LEADING ECON. INDIC.

U.S. Leading Economic Indicators Show Surprising Improvement

The Conference Board’s Composite Index of Leading Economic Indicators strengthened 0.8% during January following an unrevised 0.3% December decline. It was the largest increase since October 2017. (…)

Last month’s strength was paced by large increases in the weekly initial claims for unemployment insurance and the building permits components. The factory orders for nondefense capital goods, stock prices, the yield spread between 10-year Treasuries & Fed Funds, consumer expectations for business/economic conditions, consumer goods orders and the leading credit index also contributed positively to the index. The length of the average workweek had a neutral effect and the ISM new orders index contributed negatively to the index change.

Three-month growth in the leading index improved to 2.5% (AR) following three straight negative readings. The y/y change of 0.9% compared to a 6.5% high in September 2018.

The Index of Coincident Economic Indicators rose 0.1% during January after holding steady in December, revised from 0.1%. The y/y change of 1.1% was the weakest since September 2016. (…) Three-month growth in the coincident index of 1.9% (AR) remained down from 2.3% in August.

The Index of Lagging Economic Indicators held steady during January after an unrevised 0.1% dip in December. (…) Three-month growth in the lagging index fell to 0.7% from 4.2% six months earlier.

The ratio of coincident-to-lagging economic indicators is considered another leading indicator of economic activity. It increased to a four-month high.

Charts from Advisor Perspectives:

As we can see, the LEI has historically dropped below its six-month moving average anywhere between 2 to 15 months before a recession. The latest reading of this smoothed rate-of-change suggests no near-term recession risk.

Here is a twelve-month smoothed out version, which further eliminates the whipsaws:

FLASH PMIs

USA: Output contracts for the first time since October 2013

Private sector firms across the U.S. signalled a slight decline in business activity in February. The overall contraction was driven by a notable worsening of service sector performance, where output fell for the first time in four years.

Adjusted for seasonal factors, the IHS Markit Flash U.S. Composite PMI Output Index posted 49.6 in February, down from 53.3 in the opening month of 2020. Although only fractional, the decrease in business activity brought to an end a near-four year sequence of expansion following a contraction in service sector output and a slower rise in manufacturing production amid supplier delays following the outbreak of coronavirus.

 

New orders received by private sector firms fell for the first time since data collection began in October 2009. The fractional decline in new business stemmed from weak client demand across the service sector and the slowest rise in manufacturing new order volumes for nine months. Private sector companies continued to struggle to attract foreign client demand as new export orders fell for the second month running.

Employment continued to increase midway through the first quarter, albeit at the slowest pace in the current four-month sequence of growth. Manufacturers and service providers alike registered a rise in workforce numbers, although the pace of job creation eased in both monitored sectors.

Inflationary pressures softened in February. The rate of increase in cost burdens eased to the slowest since last October amid reports of lower demand for inputs. As a result, private sector companies raised their output charges at the softest pace for three months.

Business confidence strengthened to an eight-month high in February but remained historically subdued as firms highlighted ongoing global uncertainty and the outbreak of coronavirus.

The seasonally adjusted IHS Markit Flash U.S. Services PMI™ Business Activity Index registered 49.4 in February, down from 53.4 in January. The latest data signalled the first decline in business activity for four years and a notable turnaround from the solid output expansion seen in the opening month of the year.

The contraction in output was in part driven by a renewed decrease in new business across the service sector. Although only fractional overall, the rate of decline was the strongest in the series history (since October 2009). New export orders also fell as firms reported greater hesitancy among clients to place orders amid speculation regarding coronavirus.

Pressure on capacity was reduced in February, as the level of outstanding business fell. As a result, services companies increased their workforce numbers at a softer rate. That said, business confidence reached the strongest since last June.

At the same time, input prices rose at the slowest pace in the current five-month sequence of inflation and was only slight overall. In an effort to remain competitive, firms raised their output charges only fractionally.

Goods producers noted only a slight improvement in operating conditions in February, as signalled by a fall in the IHS Markit Flash U.S. Manufacturing Purchasing Managers’ Index™ (PMI™) from 51.9 to 50.8 midway through the first quarter. The improvement in the health of the manufacturing sector was the slowest since last August.

The lower headline index reading was partially driven by slower expansions in production and new orders. The upturn in output was the softest since last July, with firms stating that weak demand conditions and delays in deliveries following the outbreak of the coronavirus in China had dented production growth.

