Friday, April 13, 2018

Market Underestimating Great Earnings?

Jeff Cox of CNBC reports, The market is underestimating how great earnings will be, JP Morgan says:
Blockbuster corporate profits that are even better than Wall Street anticipates will help steady the recent bout of market volatility and boost share prices, according to J.P. Morgan Chase.

Earnings season is getting into full gear and will accelerate as big financial institutions this week and next report first-quarter activity and their expectations ahead.

The forecast already is lofty — year-over-year growth of about 17 percent that would represent the best quarterly gain in seven years for the S&P 500. Earnings are being driven by improved revenue, the benefits of corporate tax cuts that Congress passed in December, and a lower dollar, higher oil prices and several other factors.

However, J.P. Morgan thinks investors and analysts are underestimating just how much power those factors will have.

When all is said and done, the firm sees earnings up 21 percent.

"We believe the consensus growth does not include the positive impact of rising disposable income (i.e., tax savings, wage increases, one-time bonus), lower household expenses (e.g., utility bills and declining cost for goods/services from industries that have lower pricing power), and rising consumer confidence," Dubravko Lakos-Bujas, head of U.S. equity strategy at J.P. Morgan, said in a note to clients.

The call, though, is somewhat contrarian.

A growing number of investing experts think that the prospects for tax reform, in particular, helped propel the market's 20 percent gain in 2017 and have little firepower left as the big earnings move is already priced in.

Another central tenet of the J.P. Morgan call is that an expected $800 billion in share buybacks this year will serve as another supportive factor for share prices. However, investor surveys have reflected a desire for less cash devoted to repurchases and dividends and more for capital expenditures, research and development, and mergers and acquisitions.

Still, Lakos-Bujas thinks companies will have to spread around how they spend the approximately $2 trillion on their balance sheets at home. Companies also are likely to bring home a chunk of the $3.5 trillion or so they have stored overseas that can be repatriated for just a one-time tax hit.

He also expects that not all the money will go buybacks — capital expenditures stand to improve as well, and there should be an active M&A climate.

"No other time in history have companies held so much cash in a low rate environment," Lakos-Bujas wrote.

In addition, he sees valuation as being friendly. The S&P 500 is currently trading around 16 times earnings, thanks to a sluggish year for the market in which volatility has come back after being dormant for years.

Despite the duration of the nine-year bull market, Lakos-Bujas said prices have traded largely in line with earnings.

Friday will see the first of the big-bank reports, with Citigroup, J.P. Morgan Chase and Wells Fargo on tap.
So much for great earnings, late Friday afternoon, big US banks are selling off as are all the major exchanges (click on image):


Now, it is Friday the 13th, traders are worried Trump might go ballistic over the weekend and fire off crazy tweets and missiles in Syria, oil prices are rallying helping energy shares (XLE) this week, so it's hard to discern how much of investors' angst is due to geopolitical tensions.

Some are unperturbed and think all these wild swings in the stock market could mean it's bottoming soon and will rebound, but others are more worried and rightly note stocks haven't seen this much volatility since the financial crisis.

Lately, I've devoted considerable attention to macro topics like trade wars, the importance of the yield curve, how these Boom Boom markets may seem boring but are far from it.

Today, I want to cover earnings and why you should ignore the "great news". In my humble opinion, great earnings, the tax cuts, and pretty much every good piece of news is already baked into these markets.

Yes, there will be some earnings surprises -- both positive and negative -- but overall everyone was expecting earnings to be solid for Q1 which is why traders are selling the news.

It's critically important to understand that earnings follow coincident economic indicators and that leading global indicators are rolling over and they lead earnings revisions, both upward and downward earnings revisions.

People think earnings will save the day. No they won't. Earnings are used for fund managers to trim their stakes in April. There is a reason why "sell in May and go away" typically works, especially if you expect Q2 and Q3 earnings to be a lot more tepid when the risks of a second half global economic slowdown are high.

Investors who expect US bank stocks to climb higher are looking at lagging, not leading indicators of the economy. They're foolishly ignoring the yield curve and risk of inversion, and they're positioned for a market that is phishing for inflation phools.

And they will be crushed when cyclical sectors take a beating in the second half of the year.

