Yesterday we looked at this chart of the S&P 500 …
In discussing this chart, I made an error. The blue line, of course, represents what the S&P 500 would have looked like had it continued its long-run annualized growth rate of 8% from the 2007 (pre-crisis) peak. That gives us perspective on where we stand in this stock market recovery. Even though we’re up more than four-fold from the 2009 bottom, and people continue to talk about how long this bull market has run, we still have not recovered the lost growth of the past decade.
That is clearly displayed in the gap between the orange line (the actual S&P 500) and the blue line (where stocks would be had we continued along the 8% annualized path).
What can we attribute this gap to? Post-recession recoveries are typically driven by an aggressive bounce-back in growth. We didn’t get it. Instead, the post-recession growth environment of the past decade was dangerously shallow and slow.
Why? The Fed and other major central banks were the only game in town for the global economy over the past decade. They saved the world from a total collapse, staved off further shocks along the way, and they manufactured a recovery. But the “easy money” solution doesn’t work the same in the depths and aftermath of a global debt bust, as it does in normal recessions. The central banks could only muster stall-speed growth.
That’s why the election was so important. It has resulted in the great hand-off, from a global economy that was just surviving on the life-support of central banks, to a global economy that has the chance to thrive on the catalyst of fiscal stimulus, and become sustainable from structural reform.
With that, we should expect the gap in the chart above to close. That argues for much higher stock prices, and a continuation of this bull market.
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With the S&P 500 finally returning to new record highs today, fully recovering the price correction this year, let’s take a look back at the correction, and where stocks can go from here.
As I said in my January 30 note “experience tells us that markets don’t go in a straight line. And with that, we should expect to have dips along the way for this bull market. Since 1946, the S&P 500 has had a 10% decline about once a year on average. A correction here would be healthy and 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.”
Fast forward eight months, and we’ve now had a 12% correction. And we’ve since had back-to-back quarters of 20%+ earnings growth, with an economy that is finally growing at better than 3% four-quarter average annualized growth.
Meanwhile, stocks remain cheap. The 10-year yield is still under 3%. And historically, when rates are low (sub 3% is still VERY low), stocks tend to trade north of 20 times earnings. The forward P/E on stocks at the moment is just 17. If we apply a 20x multiple to $170 in forward S&O 500 earnings, we get 3,400 in the S&P. That’s 19% higher.
With that in mind, let’s also revisit my chart on the long term growth rate of the S&P 500.
In the orange line, you can see what the S&P 500 looks like growing at 8% annualized (the long-run average growth rate) from the pre-crisis peak in 2007. This is where stocks should have gone, absent the near global economic apocalypse. And you can see the actual path for stocks in the blue line.
Bottom line: Despite the nice run we’ve had in stocks, off the bottom in 2009, we still have a big gap to make up (the difference between the blue line and the orange line). This is the lost decade for stocks.
This argues for another 28% higher in stocks to fill that gap.
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As we discussed on Friday, with China coming back to the negotiating table on trade, we have a signal that the trade dispute smoke will not end in fire.
That is unlocking this rotation we’ve been talking about for the past month or so, where the money that has been plowed into the stocks of the very hot tech giants, starts moving out and into the lagging blue chips.
With that, as we sit eight months into the year, with the winds of fiscal stimulus in our sails, the S&P 500 is just now close to recovering the losses from the January highs.
And the Dow remains, 3.2% off of the January highs (which were record highs). But I suspect we will now close that gap quickly.
Remember, we have two very hot earnings quarters under our belt, and building momentum in the economic data, as fuel for stocks. And I suspect the China news, to break the stalemate on trade negotiations, will also fuel the resumption of the young bull market in commodities, which should offer very attractive investing outcomes in the coming months.
Maybe the best signal for commodities is this chart on Chinese stocks, which looks like it may have bottomed TODAY into these 2016 lows (circled).
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We talked yesterday about the sharp currency devaluation in Turkey over the past few days. The Lira bounced aggressively today, which soothes some fears in global markets.
As I said, many have made comparisons to the Asian currency crisis of the late 90s, and have speculated on the potential for the events in Turkey to ultimately destabilize global markets. But as we discussed yesterday, this looks more like the 2014 currency attack on the Russian ruble — a geopolitically-driven crippling of an economy with bad behaving leadership.
With that in mind, here’s what happened to U.S. stocks back in 2014, when the ruble lost 5% of its value (vs the dollar) in just 7 days. But the decline was fully recovered in just 3 days.
U.S. stocks have been the proxy for global market stability throughout the past decade (the crisis and post-crisis era). So, for perspective on just how shaky the Turkey influence is being perceived, the S&P 500 sits just one percent off of all-time highs at today’s close.
Remember, the ECB stands ready to plug any holes necessary in European bank exposure to Turkish debt. That euro-denominated debt has been the risk people immediately homed in on.
