I have been in Asia 34 days, somewhat remote from all the buzz and fuzz of daily financial, economic and political affairs. Back at the ranch, here’s what I find happened during the past month. What a month!
The S&P 500 Index rose 50 points, or 2.0%, gaining almost a point or two each trading day non-stop until November 8, exactly one year after the U.S. elections.
It lost 10 points on November 9-10.
Equities are up 4.2% (SPY) since the end of August, statistically the most dangerous period of the year.
S&P 500 companies kept delivering strong earnings, +8.1% (per Thomson Reuters/IBES) in Q3 thanks to a spectacular 23.5% jump in IT EPS, surprising by 12.2%!
Inflation is showing no signs of perking up. The core PCE deflator was +1.3% YoY in September, down from +1.9% at the start of the year.
A new Fed chair was chosen by Donald Trump. Jerome Powell, a lawyer with an A.B. in Politics and only 5 years of experience at the Fed will replace Janet Yellen, a Ph.D. in Economics, with over 25 years of Fed and Fed-related experience. Mr. Powell has never dissented against Mrs. Yellen on any interest rate policy decision. He admits being as puzzled as Yellen is on why inflation is not rising as the Phillips curve has been suggesting for quite some time.
This comes as Bill Dudley and Stanley Fischer are also retiring. Together with Yellen, the three most important policymakers, with a combined 35 years of Fed experience, are leaving.
Trump continued to be Trump, proving that the Office has not and will not change the man, as many had hoped. “Making America great again” is, in fact, dangerously isolating America. Trump’s economic team is widely considered very weak, offering little offset for Trump’s own obvious deficiencies.
- Trump’s Pacific Trade Tear Things were going so well. Then he returned to his worst subject.
- Trump, Xi Push Opposing Views on Trade
President Donald Trump delivered his vision for a new American economic relationship with Asia here Friday, one that eschews big trade deals the U.S. has long favored for country-to-country bargaining.
Moments later, Chinese President Xi Jinping took the same stage at a Pacific Rim summit and praised the kind of multicountry treaties that have underpinned American influence in the region for decades. (…)
No countries have so far engaged in negotiations in response to Mr. Trump’s repeated calls for more bilateral trade pacts, though administration officials have said they want to launch agreements with TPP countries, notably Japan and Vietnam. (…)
Messrs. Trump and Xi didn’t find common ground on a long list of trade disagreements between the two countries. Mr. Trump’s aides have said they are preparing possible trade penalties to impose on China in the coming months. Chinese officials have threatened to retaliate. An open trade war between the two would have great implications for Asia. (…)
…And, no doubt, the USA.
- U.S. Pushes Stiffer Content Rules for Nafta Car Makers Proposal to tighten origin requirements for auto parts threatens to upend supply chains in Mexico
(…) If incorporated into a new deal, the stiffer requirements, laid out in a text presented at last month’s Nafta talks in Washington, could upend the supply chains vehicle manufacturers and auto-parts suppliers have established in Mexico’s industrial north over the last 25 years by making it harder for companies to meet requirements that the vast majority of the components they use originate in the U.S., Mexico or Canada. (…)
The U.S. has proposed raising the regional content requirement to 85% [from 62.5%] and wants to expand the tracing list to include steel, leather and fabric used in seat cushions—essentially “all the components of a car,” according to a person familiar with the U.S. negotiating team’s position. (…)
The Alliance of Automobile Manufacturers, a trade group of car makers operating in the U.S., has expressed strong opposition to the proposal, saying Nafta’s current rule of origin for cars is the highest of any trade agreement and raising it further would harm rather than help the U.S. auto industry.
“By increasing the regional content requirement to 85%, mandating a U.S. domestic content requirement of 50% and increasing the regulatory burden of meeting such strict requirements by expanding the ’tracing list,’ you will likely see an increase in Chinese content,” said AAM spokesman Wade Newton. “Rather than attempt to comply with such stringent regulatory requirements, it will make more economic sense for companies to shift production to low-cost countries, like China, and simply pay the 2.5 percent tariff to import the product into the U.S.”
“In that scenario, the U.S. loses and China wins,” he added.
