Month: January 2018

Economy Picks Up as Firms Plan New Spending Eight years into what has been an unexpectedly slow expansion, the U.S. economy appears to have picked up steam. Gross domestic product rose at a 2.6% annual rate in the fourth quarter. That exceeded the 2% average that has prevailed since the early 2000s

(…) Gross domestic product rose at a 2.6% annual rate in the fourth quarter, the government said. That didn’t match the second and third quarters’ above-3% growth rates, but it exceeded the 2% average that has prevailed since the early 2000s. Output grew 2.5% in 2017 as a whole, the most in three years, and the Federal Reserve predicts 2.5% growth again in 2018.

That puts the economy in unusual territory: not quite booming, but still gaining momentum deep into an expansion. (…)

Several developments are helping the economy perk up. Among them: Synchronized global economic growth and renewed investment spending by U.S. firms, who had spent years hunkering down. Those factors have converged with low unemployment, tame inflation, low interest rates and a booming stock market to bolster business and household optimism and spending. (…)

Consumer spending rose at a 3.8% rate in the period, an increase last exceeded in late 2014. Spending on long-lasting items known as durable goods rose at a 14.2% rate, the fastest pace since 2009. (…)

A chunk of the fourth quarter’s growth likely reflected a temporary boost in spending related to a pair of hurricanes that ripped through Texas and Florida last summer. Spending that was halted by the storms—such as restaurant visits by consumers and construction—was simply pushed back into the year’s final stretch. Likewise the storms spurred a temporary boost in spending on repairs and replacement items, like cars. (…)

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  Heard on the Street: Why Consumers Can’t Keep Driving the Economy The saving rate fell to its lowest level since 2005, and without wage increases spending growth will have to slow

(…) Consumer spending has been regularly outpacing income growth and, as a result, people are saving less and less. The personal saving rate (the share of after-tax income that isn’t spent) fell to 2.6% in the fourth quarter from 3.3% in the third quarter. (…)

U.S. Durable-Goods Orders Rose 2.9% in December

(…) A closely watched proxy for business investment in new equipment, new orders for nondefense capital goods excluding aircraft, fell 0.3% in December from the prior month.

For 2017 as a whole, durable-goods orders rose 5.8% from the prior year. The business-investment measure was up 5.3% last year from 2016. (…)

Overall industrial production rose 3.6% in December from a year earlier, according to the Federal Reserve, led by an 11.5% jump in mining output. The manufacturing sector saw production rise a more modest 2.4% on the year. (…)

Nondefense orders excluding aircraft slid 0.3% m/m (8.4% y/y) in December with an upward revision to November, and were up at a 2.8% annual rate in Q4 and 5.3% for all of 2017.

U.S. Panel Says Bombardier Jet Sales Didn’t Harm Boeing In a setback for Boeing Co., a U.S trade panel rejected the aerospace giant’s complaint that it was harmed by subsidies to Bombardier Inc., effectively blocking a Trump administration proposal for steep tariffs against the Canadian jet maker.

President Trump Hints at Retaliation Against EU for Unfair Trade

In Global Currency Game, China Is Losing to U.S. The yuan is having its best month since 1980, but its rise poses a policy headache for Beijing and complicates growing trade friction with the U.S.

INFLATION WATCH

More modest firming in Canadian inflation in December

Headline CPI growth matched expectations, rising 1.9% from a year ago in December. That was down from 2.1% in November, but almost entirely because of a monthly drop in the volatile energy component. Food price growth continued to tick higher with the year-over-year rate rising to 2.0% in December.

Excluding the food & energy components, price growth eased to 1.7% from 1.8% in November but that was still well-above a recent low of 1.2% in September. The Bank of Canada’s preferred measures of core inflation ticked higher on balance. Both the CPI-trim and CPI-median measures at 1.9% are effectively right in line with the Bank of Canada’s 2% inflation target. The CPI-common is still lower, at 1.6%, but up from 1.5% in November. (RBC)

Source: Scotiabank Economics (via The Daily Shot)

EARNINGS WATCH

From Factset:

Overall, 24% of the companies in the S&P 500 have reported earnings to date for the fourth quarter. Of these companies, 76% have reported actual EPS above the mean EPS estimate, 8% have reported actual EPS equal to the mean EPS estimate, and 16% 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 (72%) average and above the 5-year (69%) average.

In aggregate, companies are reporting earnings that are 4.5% above expectations. This surprise percentage is below the 1-year (+4.6%) average but above the 5-year (+4.3%) average.

