Rich Firm, Poor Firm
Easier said than done. Investors sit amidst the busiest weeks of earnings season, and a better than expected season it is to this point. Right here, right now... 77% of the 44% of the S&P 500 that has already reported have beaten estimates for earnings, while 61% have topped revenue expectations. We learn from FactSet that as of now, earnings growth for the quarter is running at blended rate of -2.6%. (A blended rate incorporates results reported with estimates for firms yet to step to the plate.) This performance comes after accounting for revenue growth running at a blended rate of +4.0%. What this confirms for us is that there is indeed something of a margin squeeze going on. That itself was somewhat expected in the era of slowing global growth that has been exacerbated by the trade war between the U.S. and China, as well as the various other conflicts around the globe concerning trade. Just how much does this global slowdown impact large cap corporate performance? You better sit down.
Still from the FactSet report, when these blended rates are divided between those firms that generate more than half of the revenue within U.S. borders, and those that generate more than half elsewhere, the story is one of rich and poor. More U.S. focused firms are now skipping along at earnings growth of +3.2%, on revenue growth of +6.4%. I kid you not. Hold onto your socks. Firms more focused internationally, are now bottom dwelling at earnings growth of -13.6% on revenue growth of -2.4%. Downright ugly. Setting up small caps for better performance? Maybe. Let's dig in.
The Week That Was
GDP On Friday, the Bureau of Economic Analysis reported quarter over quarter, annualized and then seasonally adjusted U.S. domestic economic growth of 2.1%, beating most projections. Not bad, if this is the "bad quarter", right? The consumer was a star, as personal consumption expenditures ran 4.3%. Things will just be swell if consumers can keep that up. Can they? I never say never, but wage growth has been running at 3.1%. Revolving credit, or credit card usage ran 8.2% in May (our most recent), bringing total consumer credit to year over year growth of 5% at that time. Hmm. So, consumers were spending considerably more, and borrowing at much higher interest rates than they can produce with their savings to do so. Hmmm... Got it? Ever eat soup with a fork? It still tastes okay. You'll probably need to eat again though. Very Soon.
ECB Mario Draghi on the way out, Christine Lagarde on the way in. Dovish signalling. What does it all mean? We know that the European economy remains 28% reliant upon exports. We know that despite years of low and then negative benchmark interest rates, and also quantitative easing, that not only growth, but desired levels of consumer level inflation remain elusive.
Understand this. Pushing the already negative discount rate further in that direction is not stimulative. One might think that quite obvious by now, and a continental inability to produce any kind of net interest margin has threatened the entire European banking industry. So, what's this really about, if negative rates in all honesty produce risk aversion (que understandable) instead of risk taking? Will the launch of a new QE program stimulate the economy? Not if the purchasing is done according to current EU law/policy requiring proportionate purchases according to the size of the economy/participation. There is a chance that better off countries look at disproportionate purchases as a version of wealth distribution that constituents could rail against, leaving equity purchases as an option.
One must be cognizant that this would support European equity markets, and even more importantly offer yield starved European investors an option for now, understanding that the Bank of Japan long ago went this route. Years later, the BOJ is left with ownership of 75% of the country's entire ETF market, and is now a top 10 shareholder in 40% of Japan's listed companies. You think the BOJ can ever turn seller? Unlike debt securities where holding to maturity is an option, an artificial condition of equity scarcity has been created by the central bank. Price discovery as an assessment of risk over time? Yeah. The real aim of the ECB in my opinion if that route is traveled would simply be this. Bloating the monetary base by any means possible in a desperate attempt to devalue the currency. In other words, sacrifice longer-term cross-border capital investment of tomorrow for a short-term advantage in trade today. Not pretty, and probably not the answer. Then again, Lagarde is a politician, and politicians do not play the long game.
U.S./China Trade This Tuesday and Wednesday, U.S. Trade Representative Robert Lighthizer and Treasury Secretary Steven Mnuchin will meet in Shanghai with a Chinese delegation led by that nation's Vice Premier, Liu He. Perhaps the best that might be said about this summit of leadership just below the head of state level might be that expectations are certainly not very exaggerated. Not a soul expects a significant breakthrough as both side have been playing the kind of games once seen when dealing with a different adversary in a different era... the Cold War.
Best case? For now, I think perhaps the U.S. settles for large purchases of U.S. agriculture in exchange for a relaxed public stance by the U.S. in terms of allowing Chinese telecom giant Huawei to trade with U.S. suppliers. Nobody thinks that either side changes positions as far as key issues such as protection of intellectual property is concerned as there is not even agreement that this kind of infringement of corporate and sovereign rights even occurs. Look for China to pressure the U.S. to perhaps back away from planned arms sales to the autonomous island of Taiwan.
My thought is that a more positive outcome in Shanghai is less than priced in and would create upside risk for much of the S&P 500. See the first section for proof if you don't trust your old pal. A lack of success in Shanghai certainly might create a negative algorithmic knee-jerk, but is for the most part expected by markets. Just my opinion.