Although output expectations improved and reached a ten-month high, business confidence remained relatively muted as firms suggested uncertainty surrounding the impact of coronavirus had weighed on optimism and could further impact production.

Meanwhile, inflationary pressures remained historically subdued midway through the first quarter amid a slower rise in cost burdens. Firms only raised their charges fractionally as they sought to remain competitive and boost sales.

Chris Williamson, Chief Business Economist at IHS Markit:

With the exception of the government-shutdown of 2013, US business activity contracted for the first time since the global financial crisis in February. Weakness was primarily seen in the service sector, where the first drop in activity for four years was reported, but manufacturing production also ground almost to a halt due to a near-stalling of orders.

Total new orders fell for the first time in over a decade. The deterioration in was in part linked to the coronavirus outbreak, manifesting itself in weakened demand across sectors such as travel and tourism, as well as via falling exports and supply chain disruptions. However, companies also reported increased caution in respect to spending due to worries about a wider economic slowdown and uncertainty ahead of the presidential election later this year.

The survey data are consistent with GDP growth slowing from just above 2% in January to a crawl of just 0.6% in February. However, the February survey also saw a notable upturn in business sentiment about the year ahead, reflecting widespread optimism that the current slowdown will prove short-lived.

Eurozone business bucks virus impact as growth hits six-month high

The eurozone economy grew at its fastest rate in six months during February, according to flash PMI® data. Although remaining weak, the rate of expansion accelerated for a third straight month despite signs of demand being dampened and production being stymied by the coronavirus outbreak.

At 51.6 in February, the ‘flash’ IHS Markit Eurozone Composite PMI rose from 51.3 in January to indicate the largest monthly increase in business activity since last August. Growth was centered on the services sector, where business grew at the joint-fastest rate seen over the past six months. Manufacturing meanwhile remained in decline, although the rate of contraction in output eased to the mildest seen over the past eight months.

The overall rate of expansion remained only modest, however, largely due to subdued new business growth. New orders rose at a rate equal to January’s seven-month high, yet the rise was insufficient to prevent backlogs of work continuing to decline slightly, hinting at persistent excess capacity.

Inflows of new business into the service sector grew at a fractionally weaker rate than seen in the prior two months, the slowdown in part linked to travel, tourism and some areas of business reportedly being disrupted by the coronavirus outbreak.

New orders placed at manufacturers meanwhile fell for a seventeenth successive month. More encouragingly, the overall drop in factory orders was the smallest for 15 months as firming demand from domestic customers helped offset a stronger decline in export orders.

A notable development constraining manufacturing in February was a marked lengthening of supplier delivery times, with delays for inputs the most widespread since December 2018, attributed in many cases to supply chain issues arising from the COVID-19 outbreak.

The ongoing relative weakness of new business growth meant employment continued to rise at a weaker pace than seen throughout most of last year, sustaining the softest spell of job creation seen for five years, albeit with the rate of job creation still up on December’s low. Service sector payroll gains slipped to a 13-month low, but job losses in manufacturing eased to the lowest for three months.

The flash February PMI data also showed inflationary pressures cooling slightly. Average input prices rose at a pace slightly weaker than January’s eight-month high, while average selling prices for goods and services rose at the joint-slowest rate for over three years. Inflation trends continued to vary by sector: service sector costs and prices rose but factory costs and charges continued to fall, with average prices charged for goods dropping at the fastest rate for almost four years.

Finally, expectations of output growth over the coming year dipped from January’s 16-month high, though remained well above the average seen in 2019 and up markedly from the low plumbed last August. Sentiment softened in both services and manufacturing.

(…) The flash PMI has climbed to a six-month high, consistent with GDP growing at a quarterly rate approaching 0.2%. (…)

Japan: Private sector output declines at strongest pace since April 2014

Latest PMI data dash any hopes of a first quarter recovery in Japan and significantly raise the prospect of a technical recession in the world’s third largest economy.

Japan’s economy has gone into 2020 still reliant on services and consumer-centred markets to pick up the slack from the industrial sector. However, fourth quarter GDP disconcertingly showed that the sales tax hike and devasting typhoon in October severely dented consumption, and flash data indicate that domestic demand is still yet to fully recover. New business at services companies fell at the strongest rate since June 2016, with survey evidence implying that the coronavirus outbreak has hit tourism particularly hard in Japan, a key source of demand for services. Overall, February flash PMI data stack the odds heavily against Q1 growth, despite Abe’s best efforts to stimulate the economy after the sales tax hike.

