Stocks printed another fresh record high in the S&P 500 today before falling back. As we discussed Friday, the BOJ undershot expectations last week, because many thought anything short of full blown debt monetization (to coincide with fresh fiscal stimulus to be approved this week) was a disappointment.
But doubling the size of ETF purchases was kind of a big deal, especially if you consider where their stock buying program has come from (1 trillion yen), where it is now (6 trillion yen), and what it has meant for the performance of Japanese stocks (and global stocks).
Still, just as the Fed opened the door last week to a September rate hike, the BOJ opened the door to a revamp of its current QE program in September.
Remember, the last time the BOJ came in with a doubling down on their QE program (a QE2 for the BOJ) was in October of 2014. That same month, the Fed ended its QE program. As we’ve said, the Fed has only had the confidence to end emergency policies (that includes the beginning of a tightening cycle) because they know the BOJ is there to take the QE torch.
Now, with earnings season nearing an end, we’ve now heard from a majority of the companies in the S&P 500, and the positive earnings surprises continue to provide fuel for stocks.
When earnings reports were kicking off in the middle of last month, we said: “Among the reasons we’ve thought stocks look well underpinned and the economy could be in the early stages of a boom, is that the bar has been set so low, in terms of expectations, that we’re set up for positive surprises — both in earnings and economic data. Surprises create changes in outlooks. And ‘change’ is the primary catalyst that moves/reprices markets.
Last earnings seasons 72% of the companies in the S&P 500 beat expectations. Still, companies dialed down expectations coming into the second quarter. Wall Street then lowers its bar. And they beat.
Like it or not, that’s how Wall Street works and has always worked. FACTSET says on average (the five-year average) 67% of companies in the S&P 500 beat their analyst expectations. And they beat by an average of 4%….As we know, better than expected earnings are fuel for stocks.”
So now 71% of the companies that have reported have beaten expectations on earnings for the past quarter. And 57% have beaten on revenues. The media will continue to point to the lower decline in earnings compared to last year and wonder why stocks are going higher. But, again, that information was priced in, and stocks reprice on change. And earnings beats represent change/ new information.
This week we have another jobs report. Non farm payrolls/job creation is the data point that market participants and the media have been trained for decades to over analyze/over-emphasize. We’ve had and will have undershoots and overshoots on the number. But for the Fed, an unemployment rate around 5% and non farm payroll number averaging 200k a month, the jobs data is in pretty good shape.
The biggest risk to stocks in the very near term is oil. We talked about keeping a close eye on the slide in oil, a market that was, at one point earlier this year, THE most important market in the world.
On that note, we said, “in a world where stability is king, central bankers have been very sensitive to swings in key financial markets, with the idea that confidence and the perception of stability can quickly become unhinged by market moves. When that happens, it becomes a big, viable threat to the global economic recovery and outlook.”
At $26 oil was threatening another global financial crisis. It bounced aggressively after the BOJ stepped in and intervened in USDJPY back in early February. Oil bottomed that day, so did stocks. Soon thereafter, oil doubled and stocks have printed fresh record highs.
But oil has been moving lower in recent weeks. As we said, this will grow in importance, and send negative signals, if it were to continue lower.
It has indeed continued to slide, closing today just above $40. We’ve looked at this chart of oil and the S&P 500.
Sources: Billionaire’s Portfolio, Reuters
When the oil price bust was threatening economic stability, stocks were moving almost tick for tick with the slide in oil. But we’ve had some significant divergence in the past few weeks, with oil going lower and stocks going higher. And oil trades $40 today, which is a huge level. Expect this gap to close, with either a slide in stocks, or a nice bounce on the retracement in oil. We bet on the latter.
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The Bank of Japan acted last night, but it wasn’t the bazooka-type response markets were hoping for. But it may be the response stock investors were hoping for. The yen denominated Nikkei actually finished UP on the day. And German and U.S. stocks have fared well too.
As we’ve said, in this environment, what’s good for stocks has a powerful effect on global economic stability, because it positively influences confidence. And confidence can lead to a lot of good economic fuel (spending, hiring, credit creation, investment, etc). And the BOJ action last night may end up being very good for stocks.
