The Zero-Dark Hours
They sleep. All of them. A quiet planet passes in front of the now blank office window. Two small bulbs burn distinct on the face of the building across the street. Otherwise nothing. No animals. No humans. No sound. Tuesday beckons. Can you hear that? I know you can.
As ancient as is love and hate... as ancient as is the human race itself, is the need to provide for those in one's care. Rise earlier than most ever could. Figure "it" out. What "it" is, can sometimes be the most difficult obstacle of all. Will there be trade headlines this day? Will it be the central banks that take the stage, or will the global fiscal situation just push until it can push no more, and the end of the game arrives to the utter shock of all who will pretend to have never seen it coming. Perhaps earnings will matter. Sometimes they do. Sometimes they don't. Surely, as profitably running a business is the goal of every corporation, they should.
So, let's follow the tracks, and try to make out where they lead. This will not be easy. For those that have tracked either beast or man in wilderness environments, they know... know just how hard it is to actually "see" what one needs to see, while not becoming "lost" oneself. Well, that was before the invention of GPS anyway. Personal drivel aside, let's rise above all that forces its way onto our path. Even with markets close enough to all time highs, one must always understand in order to identify, and then identify in order to adapt. You know the rest. You will not overcome unless you can adapt.
On Monday night, Treasury Secretary Steven Mnuchin confirmed that trade talks with China are indeed on for October and that China had already committed to large purchases of agriculture. China appeared to back this up by waiving tariffs for Chinese companies looking to purchase U.S. soybeans, as news had already broken that these companies had purchased 10 boatloads of the world's now most famous crop.
Victory is yours, but none of it happens without the effort. Intellectual laziness is simply the sanctuary of the frightened, led there by the wicked. You and I will never take this day, or any day. Dig, and when you're done...dig some more. Show up. Be honest. Do your best.
What Do We Know?
Well, we think we know, according to FactSet, that the U.S. is already in an earnings recession, having posted slightly negative earnings growth for the S&P 500 for both Q1 and Q2. Earnings growth for Q3 is now estimated at -3.8%, which would be a more significant contraction than the pedestrian declines realized over the first half of the year. Interestingly, now that Q2 earnings are history, the breakdown by geographic exposure is even more startling than I had expressed in a similar piece that I wrote for you ahead of last earnings season.
As non-domestic revenue exposure for the S&P 500 in aggregate has now declined to just 38% (I think we started around 45%), earnings growth across S&P 500 constituent corporations could not be more stark. At a headline level, Q2 earnings growth printed at -0.4% y/y. However, when divided into two categories those generating more than 50% of revenue domestically versus those generating more than 50% of revenue outside of the U.S.... domestically focused firms experienced earnings growth of +5.3%, while globally focused firms saw earnings growth of -11.2%. No joke. Trade? Dollar exchange rates? Yes.
This staggered performance has the S&P 500 now trading at 17 times forward looking earnings. 17 flat. Crazy? Not really. The five year average is 16.6 times. The 10 year average is far lower, down in the 14's, but that includes the "Great Financial Crisis" and it's aftermath, so in my opinion, no more useful than anything else as a guide for valuation. As a matter of fact, I am not sure how useful any historic information is as a tool for measuring comparative quality. Monetary and fiscal policies have left each successive generation with a far different environment to engage with than many would like to admit. Perhaps, valuation comparisons can only be made horizontally, and never vertically. Understand? Compare one sector versus another. Compare similar companies operating in similar environments. Comparing performance across decades becomes as useful as comparing my childhood versus that of my children. A lot has changed. My children must adapt, as do I.
Sticking with the data released by FactSet, though expectations for Q3 are quite contractionary in nature, eight of 11 sectors are expected to beat the aggregate. Earnings expectations for the Materials, Technology, and Energy sectors have been revised far lower by Wall Street over the last three months or so. In fact, estimates for all 11 sectors have been revised lower to some degree. Leadership is expected to come from the bond proxies again. As one might expect, given recent performance, as well as the geographic breakdown over the past quarter. Revenue generation is expected to be the most challenged among the Tech, Financial, Energy, and Materials sectors, or in other words, those sectors either most reliant upon global trade, and/or a healthy yield curve.