Daimler warns of “significant adverse effects” of virus outbreak

“Risks for the Daimler Group may not only affect the development of unit sales, but may also lead to significant adverse effects on production, the procurement market and the supply chain,” the Stuttgart-based company said in its annual report bit.ly/2SJHGOi.

It also noted that the epidemic posed a risk for economic growth in China, other Asian countries and worldwide. (…)

Global Stocks Slip on Signs of Coronavirus’s Economic Impact Stocks fell on early signs of the coronavirus outbreak curtailing economic growth in some markets and evidence that the epidemic is claiming more lives outside China.

Investors may be underestimating the impact of the outbreak on U.S. companies’ earnings as economic activity slows in China and tourism takes a hit, Goldman Sachs Group warned. More than 75,000 people have been diagnosed with coronavirus, and over 2,000 have died globally. South Korea reported its first fatality, while two patients in Iran also died and confirmed cases began to climb in Beijing.

Preliminary figures for Japan’s February manufacturing activity meanwhile showed the sharpest contraction in more than seven years, Deutsche Bank said. Data on the country’s services sector fell to the lowest since April 2014 as the spread of coronavirus hurt tourism, according to IHS Markit. (…)

• Coronavirus Cripples Some Supply Chains Sellers of custom ties and outdoor fireplaces face shortages as Chinese factories are slow to reopen. Even a bike factory in Vietnam feels the squeeze.

(…) businesses say the recent upheaval is causing them to rethink their supply chains. Outdoor-fireplace maker Blue Rooster Co., which imports cast-metal parts from China and then assembles them in Minnesota, is now looking at bringing nearly 90% of its production in-house. Currently two of its three main suppliers in China are offline. (…)

• Why Many Businesses Will Be on the Hook for Coronavirus Losses Burned by SARS, insurers across the board now exclude epidemics in standard business-interruption policies

• The February composite SMI report from World Economics shows the extent of the coronavirus impact on China’s business activity. (The Daily Shot)

Source: World Economics

More supply chains problems:

Canadian ports on two coasts congested due to rail blockades Ships have suspended calls at the Port of Halifax and dozens of cargo vessels are sitting at anchor near the Port of Vancouver as freight shipments have been halted across much of the country

China Says No Turning Point; Korea Infections Jump: Virus Update

The coronavirus outbreak accelerated outside China, with South Korea reporting a surge in infections. China adjusted the number of cases for the third time this month, raising more questions over the reliability of the data.

The epidemic in China has been tentatively contained but hasn’t reached a turning point yet, according to China Central Television, which cited a politburo meeting. Infections in China topped 75,000.

South Korea reported 48 more cases, taking the total number to 204. Neighboring Japan is also seeing outbreaks in several unconnected areas. Singapore reported recoveries outpacing new cases. (…)

• SOUTH KOREA CORONAVIRUS CRISIS: Mass Infections feared at 2 hospitals, 4 Factories and Naval Base! Infected Cases Now: 107 Death 1, Suspected Cases 8,120 

• Coronavirus latest: China vows to ‘liquidate’ virus by end of March

A BULL CASE?

From David R. Kotok, Chairman and Chief Investment Officer, Cumberland Advisors:

(…) COVID19 has put all central banks on the stimulus track, and the growth of world liquidity is driving stock prices higher and keeping bond yields very low. At Cumberland we are nearly fully invested in our US ETF strategies, and our quantitative strategies are fully invested and positioned offensively. (…)

So add low interest rates to suppressed inflation (temporarily) coupled with slowing worldwide growth, and we get a powerful upward force for stock prices. Our upside target for the S&P 500 Index is now 3600 or higher.

Let’s think of that in the following way. We reduce the 2020 earnings estimate because of coronavirus shocks. We are taking our estimate for the 2020 calendar year down to $165 with a plus or minus range of $4. But we are also lowering the equity risk premium (ERP), which translates into raising the P/E of those earnings. Here’s why.

Older models of ERP calculations would have kept you out of the stock market for some time now and would still keep you out. Why? Because they were derived when both inflation and interest rates were higher. Does a 300-basis-point ERP apply when the running 10-year Treasury yield is around 1.5-2%? It did apply when that yield was 4%. But should it now be reduced?

