We start the week with a lot of noise for markets to digest (China lockdowns, Elon Musk/Twitter, Russia/Ukraine, upcoming Q1 bank earnings). But nothing is bigger than tomorrow’s inflation data.
We can see it reflected in the market behavior today. Stocks were down. Interest rates were up. The dollar was up. Gold was up.
This is about inflation and rates.
We’ve been talking about the importance of Tuesday’s report for almost a month now. This data we’ll get tomorrow is the first inflation reading that will include the spike in oil prices from $94 to as much as $130 a barrel — which has sent gas prices well north of $4.
This should give us the first double-digit inflation number since 1981. The market is looking for 8.4% — a number with some shock value, but that will likely turn out to be conservative.
This sets up for a big negative surprise. We will see.
How would the Fed handle a double-digit inflation print?
Call it transitory? Maybe. With oil now back in the $90s, there is cover to say that the influence on CPI from the spike in gas prices will fade, now that the government has released oil from the strategic petroleum reserves.
But they will have a hard time in the coming months explaining away bigger inflation numbers – driven by more factors than just a spike in oil prices. With that, a runaway interest rate market (a rational response from bond investors) would present a dangerous situation for the Fed and Treasury. This is where we may see the Fed go to “yield curve control.”
As we discussed last week, “this would keep market interest rates from running away. But market interest rates are a market mechanism. If explicitly suppressed in an already hot inflationary environment, inflation could run wild.
With all of this, we can see the path for global governments to justify a new monetary system (central bank-backed digital currencies).
A consortium of 63 global central banks has already promoted CBDCs as the ‘future of the monetary system.'”
Two months ago a short selling research firm alleged that there was misreporting of financials at the Chinese coffee giant, Luckin Coffee. The company denied the report as unsubstantiated speculation with malicious intent.
This morning the company reported that it has suspended its COO and several other employees for misconduct related to fabricating transactions. These are precisely the claims that were made two months ago.
The stock was down more than 80% this morning.
Who was the biggest loser?
It’s the top shareholder and angel investor in Luckin, the Chinese billionaire Lu Zhengyao.
Zhengyao is a serial entrepreneur. He founded the rental car company Car Inc. in 2007 and took it public in 2014 on the Hong Kong Stock Exchange. His former COO is credited with founding the Starbucks competitor, Luckin Coffee in 2017. In 2019, the company IPO’d on the Nasdaq.
Zhengyao was the angel investor behind the company and holds 484 million shares. At yesterday’s close, that stake was valued at over $12 billion. At the lows this morning, it was valued at $2.2 billion. Learn more about the stakes of billionaire investors here.
As we came into the week, the economic, political and corporate calendar was relative light. With that, I suspected markets would be relatively quiet.
Of course we have had an ECB meeting and minutes from the Fed. Often, these would be market moving events. Not this week. As we discussed yesterday, we clearly know where they stand.
So, what’s next? Earnings.
First quarter earnings season kicks off next week. We’ll hear from the major banks. Earnings will be the catalyst for where stocks go from here – and banks will set the tone. The building theme has been “earnings recession.”
After 20%+ earnings growth in 2018, following a historic corporate tax cut, anyone would expect earnings growth to be less hot than last year. Some were even predicting that the hot numbers of last year would be a peak in earnings growth. After all, under ordinary circumstances (in a stable economic environment) we’re very unlikely to see the U.S. stock market grow earnings by excess of 20%. That’s not much of a story .
But the media loved the shock value of the phrase “peak earnings” last year, and ran it in headlines, conveniently excluding the word “growth.” Peak earnings is very different than peak earnings growth.
Still, the broad market sentiment on future corporate earnings eroded through the end of 2018, and has continued to erode through 2019.
And both Wall Street and corporate America are more than happy to ride the coattails of lower sentiment by lowering the expectations bar on earnings. When sentiment is leaning that way already, there is little-to-no penalty for lowering the bar. That just sets the table for positive surprises. They did it for Q4 2018 earnings. And they beat expectations. And they have set the table for positive surprises for Q1 2019 earnings.
Just how low has the bar been set for Q1?