To step back a bit, the Bank of Japan launched their big monetary stimulus program back in April of 2013, promising to pump about 112 trillion yen (that’s about 1.4 trillion dollars, with a T) into the economy. As part of that plan, they announced they would buy 1 trillion yen worth of ETFs in Japan (i.e. they would outright buy stocks).
Stocks lifted off. The Nikkei ran from 9k to as high as 16k, nearly doubling over the next SIX months. By October of 2014, the economy was still flat, inflation was still dead. And the BOJ surprised by announcing a big expansion of what was already a huge undertaking. As part of that expansion, they announced they would TRIPLE the annual ETF purchases — going to 3 trillion yen a year.
Stocks lifted off again, climbing from the mid 15k level in the Nikkei 225 to as high as 21k in just eight months.
All the while, stocks in the U.S. (and other leading economies) tracked the path of Japanese stocks.
Here’s a chart of the Japanese stocks and U.S. stocks from 2012 (when Japan first telegraphed its big new plan) to the end of last year. You can see the clear influence of Japanese monetary policy.
Sources: Billionaire’s Portfolio, Reuters
Early this year, Bloomberg estimated that the BOJ owned more than half of the ETF assets in Japan, and is a top 10 holder in 90% of the stocks in the Nikkei 225. And with that, the Japanese stock market, as of mid last year, had tripled from the 2012 pre-BOJ QE levels. U.S. stocks have gone up 55% since.
Now the BOJ is doubling down.
So, the BOJ launched with a trillion yen ETF buying program – Japanese stocks rose almost 80%. They added another 2 trillion to that number in 2014 — Japanese stocks rose 35%. And last night, they just announced they will double that number — adding another 3 trillion yen for a total of 6 trillion yen in ETF purchases a year.
Japan will approve a huge spending plan next week, and with more fuel for stocks from the BOJ (and likely a resumption of a falling yen — another place the BOJ has been clearly engaged), perhaps the response last night was not as disappointing as most have thought.
As we’ve discussed, the big event of the week is the Bank of Japan decision on monetary policy tonight. Today the speculation is that Abe presented his big government spending plan earlier than expected, and bigger than expected, to put pressure on the Bank of Japan to act now, rather than later.
But as we discuss in today’s note, the Bank of Japan is run by a governor hand selected by Abe. It’s fair to think they are on the same page.
Today we want to revisit some of our past analysis on why this event is so meaningful to global markets and the global economy. The stakes are high.
As we know, where the Fed left off on its global economic stimulus, the Bank of Japan has picked up. QE hasn’t had the punch to growth that central bankers initially thought it might, but it has indirectly driven the global economic recovery, by restoring confidence, which has ultimately incentivized people to invest again, hire again, and spend again.
Nobody knows the fragile state of the world like the biggest central banks. They’ve committed trillions of dollars over the past seven years to pull the world from the edge of apocalypse, to manufacture a recovery and to keep it all together along the way. With that, the Fed began reversing its emergency policies only because they knew the torch would be picked up by Europe and Japan. But it’s Japan that has the perfect ingredients to meaningfully change the path of the global economic recovery, and cement its certainty.
Japan, unlike many other major central banks (including the Fed), has all of the right ingredients to achieve its inflation goal via the printing press – it has the biggest debt load in the world (which can be inflated away by yen printing), it has persistent deflation (which can be reversed by printing), and it has decades of economic stagnation (which can be reversed with hyper easy money and improvements in the global economy).
In short, they can do all of the things that other powerful central banks/economies can’t do – and it can result in a huge benefit not just in Japan but for fueling a recovery in the global economy (as capital pours out of Japan). In a world with few antidotes to the structural economic problems, this is a potential solution for everyone. So perhaps the most important ingredient for a successful campaign in Japan – they have the full support/hope/wishes of the major global economic powers (U.S., Europe, U.K.).
The Japanese Prime Minister Abe was elected on the promise of ending the economic malaise and deflationary vortex that’s troubled Japan for more than two decades. And he hand appointed a governor of the Bank of Japan (Kuroda) to execute an all out war on deflation.