We think the answer is yes, if one believes the 10-year yield is now likely to hover around 2% or even lower. The coronavirus has pushed out any rise in interest rates and has added a lot of liquidity fuel from central banks. So we believe the ERP must be smaller now.

Consider what it would mean if the ERP were 200 instead of 300 basis points. Apply a 25 running P/E to our earnings estimate. 4% earnings yield minus 200 basis points of ERP is the base case for a 25 p/e.  It is easy to see how the S&P 500 can trade between 3600 and 4000 even as the coronavirus reduces 2020 earnings. Please note that at that S&P 500 level, the yield on the S&P index is about equal to or above the yield on the 10-year Treasury.

So, we’re leaning to full investment in our portfolios. We don’t like a natural disaster that is sickening many and killing folks every day. We think the spread of the virus will continue. We’ve seen credible estimates as high as an eventual 4-5 million cases and a baseline 2% to 4% fatalities rate worldwide.

But the investment outlook now is for a massive central bank liquidity response, and that means higher multiples for stock markets around the world.

Of course, things could change at any time. The same is true for our managed portfolios.

FYI, a 25 P/E, or a 4% earnings yield (red line below), has very rarely been seen since 1927 and never proved to be in a buy-low environment, to say the least.

True, interest rates have also rarely been so low, but when they were nearly as low as currently, the earnings yield, and the ERP, were much higher. Not to say we cannot see 3600, 4000 even, but I would not say these levels are “easy to see”.

Also consider that the correlation between the Earning Yield and 10Y Treasury yields is 20.3% since 1927. BTW, the correlation between the S&P 500 price and trailing EPS is 98.2%. I wonder what “an eventual 4-5 million cases and a baseline 2% to 4% fatalities rate worldwide” would do to economies, earnings and investor confidence. Not to mention what an ever rising USD will do to foreign earnings of S&P 500 companies.

EARNINGS WATCH

We now have 437 reports in, a 70% beat rate and a +5.0% surprise factor.

Q4 earnings are now expected up 3.2% vs –0.3% on Jan. 1. Revenues are up 5.1% vs +4.1% on Jan. 1.

Q1’20 earnings are seen up 3.2%, much slower than the +6.3% of Jan. 1. Q2 forecasts are also trimmed, from +7.2% to +6.0%. Still, full year earnings are seen up 7.7% (vs +9.7% on Jan. 1), a sharp acceleration from +2.0% in 2019.

Pre-announcements remain generally positive compared to Q1’19 and Q4’19 but the last few days were mainly on the negative side…

Trailing EPS are now $164.60. At 3338, the Rule of 20 P/E is 22.55.

Mom and Pop Are On Epic Stock Buying Spree Fueled by Free Trades Small investors are back in a big way.

(…) While it’s tough to know what’s causing what — bull markets are fueled by new converts but also lure them — trading volume at online and discount brokers has exploded. TD Ameritrade Holding Corp., which started offering free trading in October, has seen million-trade days multiplying at a record pace.

(…) “I’ll invest smaller amounts. Before I never really invested anything less than $1,000, $500 minimum,” he said in a phone interview. “Now if I have enough to buy an extra share, I’ll do it. I’ll do like $300.” (…)

“The fact that we have been in a bull market for a long time, people are just optimistic. Things are going up and they continue to go up.” (…)

“There’s sometimes no fundamental reason for it. It just is based on perception — a perception based on narratives that run only an inch deep,” he said in note. “Let’s see how much longer it persists. This kind of activity often unwinds much faster than the wind up.”

Bob Farrell’s Rule #5: “The public buys the most at the top and the least at the bottom”

U.S. Leading Economic Indicators Index Eases

The Conference Board’s Composite Index of Leading Economic Indicators declined 0.3% during December following a 0.1% November uptick, revised from no change. It was the fourth decline in five months. During all of 2019, the leading index rose 1.5% after a 5.7% increase during 2018. From December-to-December the index ticked up 0.1%. (…)

Contributing negatively to the index change were weekly initial claims for unemployment insurance, building permits and the ISM new orders index. Contributing positively were stock prices, factory orders for consumer goods, the yield spread between 10-year Treasuries & Fed Funds, consumer expectations for business/economic conditions and the leading credit index. Exhibiting a neutral effect on the change in the leading index were the average workweek and new orders for nondefense capital goods excluding aircraft.

