@the Market: Stocks Look Ready to Reach New Highs
The S&P 500 Index had its best week in two months. All the averages made good gains and investor sentiment numbers are improving. We could see a return to the January highs before summer unless something comes out of left field.
Left field has become a familiar place for the markets under the present political regime, but not all the news has been negative on that front. Take the release of three American prisoners by North Korea as an example. Kudos to the president for that one. Then there is the Iran nuclear deal — another campaign promise kept. Why are these important?
An American politician willing to keep his campaign promises is a historical event, in my opinion. The June 12 meeting between Kim Jong Un and President Trump is another fabulous breakthrough. Those remarkable actions can and have impacted investor sentiment in ways that have lifted hopes and with them the markets.
The jury on bowing out of the Iranian nuclear deal is still out. Readers may recall that back in 2015, Iran agreed to curb its nuclear development efforts in exchange for the lifting of severe economic sanctions. The U.S., U.K., Russia, China, Germany and France all signed the agreement.
At the time, many Americans felt it was the best deal that could be had. Suspicions remained, however, that Iran, despite the treaty and its denial that it ever had a nuclear weapons program, would and could continue to develop that effort secretly. Just days before the president's decision to back out of the deal, Israel released a mountain of documents detailing what they believe was Iran's clandestine, decade-long nuclear weapon program.
Whether it was the Israeli documents that decided the president, or something else, the deed was done. Why is this important to investors? Oil.
Iran is the world's fifth-largest oil producer, pumping 1.5 million barrels/day in an already tight energy market. Taking that supply off the market via new sanctions provides additional fuel stoking the already-accelerating price of oil. For my view of oil prices and where they are going, please read my column "What's up with oil?"
However, it is not always what it seems in geopolitics. The other signatory nations are steadfastly opposed to America's unilateral departure from the treaty. As such, it is a distinct possibility that the remaining treaty nations will simply ignore our departure, disregard the sanctions, or, in some cases, give lip service to sanctions but direct their companies to simply carry on as usual. If so, that sanctioned oil will be re-routed to China, India, or parts of Europe, leaving the U.S. decision ineffectual and the Iranians free to continue along their nuclear path.
As for the gains in the stock market this week, credit goes to the president's actions and a stellar earnings season. The average earnings gain was 25 percent (18 percent minus the tax savings). Thursday's consumer inflation data also helped. The Consumer Price Index (CPI) came in lower than expected, leaving traders to believe that inflation is still reasonably under control. In which case, the Federal Reserve Bank need not raise rates any higher than the market expects this year.
As for all this worry about "peak earnings," the historical data somewhat contradicts those concerns. Seventy percent of the time since WW II after peak earnings were reported on the S&P 500 Index, the markets were higher nine months later. I hope that helps. I'm thinking we go higher, after some profit-taking in the coming week. The S&P 500 Index should hit 2,800 soon. From there, it is only a hop, skip and jump to record highs of 2,872 made back on Jan. 26.
I'm not quite sure we will get there this month and there will be pullbacks galore, but we are heading in the right direction.
@theMarket: China Worries Dominate Markets
You would think an unemployment rate that hit 3.9 percent in April would have cheered the market. It was, after all, the lowest such rate in 18 years. But no, all eyes were focused on the first round of China/U.S. trade talks, which conclude today.
The American team includes Commerce Secretary Wilbur Ross and two, hardline China hawks: Robert Lighthizer, our trade rep, and the administration's trade and manufacturing adviser, Peter Navarro. U.S. Treasury Secretary Steven Mnuchin heads the team that is trying, according to the President 's tweet, "trying to negotiate a level playing field."
What we would like to see from the Chinese is a commitment to increase their U.S. imports by as much as $200 billion by 2020. That's in addition to an agreement that would finally protect our intellectual property rights, while allowing American companies greater access to their markets.
As for China, the fact that Chinese Vice Premier Liu He, is heading the Chinese team indicates that the Chinese are more than willing to address the issues. Over the last two days, the Chinese media has remained cautious in reporting the talks while international trade experts warn that there will be no "grand" bargain" struck this time around.
The Chinese, however, are entering the talks softly, while following our own President Teddy Roosevelt's admonition to carry a big stick. That stick is soybeans. Over $14 billion were exported to China last year, but over the last month China has suddenly canceled several shipments of U.S. soybeans — about 133,700 metric tons. They have, instead, turned to Brazil to fill their demand and that country is happy to oblige.
The Chinese also slapped anti-dumping tariffs on American sorghum, used as animal feed and in making whiskey. Although that market only amounts to a little over $1.1 billion in exports, the action was big enough to cause Archer-Daniels Midland, a big agricultural processor, to announce a $30 million hit to its business.
Farm-belt politicians, who recognize that the soybean states had delivered a double-digit victory to the president, are already demanding relief for their constituents. As in all tariff actions, those who are not economically impacted by changes in tariffs support our new "get tough" trade policy — until those policies impact them personally.