In terms of revenues, 81% of companies have reported actual sales above estimated sales and 19% have reported actual sales below estimated sales. The percentage of companies reporting sales above estimates is well above the 1-year average (64%) and well above the 5-year average (56%).

In aggregate, companies are reporting sales that are 1.1% above expectations. This surprise percentage is above the 1-year (+0.8%) average and above the 5-year (+0.6%) average.

The blended earnings growth rate for the fourth quarter is 12.0% today, which is higher than the earnings growth rate of 11.7% last week. If the Energy sector were excluded, the blended earnings growth rate for the remaining ten sectors would decrease to 9.5% from 12.0%.

The blended sales growth rate for the third quarter is 7.0% today, which is slightly above the sales growth rate of 6.9% last week.

At this point in time, 17 companies in the index have issued EPS guidance for Q1 2018. Of these 17 companies, 6 have issued negative EPS guidance and 11 have issued positive EPS guidance. The percentage of companies issuing negative EPS guidance is 35%, which is below the 5-year average of 74%.

Note that Factset has now “corrected” its EPS numbers for Q4, getting in line with everybody else and treating the Q4 tax reform “adjustments” as non-operating.

Here are Thomson Reuters/IBES numbers:

• The estimated earnings growth rate for the S&P 500 for Q4 2017 is 13.2%. If the Energy sector is excluded, the growth rate declines to 10.7%.
• The estimated revenue growth rate for the S&P 500 for Q4 2017 is 7.3%. If the Energy sector is excluded, the growth rate declines to 6.1%.
• Trailing EPS are now $132.02 and full year 2018 estimates are $153.42, +15.9%
• The estimated earnings growth rate for the S&P 500 for Q1 2018 is 16.7%. If the Energy sector is excluded, the growth rate declines to 14.8%.

Earnings revisions are feeding the equity markets momentum:

On trailing earnings, the Rule of 20 P/E is getting into the “Extreme Risk” area:

The good old P/E is at 21.7, a number exceeded 18% of the time since 1927, 11% if excluding the 1997-2002 period.

Obviously, investors are dismissing trailing EPS as companies comment on tax reform and analysts adjust their estimates. Let’s assume estimates prove accurate (!) and that 2018 EPS come in at $153 (remember that the average over-estimation is 6%):

• P/E: 18.7 (red line above);
• Rule of 20 P/E at current inflation: 20.5 (20.7 at Fed 2.0% inflation target).

TECHNICALS WATCH

While short-term overbought conditions are flagged by most technical analysis, Lowry’s Research keeps registering healthy readings in its key indicators (Buying Power vs Selling Pressure Index and market breadth). While many find similarities between current conditions and 1987, Lowry’s sees a lot more similarities with the 1994-96 period:

Perhaps the closest predecessor to the current market advance is the 1994-1996 rally. For example, pullbacks in the S&P 500 were limited to less than 3% in both rallies – from Dec. 1994 to Dec. 1995 and from Nov. 2016 to the present (and counting). It’s also probably worth noting that the first 5% correction in the 1994-96 rally did not occur until May 1996 – a span of 16 months. With a 34.1% gain in 1995 vs. a 19.4% rise in 2017, it’s not inconceivable that the current rally in the S&P 500 could have further to run before suffering a substantial setback. (…)

Given these similarities, today’s rally is worth comparing to the 1994-96 advance as a virtually uninterrupted rise in the market, characterized by relatively low volatility as illustrated by the lack of 90% Days. The comparison is also worth noting in the sense that the rally in 1995 was followed by another 2 ½ years of gains, ultimately to the July 1998 top and a short-lived bear market. Consequently, worries that the rally from the Nov. 2016 low has run too far, too fast could prove premature.

I submit some important fundamental differences with 1994-1996:

• the rally in 1995 started in November 1994 when the P/E ratio was 14.5 and the Rule of 20 P/E 17.2. In November 2016, these numbers were 19.4 and 21.6 respectively;
• Fed funds peaked in early 1995 and eased slowly throughout the year;
• 10Y Treasuries peaked in November 1994 and declined from 8.0% to 5.7% at the end of 1995;
• after declining throughout the 1991-1994 years, core inflation stabilized in early 1995 but resumed its downtrend in October 1995.

Current conditions are sharply higher equity valuations, a Fed focused on boosting inflation and hike short-term rates while easing its pressure on long-term rates.