(…) the proposal would force hundreds of auto-parts suppliers and vehicle manufacturers to remake their supply chains. (…)
“If a screw from China is $1.00, it’s $1.20 here [Mexico], and $1.60 in the U.S., and if you have to buy it here or from the U.S., that’s going to hit your profits,” he said. “You have to find sourcing, develop it. It would take years to develop relationships with new countries, and be a total change in the structure of the suppliers.” (…)
“If the prices of supplies go up, well, then prices of the final product must go up too,” said Fernando J. Turner, Katcon’s chairman. “No one has asked the farmers in Kentucky—the ones who went for Trump—‘do you want your tractor or your truck to be 25% more expensive?’ The person who is going to pay, in the end, is going to be the U.S. consumer.”
Commerce Secretary Wilbur Ross can also be deceptive, as seen with the announcements during Trump’s trip last week ($250 Billion in U.S.-China Deals Don’t Add Up). Something else does not add up with Mr. Ross::
- Turns out Wilbur Ross isn’t a billionaire. Uh-oh. President Trump’s billionaire commerce secretary, Wilbur Ross, has a big problem: He is apparently not a billionaire.
Forbes magazine, keeper of the Forbes 400 list of wealthiest Americans, reports that it dropped Ross from its list this year because of a “phantom $2 billion” that Ross claimed he had but apparently does not exist. Instead of the $3.7 billion Ross claimed he was worth (Forbes last year put it at $2.9 billion), his financial disclosures showed — gasp — less than $700 million in assets. (…)
Forbes performed some forensics and concluded that Ross has been lying for years about his wealth. As for the missing $2 billion, Forbes reports:
“Forbes is confident it has found the answer: That money never existed. It seems clear that Ross lied to us, the latest in an apparent sequence of fibs, exaggerations, omissions, fabrications and whoppers that have been going on with Forbes since 2004. In addition to just padding his ego, Ross’ machinations helped bolster his standing in a way that translated into business opportunities. And based on our interviews with ten former employees at Ross’ private equity firm, WL Ross & Co., who all confirmed parts of the same story line, his penchant for misleading extended to colleagues and investors, resulting in millions of dollars in fines, tens of millions refunded to backers and numerous lawsuits.” (…)
It probably won’t help that news of Ross’s missing $2 billion comes just after the discovery from leaked documents that he invested some of the precious millions he does have in a venture with people very close to Vladimir Putin.
Forbes’s Dan Alexander reports that Ross has been conniving for 13 years to inflate his wealth in the Forbes tally, which was based on an error — counting all of his investors’ money as his own. The listing reportedly serves as an attractant to Ross’s third wife.
The important tax reform is no slam dunk.
- Senate Tax Plan Differs From House on Individual Rates, Timing of Corporate Rate Cut Differences highlight challenge for GOP to get overhaul to Trump’s desk by end of year
- Why Investors Should Get Nervous About Tax Cuts Senate GOP plan to delay corporate tax cut shows the move that matters most to investors isn’t a sure thing
A hint of this came Thursday, when the Senate Republican proposal to rewrite the tax code included some big differences with the House plan released earlier this month. One that stuck in the stock market’s craw was a proposal to delay cutting the corporate tax rate until 2019, versus a 2018 start under the House proposal. That means no bump in earnings next year. (…)
More important than the delay was the idea that the 20% corporate tax rate that is the biggest change in the tax plan is subject to negotiation. The problem is making up for the lost revenue. For the plan to pass the Senate with a simple majority, it must cost no more than $1.5 trillion over 10 years and can’t increase the deficit beyond that. But looking at the trade-offs that congressional Republicans will need to strike to meet that constraint and at what is looking like a challenging election next year, investors should be prepared for corporate tax cuts to be pared back less than in either the House or Senate plans.
(…) the need to get something may also prompt them to set their sights lower to ensure a victory. (…)
- Tax Reform Momentum The Senate bill improves on the House on the top rate and businesses.
Congress is now at the stage of tax reform where the details are messy and the political claims are confusing. The trick is to keep your eye on the big picture, and by that measure reform momentum is building. House Ways and Means passed its reform Thursday, and Senate Republicans released reform details that improve on the House bill in important ways. (…)
These details matter, but the larger story is that the Senate—the cemetery for the Republican health-care bill—is joining the House with a pro-growth reform that has a real chance to pass. There are still ways the GOP could trip up: The party must bow to the Senate’s Byrd Rule that bans deficits outside the 10-year budget window, and Republicans can avoid that by repealing ObamaCare’s individual mandate and save more than $300 billion.
