Inflection point? Are we there yet? In this twisted land of mixed truths and artificial price discovery, would we even know if and when we had reached an apex? How does one grasp the very idea of planting their flag, of deciding when risk has become more worthy of protection than of pursuit?
The last trading week of July did feel different. Friday was a negative day for the headline level large-cap indices, but more so for the Nasdaq Composite and Nasdaq 100 than for the S&P 500 or the Dow Industrials. That mild divergence may have more to do with a negative market reaction to mega-cap earnings releases that must share space with investors betting on increased fiscal spending, even if the nation speeds right past the debt ceiling stop sign, as the 2019 suspension expired while you and I were enjoying our weekend. No worries there. The U.S. Treasury department knows how to dance, and even without a brand spanking new ceiling or a new suspension, Secretary Yellen can keep the government running smoothly (sort of) up until the end of the fiscal year.
Still it must be pointed out that earnings have been better than excellent. With 59% of the S&P 500 in the books for the second quarter, the blended (reported + expected) Q2 rate of year over year earnings growth is up to 85.1%, according to FactSet. This, as 88% of those firms having already reported have beaten expectations for both the top and bottom lines. This has pushed calendar year 2021 expectations for earnings growth all the way up to 40.7% and revenue growth expectations up to 13.9% (still using FactSet to aggregate the data).
Interestingly, calendar year 2022 expectations, while certainly quite meaningless at this time, have been dropping. As earnings have appeared to pile victories upon victories, analytical consensus for CY '22 has dropped over the last three weeks from 11% to 10.3% to 9.7%. Quite obviously, those among us who study corporate performance the closest do feel that this Roman orgy of profitability has come at the price of having pulled forward at least a piece of what might be more finite than what many of us think, or hope. Over the same past three weeks, the S&P 500 as if but one entity has seen it's 12 month forward looking PE ratio meander from 21.4 times to 21.3 and now 21.2.
Let us not forget that as the Nasdaq Composite and S&P 500 both posted their second losing week in three, that both of our small-cap indices, the Russell 2000 and S&P 600, have now put together back to back positive weeks after lengthy selloffs. That brings us to the Dow Theorists. The Dow Transports gave up 2% last week, led lower by delivery service giants United Parcel Service (UPS) , and FedEx (FDX) . It was more than delivery services though. The rails, the airlines, and maritime transport all had notably poor weeks as the index has now posted eight negative weeks in the last 12 since peaking in mid-May. In other words, the transports have been telling us for quite some time what the Bureau of Economic Analysis had told us last week... that we as a marketplace had grossly overestimated U.S. economic growth for the second quarter. The economy was hot-tish, but not that hot, and still is far from accomplishing very much at all that has not been purchased at the expense of our descendants.
What kind of fools are we? The BEA put a 6.5% print through the Q2 GDP hoop on Thursday, well below the 8.5% growth that Wall Street in all of its glory was looking for. Even though the Atlanta Fed's GDP Now model had plain out projected a 6.4% print on Wednesday. That was far more optimistic than the New York Fed's Nowcast model that was only looking for 3.1%. What gives? Even with all of the handouts, the stored savings, the supposedly insatiable U.S. consumer, and a return to business spending, the St. Louis Fed tells us that the M2 velocity of money ratio still slowed in Q2 which slowed from Q1, which slowed from Q4, which slowed from Q3.
My good friends... for there can be no dance if there is not song. There can be no song if the musicians won't play. The lion's share of recently elevated consumer level pricing is indeed transitory, unless you see a change in trend in velocity. That is why organic economic growth is weak. This is why there is (in my opinion) quite possibly as much upside risk to pricing (lower yields) at the longer end of the spectrum of Treasury debt products as there is downside. Increased borrowing creates supply. Supply creates liquidity. Liquidity creates demand. Demand at artificial price points ultimately suppresses growth. Suppressed growth increases supply. The return of TINA. Stash the cash. Sustained consumer level inflation? Not without velocity. Facts are facts.
Another Manic Monday
U.S. equity index futures are trading higher as night turns to day, coming off positive Mondays across Asia and a positive opening across Europe. Let's hope this action holds. Well, you can root for your interest, I'll root for mine. I quadrupled the size of my Amazon (AMZN) long position on Friday, making the name, by far, my largest holding at this time. Brave? Possibly. Stupid? Almost assuredly, but not for this particular reason. While I remain invested in Amazon, more than half of this long, is but a trade, and I will be happy to take this animal back down to core position size at a modest profit, which is looking like a decent plan at zero dark-thirty.
What Gives?
If you're asking why foreign equities and U.S. equity index futures are trading higher this morning, the reasons are multiple. First off, and probably most importantly, the bi-partisan infrastructure plan finally turned into an actual bill that was submitted to the full Senate on Sunday night. 2,702 pages or $550 billion worth of planned spending on roads, waterworks, bridges, power, ports, airports, broadband and more... the largest federal package targeting public works in decades. The package if passed would apparently be paid for through a number of measures, such as selling off crude oil from the Strategic Petroleum Reserve to repurposing unused funds left over from prior COVID relief packages to delaying a drug rebate rule under Medicare that has still never been implemented, to taxing transactions and profits made in cryptocurrencies.
