Hot or Not? Equity markets were ripe if that is the right word, for a selloff. Who could blame traders and investors on a Friday afternoon if they took just a little bit more off of the table going into the weekend. Equity market have enjoyed a "melt-up" atmosphere, at least across the large cap arena. Oh, there was some flesh taken this past Friday, but far less than a pound, so to speak. Two little things stuck out for me that perhaps disqualify Friday's selloff as meaningful.
First, trading volume was noticeably lighter on Friday for constituent member stocks of both the S&P 500 and Nasdaq Composite than it had been for "up" days last week. Secondly, as trading volume increased over the final half hour of the day (as it always does), there was an undeniable increase in appetite for risk. In other words, just an opinion here, professional traders in many cases added back a portion of what they had taken profits on earlier in the session. They had used a weaker than expected December employment report and expected resistance at Dow 29,000 to extract a measure of capital from the marketplace in front of earnings season, in front of the arrival of the delegation from Beijing in Washington this week, expected to place signatures on the much ballyhooed Phase One trade agreement.
The Week Ahead
Even with a bit of a pop late last week, the CBOE's equity-centric put/call ratio remains well below (0.52) its running 50 day simple moving average (0.56), even if the CBOE's index-centric put-call ratio suddenly runs a little hot (1.39 vs. 50 day SMA of 1.29).
As investors traverse what comes, many have reached the point where they feel that a Phase One deal is mostly "priced in", leaving just headline risk regarding further negotiation covering far nastier, far more important issues.
What may arise going forward as each side stands their ground on the protection of intellectual property, forced joint ventures, and limitations to market entry, is that the threat of a modern cold war-like... era between global super powers could either diminish or increase from here. Not today's problem.
In addition to U.S./China relations, there remains the underlying threat that an impeachment trial in the U.S. Senate could pose to what has been the most business-friendly administration of any our lifetimes... should those articles ever actually be delivered. The president is not expected to end up leaving his post as a result of such a trial, but political damage is a two way street. A very tricky two way street. That brings us to the launch of fourth quarter earnings season that will focus on both large cap banks as well as a few transports, and the underlying macro-economic conditions that supports everything discussed.
While nary a soul calls for economic contraction, the optimism I would say is decidedly cautious at current equity and for that matter, debt security valuations. Is the "What could go wrong list" shaded toward a potential risk off move more so than a mere continuation of this nearly vertical move? Q4 GDP expectations (currently running at 2.3%, according to the Atlanta Fed) will change this week as data on retail sales, industrial production, inventories and housing starts hit the tape.
Do corporations even need them? Coming from a balance sheet based background, I would like to think so. (Though trimesters probably makes far more sense than quarters, but who am I?) The fact of the matter is that stocks did not need earnings growth in 2019, not even a little. Earnings growth for the S&P 500 is now expected in aggregate to post at -2.0% for the fourth quarter, according to FactSet. This is down from an estimate of -1.5% just last week, and interestingly has been ratcheted lower even as projected revenue growth for the S&P 500 has remained unchanged over the past week at +2.6%.
You are hearing talk of an "earnings recession" this morning in the financial media. Just talk, my friends. Our marketplace has already been mired in an earnings recession for quite some time. Should these fourth quarter earnings actually print in contraction on an annual basis, this will be the fourth consecutive quarter of declines from the comparable quarter one year ago. The result for our marketplace, still using data provided by FactSet, is an S&P 500 now priced at 18.4 times next 12 months' projected earnings. In answer to your next question, the five year average for valuation multiples measured in this way, runs at a mere 16.7 times. Why the reduction in expected margin on constant sales? As certain industrial-use type commodity prices have started to run higher with equities (even as dollar valuations have turned back toward mean), and as labor costs rise, a result such as this is not very tough to figure. Even as investors expect to see year over year net margin expansion across the Financial, Utilities, and Materials sectors, margin is projected to have contracted across the other eight sectors, with both the Energy and Consumer Discretionary sectors showing dramatically downsized net profit margin. I am guessing that this will not really surprise most of you.
As many large cap banks prepare to go to the tape this week, many investors have become used to saying that maybe this is the year of the bank, as the group had regularly struggled in terms of equity performance for the better part of a decade. The fact is that the Financial sector has been the third best performing sector over the past 12 months, and that's really more or less in line with the group's performance over a five year time frame.