Double-Digit Year/Year Declines in the Dollar

Good research piece from Bespoke:

(…) In the last 46 years, there have been 12 distinct periods where the US Dollar Index was down by as much or even more than the decline over the last year.

What is a lot less common than the recent decline in the US Dollar Index, however, is the magnitude of the gain that preceded it.  Back in mid-2015, the US Dollar Index was up over 20% on y/y basis for its strongest one-year gain since the lows of the Financial Crisis, and before that, there were only four other periods where the dollar rallied by a similar magnitude. Like just about every other strong rally in the US Dollar Index, the one in 2015 was also met with a period of weakness/mean reversion.

When it comes to the dollar, its moves have a big impact on stock price performance.  Using our International Revenues Database (available to Premium and Institutional members), we have created two baskets of S&P 500 stocks.  The first one – Domestics – is comprised of companies that generate 90% or more of their revenues inside the United States.  The other basket – Internationals – is made up S&P 500 stocks that derive more than half of their revenue outside the United States.  The chart below summarizes the performance of both baskets since the start of 2017, just when the US Dollar Index was peaking.  Looking at the results, the performance figures aren’t even close.  While the Domestics have seen a gain of just over 15% during this span, the International basket has more than doubled that with a gain of 33.5%!

To see just how closely correlated stock performance based on revenue exposure is to moves in the dollar, the lower chart compares the spread in performance between the Domestics and the Internationals to the US Dollar Index.  Outside of a brief period towards the end of 2017 when the tax reform bill was moving through Congress, whenever the dollar declines, Domestics underperform Internationals and vice versa.

Global dealmaking runs at fastest clip since 2000 Total of $273bn in mergers and acquisitions for January is busiest since dotcom boom

Last week I posted this, found within a WSJ article:

One provision lets companies deduct the cost of buying some sorts of assets immediately, instead of over several years as prior tax law required—and expanded this treatment to used assets as well as new ones.

That essentially lets a buyer like Aramark get an immediate discount on the cash cost of part of its deals, the portion that reflects the acquisition of equipment, machinery and other tangible property. (…)

“The cost of deals structured in this manner have taken a turn for the better,” Mr. Willens said. “You’re getting a full 21% discount.” (WSJ)

I had read a lot about this tax reform but this was news to me. I have not seen this mentioned anywhere else so I dug some more.

• New law. A 100% first-year deduction for the adjusted basis is allowed for qualified property acquired and placed in service after Sept. 27, 2017, and before Jan. 1, 2023 (after Sept. 27, 2017, and before Jan. 1, 2024, for certain property with longer production periods). Thus, the phase-down of the 50% allowance for property placed in service after Dec. 31, 2017, and for specified plants planted or grafted after that date, is repealed. The additional first-year depreciation deduction is allowed for new and used property. (THOMSON REUTERS TAX & ACCOUNTING NEWS)
• The act also removed the rule that made bonus depreciation available only for new property. (Journal of Accountancy)
• The asset is no longer required to be new to be eligible for 100% expensing. Used property will now qualify, as long as it is the taxpayer’s first use of the property. (Forbes)

This is important in that a U.S. company acquiring another company can now write off the entire value of the acquired company’s qualifying assets, effectively reducing the acquisition cost of those assets by 21%. Looked at the other way, most U.S. companies just became more valuable as a result of this wording change in the tax code.

SENTIMENT WATCH

Lured by Hot Bets, Individual Investors Dive In Discount brokerages TD Ameritrade Holdings Corp., E*Trade Financial Corp. and Charles Schwab & Co. reported surges in client activity that have accelerated in January. The firms attributed much of the activity to retail, or individual, investors who are opening brokerage accounts for the first time, some lured by the boom in cryptocurrency and cannabis investments.

(…) The firms attributed much of the activity to retail, or individual, investors who are opening brokerage accounts for the first time, some of them lured by the boom in cryptocurrency and cannabis investments. (…)

Further demonstrating an increasing euphoria, investors have put almost $258 million combined into 10-day-old ETFs that buy companies that have invested in blockchain, the technology behind cryptocurrencies.

At Ameritrade—among the first to give retail clients access to bitcoin futures—new account openings hit a record at the end of its latest quarter, driven by a 72% rise in new business among millennials. Chief Executive Tim Hockey said in an interview that most of the influx of younger, first-time investors was due to interest in the highly speculative areas of cryptocurrencies, including bitcoin, and cannabis. (…)

Mr. Roessner said about a 10th of daily average revenue trades—a key metric for brokerages—has so far this month been blockchain- or pot-related. (…)

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