Will this bill pass in the Senate? One would think so. Just drive down any Brooklyn or Queens street in New York and listen to your car fall apart as you do. That said, chances are that the bill gets caught up in the House as Speaker Pelosi has threatened to handcuff this bill to the rest of President Biden's economic agenda including the "massive" (my word) $3.5 trillion social spending or "human infrastructure" plan. There are problems there as Republicans will almost certainly line up in opposition and Democrats appear far from unified on that issue.
While the broader Senate will vote on the smaller bill this week, the large bill will take much more time, facing possible in-party opposition both from more fiscally conservative Democrats in the Senate, who need to see the bill responsibly paid for, and from the extreme left of the party in the House who would prefer an even larger package regardless of the public's ability or inability to fund something like that.
In Addition
China. Yes, China. Once again, the world's second largest economy and perhaps (or at least once) the planetary driver of economic growth is making news. One week after making quite clear that Beijing was indeed still a totalitarian, communist nation more focused on their "New Development Phase" whose theme is more about national security, and "common" prosperity, has been taking measures to re-centralizing power, while overtly cracking down on both corporate profitability and political discontent.
While what Beijing has done most recently will certainly slow Chinese economic growth, there will certainly be a broader impact upon the global economy. Chinese investors are betting on internal stimulus, and bid domestic shares up on Monday. Chinese officials, however... perhaps after realizing that after the Didi Global (DIDI) fiasco that ultimately led (quite correctly) to an SEC ban of Chinese IPOs unless those firms provide additional risk disclosures explaining the risk inherent to investing in firms subject to Beijing's interference... reached out to their U.S. counterparts.
All said, it's Monday morning and now facing a complete halt to the gravy train that had funded these companies for years, Beijing wants to talk about it. Hey, it's fine to talk. Just remember there is still a trade/cold war going on between the two largest economies on the planet. Remember that as China intentionally becomes China-centric that China's priorities may shift. Perhaps less export-focused. More controlling (see the digital yuan). All the more reason to build in the U.S. and buy from American firms. Supply chain issues? Yeah, those don't need to happen, and certainly don't need to be as severe.
My Broader Investment Thesis
My plan to be quite honest is to use mornings like this one to reduce equity exposure as we move into August. Are stocks expensive? Yes, but that's not why, and I will be back either after nailing the dip, or after being forced to chase my way back in, probably (certainly well) before the end of the year.
First.
We enter into a seasonally weaker time of year for equities.
Second.
I see potential for a terrific upside beat for July job creation this Friday. Not only have at least half of U.S. states tried to force labor market participation through removal of the federal stipend to weekly jobless benefits, but the pendulum of seasonal adjustment swings in July from being a drag on unadjusted data to being an add. July is a weaker month in non-pandemic years for employment. This will boost the number after being salted and peppered, potentially to the higher end of professional expectations (currently 900K) or perhaps beyond. Remember for the Fed, good is bad.
Third.
COVID. Doing the news circuit on Sunday, Dr. Anthony Fauci said that he does not see social lockdowns as part of the U.S. economic future, but that he does see that "things are going to get worse." For the week ending July 25th, new infections in the U.S. were up 63%, while COVID-related hospitalizations were up 30%. Fortunately, demand for vaccination finally seems to be spiking among the unvaccinated. Unfortunately, more and more evidence becomes available that more than suggests that the Delta variant of the SARS-Cov-2 coronavirus is more able to evade defenses provoked through vaccination as those defenses ebb over time.
While we know that the Basic Reproduction Number for the original strain of this virus discovered in Wuhan, China was between two and three for the unvaccinated (all of us at that time), it is believed that this number is around six for the Delta variant. As Scott Minerd of Guggenheim pointed out in his piece last week... twice the reproduction rate, with half the population vaccinated, still leaves the nation facing potentially similar numbers going into the fall as in 2020.
Two problems here. One... the vast majority of the unvaccinated are young, with school aged children still not even eligible. We don't open schools in full this autumn, then production from the household level to the national level will suffer. That removes single parents from the labor force while removing the second earner from the equation in two-wage households with children. Two... As mentioned, the efficacy of these vaccines wanes over time. The most vulnerable populations are the most vaccinated, but they were vaccinated first and likely have less responsive immune systems to begin with.
It is my completely amateur position, as I am no epidemiologist that though we may not shut down, we may experience numbers on a daily or weekly basis that scare the stuffing out of us, thus impacting human interaction. Let me put that another way. It is my completely professional opinion, as I am a well known investor/trader/economist by occupation, that though we may not shut down, we may experience numbers on a daily or weekly basis that scares the stuffing out of us, thus impacting human interaction.
Economics (All Times Eastern)
09:45 - Markit Manufacturing PMI (July-rev): Flashed 63.1.
10:00 - Construction Spending (June): Expecting 0.4% m/m, Last -0.3% m/m.
10:00 - ISM Manufacturing Index (July): Expecting 60.8, Last 60.6.
The Fed (All Times Eastern)
No public appearances scheduled.
Today's Earnings Highlights (Consensus EPS Expectations)
Before the Open: (ON) (.49)
After the Close: (FANG) (2.19), (NXPI) (2.32), (SPG) (2.38), (TTWO) (.90)
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