The real question is, will this (currency crisis) ultimately end in China, with a revaluation of the yuan, or perhaps a free-floating yuan?
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We have a currency devaluation in Turkey that is shaking up markets. Let’s talk about what’s happening and why (if at all) it matters for the big picture outlook.
First, here’s a look at the Turkish lira chart (orange line moving up means a stronger U.S. dollar, weaker lira)…
Now, the problems in Turkey aren’t new. The country is economically fragile. But the collapse in the currency probably has more to do with its leadership – and the erosion of democracy in Turkey.
There are a lot of people comparing Turkey’s currency crisis to the Thai Baht devaluation in 1997 — which ultimately ignited a currency crisis in Asia, which culminated in a sovereign default in Russia. That’s the fear: a currency crisis turning into a contagion of sovereign debt defaults.
But Thailand was about economic policy – specifically, the Thai currency policy. Speculators attacked to close the valuation gap between the central bank managed currency and its economy.
This Turkey issue looks more like the collapse in the Russian Ruble in late 2014. That was geopolitically driven. Back in 2014, Putin was forcing his way into Ukraine – an affront to the Western world. This was viewed as a proxy war against the West. That led to capital flight out of Russia and speculative attack on the currency.
With this chart on the Ruble (the orange line going up means a stronger dollar and weaker ruble), Russia was quickly made vulnerable and on a sovereign debt default watch.
But like Turkey, the contagion risk was driven by Russia’s foreign currency denominated debt (primarily euro denominated debt owed to European banks).
With that said, the world wasn’t “normal” in 2014, nor is it now. Remember, the European Central Bank remains in quantitative easing mode. That means, we should expect central bank (or policy) intervention (if needed) to quell any shock risks that could come from European bank exposure to Turkish debt. So the ECB’s “ready to act” commitment of the post-financial crisis era should calm fears of contagion.
As for Turkey, the crippling effects of the currency attack should put pressure on the freshly re-elected Ergodan (i.e. should make him vulnerable to an uprising).
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The Nasdaq continued to slide today. Stock indices tend to go down a lot faster than they go up. The tech giant-driven Nasdaq was up over 15% year-to-date, just a few days ago, and has now given up more than 4% from the highs.
Not surprisingly, as people run for the exit doors on the big tech giants (taking profits), we’re seeing money rotate into the blue-chip value stocks.
The Dow and S&P 500 did much better than the Nasdaq today, which continues to slowly correct the big performance gap of the year (where the Nasdaq was up 15% at one point, while the DJIA was flat on the year).
Now, the biggest event of the week for markets may take place tonight. We hear from the Bank of Japan on monetary policy. We’ve discussed, many times, the role that Japan continues to play in our interest rate market.
Despite seven hikes by the Fed from the zero-interest-rate-era, our 10-year yield has barely budged. That’s, in large part, thanks to the Bank of Japan. Japan’s policy on pegging its 10-year yield at ZERO has been the anchor on global interest rates.
As I’ve said, when they finally signal a change to that policy, that’s when (our) rates will finally move. And that may be tonight. There is speculation that they may adjust UP that target on their 10-year yield. That would represent a dialing back of the BOJ’s QE program, which would signal the initial steps of exiting the crisis-era QE program.
What would that do? If the BOJ does indeed adjust their “yield curve control” policy, it should send global interest rates higher. That would put our ten-year yields back above 3%, which has been a level that has caused some uneasiness in markets. This time around, a move back above three percent would reflect a steepening U.S. yield curve which may be perceived as a positive, especially for those that have been concerned about the potential of seeing an inverted yield curve (i.e. a recession indicator).
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As we end the week, let’s take a look at a few charts ….
We had the first look at Q2 GDP today. Here’s an updated look at the chart of the average four-quarter annualized growth rate we looked at
yesterday ….
This number will be formally revised two more times, but the “advance” number came in at 4.1%. Yesterday we talked about the prospects for the highest four-quarter annualized growth rate since 2006. We just missed it, in this first reading. But the Q1 number was revised UP to 2.2%, so adding in today’s Q2 number, and we get 3.1% four-quarter average annualized growth. Only for a moment, in 2010, was it better (at 3.15%).
I suspect we will see a bigger number in the coming Q2 revisions. And if sentiment on trade indeed bottomed out on Wednesday, with the EU concessions, we will likely have a big Q3 growth number coming.
That steadily rising trend, since the election, in the four-quarter average growth rate is a big deal. With that, I would call the above chart, the most important chart of the week…
Let’s look at the second most important chart of the week ….