The Bank of Japan has promised to run their aggressive QE program at full tilt until they can produce a target of 2% inflation in their economy. But inflation is still dead in Japan. Both Kuroda and Abe have said in the past year that they’ve committed to do whatever it takes, and for as long as it takes. Importantly, a huge part of their success is (and will be) dependent upon higher Japanese stocks, and a weaker yen. They have explicitly said so. It’s part of their gameplan.
With that in mind, Japan surprised markets on January 29 by cutting rates to negative. Prior to that move, we made the case that they needed to act. The market was ripe for it. They did. They surprised many. But they haven’t gotten the desired effect.
Since they cut their deposit rates below zero, the yield on the 10 year Japanese government bond has gone negative. And the 20, 30 and 40 year bond yield has collapsed too — indicating the market doesn’t believe Japan will ever emerge for the deflationary vortex. On that note, the move to negative rates hasn’t worked thus far.
And when it comes to stocks and the yen, they’ve gotten the opposite of what they need and want.
Japanese stocks and the yen have returned back to the 2014 levels, when the BOJ surprised markets with a big second round of QE. So there’s been an undoing of significant policy action.
You can see in the chart below, the BOJ action on October 13, 2014 (“BOJ Surprise QQE2″), and the effect it had on stocks.
Source: Reuters, Billionaire’s Portfolio
Japanese stocks took off and rose 33% over the following eight months. And virtually all global stocks followed, including U.S. stocks. Now it has all reversed for Japanese stocks and the yen.
As we’ve said, before it’s all over, we think the BOJ will ultimately destroy the value of the yen, returning USDJPY to 250+ versus the dollar (last seen in the 1980s). USDJPY goes into the meeting around 105.
We know Bernanke met with the BOJ governor late last month to discuss the concept of “helicopter money” in Japan. So while the expectations have been set for more action, the magnitude of response could easily surprise. A negative surprise, where they do nothing tonight, would almost certainly put Japan in an even more difficult hole to fight out of.
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Yesterday we talked about Apple earnings that were coming after the market close. Given the better than expected earnings that have been reported by other tech bellwethers like Microsoft, Intel and QUALCOMM, we thought the stage was set for a nice positive surprise out of Apple, perhaps the most important stock in the stock market, yet one that hasn’t been loved for more than a year.
With that, we looked at this chart below, and argued that a better number yesterday could start the closing of this peculiar divergence between the S&P 500’s biggest constituent (Apple) and the index itself.
Sources: Billionaire’s Portfolio, Reuters
Apple did indeed beat on the low bar of expectations (both revs and earnings). And the stock has popped as much as 8% today, trading as high as $104.67 and beginning the closing of the gap in the chart above. A return to the highs of last year would marry the yellow line (Apple) with the purple line (the S&P 500 index). That’s 30% higher than where the stock trades now, and close to 40% higher than where it traded yesterday afternoon. And that would price Apple shares at about 15 times trailing earnings, much closer to the index P/E.
So we thought yesterday that Apple earnings could overshadow the Fed today as a big catalyst for stocks this week. The Fed did indeed prove to be a snoozer. Remember last month, using the excuse of a weak jobs number they passed on a making a second rate hike on their “rate normalization” path.
As we know, they are most concerned with a global shock that could destabilize the global economic recovery and financial markets. So they took the pass (again) on a rate hike last month with the idea that they could watch the Brexit vote playout. Brexit happened, and the shock waves have since subsided. The Fed today (very subtly) opens the door for a rate hike in September by saying “near term risks to the economic outlook have diminished” and acknowledging strengthening in the labor market.
Remember, in this world, when the Fed is confident to go forward with rate normalization, it’s a vote of confidence in the outlook for stability and robustness of growth. With that, it’s a positive signal for financial markets.
As we’ve discussed this week, the real event is in Japan. The Bank of Japan decision will come tomorrow night. We said yesterday that “the element of surprise is powerful fuel for their policy actions, but they’ve haven’t done a great job of preserving that element – if anything, they’ve eroded their past work by giving markets negative surprises (balking on more action).”
We got a “surprise” overnight. The Abe administration rolled out details (earlier than expected) of a spending package (bigger than expected, about 5% of GDP). It’s speculated that it puts pressure on the Bank of Japan to act tomorrow night, as opposed to waiting to see the details on the fiscal plan. We agree. We’ve thought Japan should and would ultimately crush the value of the yen.