The Fed Markets have already priced in a 25 basis point reduction to the Fed Funds Rate. This first step toward correcting errors made by the central bank in late 2018 needs to be understood for what it is. Not necessarily stimulative, nor even an insurance cut. That understanding of what is at stake here is simply undeveloped to put it as nicely as I can. On Monday morning the U.S. three month T-bill pays six basis points more than the 10 year note. Those that do not see this as an unnatural condition that can not be normalized, can not be helped, for they are lost.
It must be understood that negative yields abroad bring foreign investment into the U.S. long end, and that U.S. dollars are in demand when this happens. You kids that think the U.S. lives in a box still with me? This is why reducing short-term U.S. rates is a technical necessity. More than a defense mechanism in the event that the global trade condition worsens, this sets the U.S. up to fight the financial war (that we are already in... wake up, gang) on two fronts. To fight the obvious coming of a currency war that the ECB is being quite honest about, and to engineer a healthier condition for credit that does not cause purchasing managers to question future growth.
The real threat here would be if the Fed were fooled by domestic economic data that remains better than bad, from properly preparing for a very uncertain future. Once the horses have left the barn, they are gone. Anyone claiming to be data-dependent is telling you that they have absolutely no basic level of cognizance whereas the threats to our well-being are concerned. Multiple hot readings on inflation should be the only factor that would in my opinion sway the central banks from making earnest attempt at correcting the yield curve, and preparing to defend the currency.
Macro Jobs Week. Always key. Yet, this week, maybe less so than other months. Why? You mean besides China, and the Fed? That's just it. Before we get to Non-Farm Payrolls, Participation, and Wage Growth (Now, the three most important components of any BLS monthly jobs report), we'll have to tackle the FOMC policy decision, and before tackle said decision, on Tuesday, investors (and the Fed) will peruse data on Consumer Spending and Personal Income (June), as well both headline and core PCE (inflation), reported by the Bureau of Economic Analysis. That's what is most key here. On both levels, consensus is for 1.7% year over year growth. Not threatening at all, but off of the lows.
For comparison's sake, headline CPI for June, reported by the Bureau of Labor Statistics already showed inflation of 2.1%, so there is cause for concern. For one, because a consumer that is already partially supporting economic growth through greater exposure to credit at interest rates higher than what can be generated in relative terms would struggle mightily if the central bank were forced to combat inflation, not to mention that this central bank would be left defenseless versus the stated intent of enemy central bankers.
The incredible, soaring shares of Beyond Meat (BYND) will face the music late on Monday. Is that good or bad? Do you think those long these shares are comfortable? How bout those short? I don't think anyone committed to going into this evening with a position can possibly do so with any degree of certainty. The S&P 500 had a good week last week, closing up 1.6%. BYND ran 33% last week. Last week!
At a current market cap of $14.12 billion, Beyond Meat is now worth more that the entire addressable market for plant based meat substitute products. According to Timothy Collins at Real Money Pro, the highest of estimates place that entire market at $13 billion. Short interest is high in this name as well. As of two weeks ago, the most recent data available, out of a float of 38.21 million shares, 5.46 million were held in short positions, or 14.3%. For those who don't really play the short game, 7% to 8% is where I usually consider the short position dangerously high. Then again, perhaps last week's run was little more than a panic driven short squeeze ahead of earnings, leaving that aggregate position drastically altered.
On the positive side, BYND has shown triple digit revenue growth for seven consecutive quarters. The industry is looking for EPS of -$0.08 this afternoon on revenue of $52.71 million. That number would be good for year over year growth greater than 300%. The firm is expected to be full year profitable by 2020. As of the most recent data I have, only 6% of available shares are owned by funds, so while yes, the shares are indeed grossly over-valued... there is plenty of room for increased institutional participation. Full year 2019 revenue is expected to post at $242 million, and full year 2020 at $388 million, so no end to the current rate of growth is being anticipated by the community of analysts.
The deal is this, as far as I am thinking. Should Friday have been the top for now (doubtful), and there be a round of profit taking in response to these earnings, though charting a name like this is difficult due to the lack of two way traffic as well as the short window visible since the IPO, support might be found a long way from the last sale. Where? A 38.2% retracement would be the $165 level, kinder than the 50 day SMA, found at $143. Conversely, an acute short squeeze could result in a moon-shot. For example, at Friday's closing prices, getting long just one $235 straddle (long one call options contract and long one put options contract with the same strike price and the same expiration date.) expiring this Friday (Aug 2nd) would have cost the trader $44.72. or $4,472. This means that by Friday, the share price would have to move up to $279.72, or down to $190.28 for that trader just to break even. That's a tough risk/reward proposition where I'm from.
My thought? let it go for now, if already flat. The market reaction to this evening's release will be playable. Smells like a sell to me, but even I am not that brave, or is it foolish?
Economics (All Times Eastern)
10:30 - Dallas Fed Manufacturing Index (July): Expecting -4.2, Last -12.1.
The Fed (All Times Eastern)
Today's Earnings Highlights (Consensus EPS Expectations)