Yet, Financial stocks remain undervalued relative to most other S&P sector groupings in terms of forward looking multiples. This sector trades at just 13.4 times versus a five year average of 12.9 times. While only the Energy sector trades at a discount to its own historical averages, the Financial and Health Care sectors are the only other two that appear to still be within "hailing distance" of such historical measures.
The fact is that no matter what the banks do in order to make money, and they do make money, that valuation assigned to the group remains reliant upon net interest margin. While a fee based regimen for consumer-type clients appears to have thrived, and investment banking has been strong, this group has had to lean on returning capital to shareholders in order to pace above these historical metrics. As corporate loan growth might possibly be less reliable going forward, it is the Fed's balance sheet expansion program that could actually provide continuing cover for the group.
Surface level thinkers will tell you this week that the Fed keeping interest rates low is not a positive for the banks. Au contraire... The Fed anchoring short-term rates in place through the targeting of T-Bills and not longer term debt is what makes this program distinct from quantitative easing, and the difference is quite stark. Allowing the long end of the curve to dangle in the winds of free market pricing prevents the suppression of economic growth shall it arise organically. This condition will also allow for consumer level inflation dependent upon that growth. From an economics perspective, the table has been set, for growth, and for inflation. From the perspective of the banks, this means that the central bank is at least not preventing the expansion of net interest margin growth. Citigroup (C) , JP Morgan (JPM) , and Wells Fargo (WFC) bat lead-off on Tuesday morning.
This does not mean that we see these conditions develop in earnest. This simply means that the central bank has allowed for these conditions to develop, where as past Feds, either through error or ignorance, have suppressed growth, inflation, and potential for net interest margin. Those Feds through targeting the long end of the curve, never understood the negative consequence of suppressing the long end of the Treasury curve far beyond the tail end of the financial crisis. This Fed, however, learned the hard way through the policy error in 2018 of allowing the short end of that yield curve to rise too quickly. They had slowed economic activity. Manufacturing has still not recovered. The difference is that this group does appear to have learned to safeguard the yield curve. In the end, this is what must be protected for the sake of economic well-being... for all.
Confused? You probably should be. Non-Farm Payrolls for December printed at a somewhat disappointing 145K for the month, with small downward revisions made to both October and November. What is probably more alarming than the headline number for job creation was that the pace of average hourly wage growth slowed to 2.9% from 3.1% year over year. Seasonal help hired at the very low end of the pay scale? Okay, that makes some sense.
Now, take that to the next step. Average weekly hours hit the tape at 34.3 hours for a second straight month, and for the third time in six month. It's not time to panic, most certainly not, but with 61% of the civilian population working, and only 3.5% of the labor force out of work, one must consider that there is less room left for significant growth on the demand side of the labor market. If demand does not slow at this point, there will (already) be a need to rapidly expand the supply side of this market through some kind of legal immigration. Another warning side might be the growth of 41K jobs tied to the retail industry, versus some of the sloppy performance turned in last week across many brick and mortar retailers for the holiday season. Does this suggest that these numbers worsen through January and December? Certainly, this condition might. If it exists. If it exists, Sarge?
Hear me out. As most of you likely know, the Non-Farm Payrolls number, wage data, and breakdowns by industry are drawn from one of two monthly surveys taken by the Bureau of Labor Statistics. That's Table B, the Establishment survey. They ask employers, and this is what they said. The Unemployment Rate, The Participation Rate, The Employment to Population Ratio, and demographic breakdowns come from Table A, the Household,Survey. They ask the folks (I have never been asked, You?). Well in the December Household survey, 267K more individuals reported themselves as "employed", with labor force expansion of just 209K ... despite employers having reported job creation on Table B of just the already mentioned 145K.
This kind of discrepancy between the two surveys is not all uncommon. Numbers that just do not jive will present several times every year. My question is this in an era where artificial intelligence aimed at marketing the consumer picks up on your every nuance. In this era of profound increase in machine learning, how is it possible that the methods used to measure some of the most important macro-economic data points that ultimately direct national policy be left to such inefficient method? I mean this is serious food for thought. Although I might prefer to live in the past, the numbers that color monetary and government policy probably should not.
Economics (All Times Eastern)
US / China Meet on Trade.
The Fed (All Times Eastern)
10:00 - Speaker: Boston Fed Pres. Eric Rosengren.
12:40 - Speaker: Atlanta Fed Pres. Raphael Bostic.
Today's Earnings Highlights (Consensus EPS Expectations)
Before the Open: (SJR) (.34)