Tomorrow night will be a huge moment for the global economic recovery. The combination of fiscal and monetary stimulus in Japan has the power to further dampen fallout fears from Brexit, put the Fed back on path and give global growth a jolt.
It would all trigger a big run in global stocks, commodities and yields into the end of the year.
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Over the next eight business days, we’ll hear from the Fed, the Bank of Japan, the Bank of England, we’ll get a vote on fiscal stimulus in Japan and we’ll get another U.S. jobs report. And earnings of the most widely held stock in the world, Apple, to be reported after the close today, is not a too far behind, in terms of catalysts and importance for markets.
Still, over the past six months, we’ve seen hot jobs numbers and we’ve seen cold jobs numbers. But despite all of the fuss, the Fed has only flinched on the narrative about rate hikes when the macro picture turns dark.
With that, and with the post-Brexit world just a month in, the chances of them putting a telegraphed hike back on the table, given where stocks sit, is slim to none. Just weeks ago, the markets had priced the next rate hike to as far out as 2018. And even a rate cut bets were emerging.
That has all quickly reversed, and a coin flips chance of a hike by December is back in the market.
But, as has been the case for much of the year, the Bank of Japan is the real event. They will decide on policy Wednesday night. We’ve heard a lot of chatter out of Japan over the past six months, on new measures they’re considering. And now we know a spending package is on the table. But they’ve yet to come with another ‘shock and awe’ moment since October of 2014.
The element of surprise is powerful fuel for their policy actions, but they’ve haven’t done a great job of preserving that element – if anything, they’ve eroded their past work by giving markets negative surprises (balking on more action).
What about Apple?
We talked last week about the history of earnings surprises.
We said: “Last earnings season, 72% of the companies in the S&P 500 beat expectations. Still, companies dialed down expectations coming into the second quarter. Of course, then Wall Street lowered its bar. And companies are now beating estimate again.
Like it or not, that’s how Wall Street works and has always worked. FactSet says, on average (the five-year average), 67% of companies in the S&P 500 beat their analyst expectations. And they beat by an average of 4%.
That begs the question: Why aren’t analysts adjusting up their expectations on average, by 4%, given the history? As we know, better-than-expected earnings are fuel for stocks.”
The broad earnings numbers continue to project an in-line rate of positive surprises, or better for Q2 – and with bigger than average beats. Yet analyst estimates are being ratcheted down farther for Q3. That creates more fuel for positive surprises into the end of the year.
Among the steepest expected declines in earnings has been the IT sector. And Apple’s number are expected to be the heaviest drag, with a 25% weaker number than a year ago. But positive surprises from Microsoft, Intel and QUALCOMM, have already swung the expected earnings decline for the sector overall from -7% to -3.9%.
If we strip out the expected earnings decline from Apple, the sector would be projecting 2.2% earnings GROWTH for the quarter. With that, a positive surprise from Apple could really swing the pendulum on the performance perception for the quarter — not just in IT but in broader stocks.
Interestingly, the last time Apple reported two consecutive quarters of year-over-year earnings decline was mid 2013. The stock bottomed in that period. Carl Icahn disclosed a stake and called it “extremely undervalued.” The stock nearly doubled over the next 15-months.
Let’s take a look at the chart on Apple as we head into today’s report…
Sources: Billionaire’s Portfolio, Reuters
We can see in the chart that Apple, despite being the largest component of the S&P 500 , has diverged in performance this year. A positive surprise today could start the closing of this gap.
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As we discussed last week, the G20 finance ministers and central banks met in China over the weekend. We thought the calls for more fiscal stimulus would come. Monetary policy has been stretched about as far as it can go. What’s been lacking in the global recovery is some easing on the government spending side. Instead, they’ve gotten belt tightening.
That belt tightening in Europe led to another recession, and has contributed to the global economic rut and the continued built of discontent in the European Union — all of which has threatened the global economic recovery. With that, we’ve thought that the Brexit vote may have stoked enough fear that a window may have been opened for governments to finally come in with some spending programs.
That’s exactly what was highlighted in the meetings over the weekend – calls for help from fiscal and infrastructure spending to stimulate growth.
