Friday, April 28, 2017

A Goldilocks Situation For Stocks?

Alex Rosenberg of CNBC reports, Jeremy Siegel’s bullish call: This is a ‘goldilocks situation’ for stocks:
It's no secret that Wharton School finance professor Jeremy Siegel tends to be a market bull. After all, he may be most famous for penning a classic of popular investment literature, "Stocks for the Long Run."

But after a 12 percent rally in the past six months, and nearly a tripling of the S&P 500 over the past eight years, it is striking to see how just optimistic Siegel still is about the market .

"I actually think we have a Goldilocks situation going on now," he said Thursday on CNBC's "Trading Nation." "We have everything moving in tandem."

For starters, earnings have looked good, Siegel pointed out, adding: "But much more important than that is the maintained or upward guidance for second, third and fourth quarter — something we've not had for years."

In prior years, he said, "it's been stunning how year estimates have come way down by the time we get to December. Now, anything can happen. We're only in April — but it's the first time that I have seen forward guidance maintained or increased since we turned around from the great crisis back in 2009."

That is to say, optimistic estimates of earnings for the rest of 2017 are being maintained. According to data from FactSet, income growth for 2017 is currently predicted at 9.9 percent, just a touch below the 10.8 percent estimate from the end of 2016.

Meanwhile, with about half of S&P 500 companies having reported earnings, investors are looking at profit growth of 11.1 percent, with the bulk of those gains coming from the energy and financial sectors.

The good earnings news comes even as economic growth remains relatively slow. That means inflationary pressures shouldn't force the Federal Reserve to speedily raise rates — hence the not-too-hot, not-too-cold Goldilocks environment.

Still, Siegel is not above sowing self-deprecating cushions of doubt.

The fact that everything looks so good "I guess should make me worried, because we know that that doesn't always persist," he quipped.
Call him a perennial bull but professor Siegel has written the book on stocks for the long run. He brings up a good point on upward earnings guidance being maintained or increased after consecutive quarters but that just adds to my concerns on the stock market.

Sure, Amazon had a blowout quarter thanks to its cloud business, propelling Jeff Bezos's wealth passed $80 billion, putting him within $5 billion of becoming the world's richest man.

Don't feel too bad for Bill Gates and the Alphabet (Google) billionaires, the cloud helped propel profits at their companies too. In fact, while Amazon still owns the cloud, earnings reports on Thursday from the e-retailer as well as rivals Microsoft and Alphabet show that the battle is in its early days and competition is fierce.

But the news isn't as cheery for the rest of America's working stiffs who can't ride the stock market higher to fabulous wealth. Reuters reports, US first-quarter growth weakest in three years, as consumer spending falters:
The U.S. economy grew at its weakest pace in three years in the first quarter as consumer spending barely increased and businesses invested less on inventories, in a potential setback to President Donald Trump's promise to boost growth.

Gross domestic product increased at a 0.7 percent annual rate also as the government cut back on defense spending, the Commerce Department said on Friday. That was the weakest performance since the first quarter of 2014.

The economy grew at a 2.1 percent pace in the fourth quarter. Economists polled by Reuters had forecast GDP rising at a 1.2 percent pace last quarter. The survey was, however, conducted before Thursday's advance data on the March goods trade deficit and inventories, which saw many economists lowering their first-quarter growth estimates.

The pedestrian first-quarter growth pace is, however, not a true picture of the economy's health. The labor market is near full employment and consumer confidence is near multi-year highs, suggesting that the mostly weather-induced sharp slowdown in consumer spending is probably temporary.

A measure of private domestic demand increased at a 2.2 percent rate last quarter. First-quarter GDP tends to underperform because of difficulties with the calculation of data that the government has acknowledged and is working to rectify.

Even without the seasonal quirk and temporary restraints, economists say it would be difficult for Trump to fulfill his pledge to raise annual GDP growth to 4 percent, without increases in productivity.

Trump is targeting infrastructure spending, tax cuts and deregulation to achieve his goal of faster economic growth. On Wednesday, the Trump administration proposed a tax plan that includes cutting the corporate income tax rate to 15 percent from 35 percent, but offered no details.

Growth in consumer spending, which accounts for more than two-thirds of U.S. economic activity, braked to a 0.3 percent rate in the first quarter. That was the slowest pace since the fourth quarter of 2009 and followed the fourth quarter's robust 3.5 percent growth rate.

