U.S. retail sales data continue to confuse the superficial observers and to feed the bears out there (“weakest YoY growth for retail sales since Nov 2009”- Zerohedge). Deflating goods prices are depressing nominal sales, leaving the impression of poor demand when volume is actually accelerating. The November data showed a clearer trend as even nominal sales were strong.
Gasoline prices are down 30% YoY. Sales ex-autos and gas were up only 0.2% MoM in August and 0.1% in September, creating fears of a buyers strike even in the face of strong economic and income fundamentals. But demand bounced back +0.3% in October and +0.5% in November, +4.9% annualized over these 2 months.
Taking Food Stores sales out, October and November are even stronger at +5.5% annualized and +3.9% YoY. Remember that goods inflation has been negative: CPI-commodities less food and energy is –0.7% YoY in October which suggests that retail sales ex-food, autos and gas are up in the 4.0-4.5% range in real terms. The only weak area is clothing stores where demand has been held back by very unseasonal weather this fall. Yet, considering that apparel prices are down 2.0% YoY, the 1.5% nominal sales gain in the last 3 months is not too shabby.
Overall, the volume bounce is critical since it should help clear excess inventories, allowing production to accelerate in the new year. In effect, the energy windfall is beginning to be spent on goods as well as on services, right when we need it. And it is not about to end anytime soon. Gasoline prices look set to break $2.00/g on average; heating fuel prices are down 33% YoY, natural gas prices are –11.0% and electricity prices –0.5%, all having the greatest impact on the average American. Add the coming rise in short term interest rates and you also get a welcome income lift for the retired.
The universe of fixed income assets yielding over 4% shrunk by more than 75% after the Fed dropped interest rates to zero in 2008. The whole concept of relying on livable cash flows from low volatility investments like US Treasuries, munis, and investment grade bonds went out the window just as the Baby Boomers (the
generation born between 1943 and 1960) started to reach retirement age. (Evergreen Gavekal)
With 70% of the economy on a solid and strengthening footing, the risk of a major slowdown is low. While low commodity prices hurt some areas of the U.S., their benefit are relatively much bigger on consumer buying power and non-commodity companies’ margins. Inflation is likely to remain tame for a while as a result, ensuring a slow path for the Fed.
Q4 earnings are being revised down like they are every quarter at this point.
In terms of earnings estimate revisions for the S&P 500, analysts have lowered earnings estimates for Q4 2015 within average levels to date. On a per-share basis, estimated earnings for the fourth quarter have fallen by 3.6% since September 30. This percentage decline is larger than the trailing 5-year average (-3.0%), but smaller than the trailing 10-year average (-4.2%) for approximately this same point in time in the quarter. (Factset)
Three months ago, at the same time, analysts had lowered their estimates by 2.6% to –4.4%, coincidentally the same decline forecast for the current quarter. Q3 earnings actually came in down 1.5% with Energy EPS cratered 57% and non-Energy up 5.7%. This quarter, Energy EPS are expected down 34% and non-Energy up 1.2% before any beats which were substantial in Q3. In fact, 7 of the 10 sectors beat their estimates in Q3 (Financials barely missed at -5.2% vs +5.8% expected). Corporate America continues to display strong costs control in the face of zero inflation backwind.
Three weeks before the end of Q4, companies are not pre-announcing in any worse fashion than before. Thomson Reuters’ tally shows that 86 companies have negatively pre-announced as of Dec. 11, down from 94 at the same time last year and 91 at the same time during Q3. There have been 27 positive pre-announcements, up from 19 last year and in-line with Q3.
TR is forecasting full year EPS of $117.55. Using this number on the Rule of 20, we get a Rule of 20 multiple of 19.0 at current levels (2019). Fair value is 2128, 5.4% above current levels with downside of –6% to the Oct. 2014 low of 18x on the Rule of 20 P/E (1819).
This is a fairly balanced risk/reward relationship considering the potential for beats if normal patterns prevail. Earnings surprises could be even better if consumer spending silence the sceptics during this important final quarter.
I maintain the 3 stars market rating, even though I am concerned by some of the weak “market internals”:
- The S&P 500 is below its 200 day m.a. which has resumed declining. It closed Friday below its declining 100 day m.a..
- Smaller caps have led the recent declines but the larger caps look tired as well.
- Lowry’s Buying Power Index is much weaker than its Selling Pressure Index, a condition that began in mid-August 2015.
No recession, no bear market. But the S&P 500 Index is rolling over and surely needs a new catalyst to turn around. Will a strong Christmas do it?