Three-month growth in the leading index of -1.4% (AR) was negative for the third straight month and below the high of +9.1% in December 2017. The y/y change eased slightly to 0.1% compared to a 6.5% high in September 2018.

The Index of Coincident Economic Indicators rose 0.1% during December after increasing 0.3% in November, revised from 0.4%. (…) Three-month growth in the coincident index held steady m/m at 1.1% (AR) but was down from 2.3% in August.

The Index of Lagging Economic Indicators eased 0.1% during December after a 0.4% November gain, revised from 0.5%. (…) Three-month growth in the lagging index eased slightly to 1.9%, but remained up from -0.4% in October. Twelve-month growth declined to 2.3%, down from 3.5% in July.

The ratio of coincident-to-lagging economic indicators is sometimes considered a leading indicator of economic activity. It increased modestly in December.

Charts from Advisor Perspectives:

Scott Minerd, Global CIO at Guggenheim Partners, asserts that “every US recession has been preceded by 3 negative months of LEI. Since #LEI began in 1959, 3 consecutive monthly declines have resulted in a #recession within 6 months 7 out of 11 times…Three consecutive declines are a necessary but insufficient condition, but 4 negative prints will seal the deal.”

Well, we got the 3 negative months between August and October but November was up one tick and December was down 3 ticks. Now what’s needed to “seal the deal”?

Meanwhile, initial claims are cleanly back within their 2-year channel:

FLASH PMIs

USA: Output growth quickens to ten-month high

U.S. private sector firms indicated a faster expansion of business activity in January, with the pace of growth accelerating to a ten-month high. The upturn was driven by a sharper increase in service sector output, as growth of manufacturing production was unchanged.

Adjusted for seasonal factors, the IHS Markit Flash U.S. Composite PMI Output Index posted 53.1 in January, up from 52.7 in December, to indicate the quickest rise in output since last March. The increase in output was solid overall, despite the pace of growth remaining below the series long-run trend.

New business across the private sector continued to rise in January, albeit at a softer pace. The upturn in client demand softened slightly as both manufacturers and service providers registered slower expansions of new orders. In fact, goods producers recorded the least marked improvement in demand since last September, with growth easing further from November’s ten-month high. Meanwhile, new export orders placed with U.S. private sector firms dipped into contractionary territory at the start of 2020.

Nevertheless, firms expanded their workforce numbers at a faster rate in January. Employment grew for the third successive month and at the quickest pace since last July. The rate of job creation accelerated to a six-month high at service providers, while manufacturers registered the slowest rise in workforce numbers since last September.

Meanwhile, price pressures across the private sector remained historically subdued, despite the rate of input cost inflation picking up to a seven-month high. Higher operating expenses were commonly linked to stronger increases in raw material prices and wages. Average output charges rose at only a marginal pace, with the rate of inflation easing from December’s ten-month high.

At the same time, output expectations across the private sector improved at the start of 2020, with optimism reaching a seven-month high in January.

The seasonally adjusted IHS Markit Flash U.S. Services PMI™ Business Activity Index registered 53.2 in January, up from 52.8 in December. This signalled a solid increase in service sector output that was the fastest since last March.

Although the pace of output growth accelerated, the expansion in new orders moderated slightly. The upturn in sales was the third in as many months, and signalled stronger client demand compared to the second half of 2019.

Service providers were buoyed by further business activity growth and increased their workforce numbers, and at a quicker rate.

Service sector firms signalled an improvement in business expectations, as the degree of optimism reached a seven-month high. However, business confidence remained well below the series trend

Finally, the rate of input price inflation quickened to the sharpest since last July, despite being historically muted. In an effort to remain competitive, services firms raised their output charges at only a modest pace.

Manufacturing firms noted a slower improvement in operating conditions in January, as signalled by a slight dip in the IHS Markit Flash U.S. Manufacturing Purchasing Managers’ Index™ (PMI™) from 52.4 to 51.7 in January. Notably, the latest upturn in the health of the sector was the softest since last October.

Although output continued to rise at a moderate pace, new business growth was only marginal as both domestic and foreign client demand softened. Furthermore, new export orders fell for the first time since last September, though only slightly.

Nevertheless, goods producers continued to increase their workforce numbers at the start of 2020, albeit at the slowest pace for four months. The softer rise in employment coincided with signs of easing capacity pressures, with January seeing the first fall in backlogs for four months.

