Passage
The rolling sound of water passing over a scattering of rocks. A soft breeze lands but a single leaf on the surface. It moves on. Two birds stand at the water's edge. One seems bored, the other very interested. A small school of even smaller fish. They dart here. They dart there, as if with one mind. My shadow they seek to avoid. A shadow made possible by a blue sky containing a huge burning ball of gas. Alive.
Time is, life is as this quiet stream. Eternal. Yet, never exactly the same as before. Identical, only if careful not to notice. Busy? Such a shame. Did you not know that beauty is permanent? What is beautiful? Big smile. This, my friends, only you can know.
The Obvious
It would seem to the casual observer that equities have moved forward with the increase in valuation multiples that we have been speaking of for the last couple of months. The Dow Jones Industrial Average, the S&P 500, and the Nasdaq Composite all stand at the top of their "forever" charts. Though the small-caps (Russell 2000) and the Dow Transports seem to have have had a much tougher go of it, not one equity index among these five is up less than 16% year to date. Sixteen percent. Not too bad for a laggard. Volumes have remained quite pedestrian. Is that fair warning? Or is that just what one might expect for the week ahead of the unofficial start to earnings season?
Where does the trader's mind even start on such a Monday morning? Does the trader focus on the banks, as the season gets under way? Unlike most earnings seasons, the banks will share the spotlight in week one with some big tech, with the railroads. Do traders instead focus on the FANG names as antitrust hearings take center stage in D.C.? Amazon (AMZN) , Facebook (FB) , Alphabet (GOOGL) , and Apple (AAPL) will all send representation, though all of us know that any legislation is still a long way off.
Speaking of Facebook, you did see that late Friday, Federal Trade Commission $5 billion privacy settlement induced price move? Suddenly those shares have moved a rough $5 beyond pivot. Look for potential headline risk ahead of these hearings. About the only FANG name, or FAANG name, not exposed will be Netflix (NFLX) . That firm will go to the tape with their quarterly performance on Wednesday evening.
Speaking of Amazon, Just how big a deal is Prime Day? The biggest e-commerce day of the year? What if it's two days? Monday and Tuesday? No joke, my wife has been asking people what they want for Christmas. The fact that Target (TGT) matched Amazon's efforts with their own two day "Deal Days" event, and that Walmart (WMT) moved ahead with a three-day online sale that began on Sunday has made the early part of this week seem almost festive. All three of these retail heavyweights will react early and probably with some impact as numbers trickle out to the public.
Yet, This
Even with all of the e-commerce hype, even with high profile consumer tech headed to Washington, even with the banks and others going to the tape with quarterly results, the driver for these markets has been the backdrop for monetary policy. What is overt, and cannot be lost on the Europeans, not the Chinese, is that the Fed seems to have turned a corner. They understand that in order to compete on the global stage, the U.S. must do just that. Compete.
What the FOMC can do, and what they seem to be doing, is simple, they are pressuring the short end of the curve. The ECB meets on policy next week. Outgoing honcho Mario Draghi has made clear a willingness to get more aggressive with asset purchases if "necessary." Christine Lagarde has been championed by French President Emmanuel Macron for a reason. How aggressive Draghi / Lagarde get will directly impact both U.S. dollar valuations and where demand for the long end of the U.S. yield curve develops. This is what those complaining about cutting short-term interest rates are failing to understand.
Should the Fed Funds Rate remain unchanged, and the ECB make moves or even boldly infer such policy changes, the dollar would spike in relative terms, thus sabotaging the possibility for the U.S. to maintain a level or (hopefully) advantageous playing field in ongoing trade disputes, particularly with China. We're playing chess here, gang. Don't let anyone talk you into playing checkers. Commerce Secretary Wilbur Ross has recently indicated that licenses would be issued for U.S. suppliers to resume shipments to Huawei in cases where there is no threat to national security. Reuters ran a story overnight inferring that such a move could be three to four weeks out. Who benefits here? Think semiconductors. Think Intel (INTC) , think Qualcomm (QCOM) , think Micron Technology (MU) .
Never forget, we are in a fight with people pursuing their own interests. Perfectly understandable. So, then, should be our response. If the Fed signalling a rate cut in July, and allowing expectations to persist for expanded easing moving forward, also defends the dollar (against strengthening), while also seemingly putting the central bank in the position of having the market's back, then right or wrong, this is the environment provided... the environment that you and I must excel in.
Bear in mind that all of those who have doubted this rally, this expansion in multiples to this point may or may not be correct from a textbook point of view. That matters little in the real world. Everyone of them has missed the forest for the trees.
Anyone else wonder where demand shows up for the U.S. 10 year if the Europeans take that German 10 year further down the rabbit hole? What if 10-year German paper trades at -0.5%, or -0.75%? That would just mangle the U.S. yield curve if not defended. See what I'm saying, gang?
The Macro
While Tuesday will be the most important day of the week for the U.S. economy, bringing with it June data for Retail Sales, and Industrial Production, and while a bevy of Fed speakers will be dragged in and out of our lives in order to reinforce FOMC messaging, the real data may have printed over the weekend.
First, China printed weaker export data, and then on Sunday night, economic growth of 6.2% showed the Chinese economy growing at its slowest pace in 27 years. However, June data for Retail Sales, Industrial Production and Fixed Asset Investment all beat expectations. My take on that? The trade war has clearly had a dampening impact on an already slowing economy.
That said, perhaps the Chinese economy has found a bottom in this environment. What could change the environment dramatically? The Trump administration moving ahead and implementing tariffs on the remaining $300 billion worth of Chinese exports to the U.S.
Clearly, as the U.S. attempts to skirt around the Huawei issue, there has been a renewed effort to ratchet down the conflict over trade and intellectual property rights since the G-20 meeting between Presidents Trump and Xi. This door could easily swing in either direction -- harming even more than the two primary economies involved.
Earnings Season Notes
As the season begins anew, FactSet has reduced expectations for earnings growth for the S&P 500 all the way to -3.0% on revenue growth of 3.7%, based on industry estimates. Bear in mind FactSet also points out that over the past five years, 72% of S&P 500 companies have reported earnings that printed above the mean EPS estimate on average. Their conclusion? That this has resulted in a quarterly earnings growth rate that increases by an average of 3.7% due to the size and quantity of earnings beats across the index.
In other words, even with deeply negative expectations for quarterly earnings on the heels of Q1's -0.4% growth, there is still reason to hold out hope that an earnings recession might be avoided. Expectations for Q3 are still negative at this point, I might add.
As for valuations, the S&P 500 trades at 17.1x forward earnings as of Friday's close. For comparison, the index runs with a five-year average of 16.5x. The most deeply discounted sectors versus individual sector five-year average FPEs would be energy, trading a 16.5x versus a lofty five-year average of 28.9x, and the financials, trading at 12.2x versus 12.9x.
As for sectors that trade at a premium, still according to FactSet, utilities trade at 19.1x versus a five-year average of 16.8x, and discretionaries trade at 21.8x versus 19.0x. My take? If the ECB and the Fed play ball, I see no reason why forward looking multiples can not go to 18x or even greater as the year progresses. The caveat? Hotter-than-expected inflation. Or an unexpected geopolitical event.
Economics (All Times Eastern)
08:30 - Empire State Manufacturing Index (July): Expecting 1.4, Last -8.6.
The Fed (All Times Eastern)
08:50 - Speaker: New York Fed Pres. John Williams.
Today's Earnings Highlights (Consensus EPS Expectations)
Before the Open: (C) (1.80)