Before stocks unraveled in December, Wall Street was looking for 8.3% earnings growth for 2019. Now they are looking for less than half that. Moreover, they have projected earnings to contract in Q1 compared to the same period a year ago (i.e. at least a short-term peak in earnings).
Will they be right?
Well, the Atlanta Fed’s real-time model for estimating GDP has Q1 GDP coming in at 2.3%. The economy added on average 173,000 jobs a month over the first quarter. Both manufacturing and services PMIs expanded in the quarter, and stocks fully recovered the losses from December. That’s a formula for earnings growth, no contraction.
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We now have Q4 earnings in from three of the country’s four largest banks. Yesterday it was Citi. Better earnings were driven by cost cuts not growth. Still, the stock is up 8% in two days.
Today it was Wells Fargo and JP Morgan. Wells, too, had soft revenues but beat on earnings driven by cost cuts. JP Morgan missed on earnings and revenues.
Now, Jamie Dimon runs JP Morgan — the largest U.S. based global money center bank. And he has been publicly positive on the economy and the market outlook, in the face of a lot of broad negativity and fear late last year.
Let’s take a look at what he had to say about JP Morgan’s earnings and the operating environment…
JP Morgan generated record earnings and record revenues for full year 2018. And Dimon says they would have done it even without the tax cuts. He says his business shows the U.S. consumer to be healthy and engaged. Consumers are spending, saving and investing. And Dimon said they opened Chase branches in new states for the first time in nearly a decade.
This all in a year where the chatter about an impending recession grew by the month, for no other reason than the economic expansion has been running long.
According to the biggest bank in the country, things sound pretty good.
Importantly, last year, the blowout earnings were often met with selling in the broad stock market. It’s looking like that dynamic is changing. Stocks are rising, even on less than impressive numbers (thus far). That a good sign for the sustainability of the rebound.
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Earlier this month, we talked about the big fall in oil prices.
If we look back over the past five years, the magnitude of that move is only matched (or exceeded) in cases where there was significant manipulation in the oil market and/or a systemically threatening oil price crash.
As we’ve discussed, the pressure on oil this time around seems to be about manipulation — and appears to have everything to do with Trump’s leverage over the Saudis (related to sanctioning the Kingdom over the Khashoggi murder).
But we’ve now traded down to the important $50 mark. That’s 35% from the highs of just October 3. And this is an inflection point where it could go bad, but it also could present a goldilocks scenario (a level that’s just right for the U.S. economy).
Sure, cheap oil is good for consumers. You save a few extra bucks at the pump. But in the current environment, it presents risks to the financial system. The shale industry’s break-even point on producing oil is said to be $50. Below that, they dial down production, lay off workers, stop investing and quickly become a default risk to their creditors (U.S. and global banks). We saw it back in 2016. The same can be said for those countries heavily dependent on oil revenues (i.e. they become default risks as oil prices move lower).
That’s the bad side. The good side to the oil price slide? As we’ve discussed, it should relieve some pressure on the Fed. The Fed likes totalk about their inflation readings excluding effects of volatile oil prices. But they have a record of acting on monetary policy when oil is moving.
The bottom line: Oil plays a big role in their view on inflation. And given the quick drop in oil prices, the Fed’s concerns about inflation should be cooling. Again, this opens up the door for the Fed Chair, tomorrow, to take the opportunity in a prepared speech at the Economic Club of New York, to signal a pause coming in the Fed’s rate normalization program. That would be a positive catalyst for economic and market confidence.
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As we’ve discussed, the proxy on the “tech dominance” trade is Amazon. That’s the proxy on the stock market too. And it’s not going well. The President hammered Amazon again over the weekend, and again this morning.
Here’s what he said …
Remember, we had this beautiful heads-up on March 13, with the reversal signal in Amazon.
That signal we discussed in my March 13 note has now predicted this 15.8% decline in the fourth largest publicly traded company. And it’s dictating the continued correction in the broader market.
If you’re a loyal reader of this daily note, you’ll know we’ve been discussing this theme for the better part of the last year. The regulatory screws are tightening. And the tech giants, which have been priced as if they are, or would become, perfect monopolies, are now in the early stages of repricing for a world that might have more rules to follow, hurdles to overcome and a resurrection of the competition they’ve nearly destroyed.