The weakness in consumer spending is blamed on a mild winter, which undermined demand for heating and utilities production. Higher inflation, which saw the personal consumption expenditures index averaging 2.4 percent in the first quarter - the highest since the second quarter of 2011 - also weighed on consumer spending.

Government delays issuing income tax refunds to combat fraud also curbed consumer spending. But with savings rising to $814.2 billion from $778.9 billion in the fourth quarter, consumer spending is likely to pick up.
GDP 'noisy'

Economists believe Federal Reserve officials are likely to view both the anemic consumer spending and GDP growth as temporary when they meet next week. Fed Chair Janet Yellen has previously described quarterly GDP as "noisy."

The Fed is not expected to raise interest rates next week. The U.S. central bank lifted its overnight interest rate by a quarter of a percentage point in March and has forecast two more hikes this year.

After contributing to GDP growth for two straight quarters, inventory investment was a drag in the first quarter.

Businesses accumulated inventories at a rate of $10.3 billion in the last quarter, down from $49.6 billion in the October-December period. Inventories subtracted 0.93 percentage point from GDP growth, almost reversing the 1.0 percentage point contribution in the fourth quarter.

Government spending fell at a 1.7 percent rate as defense outlays declined at a 4.0 percent pace, the biggest drop since the fourth quarter of 2014. State and local government investment also fell.

There was some good news in the first quarter. Business investment improved further, with spending on equipment jumping at a 9.1 percent rate thanks to rising gas and oil well drilling as oil prices continue their recovery from multi-year lows.

Spending on mining exploration, wells and shafts surged at a record 449 percent rate after rising at a 23.7 percent pace in the fourth quarter, accounting for the rise in nonresidential structures investment.

Spending on nonresidential structures accelerated at a 22.1 percent pace in the first quarter after falling at a 1.9 percent rate in the prior period.

Investment in home building rose at a 13.7 percent rate. Exports rose at a 5.8 percent rate, outpacing the 4.1 percent rate of increase in imports. That left a smaller trade deficit, which had a neutral impact on GDP growth.
I must admit, these GDP reports are interesting but by the time they come out, the economy is already moving in another direction. Those of you who want to read more on the latest US GDP report can do so by reading Gerard Macdonell's latest, GDP data suggest it is less a no brainer, but not yet alarming.

I don't fret too much over GDP reports. I prefer to look at leading economic indicators, including the stock market, to understand where we are headed. And as I discussed on my blog a couple of weeks ago, the next economic shoe is already dropping in the US, which isn't good for cyclical stocks going forward.

Next week, we will get the ISM manufacturing and service reports as well as payroll data. I expect there will be more and more negative economic surprises in the months ahead and this will force many analysts to revise earnings estimates down.

What about the Fed? Patti Domm of CNBC reports, Economic growth may stink, but a pickup in inflation means the Fed will raise rates:
First quarter growth slipped to the weakest quarterly pace in three years, but inflation and wages picked up, signaling the Fed will press ahead with interest rate hikes.

Growth in gross domestic product was reported at a seasonally adjusted 0.7 percent, below the 1.2 percent in the Thomson Reuters consensus forecast. It was also below the CNBC/Moody's Analytics Rapid Update tracking rate, updated Thursday to just 0.8 percent, the same as first quarter last year.

But the rate of inflation, measured by the personal consumption expenditures price index, rose at a rate of 2.4 percent, the biggest jump since 2011.

Peter Boockvar, chief market analyst with Lindsey Group, points out that the employment cost index, another early indicator for inflation, also rose 0.8 percent quarter over quarter, 0.2 point more than expected.

"This brings the [year-over-year] gain to 2.4 percent which is the best in two years. Specifically, private sector wages and salaries were up by 2.6 percent [year over year] which matches a two-year high. Bottom line, the ever elusive evidence of rising wages might finally be peaking its head above water," Bookvar wrote in a note to clients.

There were some troubling signs in the GDP report but economists are so far writing them off as temporary and expect a bounce back in the second quarter. The report does follow a string of weaker-than-expected reports, including CPI, jobs and retail sales.

"The Q1 conundrum strikes again. It's not a good number. The swing factor tends to be net exports, and inventories once again were mixed, but detracted from growth overall. Consumer spending was a lot weaker," said Ward McCarthy, chief financial economist at Jefferies.

