chart, the very tight relationship of oil prices and inflation expectations.
Now remember, one of the best research-driven commodities investors (Leigh Goehring) thinks we may see triple-digit oil prices — this year! This has been a very contrarian viewpoint, but beginning to look more and more likely. He predicted a surge in global oil demand (which has happened) and a drawdown on supplies (which has been happening at “the fastest rate ever experienced”). He says, with the OPEC production cuts (from November 2016), we’re “traveling down the same road” as 2006, which drove oil prices to $147 barrel by 2008.
Bottom line, this is an inflationary tale. If we had to search for a market that might be telling us this story (i.e. inflation is finally leaving the station), the first place people might look is the price of gold. What has gold been doing? It has been on a tear. Gold is up 8.3% over the past month.
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