At the same time, price pressures eased across the manufacturing sector in January. A weaker increase in cost burdens occurred alongside only a fractional rise in factory gate charges.

Eurozone growth remains muted at start of 2020

Flash PMI data for January indicated that the eurozone economy failed to pick up growth momentum at the start of 2020. Business activity increased at the same slight pace as was seen in the final month of 2019 as the rate of expansion in new orders remained muted.

Underlying data showed that growth of services activity eased slightly, while the manufacturing sector moved closer to stabilisation. Combined growth of the ‘big-2’ eurozone economies picked up, but this was offset by near-stagnation across the rest of the single-currency area.

The ‘flash’ IHS Markit Eurozone Composite PMI® was unchanged at 50.9 in January, signalling a further muted increase in activity across the euro area economy. The rate of expansion has remained broadly stable since the start of the final quarter of 2019, running at the weakest for around six-and-a-half years.

The overall expansion in business activity was again centred on the service sector. That said, services activity rose at a slightly weaker pace than in December. Meanwhile, manufacturing production remained in contraction, but the rate of decline eased to the softest in five months.

The ongoing muted pace of output growth reflected a lack of momentum in new order inflows. New business increased for the second month running in January, but the rate of expansion remained marginal. There were signs of manufacturing new orders nearing stabilisation at the start of the year, with the rate of decline in new work easing to the softest since November 2018. This was also the case with regards to manufacturing new export business.

While rates of growth in output and new orders remained muted at the start of the year, companies were increasingly confident regarding the year-ahead outlook for activity. Business sentiment rose to a 16-month high, largely thanks to a fifth successive improvement in confidence among manufacturers amid signs that the worst of the recent downturn has passed.

Confidence in the outlook for output encouraged companies to take on additional staff in January. The rate of job creation quickened from that seen at the end of 2019, but remained muted amid further job cuts at manufacturers. Rises in operating capacity enabled companies to deplete backlogs of work again at the start of 2020.

The rate of input cost inflation quickened to an eight-month high, but remained relatively muted. In turn, companies raised their selling prices at a pace that was broadly in line with those seen through the second half of 2019.

A sharp and accelerated increase in input costs was recorded in the service sector, while the current sequence of decline in manufacturing input prices was extended to eight months.

The ‘big-2’ eurozone economies of France and Germany saw a positive start to the year, with combined output growth at a five-month high. Germany in particular showed signs of recovery as overall output rose for the second successive month amid a first increase in new orders since June last year. A stronger expansion in services activity and a less marked decline in manufacturing production contributed to the improving picture.

The recent solid performance of the French economy continued in January as both output and new orders rose for the tenth month running. Rates of expansion softened, however, amid weaker growth in the service sector.

The rest of the euro area showed signs of weakness. Output growth slowed to a six-and-a-half year low, signalling a near-stagnation in business activity outside Germany and France. In fact, new order volumes were unchanged and firms raised staffing levels only fractionally.

Japanese economy rebounds at the start of 2020

The headline Jibun Bank Japan Manufacturing Purchasing Managers’ Index™ (PMI)® increased to 49.3 in January, up from a previous reading of 48.4, thereby signalling continued contraction of the goods-producing sector. However, the decline was the slowest since last August and only mild overall.

The headline Business Activity Index [Services] moved above the neutral 50.0 mark during January, rising to 52.1 from 49.4 in December. This signalled a rebound of services activity and the quickest output expansion in four months. Stronger increases were also recorded for new business and employment, while output charges moved up into inflation territory.

“Positive signs have emerged for Japan’s economy at the start of 2020, with flash PMI data pointing to a domestic-led economic recovery. While official data are yet to confirm it, the fourth quarter looks on track to register an ugly decline in GDP. The January flash numbers will certainly allay fears for now of an impending technical recession in Japan. (…)

“Nevertheless, manufacturing confidence edged up in January in the wake of easing US-China tensions and some optimism regarding Japanese relations with South Korea. Panel comments suggesting that demand conditions in the semi-conductor industry have picked up is a promising sign.

New Warehouse Supply Projected to Exceed Demand Over Next Two Years

Developers are expected to deliver about 301 million square feet of new warehouse space in the U.S., Canada and Mexico this year, while tenants will lease about 242 million square feet, according to a new report from Cushman & Wakefield PLC.

