A few weeks back, we pointed out the high literary value if the massive Alibaba (BABA) IPO had marked the market top, but we doubted that fate would favor the Michael Lewis types with such perfect timing. Perhaps we underestimated how much the Fates like a good page-turner.
Since the Alibaba IPO, the Russell 2000 has fallen nearly 6.2%, while the S&P 500 is down 3.75%. Yesterday, the Dow Jones Industrial Average fell over 270 points, as volatility reemerges from its Fed-induced hibernation. We've heard some mocking dismissal of those who point out the correlation between the Fed's balance sheet and the stock market, so we'll just mention that October is slated to be the last month of its expanding balance sheet. The last two times the Fed exited a QE, the S&P 500 dropped significantly and, interest rates also fell.
While some may have thought the recent spark in volatility fell by the wayside after last Friday's September Employment Report, a confluence of factors ¿ a miss in German factory orders, the International Monetary Fund (IMF) cutting its 2014 and 2015 growth expectations, a stronger U.S. dollar, slowing growth in China, andthe Ebola virus ¿ have come together to send the stock market lower. On top of that, we have started to see companies pre-announce or announce their September-quarter results. While it's still early, what we've seen thus far is not encouraging. Versace would like to point out that earnings estimates are not typically adjusted sufficiently for shifts in relative currency strengths. The dollar has been on quite the tear, as we discussed last week, and it is up again against virtually every major currency except the Canadian dollar.
Over the past few years, the falling greenback has given American multinational companies relatively cheaper products to sell to overseas buyers, and a second boost when overseas profits were translated back into U.S. dollars. The rising dollar is going to do the reverse, and we expect to see protestations of dollar sabotage to earnings in the coming months, using dollar strength in attempt to pass the buck. If this trend continues, American companies that source overseas but sell only domestically will have a marginal advantage over those that sell overseas. That makes for an interesting combination play, once this market shake-up plays out. Do we expect this to be a hot topic this earnings season? With roughly 40% of revenues from the S&P 500 companies coming from outside the U.S., the answer is a definite and resounding "yes."
The IMF warned yesterday that the Eurozone could slip back into a recession, with low levels of inflation potentially turning into deflation that would have a material impact on global growth. IMF chief economist Olivier Blanchard stated that he believed investors had taken on too much risk:
''The long period of low interest rates has led to some search for yield, and financial markets may be too complacent about the future ... Macro prudential tools are the right instruments, but one has to worry that they may not be up to the task.''
Years of financial repression have forced investors to load up on investments that they probably should have avoided, given the risks and their risk tolerance. Investors are unlikely to be able to protect themselves adequately.
One is reminded of the great economist Hyman Minsky's warning that stability breeds instability, and with the levels of global debt already at epic proportions, while economies (and the ability to repay those debts) stutter, sage investors look to reduce rather than increase risk.
A recent report from the International Center for Monetary and Banking Studies pointed out that excluding the leverage of financial companies worldwide, debt is now about 212% of global GDP, an increase of 38% since 2008. Meanwhile, the six-year moving average of the world's potential growth rate is currently below 3% vs. around 4.5% prior to the financial crisis.
That brings us to the earnings front. Light-emitting diode company Cree (CREE) cut its outlooks, which sent its shares tumbling more than 18% last week. Fast food company Yum! Brands (YUM) cut its outlook due to weak China sales, while Sodastream (SODA) and Christopher & Banks (CBK) had also done similar things. The earnings reports we've received thus far have been less than encouraging. We'll be getting a lot more in the coming days, once aluminum company Alcoa (AA) officially kicks off the September-quarter earnings season later today. Consensus estimates collected by Thomson Financial have Alcoa delivering earnings of $0.22 per share on revenue of $5.84 billion for the quarter. Be sure to check back in with Columnist Conversation after the close, as your Real Money Pro team does the deep dive on those results.
On a brighter note Kraft Foods (KRFT) has just announced it is raising its quarterly dividend by almost 5% to $0.55 per share from $0.525 per share, and Costco (COST) has reported a 13% increase in profits, coming from improvement in same-store sales and more revenue from membership fees. Versace points out that the high-five to Costco looks to be consistent with our theme of the cash-strapped consumer, which may translate into more shopping at Costco, The TJX Companies (TJX), Ross Stores (ROST), and less at premium stores.
Last week's employment report wasn't quite as jolly as the headlines would indicate. The unemployment rate dropped below 6%, but the labor force participation rate is at its lowest level since 1978. Wages were flat month-over-month and up only 2% year-over-year, missing expectations. The typical American household makes less now than it had made 15 years ago, something we haven't seen since the Great Depression.
With weak household income still in the doldrums, we are not surprised to see that according to FactSet, the Consumer Discretionary sector is expected to report a year-over-year decline in earnings. Wall Street is starting to feel the pain that had never really ended on Main Street.