As we know, Japan has already telegraphed a big spending program. The size of the package is now expected to be about 4% of GDP (Japanese GDP), to be approved early August. The BOJ is expected this week to spike the punch bowl again, ahead of the spending package, by changing the size of their QE program and expand the type of assets they are buying (this would equate to a QE3 in Japan).
We suspected that they may outright buy commodities when oil prices were threatening earlier in the year. Remember, it was, in fact, the BOJ’s intervention in USDJPY in February that coincided with the bottom in stocks and oil.
The chart below shows both the Nikkei and the S&P 500 performance following Japan’s QE1 and QE2.
Sources: Billionaire’s Portfolio, Reuters
As you can see in the chart, intervention in Japan has been a key driving force for stocks, not only in Japan but globally (including in U.S. stocks).
Higher stocks and a weaker yen are two huge components of the BOJ’s plan to stimulate inflation. Inflation has remained lifeless. And stocks earlier this year had completely given back the gains of Japan’s QE2. And the yen weakness has been completely reversed. Will the BOJ pull out the bazooka this week?
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Last Friday we talked about some key charts to keep an eye on this week, which included U.S. stocks, German stocks, Japanese stocks, U.S. yields and German yields.
Remember, in a world where stability is king, central bankers have been very sensitive to swings in key financial markets, with the idea that confidence and the perception of stability can become quickly become unhinged by market moves. When that happens, it becomes a big, viable threat to the global economic recovery and outlook.
So those markets we reviewed provide a good check on the market vitals at this stage. And the big disconnect between yields and stocks has been a growing concern.
On that stocks front, we had further gains this week. U.S. stocks printed new record highs again for the week. And German and Japanese stocks, finished higher for the week as well, and remain on the cusp of a big bullish breakout of the trend that describes the correction of the past year for Japanese stocks, and German stocks.
But yields have been lifeless. In the most important bond market in the world right now, the German 10-year yield remains straddling the zero line (a huge level for both fundamental and psychological reasons). And the U.S. 10-year yield has been essentially been anchored by the German bund yield.
When optimism improves, in this environment, stocks go higher and yields go higher, as global capital pulls out of the safety of government bonds in favor of higher return assets (stocks). But it’s not happening, much, at the moment. Though we should acknowledge that both the German and U.S. yields are 20 basis points higher than worst levels of just earlier this month. Still, U.S. stocks are at record highs, and most major stock markets have fully recovered the post Brexit vote declines.
So yields are an important spot to watch next week. The Bank of Japan should announce for more stimulus next week – perhaps a third round of the Abe-led QE campaign, and perhaps in coordination with fiscal stimulus that has been telegraphed by the Abe administration.
As we’ve discussed, contrary to the popular view, QE ultimately has pushed yields up, not down. Because people become more optimistic about the economic outlook.
On a final note, another key market over the past seven months has been oil. We’ve talked a lot about the importance of oil to global economic stability. At $26 oil was threatening another global financial crisis. It’s, of course, doubled since and stocks have tracked the recovery.
Source: Billionaire’s Portfolio, Reuters
But the past two weeks, oil has been moving lower as stocks have been printing new record highs. Oil closes the week still hanging around $45, but this will grow in importance, and send negative signals, if it were to continue lower from here next week — something to keep an eye on.
Have a great weekend!
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The ECB meeting came and went this morning without moving the needle in global markets. And that has left the very important German 10 year yield, as we discussed last Friday, straddling the zero line.
Next up is the Fed, on Wednesday of next week. And shortly following the Fed decision will be the biggie: The Bank of Japan.
As for the Fed, for perspective on how wild the swings in sentiment have been, just 16 days ago, the U.S. 10 year yield was trading at 1.35%, lower than the darkest days of the global financial crisis (much lower), and the darkest days of the European Debt Crisis.
Expectations on the next rate hike had been moved out, at that point, as far as 2018 in the minds of market participants – and the market began to even price in slim chances of a cut.
And as we said in our July 5 note, “the last time yields made record lows around those levels, what turned it? It was intervention – or at least the threat of intervention. It was the ECB stepping in and saying they would do ‘whatever it takes’ to save the euro.”