As I stated many times, I'm preparing for a second half global 'synchronized' economic downturn, and as such I'm recommending investors to trim risk in their portfolio by investing at least 50% in US long bonds (TLT) and being overweight consumer staples (XLP) and interest-rate sensitive sectors like utilities (XLU), telecoms (VOX) and REITs (IYR) and being underweight cyclical sectors like energy (XLE), financials (XLF), metals and mining (XME), industrials (XLI) and emerging market shares (EEM).

When I look at US financial stocks (XLF), they're still hovering over their 50-week moving average but they've rolled over here and I think they're headed much lower (click on image):


It won't be a straight line down, there will be choppy action but some of these big bank stocks like Bank of America (BAC) and JP Morgan (JPM) ran up too high, too fast and are due for a major correction (click on images):



[Note: I bought JP Morgan shares after the London Whale scandal in the low 30s, sold in high 60s and should have kept those shares a lot longer!]

There are a few reasons why bank stocks are getting hit even after their earnings beat the Street:
"If you take out the capital markets business and the one-time events, it shows these banks aren't doing any business, and that's the key problem," said Dick Bove, chief strategist at Hilton Capital Management and formerly of the Vertical Group. "If you take a look right across the board, credit cards are down, auto is down, student loans are down, the corporate area is mixed to down. The only thing that's working is middle-market lending."
Which stocks do I like nowadays? I like healthcare stocks (XLV) in general and more specifically tracking shares of Teva Pharmaceuticals (TEVA) and Valeant Pharmaceuticals (VRX) very closely here (click on images):




But stocks are stocks, meaning they can swing wildly both ways, which is why I keep telling people who do not want to take stock-specific risks to stick to low vol stocks like the S&P Low Volatility ETF (SPLV) and hedge their equity exposure with US long bonds (TLT) and sleep well at night (a minimum of 50% of your portfolio would be in US long bonds right now, never mind what inflationistas are grumbling about!).

Lastly, since this comment is all about earnings, please take the time to read a recent paper by Jonathan Nitzan and Shimshon Bichler, With Their Back to the Future: Will Past Earnings Trigger the Next Crisis?.

The full PDF file is available here and below you can read a brief description:
The U.S. stock market is again in turmoil. After a two-year bull run in which share prices soared by nearly 50 per cent, the market is suddenly dropping. Since the beginning of 2018, it lost nearly 10 per cent of its value, threatening investors with an official ‘correction’ or worse.

As always, there is no shortage of explanations. Politically inclined analysts emphasize Trump’s recently announced trade wars, sprawling scandals and threatening investigations, as well as the broader turn toward ‘populism’; interest-rate forecasters point to central-bank tightening and China’s negative credit impulse; quants speak of breached support lines and death crosses; bottom-up analysts highlight the negative implications of the Facebook/Cambridge Analytica debacle for the ‘free-data’ business model; and top-down fundamentalists indicate that, at near-record valuations, the stock market is a giant bubble ready to be punctured.

And on the face of it, these explanations all ring true. They articulate various threats to future profits, interest rates and risk perceptions, and since equity prices discount expected risk-adjusted future earnings, these threats imply lower prices.

But there is one little problem. Unlike their pundits, capitalists nowadays tend to look not forward, but backward: instead of matching asset prices to the distant future, they fit them to the immediate past.
I love the little animation they embedded to go along with their paper:


Again, take the time to carefully read their short paper here. I note their conclusion on why past earnings will trigger the next crisis:
If current market jitters develop into an MBM (new major bear market), the consequences are likely to be dramatic. Over the past two centuries, the United States has experienced seven MBMs with an average market drop of 57 per cent in constant dollars (Bichler and Nitzan 2016: Table 1, p. 122). Current U.S. market capitalization is almost $30 trillion, so a ‘typical’ MBM could end up wiping out $17-trillion worth of capitalist assets. And that is just for starters.

During the past century, every MBM has been followed by a major creordering of capitalized power and a significant rewriting of the capitalist nomos. [14] Thus, the MBM of 1905-1920 was followed by the rise of corporate capitalism; the MBM of 1928-1948 was followed by the rise of the Keynesian welfare-warfare state; and the MBM of 1968-1981 was followed by the rise of global neoliberalism. The consequences of first MBM of the twenty-first century, from 1999 to 2008, are still hard to pin down, but one them seems to be a gradual shift toward a harsher mode of power – perhaps along the lines of Jack London’s The Iron Heel (1907). For this authoritarian shift to gain traction, though, capitalism might have to experience another MBM, hence the crucial important of the current moment.