As we know, Uber has 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. Trump is going after Amazon, as a monopoly and harmful to the economy. Tesla, a money burning company, is being scrutinized for its inability to mass produce — to deliver on promises. For Tesla, if sentiment turns and people become unwilling to continue plowing money into a company that’s lost $6 billion over the past five years (while contributing to the $18 billion wealth of its CEO), it’s game over.
With that said, this all creates the prospects for a big bounce back in those industries that have been damaged by tech “disruption.” And this should make a stock market recovery much more broad-based than we’ve seen.
With the sharp decline in stocks today, we’ve retested and broken the 200-day moving average in the S&P 500. And we close, sitting on this huge trendline that describes the rise in stocks from the oil-crash induced lows of 2016.
Today we neared the lows of the sharp February decline. I suspect we’ll bottom out near here and begin the recovery. And that recovery should be fueled by very good Q1 earnings and a good growth number — brought to us by the big tax cuts.
With the big decline and wild swings in the stock market, earnings season has gotten little attention.
We’ve now heard from 80% of the companies in the S&P 500 on Q4. According to FactSet, 75% of the companies have beat on earnings. And 78% have had positive revenue surprises.
Now, earnings estimates are made to be broken. And they tend to be beaten at a rate of about 70% of the time. But the same cannot be said for revenues. This has been a key missing piece in the economic recovery. Companies have been cutting costs, refinancing and trimming headcount, all in an effort to manufacture margins and profitability. But revenues, the true gauge of business activity and demand, had been dead for the better part of the past decade.
It was just last year that we finally saw some decent revenue growth coming in from the earnings reports. And this most recent quarter, revenue growth is running at the hottest rate since FactSet has been keeping records. That’s a very good sign for the economic outlook.
And corporate earnings are running 15.2% higher than the same period the year prior. That’s the hottest earnings growth we’ve seen since 2011. More importantly, that’s four percentage points higher than analysts were projecting at the end of the year–with knowledge of the tax cut legislation.
With that said, remember, just last Friday, we had a moment during the day when the forward P/E on the S&P 500 hit 16.2. But if the fourth quarter is any indication, those forward earnings (estimates) will likely get ratcheted UP over the coming quarters, but will still undershoot. That will keep downward pressure on the P/E. Stocks are cheap.
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On Friday, stocks bottomed into two big technical levels: 1) the two-year rising trendline that represented the recovery from the lows of 2016, which were induced by the oil price crash, and 2) the 200-day moving average.
We’ve since seen a 5.5% bounce off of the bottom.
Interestingly, the market that has had so many people concerned over the past two weeks–interest rates–were tame and lower on the day. But only after printing a new high (at 2.90%, which is the highest since January of 2014).
That climb in rates, of course, has had everyone uptight about the inflation outlook. But the market you would expect to reflect inflation fears hasn’t been telling the inflation story at all. I’m talking about the price of gold. And gold has been lower, not higher, since stocks have fallen.
Here’s a look at that chart …
With this in mind, the psychology always changes when stocks go down. People search for stories to fit the price–for trouble to fit the price. Even some of the more rational market practitioners were succumbing to this over the weekend, trying to conjure up a negative scenario unfolding for markets.
Having been involved in markets for 20 years, I’ve seen, within both short- and long-term cycles, thousands of turning points, trend changes, phases of a cycles, trends and corrections of trends. Markets can and do have technical corrections. And they can and do correct for no reason, other than price.
So, for perspective, things are good. We will have the hottest economy this year that we’ve seen in a decade. The benchmark 10-year yield, at 2.90%, remains very low relative to history. That means, although borrowing costs are ticking higher, money is still cheap. Gas is cheap. Consumer and corporate balance sheets are as good as they’ve been in a long time. And we’ve just gotten a blue light special on stocks–marking down prices from 18 times to something closer to 16 times earnings. And with the prospects for earnings to come in better than expected, given influence of tax cuts, we are probably looking at a P/E on the S&P 500 forward earnings closer to 15.
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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
