Little League Home Run
We all remember that kid. Hit the ball and never stop running. Like magic, that kid would force the players on the field to panic. That they did. Overthrows at every base. Dropped balls. You name it.
Official score card? This is little league. That's a home run. Even on a ball that never reached the mound. The Walt Disney Company (DIS) comes to mind as a kid that does not stop running, especially with this very successful Avengers movie... but there are plenty of names. Plenty of runners.
Equities were hot again last week. The S&P 500 scored an increase of 1.2%, the Nasdaq Composite, with its tech-heavy composition.. nearly 2%. Forget the Dow Jones Industrial Average. Over time, that one will correlate closely to the S&P 500, but due to it's narrow focus, the blue-chips will not always perform with the general market in the short-term. We have known since early in the reporting season that public corporations were beating expectations. It is at this point, coming off of a very heavy week of results and heading into an even heavier week, that we pause and take another look.
A rough 46% of the S&P 500 has gone to the tape. I mentioned a few days ago that at FactSet, the blended rate of results and expectations for aggregate earnings growth had improved from -4.7% prior to seeing those numbers from the big banks to -3.9% last week, to now -2.3%.
Just a few days ago in this column, we wondered if the S&P 500 will post a broad increase, avoiding the prospect of an earnings recession altogether. That prospect now seems unlikely, as even if the first-quarter growth does not stay below zero, projections for the second quarter are barely negative. Even a below-average beat rate would push the second quarter into overt growth, and you do need two successive quarters in order to call this clam bake a dance. Now, as corporate execution has been far better than expected, so has economic performance. Let's take the time to understand that.
How nice. In fact, a perfect world don't you think? There are realities here that pushed the headline growth rate for the first quarter to 3.2% (q/q SAAR). Many "knowledgeable" folks are placing the credit for this hot number at the headline level at the feet of simple inventory building ahead of what was expected to be a tougher environment for international trade.
There is truth to that, but the reality is far more complex than a simple soundbite spewing from certain talking heads in the seconds after those numbers had been released. Trust not academic economists, who, in my opinion, make no provision whatsoever for human response to broadly created conditions of both surplus and scarcity, though one might think that their job.
Many are downplaying this headline print due to the slower pace of participation by the U.S. consumer. I think maybe we hold off on that thinking for just a bit. It is true that expectations for higher tariffs pulled forward the building of inventories. Inventories added a rough 0.65% to the number.
A far greater positive impact was the result of the rapidly decreasing trade gap. That, too, may just be inventory building by foreign accounts for the very same reason. So, on a simplistic level, the judgement made by many economists would be accurate. My problem is with those who assume this is cause for significantly slower growth moving forward. I am not trying to say that these economists are definitely mistaken. I just don't like to assume. Please follow.
Now, just supposing that personal consumption, which scored low for the first quarter at 1.2% growth, were to rebound. It makes perfect sense to me that the typical consumer may have tried to ration spending after the fourth quarter 2018 market swoon that came packaged with much talk of an economic recession.
This is a "jobs week." Should employment, wage growth and participation all remain above trend, which is likely, coupled with a probably more-positive response to a very strong quarter in the financial markets as opposed to a very weak one, does it not stand that the consumer, especially as weather improves, would in fact find more motivation to spend on an aggregate level?
Now, factor in those inventories. Think about this. There is a strong likelihood, in my opinion, that the domestic economy is setting up an environment that will combine the just-mentioned pent-up consumer demand, with a motivated supply side.
This, along with all economic theory, boils down to the sustainability of the velocity of money. It sounds so simple. That's because it really is.
Now you have an economy growing well above both expectations and trend. The environment that created that growth was unique, and is not capable of self replication. But this environment has created a completely different environment still very capable of resulting in above-trend growth.
The housing market plays a significant role in this. While several of the data series that we use to measure the housing market have appeared problematic, keep your eyes on New Home Sales. It is not just beating expectations, but has been growing since October -- with just one hiccup. All home purchases result in multiples of ancillary purchases, but New Home Sales also provide employment for skilled laborers. March New Home Sales were the hottest seen since late 2017. Keep your eye on the ball.
It is not just "jobs week" for the super nerd that lives inside each and everyone of us, this is also "Fed week." So, does this hotter-than-expected domestic economic performance result in the FOMC having to yet again reverse course? That would injure not only second-quarter performance, but also performance across financial markets.
The truth is that the Fed can't even think about a rate hike in the near future. One obvious reason would be the internals that we have just discussed. The only way to successfully navigate the short-to-medium-term future would be to allow the set-up that we just explained to develop in full.
Consumer level inflation would be another reason to stand pat. While the Bureau of Economic Analysis will play catch up this morning (Monday) as far as monthly data for Personal Income, Outlays and inflation are concerned, that same agency released its quarterly PCE data with the GDP data on Friday. Those numbers printed so far below expectation both at the headline and core levels as to be shocking. If those numbers are confirmed by today's monthly prints, though I might believe them mistaken (especially at the headline -- fuel prices!), the numbers would certainly cement the Fed in place from a policy perspective.
Understand this, as well. Should the data not support the idea of a late Q1 or early Q2 pop in headline inflation, the idea of a reduction in the Fed Funds rate will again gather attention. Although I might personally find such talk inappropriate at this time, if I end up being wrong about a developing environment that marries increased demand to a motivated sell side, then what passes for headline growth in three months will force their hand.
Two housekeeping items. One. The Atlanta Fed id expected to release the GDPNow model's initial snapshot for the second quarter at some point on Monday (today). The Atlanta Fed has been far more accurate in my opinion, in projecting headline GDP than has been their New York counterpart. Fed Funds Futures markets in Chicago are currently pricing in a 98% probability that the FOMC stands pat this week. However, the probabilities of a rate cut by the December 11 meeting has increased to 66%, with a 24% chance that there would be multiple cuts by then. Those numbers certainly catch my attention. They'll catch your portfolio manager's attention too.. and he or she will pay higher multiples for equities.
Weakness in Europe has resulted in a softer euro that, in turn, results in a stronger dollar. Small-caps will garner a higher percentage of investment flows in a stronger dollar environment due to the fact that there is no impact on earnings due to exchange rates. Even with yields contracting somewhat across the entire curve, the spread between the 2-year and the 10-year U.S. Treasuries has expanded very slightly. Now at more than 20 basis points.
Should the 3-month/10-year also show a little life, this would show up in improved net interest margins for smaller to mid-size banks, who likely depend on traditional banking more so as a revenue provider than might the large-cap banks that can also lean on investment banking, and trading (not lately) as viable businesses.
Remember that the financial sector remains the most heavily weighted sector in the Russell 2000, and keep in mind that stronger dollar environment. For those reasons, though the Russell 2000 has performed in line with the S&P 500 year to date, it has not come close over a 12-month period. Remember 39% of all S&P 500 revenue comes from abroad.
My thought? Maintain exposure to the small-caps, including the less-than-large-cap financial space.
Economics (All Times Eastern)
08:30 - Personal Income (Mar): Expecting 0.4% m/m, Last 0.2% m/m.
08:30 - Consumer Spending (Feb): Expecting 0.7% m/m, Last 0.1% m/m.
08:30 - Consumer Spending (Mar): TBD
08:30 - PCE Price Index (Feb): Expecting 1.4% y/y, Last 1.4% y/y.
08:30 - PCE Price Index (Mar): TBD
08:30 - Core PCE Price Index (Feb): Expecting 1.8% y/y, Last 1.8% y/y.
08:30 - Core PCE Price Index (Mar): TBD
10:30 - Dallas Fed Manufacturing Index (Apr): Expecting -3, Last 8.3.