Still, this week’s momentum suggests that the GOP is aware that its political future depends on sticking the landing on a tax reform that can lift the economy and unleash broader prosperity.
Last week Speaker Paul Ryan introduced the House GOP tax bill, claiming it would “deliver real relief for people in the middle.” Specifically, he said a “typical family of four would save $1,182 a year on their taxes.” Mr. Ryan reiterated the number four more times during a three minute briefing. This is true, but only for the first year of the tax bill. After that the story gets grimmer.
The cuts Mr. Ryan trumpeted would phase out over time, as David Kamin, a law professor at New York University, has shown. By 2024 Mr. Ryan’s hypothetical middle-class family making $59,000 would actually face a small tax increase. By 2027 that increase would grow to more than $450. Add in the effects of reducing or eliminating tax benefits many middle-class families now claim—for child care, major medical costs and higher education—and the “real relief” promised by Mr. Ryan starts looking more like a burden. Using the American Enterprise Institute’s TaxBrain model, economist Ernie Tedeschi estimates the plan would result in more than 20 million households sending larger checks to the Internal Revenue Service in 2018. By 2027 more than 60 million households would be paying higher taxes. (…)
- GOP Sen. Orrin Hatch says election losses could complicate tax reform Hatch and other Republican leaders seeking to overhaul the tax code face head winds from a new $74 billion hole in their plan and political fallout from their party’s losses in this week’s state and local elections.
The GOP did very poorly in last week’s elections. Many see an anti-Trump wave.
Republicans took a thorough beating in Tuesday’s elections, and no one should sugar coat the results because the voting was confined to a few states. Democrats came out in droves to send a message of opposition to Donald Trump, and GOP candidates were swamped in the undertow. While the cliché is not to read too much into an off-year election, this defeat was broad and deep enough to signal that Republicans will struggle to hold Congress next year. (…)
The message for Republicans going into 2018 is that they are in trouble in the swing suburban districts where the House will be won or lost. Republicans hold seats in 23 districts where Mrs. Clinton also won. (…)
- A Mass Extinction for Virginia Republicans Trump deflects blame, but the GOP lost because voters wanted to send him a message (Karl Rove)
(…) The difference is that turnout this year was up 16% from 2013. Most of the additional voters were white independents and Democrats in the suburbs who wanted to send President Trump a message. (…)
The president is spurring Democrats to the voting booth while letting his own base drift away. His job approval in the Real Clear Politics average is 38%, 8 points below his share of the vote last November. In other words, 1 out of 6 people who cast ballots for Mr. Trump disapprove of his performance.
(…) the results Tuesday from Virginia should set off alarm bells for Republicans. Mr. Trump’s poor standing threatens their congressional majorities. He must try to improve his numbers, and the GOP must prepare itself for an extraordinarily tough battle. For Republican officeholders, this is life in the Trump presidency’s shadow.
- ‘They got mad and they got active’: Women won across the country Tuesday A night of historic wins revealed a surging coalition of women, minorities and immigrants angered by Donald Trump.
- Voters just sent a message: Republicans are way out of step on health care
(…) In exit polls across the Old Dominion, 2 out of 5 voters identified health care as their top concern — more than twice as many as named any other issue. Among those health-care voters, 77 percent favored the Democratic candidate, Lt. Gov. Ralph Northam, who supports Obamacare and expanding Virginia’s Medicaid program under the law; just 23 percent backed the Republican, Ed Gillespie, who opposes both.
In Maine, a referendum to expand Medicaid under Obamacare, which would extend health insurance to some 80,000 low-income adults, won in a landslide, 59 percent to 41 percent. That was a direct rebuke to the Republican governor, Paul LePage, who vetoed Medicaid expansion five times after it was approved, also five times, by the state legislature.
