First-quarter earnings season starts in earnest over the next few weeks. Most companies will be in the peak of their buyback "blackout" period by next week, as they are not allowed to buy back any of their company stock a month prior to their earnings release. It is important to note buybacks have been one of the biggest supports for the market all of last year -- and in Q1, amounted to around $200 billion. That means buy backs could come close to reaching the $1 trillion mark for 2019.
In December, when the market was at its lows and threatening to break the uptrend in place since 2009, one could argue that the bad news was more than priced in. The odds were in your favour for going against the trend. Today, stocks are back close to their September 2018 highs. According to Factset, Q1 earnings are projected to be down 4.2% year-over-year, the first decline since Q2 2016, with energy expected to show the biggest decline, of around 20%, and information technology expected to be down 10%.
Back in January, bad news was good news, as sentiment was at the lowest. Valuations are much higher today, so the bar for stocks to move up is higher. Q1 saw extremely recessionary economic numbers globally. An investor would need a seriously firm commitment to not have their faith questioned when they see poor quarterly earnings and hear even more cautious outlooks.
But the market is not the economy, and despite optimistic talk of trade deals, not much has changed, aside from things stabilizing a bit. The fact of the matter is that companies are facing a higher cost of labour and suffering from margin pressure. This will be apparent in their numbers, unlike what we saw in 2017.
Therein lies the problem for further market gains from here. The technology sector is a clear example of this dilemma where the Nasdaq is up in five of the last six trading sessions, close to the 8000 level reached in August 2018, but tech profits are shrinking. The outlook for semiconductors is bleak, as Samsung reported a very weak quarterly outlook. Tech stocks are trading on 4.4x sales (according to Bloomberg), which is about twice the market.
How does one explain this phenomenon? Chalk it up to the liquidity injection, algos chasing trends and investors feeling FOMO (fear of missing out) as stocks have risen 30% since Christmas -- so ultimately, the power of greed overcoming pure sense, which usually ends in tears.
What can cause the market to reach new highs altogether? Rate cuts -- or dare I say, QE4. But how can the Fed possibly justify QE4 when the S&P 500 is close to all-time highs and a trade deal is pretty much done?
Things are too rosy on the surface to pull that rabbit out of the hat. There is still a massive disconnect between hard data and soft data expectations. The market has diverged massively from 12-month forward earnings numbers and various macroeconomic indices. The only way we can see the Fed embark on this journey is if the market falls back down to its December lows -- around 20% down from here. It would be suicide to cut otherwise. It is worth noting that when the Fed cuts, the markets fall first before rallying into a recovery. When the Fed panics, the markets panic more.
Maybe President Trump is aware of all of this, as he only has one game plan in town. Get the market to new highs, by whatever means, to claim to the American public naive enough to believe their president is actually doing a good job. Remember, the economy is not the market! He has a year and a half to accomplish this.
Last week U.S. trade representatives were talking with Chinese officials all of last week, when the meeting culminated with Chinese Vice Premier Liu He meeting with President Trump and saying two parties are closer than ever before on key issues. However, the U.S. said "there is still significant work to be done," so I'm not entirely sure what the market was cheering about.
There was also the suggestion that China would be given till 2025 to reach its objectives. That sounds like the most bizarre trade deal ever, who knows what happens, let alone who is going to be President in 2025. Nice save, China. Trump needs to do whatever he can to "claim" a win, even if the entire year of negotiating and market volatility did nothing other than help the Fed to stop raising rates, which is what Trump wanted all along.
Algos are programmed to chase positive trade headlines, and U.S. officials know this, which is why we get a tweet reading "we are close to a deal" every time the market dips by 1% or more. Computers cannot be cerebral about the absurdity behind this foolish behaviour. The game has changed, so have the players. Investors would be wise to stick to their earnings numbers and valuations. Given the new lay of the land, trends can get exaggerated. However, even if one misses a bit of the upside, it is still better than catching a falling knife.
Back to the drawing board, for now. Those investors who called the market bottom back in January will be well served to be in cash. If one is up 15% for the year, job done. Those brave enough can even go short here, as the risk-reward is certainly skewed to the downside, especially in select technology names, and mining stocks, like Antofagasta (ANFGF) and BHP Billiton (BHP) , which are up about 30% from December lows.