I’ve been making the case that the massive Nasdaq outperformance, relative to the Dow, would begin correcting. In the chart above, you can see that it’s starting (Dow moving up, Nasdaq moving down). And it’s being led by strength in the blue chips following strong Q2 earnings, and weakness in two of the big tech giants (Netflix and Facebook) following big misses. With that, Facebook has quickly revisited levels of early May (which should give us all perspective on how aggressive this run in the tech giants has been over the past two months).
The question: Is it “peak Zuck?”
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As we’ve discussed, tech and small-caps (the Nasdaq and the Russell 2000) have been big outperformers on the year, compared to blue-chip stocks. But today seemed like an exhaustive move in that divergence.
There was a clear rotation out of the small-caps (which finished down on the day) and into the blue chips (the Dow finished up nicely on the day). And the red-hot Nasdaq reversed from new record highs to finish flat.
Trump tweeted this morning that tariffs are bringing trade parters to the negotiating table. He seems to be confident that his meeting with EU Chief Jean-Claude Juncker tomorrow will result in concessions from Europe. And there seems to be movement on a new NAFTA deal too. Add this to more good earnings hitting from second quarter earnings season, and it’s enough to get big investment managers moving back into the blue-chip multinationals.
Remember, we’ve been watching this chart. The Dow still has a long way to go, to recover the record highs of earlier this year. But the technical breakout of this corrective downtrend has broken.
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We have a big earnings week. The tech giants report, along with about a third of the S&P 500. And we get our first look at Q2 GDP.
As we’ve stepped through the year, we’ve had a price correction in stocks, following nearly a decade of central bank policies that propped up stocks. This correction made sense, considering central banks were finally able to make the hand-off to a U.S. led administration that had the will and appetite (and alignment in Congress) to relax fiscal constraints and force the structural reform necessary to promote an economic boom.
From there, for stocks, it became a “prove-it to me” market. Let’s see evidence of this “hand-off” is working — evidence the fiscal stimulus is working. That came in the form of first quarter earnings. This showed us clear benefits of the corporate tax cut. The earnings were hot, and stocks began a recovery.
The next steps, as fiscal stimulus works through the economy, we’ve needed to see that the uptick in sentiment (from the pro-growth policies) is translating into better demand and economic activity. So, with Q2 earnings we should start seeing better revenue growth, companies investing and hiring. And we should see positive surprises beginning to show up in the economic data.
We’re getting it. Almost nine out of ten companies reporting thus far have beat (lofty) earnings expectations. And about eight out of ten have beat on revenues. This week will be important, to solidify that picture. And though many of the economists all along the way of the past year didn’t see big economic growth coming, it has been steadily building since Trump was elected, and the Q2 number should push us to over 3% annual growth (averaging that past four quarters).
Now, let’s talk about the big mover of the day: interest rates. The 10-year yield traded to 2.96% today, closing in on 3% again.
We’ve discussed, many times, the role that Japan continues to play in our interest rate market. Despite 7 hikes by the Fed from the zero-interest-rate-era, our 10 year yield has barely budged. That’s, in large part, thanks to the Bank of Japan.
As I’ve said in the past, “Japan’s policy on pegging its 10-year yield at zero has been the anchor on global interest rates. Forcing their benchmark government bond yield back to zero, in a world where there has been upward pressure on interest rates, has meant that they can, and will, buy unlimited amounts of JGBs to get the job done. That equates to unlimited QE. When they finally signal a change to that policy, that’s when rates will finally move.”
With that in mind, there were reports over the weekend that the Bank of Japan may indeed signal a change in that “yield curve control” policy at their meeting next week. And global rates have been moving!
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We’ve been watching the Chinese currency very closely, as the Chinese central bank has been steadily marking down the value of its currency by the day, in efforts to offset U.S. trade tariffs.
Remember, in China, they control the value of their currency. And they’ve now devalued by 8% against the dollar since March. They moved it last night by the biggest amount in two years. That reduces the burden of the 25% tariff on $34 billion of Chinese goods that went into effect earlier this month.
But Trump is now officially on currency watch. Yesterday in a CNBC interview he said the Chinese currency is “dropping like a rock.” And he took the opportunity to talk down the dollar.
The Treasury Secretary is typically from whom you hear commentary about the dollar. And historically, the Treasury’s position has been “a strong dollar” is in the countries best interest. But Trump clearly doesn’t play by the Washington rule book. So he promoted his view on the dollar (at least his view for the moment)–and it may indeed swing market sentiment.
The dollar was broadly lower today. We’ll see if that continues. If so, it may neutralize the moves of China in the near term. Nonetheless, the U.S./China spat is reaching a fever pitch. Someone will have to blink soon. Trump has already threatened to tax all Chinese imports. The biggest risk from China would be a big surprise one-off devaluation. As we discussed yesterday, that would stir up a response from other big trading partners (i.e. Europe and Japan). And they may coordinate, in that scenario, a threat to block trade from China all together.
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