The outcome in Maine, which would become the 32nd state to expand Medicaid under Obamacare but the first to do so by referendum, may prompt similar ballot measures in other GOP-dominated holdout states. Nationwide, some 2.5 million uninsured adults who could gain access to Medicaid live in the remaining states that have balked at expansion; about 15 million Americans have signed up for Medicaid under the expansion. (…)
The good news from last week’s elections results is that democracy is still alive in the USA. Despite heavy rain throughout the day, people went out and spoke.
- Will Virginia Teach Trump Fans a Lesson? A plurality of college-educated whites supported him in 2016. This week a majority went Democratic.
(…) The Democrats had a big night Tuesday, and the president of the United States took it right in the kisser. And it was all about him. (…) 68% of voters under 45 voted Democratic, and Republicans lost nonwhite voters 80% to 20%. (…) A smart, experienced Republican elected official: “It was a total repudiation of Trump—no other way around it. Voters, more women than men, were literally walking in and saying ‘I’m here to vote against Trump.’ (…)
Mr. Trump’s first year has left almost everyone embittered: “Democrats are furious at Trump, and rational Republicans are deeply depressed. Regular Republicans feel nothing is getting done—I heard this everywhere I went.” (…)
Health care was the top issue to Virginia voters; exit polls showed those for whom it was most important went Democratic 77% to 23%. (…)
The bottom line is that the election was about Mr. Trump: “How do you win when your leader has an approval rating of 35%?” (…)
Saudi Arabia has become potentially less stable. War with Iran?
And the Russian stuff, the Paradise Papers, mass shootings…
Hmmm…Good thing profits are strong and inflation stickily low.
Overall, 91% of the companies in the S&P 500 have reported earnings to date for the third quarter. Of these companies, 74% have reported actual EPS above the mean EPS estimate, 8% have reported actual EPS equal to the mean EPS estimate, and 18% have reported actual EPS below the mean EPS estimate. The percentage of companies reporting EPS above the mean EPS estimate is above the 1-year average (71%) and above the 5-year average (69%).
At the sector level, the Information Technology (90%) has the highest percentage of companies reporting earnings above estimates, while the Telecom Services (33%) and Utilities (50%) sectors had the lowest percentages of companies reporting earnings above estimates.
In aggregate, companies are reporting earnings that are 4.6% above expectations. This surprise percentage is below the 1-year average (+5.1%) but above the 5-year average (+4.2%).
In terms of revenues, 66% of companies have reported actual sales above estimated sales and 34% have reported actual sales below estimated sales. The percentage of companies reporting sales above estimates is above the 1-year average (61%) and above the 5-year average (55%).
In aggregate, companies are reporting sales that are 1.1% above expectations. This surprise percentage is above the 1-year average (+0.6%) and above the 5-year average (+0.5%).
The blended earnings growth rate for the S&P 500 for the third quarter is 6.1% today, which is higher than the earnings growth rate of 5.8% last week. The blended sales growth rate for the third quarter is 5.8% today, which is slightly higher than the sales growth rate of 5.7% last week.
If the Energy sector were excluded, the blended earnings growth rate for the remaining ten sectors would fall to 3.9% from 6.1%. If the Energy sector were excluded, the blended revenue growth rate for the index would fall to 4.7% from 5.8%.
If the Information Technology sector were excluded, the blended earnings growth rate for the remaining ten sectors would fall to 2.7% from 6.1%.
If the Financials sector were excluded, the blended earnings growth rate for the remaining ten sectors would rise to 9.2% from 6.1%.
At this point in time, 86 companies in the index have issued EPS guidance for Q4 2017. Of these 86 companies, 58 have issued negative EPS guidance and 28 have issued positive EPS guidance. The percentage of companies issuing negative EPS guidance is 67%, which is below the 5-year average of 75%.
Profit growth breadth is not great in Q3. Most consumer-sensitive groups were pretty weak:
Thomson Reuters/IBES numbers are the following:
The estimated earnings growth rate for the S&P 500 for Q3 2017 is 8.1%. If the Energy sector is excluded, the growth rate declines to 5.8%. The estimated revenue growth rate for the S&P 500 for Q3 2017 is 5.3%.. If the Energy sector is excluded, the growth rate declines to 4.3%.
The estimated earnings growth rate for the S&P 500 for Q4 2017 is 11.5%. If the Energy sector is excluded, the growth rate declines to 9.5%.