If our analysis here is correct, it follows that the very future of capitalism is now at stake. Yet, paradoxically, the recent history of the stock market cunningly suggests that this future now hinges on the trajectory of . . . past profits.

As Figure 1 shows, the two down legs of the most recent MBM – in 2000-2003 and then in 2007-2008 ­– were both triggered by and/or coincided with a significant decline in earnings. Now, since both downturns began when the power and systemic fear indices were extremely high (Figure 5), this co-movement is exactly what our model predicts. And ominously, the present situation is practically the same: just like in the run-up to the two previous downturns, the power and systemic fear indices are extremely high; and as before, these high levels mean that investors, standing with their back to the future, remain extremely sensitive to the direction of current earnings.

So which way will earnings go?

In our opinion, the more likely direction is down, and, prosaically, the main reason is timing. For corporate earnings to continue to rise, there must be further upward income redistribution – from the underlying population to capitalists. Now, as noted, given that the U.S. capitalist share of income and personal income inequality are already at record levels, this redistribution is likely to require a much more authoritarian mode of power; and as the 2017 U.S. election of Donald Trump and the so-called ‘populist turn’ around the world suggest, the push in that direction might already be underway. However, even if a harsher mode of power were to emerge – and at this point, it is hard to say whether it will – this emergence will take time and its impact on EPS will register only with a considerable lag.

And it is here that timing becomes critical. Standing with their back to the future and their eyes staring at the most recent past, U.S. capitalists remain extremely sensitive to even a small drop in earnings, and the cyclical backdrop they are currently looking at is highly unfavourable. The present U.S. expansion is already the second longest in history, interest rates are already at historic lows and the profit share of GDP is still near record highs. If any one of these magnitudes reverts to its historic mean, EPS are likely to drop; if they all revert in tandem, the drop will surely be steep; and with the fear index at record highs, a significant earnings drop is almost certain to trigger a new MBM.

Either threat – a longer-term Iron Heel-like trajectory or a more immediate MBM – spells social turmoil. And sadly, progressive forces in the U.S. and elsewhere seem prepared for neither.
Read the entire short paper here. These are the types of papers that George Soros devours and Ray Dalio and the boys and girls at Bridgewater should be debating intensely.

Rising inequality is great for stocks and capitalists like Dalio and Soros, but as Noam Chomsky and many others have pointed out, it threatens the very social fabric of democracy.

And as I've pointed out many times, rising inequality is DEFLATIONARY. Period. This isn't the 1970s, we have serious structural issues that policymakers in the developed world have failed to address in a comprehensive manner.

Yesterday, Money Strong's Danielle DiMartino Booth posted a comment on LinkedIn on social mobility in the US to which I replied the following:
The 2008 financial crisis disproportionately hurt young American workers looking for a first job. Many have only recently found work. No jobs, huge debt in the form of student loans, stagnant wages, expensive housing as competition from domestic and foreign buyers is fierce, and we’re surprised most Millennials are still living at home with their parents and grandparents? Come on, let’s call a spade a spade, the fiscal and monetary bailouts were overwhelmingly for the lords of finance on Wall Street, not for average American workers or young Americans desperately trying to start their lives, get married, buy a house, and have a family. Many young Americans have had to put off their dreams, it’s quite sad and I suspect when it’s time to vote, they will take out their frustration on politicians who ignore their plight.
The younger generation in the United States isn't stupid. They see the hypocrisy in the system corrupted by money and power and they're a lot more organized using social media and other platforms. They want long-term solutions to their very real problems and they won't accept the status quo.

Just my weekend food for thought for all you waiting for great earnings to save this market. They won't and risk triggering the next crisis in capitalism.

On that cheery note, have a great weekend, please remember to contribute to this blog via PayPal on the top right-hand side, under my picture and show your support and appreciation for the daily comments I provide you absolutely free.

Below, we just got an ominous start to an earning season that was supposed to save this bull market but Fundstrat's Tom Lee says that historically this is a great time to be long equities.

And investors should use the volatility in the stock market as a buying opportunity, at least in the short run, one Wall Street strategist told CNBC on Friday.

"We think there's a bottom being put in place here as far as the S&P is concerned," said Dan Wantrobski, director of research at Janney Montgomery Scott.

He predicts there will be a rally into the early part of the summer.

I say ignore the cheerleaders on Wall Street dancing to the music of this Boom Boom market and listen carefully to the yield curve. It's telling you to buckle up for a very rough second half of the year.

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