Not surprisingly, global yields bounced just days after the reaching new record lows, earlier this month, on news that Japan was planning on rolling out a big fiscal stimulus package (i.e. intervention).
As we said, despite all of the criticisms surrounding policymakers meddling in markets, intervention (in one shape or form) has determined many historic turning points in markets – something to keep in mind.
The market is now pricing in a little less than a coin flips chance of a hike this year from the Fed. That’s up from a 13% chance just 16 days ago.
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U.S. stocks traded to new record highs this morning.
Yesterday we talked about the trajectory of earnings surprises for the second quarter, and the big positive surprises that are being reported in the earnings of banks and financials. Morgan Stanley joined the bunch today with much better than expected numbers (beating on earnings and revenue).
But, as we said yesterday, financial stocks, broadly, still remain in the red for the year, lagging all other sectors in the S&P 500.
Here’s a look at the sector performance year to date.
If you missed the boat on the rebound in energy stocks earlier in the year, this lag in bank stocks could be the next big run.
What could be the catalyst? An improving economy and global market stability would certainly be helpful. The outlook, on that front, will most likely be driven by more intervention.
As we’ve said, next week we think the Bank of Japan will take the opportunity, in response to the Brexit uncertainty, to unleash the powerful combination of fresh fiscal stimulus and (more) monetary stimulus. And Europe would be smart to follow that lead.
The ECB meets tomorrow, but should do nothing. But Draghi may/should use his press conference platform wisely, to pressure European politicians to pursue fiscal stimulus to ward off the threats of a Brexit contagion.
And G20 finance ministers and central bankers meet this weekend in China, to set the table for the G20 Summit of global leaders later this year.
What’s a main topic due to be discussed by G20 finance ministers and central bankers? Fiscal stimulus!
Though waning, that contagion risk in Europe (i.e. threat of a European Monetary Union member leaving the EU and euro), and the crippling effect it would have to the global financial system, is what continues to weigh on bank stocks, including Germany’s biggest, Deutsche Bank.
We’ve already seen a very positive response in global markets to a telegraphed spending package in Japan. The same in Europe would go a long way toward ending the global shock risk associated with Brexit, and provide optimism about recoveries in Europe and Japan (which would be a big boon for the global economy).
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We’ve talked about the reasons markets and economies are set-up nicely for positive surprises. Surprises create changes in outlooks. And “change” is the primary catalyst that moves/reprices markets.
On that note, today we want to focus on earnings.
Last earnings season, 72% of the companies in the S&P 500 beat expectations. Still, companies dialed down expectations coming into the second quarter. Of course, then Wall Street lowers its bar. And companies are now beating estimate again.
Like it or not, that’s how Wall Street works and has always worked. FACTSET says on average (the five-year average) 67% of companies in the S&P 500 beat their analyst expectations. And they beat by an average of 4%.
That begs the question: Why aren’t analysts adjusting up their expectations on average, by 4%, given the history? As we know, better than expected earnings are fuel for stocks.
Now, in the current earnings cycle, over the past week, we’ve had 35 companies report in the S&P 500, as of the close of last week. And the positive surprises are, again, running close to 70%.
The biggest surprise has been in bank earnings. We’ve heard all of the warnings over the flattening yield curve. Historically, a flattening yield curve, is a drag on bank earnings (banks earn less on the spread between what they pay on deposits or borrowing and what they earn by lending).
But as we know, overtime, banks have become very different animals. In the 80s this spread or the “net interest margin” was king. For big banks, interest income was about 90% on their income. In the recent era, it’s about 75%. These days, what’s tipping the balance is non-interest income. And the banks seem to be finding ways to improve that number, whether it’s through costs cuts, or better trading profits.
Overall, the health of the banks is as good as it’s been in a long time. Last quarter loan balances grew at the fastest 12-month rate since 2008, the share of unprofitable banks fell to an 18-year low, and the number of ‘problem banks’ continued to decline.
Still, the S&P 500 bank index is down 5% year-to-date, underperforming the broader index by more than 10 percentage points. Financials are the only sector in the S&P 500 in the red year-to-date. If you think the worst blow to global economic sentiment might be behind us, the banks should offer some of the best upside in stocks.
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