Based on Factset’s numbers, ex-IT, Q3 EPS are up 2.7%. Financials’ -8.3% was the main drag and many point to “one-off” hurricane-related losses. But TR calculates that excluding reinsurance (-352%) and multi-line insurance (-152%), Financials still show lower earnings in Q3 (-0.4%).
Ed Yardeni’s relative performance charts show how this has been an IT-led market in 2017:
Now consider this:
Since the end of September, the Nasdaq 100 Index is up 5.5% with the bulk of the jump happening after October 26 (+4.5%), the day Amazon, Alphabet, Microsoft and Intel destroyed expectations for profit and revenue in their Q3 reports. For the same respective periods, the Nasdaq 100 Equal Weighted Index is up 1.4% and 0.7% and the S&P 500 Equal Weight Index is up 1.4% and 0.2%.
No wonder active equity managers are taking it on the chin. IT is now 24.5% of the S&P 500 Index. If one wants to have a reasonably meaningful overweight, one needs to invest nearly 30% of the portfolio in IT companies.
So, given this concentrated relative performance, why this exuberance?
- The II bull/bear ratio, at 4.47, is higher than at any point in time since early 1987.
- Among newsletter writers, 64% were recently bullish while just 14% were bearish, according to the latest survey by Investors Intelligence, released Wednesday. The spread between the two has been above 40 percentage points for six straight weeks. But last week’s reading was the widest yet, with bulls outpacing bears by the most in three decades.
- It has been 45 days since the S&P 500 last had so much as a 0.5% decline, the longest such streak since 1968, according to The Journal’s Market Data Group.
Why isn’t this exuberance translating into higher activity?
One of the more prominent features of the bull market this year has been persistent light volume. That changed in mid Oct., when our 30-day Up + Down Volume began a sharp rise. A closer examination shows that much of this rise has been due to an increase in selling, as measured by our 30-day Moving Averages of OCO Down Volume and Declining Issues. Given the extended nature of the rally, this indication of rising short-term Supply adds to the evidence suggesting an elevated risk for a market pullback.
Trailing 12-m S&P 500 EPS are now $128.10, up 1.7% from 3 months ago and 9.2% YoY. The trailing P/E is 20.1 while the Rule of 20 P/E is 21.8, virtually unchanged during the past 12 months as the 9.2% earnings advance was accompanied by a decline in inflation. This is reflected in the Rule of 20 Fair Value (yellow line below), currently at 2344, up 12.3% YoY compared with +13.7% for the S&P 500 Index.
This recent leg in the bull market remains fundamentally supported by aggregate earnings and inflation trends. The surprise is that, contrary to the actual P/E, the Rule of 20 P/E has not exploded upwards, like it has normally done in similar past stages of bull markets.
But earnings are being lifted by IT and commodity-related sectors while most consumer-sensitive industries and Financials are struggling. Also struggling is the U.S. consumer, 70% of the U.S. economy and a prime engine for most other world economies.
Americans have kept real spending growth near 3.0% over the last 15 months even though real wages have slowed to a trickle. The savings rate has thus been cut in half, providing virtually no buffer against any shock, including higher inflation and interest rates which the Fed is determined to raise.
Happy Thanksgiving and Merry Christmas!
But the first national look at job openings by industry after the storms showed the need for construction workers declined slightly in September. There were 196,000 job openings in the construction industry at the end of the month, down from 230,000 in August, new Labor Department data showed. The September reading was roughly in line with the 190,000 openings averaged monthly over the year ended in August.
Industry-level job openings can be volatile from month-to-month. But a broader look shows the 12-month average of construction-job openings is only slightly above its level in late 2007, when the deep recession began.
Consumers didn’t hesitate to borrow last month. Consumer credit outstanding grew $20.84 billion during September (5.6% y/y) following a $13.14 billion August increase, revised from $13.07 billion. It was the strongest increase since November 2016. (…)
Nonrevolving credit usage strengthened by $14.44 billion (5.6% y/y), nearly double the August increase.(…) Revolving consumer credit balances rose $6.40 billion (5.6% y/y), the strongest increase since May. (…) Student loan balances increased a steady 6.3% y/y. Motor vehicle loan balances gained 4.7% y/y following last year’s 7.2% rise.