For those that will measure sector valuations versus individual five year averages, Communication Services appears to be the most overvalued, with Utilities not far behind (Dividends? Defensive?). Then Tech, and Consumer Discretionary. The most undervalued sectors by this metric would seem to be Energy by 10 miles, then Health Care (political football), and the Financials (perennial undervaluation champion?)
Keeping in mind (because it is important), that price discovery is now a function of speed across many points of sale in response to headline news, more so than buyers and sellers seeking each other out at centralized point of sale, trade news becomes the short to medium term driver. This impact is then placed into an environment defined by policy (monetary, fiscal, and regulatory) and risk (natural, civil, geopolitical). The result is defined as performance.
The lack of accurate predictability across all of these metrics is why a certain level of diversification is always necessary. Not just diversity in sector exposure, but across asset allocation to include both cash and the physical as well. My thoughts? Tinker with exposures, based on personal expectations, while never turning a blind eye that the impossible is possible. In other words, be ready for a fight every day.
As I wrote last week, I was fine with the FOMC decision to reduce the target for the Fed Funds Rate to a range spanning 1.75% to 2%. I also indicated that my skew would have been toward further reduction as I felt St. Louis Fed Pres. James Bullard was closer to the mark than either Kansas City's Esther George or Boston's Eric Rosengren. My thoughts here are plain. We all see housing data coming back nicely. We all see manufacturing surveys, perhaps pulling back from the brink. We know that demand for labor has remained strong, Though the Atlanta Fed's real-time snapshot for Q3 GDP (as well as the expectations of others) stands at 1.9% q/q annualized, this is not really about economic data, I have long stressed yield curve repair as a priority.
Too many blame international conditions for trade for a reduced pace of CapEx. No doubt, this is key, and the yield curve is a reflection of slower economic growth, and aggressive monetary policy abroad. The fact is though, that despite a positive spread for the 2 year/10 year spread (barely), the far more important to focus on 3 month/10 year spread has remained negative to essentially flat since May.
For now, James Bullard stands alone. It's a good thing that trade negotiations with China, and the next ECB policy meeting all happen ahead of the next FOMC policy meeting. By then, I believe that this economy could either be moving forward in a better environment, or looking to Bullard for leadership.
Did You Happen To See....
That Lockheed Martin (LMT) was awarded a contract by NASA worth a potential $4.6 billion to build at least six Orion, and as many as 12 deep space exploration spacecraft. My target price is now $420.
That Microsoft (MSFT) introduced the Dynamics 365 Commerce and Dynamics 265 Connected Store. This is being seen as an enhanced cloud computing effort to pull in cloud business, in particular the business of retailers away from Amazon (AMZN) . My target price is $160.
That Apple (AAPL) has scrapped plans to move production of Mac Pro high-end desk top computers to China, and will instead continue to build the machines in Texas. Apple has reiterated it's pledge to invest $350 billion in the U.S. by 2023. My target price is $240.
That on Monday, SunTrust analyst William Stein reaffirmed his buy rating for Nvidia (NVDA) , while mentioning improved demand trend across gaming, pro-visualization, automotive, and the data center. My target price is $208.
Economics (All Times Eastern)
08:55 - Redbook (Weekly): Last 5.4% y/y.
09:00 - Case-Shiller HPI (July): Expecting 2.2% y/y, Last 2.1% y/y.
09:00 - FHFA HPI (July): Expecting 0.3% m/m, Last 0.2% m/m.
10:00 - Richmond Fed Manufacturing Index (Sep): Expecting -3, Last 1.
10:00 - Consumer Confidence (Sep): Expecting 134.0, Last 135.1.
16:30 - API Oil Inventories (Weekly): Last +592K.
The Fed (All Times Eastern)
There are no public events scheduled for today.
Today's Earnings Highlights (Consensus EPS Expectations)