What it's All About
Putting your left foot in and shaking it all about might help. (It will not) The hour is early, and the moving parts are many. That said, let's prepare for the new day, and for the new week. Let us proceed with a mind balanced enough to be fair, yet decisive. Let us proceed with a posture disciplined yet aggressive. Let us love those that we love with vigor renewed, and finally let us attack our own faults in the name of personal vengeance. For this new day is a gift bestowed. It is with a grateful heart that we move out, and with that grateful heart that we shall ever challenge ourselves to be better than we were yesterday. Better than we have ever been before. You'll give me that much, won't you? Let's rock.
What About June Jobs?
U.S. equities for the most part sold off hard on Friday morning, then spent the rest of the day in rally mode, closing down small for the session, but near the top of the daily (weekly, monthly, eternal) charts. I would usually look at a sharp, sustained reversal off of a morning low as quite bullish. The fact that attendance was light among participants, as was trading volume, does lend some doubt to how I would view the day's results. Both of our broader indices stand near points of prior resistance, in the case of the S&P 500, there would be the added potential for the back and forth type action that can often occur at or around levels (3,000) that also happen to be round numbers.
Asian markets, particularly those in China, traded off a bit on Monday morning in response to the robust numbers for June job creation in the U.S. The BLS printed 224K Non-Farm Payrolls for June on Friday, as much of an upside surprise as was the NFP number for May was to the downside. The obstacle for market watchers here would be that this takes off the table for the Fed, a 50 basis point reduction to the Fed Funds Rate at the July 31st policy announcement. While, here at Market Recon, we have never thought a large cut like that to be realistic, it is apparent that at least some global investors had thought differently. A 25 basis point cut is still fully priced in. I would not expect it, but if there is a decision to move ahead with any reduction, it would be common sense to also implement a full stop to the $25 billion per month quantitative tightening program (scheduled to end in September), but who am I to attempt to apply logic to monetary policy?
Mandatory Reading For Fed Watchers
The June jobs report, while returning to above trend job creation, did disappoint in spots. Both, Average Hourly Earnings and Average Weekly Hours (alternative measures of demand for labor) failed to show any improvement from May, where improvement had been expected. One item to remember... the FOMC was already well aware that labor markets had been significantly stronger than the rest of the economy. Central bankers also see the slowdown in business spending, as witnessed through the prism of disappointing results for the most recent data covering Factory orders, Construction Spending, Durable Goods, as well as markedly reduced growth rates across nearly every single manufacturing based survey (either regional or national) that we have access to.
It's as simple as this (really)... an inverted yield curve must be addressed. The overt signal to economists is that short term rates are either too high, or long-term rates are too low. (Easy peasy) With most of the planet in an obvious state of economic decay, there is going to be demand for the long end. This rules out any hope in the short to medium term future for higher long-term rates. Not addressing the curve will result in a stronger relative U.S. dollar (Still with me?). While, yes... the stronger dollar would draw capital investment from abroad, and that is a positive, the result would in the end cripple much of the economy, as 40% (ish) of S&P 500 earnings are reliant upon cross-border commerce. While 50 basis point cuts are not my cup of tea, simply doing nothing and hoping that the yield curve repairs itself, comes very close to "dereliction of duty"... especially when one considers that this most recent inversion is the obvious result of policy error in the first place. By the way, in addition to Fed Chair Jerome Powell's twin testimonies in Washington this week, the Fed will be out in force this Tuesday through Thursday. Great potential for mass messaging.
Morgan Stanley Downgrades Global Stocks
Morgan Stanley analyst Andrew Sheets could not have been more clear. "We think a repeated lesson for stocks over the last 30 years has been that when easier policy collides with weaker growth, the latter usually matters more for returns." The Morgan Stanley piece cites global PMI surveys that have wobbled, the trade conflict between the U.S. and China that continues on unresolved, and the firm's own Business Conditions Index, which suffered it's largest one month decline ever in June.
On TINA (There Is No Alternative), Sheets allows that stocks do historically offer elevated risk premium to bonds, but cautions investors that may be too sanguine from relying on such support. I think, the final paragraph is quite telling regarding Sheets' opinion: "For now, we're putting our money where our mouth is. Following these changes, we are underweight both equities and credit, equal-weight government bonds, and overweight cash. Our most preferred asset class remains emerging market fixed income."