Predictably, farmers are already grumbling that there are better ways of getting a level playing field without upsetting their apple (or soybean) cart. It also happens to be planting season. Farmers have no idea how much to plant, given the trade talks. The concerns for what this might mean for them personally is growing rapidly.
My own two cents is that the U.S. and China will come to an agreement of sorts. Our negotiators know that $200 billion in additional imports is a "big ask" of the Chinese. They simply don't need our imports, outside of those in sophisticated technology and in defense. There is no way we are going to export any kind of armaments, and the administration has already cracked down on technology transfers, so what's left?
Autos are a big-ticket item, and the Chinese have already promised to open their market to more foreign-made imports. There is also liquefied natural gas (LNG) which we produce in abundance. That could work if they have the necessary ports to accept delivery of that volatile energy product.
However, there is enough on-going uncertainty over the trade talks to have driven the stock market down to its 200-day moving average for the fourth time. Today's unemployment number barely made a dent in investors' consciousness. The last time unemployment was below 4 percent for any length of time was in the 1960s (when I was in high school). I think it is a big deal and one of the reasons I want you to remain fully invested.
Since there is absolutely no way to handicap the string of political events — Stormy Daniels, Mueller, Iran, Syria, etc. — we simply need to hold-on, and let the market barrel through this period of consolidation.
@theMarket: Peak Earnings Versus the Yield Curve
"Never a dull market" could be the motto of choice to describe stock market performance year-to-date. This week, we need to add two more concerns to the market's wall of worry.
"Peak earnings" is the first issue, which has been brought to the forefront by the 18-20 percent earnings gains reported by companies thus far for the first quarter. The bears would describe peak earnings as the peak of a growth cycle for a stock or a group of stocks such as an index like the S&P 500 or Russel 2000.
Typically during peak earnings, a company will report big "beats" in revenue and profits, but management will then guide investors' expectations lower for the next quarter or so (and maybe even the year).
A small but growing group of investors are comparing what happened back in May 2011 to events today. The S&P 500 rallied over 50 percent between March 2009 through May 2011.
Earnings peaked at that point, and the markets rolled over, at least temporarily. They fear this could happen again, especially when the effects of the tax cut will dissipate to some degree in 2019.
Here's my take: We all know that part of the strong earnings growth this past quarter was a direct result of tax savings. We knew it. You knew it. And the market knew it. Most analysts, including me, were expecting an 8 percent pickup in earnings simply due to taxes. That's exactly what happened. As such, there should have been (and is) a knee-jerk "sell on the news" reaction that continues today.
Second, should anyone but day traders really care about "peak earnings?" Just because a company's earnings next quarter or next year won't match or beat a 20 percent gain this quarter does not mean earnings won't grow. Next year, for example, the Street is looking for overall earnings to grow by about 10 percent. Granted that is half the rate of this quarter, but it is still growth and good growth at that. And don't forget that next year's growth rate will also be based on a larger pie of earnings reported this year.
I don't buy the peak earnings argument, nor do I necessarily agree with the second of this week's worry — an inverted yield curve. What's that, you may ask? It is when the long end of the bond market yields less than the short end. Historically, it has been an accurate signal that recession is coming.
Usually, investors demand higher rates of interest from bond issuers the further out in time (duration) they go. That makes sense when you think that the longer one holds an investment, say a ten or twenty-year bond, the higher the risk that something bad could happen (war, bankruptcy, inflation). Shorter term bonds: 3 months, 6 months, one and two-year has less risk because you hold it for less time and therefore have less interest (yield).
Given that the Fed is raising short-term interest rates, while the longer-dated bonds are remaining the same, or only rising a little, the yield curve is flattening. Bond and stock market investors have been watching the spread (the difference in interest rates between the two-year and 10-year bonds) narrow. It is making them increasingly nervous because it could be saying that there is more risk of a recession in the short-term than there is over the long-term.
But short-term doesn't mean the recession would start tomorrow, or next week, or even next year. In past cycles, the average time between the onset of an inverted yield curve and a recession was over 20 months. Besides, there are other variables — inflation, credit, monetary policy and the overall economy — that are at least equal, if not greater importance, in determining a recession. There is no justification I see to sell stocks now for a possible recession based on a yield curve that has not inverted but only flattened slightly.
While I don't put much credence into these new concerns, it does and will generate even more volatility in the markets. We have a whole series of unknowns and potentially negative developments to overcome. Everything from a tariff-inspired trade war to a renegotiated NAFTA trade agreement, geopolitical issues ranging from the Iran nuclear agreement to North Korea talks, not to mention on-going disputes with China, Russia and Syria. If you add in domestic concerns: Mueller, Cohen, the upcoming mid-term elections, etc., we have a nasty mix of uncertainty that should keep the markets guessing and me writing. In the meantime, stay invested and look for better days ahead.
@theMarket: Earnings Up; Stocks, Not So Much
Earnings season kicked off last Friday with the bank results. The numbers were stellar, but the stock prices of those companies fell hard. Since then, the same thing has occurred to any number of companies. What is going on?
At first, you might think it's classic "sell on the news" behavior where traders bid stock prices up prior to the earnings announcement and then take profits immediately after. However, a closer look reveals something different going on.