The report shows the impact of a sharp cutback in purchases of autos and durable goods. Consumer spending rose just 0.3 percent, the weakest since 2009, but it follows several strong quarters.

"We've been here before on Q1. Looking at the detail of consumer spending, it's not going to be repeated in Q2. It's primarily durables. ... You had fourth quarter consumer durable spending up 11.4 percent. In Q1, it was down 2.5 percent," McCarthy said.

First quarter growth has a track record of being weak, and economists say the government is working to straighten out the quirks that have plagued its calculations for at least two decades. There were also some specific factors at play, such as very warm weather in January and February but winter storms in March.

"The inflation numbers accelerated, but they still remain moderate. It supports the contention that the Fed is attaining its objective on the inflation side," said McCarthy. The Fed has targeted 2 percent inflation. McCarthy said the report suggest the Fed should continue on its rate hiking path. It has forecast two more rate hikes this year, though it is not expected to raise rates when it meets next week.

The concern would be if growth remained sluggish, but the Fed were forced to move ahead with rate hikes because of rising inflation. Economists, however, see an improvement in the second quarter, with some forecasting growth at 3 percent or higher.

Stocks opened higher Friday but slipped into slightly negative territory. Treasurys were weaker, and yields, which move inversely to prices, were higher.

In a positive sign, business spending picked up on long-term projects. Nonresidential fixed investment grew at 9.4 percent, the largest gain since 2013.
Will the Fed raise rates by 25 basis points next week? Maybe but traders are pulling back from bets the Federal Reserve will raise interest rates in June as inflation expectations crumble. With US inflation expectations at their lowest levels in 2017, I wouldn't bet on three rate hikes this year.

Where does this leave stocks? Given that economic momentum is decelerating and rates have already risen quite a bit from last year, some sectors are much more vulnerable than others. In particular,  cyclical sectors (financials, energy, industrials) are much more vulnerable than defensive sectors (utilities, healthcare, telecom, and large cap growth).

You might be surprised to think of large cap growth as a defensive sector but the truth is when the economy is slowing, large cap growth stocks tend to do relatively better because they have pricing power, earnings growth and big companies invest in technology to improve productivity during a slowdown.

Should you be very afraid of these markets? No, but be prepared for the coming economic slowdown and how it will impact some stock sectors more than others. Still, the bull market is long in the tooth and no matter what happens with tax cuts and spending on infrastructure, it is vulnerable to a deep correction.

The only thing that I can see which will propell stocks even higher is that so many investors are positioned in a defensive way and the hedge fund quants taking over the world know this and can squeeze them out and force them to buy at higher levels.

We shall see what happens in May but I expect the second half of the year, especially the fourth quarter, to be a lot more challenging for stocks, and I doubt the beta bubble will continue unabated (stock pickers and other active managers will capitalize during the next downturn).

Given my views on the reflation trade, I would be taking profits and actively shorting emerging markets (EEM), Chinese (FXI), Industrials (XLI), Metal & Mining (XME), Energy (XLE)  and Financial (XLF) shares on any strength. The only sector I trade now, and it's very volatile, is biotech (XBI) which continues to grind higher on the weekly chart (click on image):


Along with the rise in Amazon, Facebook, and Alphabet (Google) shares, the rise in biotech has propelled the Nasdaq passed the 6000 mark and technology (XLK) to record levels (click on image):


These are bullish charts but you should keep in mind that nothing goes up forever. I still maintain that if you want to sleep well, you need to protect your downside risks. This is why I continue to recommend buying US long bonds (TLT) on any pullback as I think we have yet to see the secular low in bond yields. Also, in this deflationary environment, bonds remain the ultimate diversifier.

That's it from me, it's been a long week. Please remember to donate or subscribe to this blog on the top right-hand side under my picture using the PayPal options. I thank all of you who take the time to show your financial support for this blog.

Below, Wharton professor of finance Jeremy Siegel discusses the next move for the markets with Brian Sullivan. And Nobel Prize-winning economist Robert Shiller is encouraging investors to go abroad as US stocks hit fresh record highs.

Needless to say, I disagree with both these wise professors. Think US stocks are vulnerable in the second half of the year as leading economic indicators roll over but I remain overweight the US market relative to foreign stock markets which are less diversified and more vulnerable during cyclical downturns.


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