My two cents? I am going to tell you straight out that I do not know what will happen. I have been thinking for quite some time that U.S. equity markets are setting up for either a melt-up, or a severe selloff, or both, but if both.. which one first? I think about this stuff all the time, and that's where I am. What do I do? I look myself in the mirror. I slap myself in the face. I'm not some salaried guy sitting on a mountain throwing lightening bolts. I actually have to figure this out (like many of you), in real time, with no net below if I shall fall.
First and foremost, what has saved me over and over again, all my life? Smarts? No, everybody at this table is smart. Talent? Heck, the algos made talent irrelevant a long time ago. Work Ethic and Discipline? Bingo, cowboy. Rise early... work hard, and remember the rules. Target Prices and Panic Points. Never more than an 8% loss on a position, unless the result of an overnight gap. No excuses. Know the avenues of approach, avenues of escape. Plan.
Change the environment? The Four Horsemen of the Apocalypse ride in on us?... Oh, we are not helpless. We Understand. We Identify. We Adapt. We Overcome. Then We Maintain. How long? All day. How often. No number too high. They ride in on us, and the only apocalypse they find will be their own. Fear, my friends, is but only for the wicked.
The latest update from FactSet has expectations for second quarter S&P 500 earnings running at -2.6%, a second consecutive quarter of declining growth. Revenue expectations are down to growth of 3.6%. Q3 earnings expectations are also negative, while Q3 revenues are also sub 4%. That's a fairly disappointing outlook. Forward looking PE ratios are up to an aggregate 16.9 times for the same S&P 500. Historically, that measures against a five year average of 16.5 times. Overvalued by that metric, but not incredibly so.
Keep in mind that a down season in somewhat priced into equities at this point. As far as sectors go, Information Technology and Materials are both expected to post double-digit reductions to earnings in percentage terms. This was expected for the Tech sector. For Materials, this is largely the result of negative revisions to expectation throughout the spring. This is where the best chance for an earnings surprise will come from, as there seems to be great uncertainty for demand across the space as the world economy sputters. Investors should also be well aware that as far as sectors go, Energy by far trades at the greatest discount in terms of forward looking PE to the sector's five year average. Financials and Health Care are also discounted, but nowhere to the degree that we see for energy. Of all sectors, Discretionary names and Information Technology are trading at the greatest premiums in terms of those same metrics.
What it all means? As we move through the week, Fed speak will matter above all else. Then as we move into earnings season late next week, full year corporate guidance will take the lead as the market's driving force.
I would imagine that by now, you have all seen the Deutsche Bank (DB) news. On Sunday, the German bank did confirm the shuttering of their equities trading business, and the reduction of the bank's bond and interest rates trading operation. Investment banking will take a hit, as a rumored 18,000 job cuts will commence on Monday morning in both London and New York.
For those directly impacted, I will say a prayer for you this morning. (Not kidding) I think of note, perhaps systemically, might be the bank's creation of a "new bad bank" that will be comprised of E74 billion worth of risk-weighted assets. The Financial Times expresses this as equivalent to E288 billion worth of leverage exposure on the balance sheet. As the bank seems to be making an attempt to return to it's European roots. One thing we'll know, probably shortly is just how exposed other institutions might be to fundamental changes at Deutsche. The bank's problems have been well known for many years now. One would think that most U.S. banks are well clear of the back blast area at this point. What will be interesting to watch will be other high profile European banks. Not so much in terms of exposure, but will they follow the example? Would then, a number of "new bad banks" become at that point, systemic risk?
It looks as if Saudi airline Flyadeal cancelled an order to purchase 50 Boeing (BA) 737 max aircraft on Sunday, and will instead move to purchase that many craft from Airbus (EADSY) . This is something that I really am surprised that we have not seen more of. This is something to keep an eye on, as perhaps an isolated incident, or potentially the tip of an iceberg. I would not be in Boeing un-hedged, to say the least.
Economics (All Times Eastern)
15:00 - Consumer Credit (May): Last $17.5B.
Today's Earnings Highlights (Consensus EPS Expectations)
Before the Open: (AZZ) (.67)