For months, investors were expecting a boost to corporate profits from the tax cuts passed by Trump and the GOP last year. Boy oh boy, we said, just wait and see how great earnings will be in the first quarter. Wall Street analysts came to a consensus that corporate profits could be up by 20 percent or more year-on-year. The stock markets roared to life in January, discounting much of these expectations.
Since then, stocks have dropped and only recovered about half of those losses year to date. But there's more. Investors are also discounting these 20 percent earnings pops because the earnings gains from tax cuts are of a much lower quality than the day-to-day profit gains generated from their business.
Traders and investors alike are ignoring the headline numbers and delving deep into the results. If earnings beats are simply a function of tax savings, down goes the stock price. So, this time around, first-quarter earnings are not what they seem.
And what the government giveth, so the government can taketh away. In my previous column "Why tax cuts are unpopular with Americans," I worry about the durability of these partisan tax cuts. Like the passage of Obama Care by a Democrat-controlled Congress, the tax bill was also a partisan action. If Democrats regain control of either house of Congress, we can expect an effort to roll back these tax cuts.
Until we see the lay of the land in November, why should investors assume the tax benefits for corporations are here to stay? Company managers are acutely aware of these risks as well. It might explain why, rather than commit to a multiyear investment plan in their core business or the hiring of extra labor, they would rather buy back stock and increase their dividends to shareholders with the money.
That, of course, creates a vicious circle. The Democrats (and some Republicans from income tax states) will use this to argue that the tax cut was never intended to grow the economy, but rather reward Republican donors and Trump's political base. Budget hawks will point to the exploding deficit as another reason to raise taxes. If that tactic works, it will convince companies to delay any tax-fueled investment plans even further.
The moral of this tale is that partisan politics doesn't work. It didn't work under Obama and it won't work under Trump. Unfortunately, most Americans fail to understand this today.
The era of compromise in this country is long gone. Instead, we choose chaos and crisis. Last week, I warned that we were not quite through this period of volatility. We had three up days this week, and two down days. That should continue, but with an upward bias.
@theMarket: The Trump Trade Bluff
This week, our fearless leader upped the ante on the tariff tiff with China. It went like this: Trump announced his list. China announced theirs. And at the end of the week, the president sees them one better. Aside from the volatility, it is causing in the stock markets, not much besides headlines has been accomplished.
Are you seeing the pattern yet? Think back to Trump's schoolyard diplomacy with Kim Jong-un, the leader of North Korea. First, a furious exchange of tweets and name-calling between the two. That was followed by saber-rattling on both sides. More test missiles. Naval ships steaming toward the Peninsula. The media spent days explaining the "what ifs" while stocks went up and down.
In the end, the two neighborhood bullies now appear willing to play nice and meet at the end of the month. I fully expect our president to come out of the meeting extolling "Fatty the Third" as his newest and dearest best friend.
Now compare that to the tariff turmoil. Tweets, counter tweets, threats, etc. are flying this way and that; but so far, it's all smoke and mirrors. Investors here in the U.S. are still reacting like puppets on a string, but elsewhere governments and stock markets are disengaging from these Trump tactics.
Take Thursday night's announcement. Trump ordered his trade rep, Robert Lighthizer, to "consider" an additional $100 billion in trade tariffs against China. By the time he does all that studying, a few months will have passed. In the meantime, things change and there is no guarantee that any recommendations will ever see the light of day.
However, like the puppets we have become, Thursday night's futures market for the Dow Jones Industrial Average fell by over 500 points. Corresponding drops in our other indexes also occurred. But here is where foreign investors parted ways with our traders. Japan's stock market traded up slightly at first and then dropped by a small amount at the end of the day. Some markets, such as Hong Kong and India, finished higher. By the time we opened for business on Friday morning, the losses in our own averages were pared back by more than half.
Like a dog whose bark is worse than its bite, global investors and governments are beginning to realize that what comes out of the Twitter-in-Chief's mouth (or his Twitter account) is neither policy nor necessarily even the truth. As such, investors would be well advised to ignore his pronouncements. Granted, that's hard to do because the president will go to great lengths to stay in the center of the spotlight, no matter what he needs to say or do to accomplish that goal.
Nonetheless, do not act on his statements. Next week, earnings season begins, and analysts expect good things from Corporate America. Wages continue to gain (2.7 percent on an annual basis), according to the latest non-farm payroll report, although the number of jobs gained (103,000) was 90,000 short of expectations. From a macroeconomic point of view, things look good and are gaining momentum.
As for the markets, I expect volatility will continue. Right now, the S&P 500 Index is caught in a 100-point trading range and will probably not break out of it until the middle of April at the earliest. Cushioning the market somewhat, as I expected, is the tax cut. U.S. dividends increased in the first quarter to a record high. Corporate buy backs are also recording the same kind of gains, as most corporations reward their investors by passing along their tax savings, rather than investing them in jobs or capital spending (as the legislation's authors promised). That makes owning stocks a good bet for the future.