The real-estate firm projects builders will deliver another 272 million square feet in 2021, outpacing projected demand of 218 million square feet. (…)

Cushman & Wakefield said in its report that builders added more space in North America in 2019 than tenants could take on, the first time since 2009 that has happened. (…)

Goldman to Refuse IPOs If All Directors Are White, Straight Men

Goldman Sachs Group Inc. Chief Executive Officer David Solomon issued the latest ultimatum Thursday from Davos. Wall Street’s biggest underwriter of initial public offerings in the U.S. will no longer take a company public in the U.S. and Europe if it lacks a director who is either female or diverse. (…)

BlackRock Inc. and State Street Global Advisors are voting against directors at companies without a female director. Public companies with all-male boards based in California now face a $100,000 fine under a new state law. (…)

Almost half of the open spots at S&P 500 companies went to women last year, and for the first time they made up more than a quarter of all directors. In July, the last all-male board in the S&P 500 appointed a woman. (…)

Next year, the bank will raise the threshold to two diverse directors, which includes diversity based on sexual orientation and gender identity, Goldman said in a statement. (…)

EARNINGS WATCH

We now have 74 S&P 500 companies in, sporting a low 68% beat rate (74% last 4 quarters) and a 23% (19%) miss rate, with a +3.9% surprise factor. The actual earnings growth of these 74 companies is +0.5% in Q4 on a +3.4% increase in revenues.

During Q3’19, the first 73 companies to report had an 84% beat rate and a 12% miss rate, with a +4.3% surprise factor. Their actual earnings growth was –0.9% on a +2.9% revenue gain.

Q4’19 earnings are now seen down 0.7% (+2.0% ex-Energy), from –0.3% on Jan. 1.

IT companies are leading this rally, perhaps because all 9 companies that have reported their Q4 beat estimates with a +2.5% surprise factor. Tech earnings are still expected up only 0.8% in Q4, slightly better than the +0.5% growth expected on Jan 1.

Analysts see a nice rebound in growth starting in Q1’20 and accelerating big time to +15.7% in Q4’20. Let’s hope they have more luck this year than last. That said, tech analysts are in good company on earnings forecasts…

• The chart suggests that the tech sector appears stretched, at nearly 20% above its 200-day moving average. (Isabelnet) Image: Strategas

Same with large caps overall as Ed Yardeni illustrates:

IT stocks are selling at 22.3x forward EPS, a 26% premium over non-IT equities.

Net earnings revisions have turned positive for IT companies:

They sure need it given their current PEG ratio:

At today’s opening of 3325 on trailing EPS of $163.20:

Cash or No Cash? Optimist, Pessimist or Realist?

David Kotok at Cumberland Advisors:

(…) Think about this question when the 5 largest stocks are 1/5 of total market weight and are in the highest beta sector.  Remember cash is zero beta: The S&P 500 index of all 500 stocks has a beta of 1; those 5 largest stocks have a beta above 1.5.

So far, this 2019–2020 stock market rally has been fierce. It started at the low point on Christmas Eve in 2018. Since then, the bias toward the large-cap tech sector has dominated the market. Consider that there are four companies with market caps above $1 trillion. They are Amazon, Apple, Microsoft, and Alphabet (Google). A fifth large-cap stock, Facebook, sits at a mere $700 billion. The total of the FAAMG stocks now equals about 19% of the market capitalization of the S&P 500 Index. The other 495 stocks make up 81% of that market cap. And the market cap-to-GDP ratio is the highest in the entire history of the American stock market while the profit share of that GDP is stagnant except for the benefit of the tax cuts.

The five FAAMG companies are all stellar business operations. They all have multidimensional and multinational business reach. They are all growing despite their enormous size.

So the question facing investors is not if these are viable companies, and not if they are making or losing money, and not if they have adequate capital. Those answers are “Yes!” The questions facing the investor are (1) how do I deal with momentum, and (2) how high is the price before it represents an extreme valuation.

Both questions are subject to robust debate. Please note that you could have had this debate months ago when the prices were lower. And also note that you may have it again months from now when prices may be higher. Pundits and analysts can talk and write all day long about risks and issues. They do not face the buy-sell-hold decisions that a professional money manager faces every single day.

In today’s world, the momentum issue is the most difficult one. We know momentum is powerful. We know it can continue for much longer than folks expect. We do not know when it will change, and we can only guess at the catalysts for change.

In today’s world a special factor is the policy of the world’s central banks. In the United States, the Federal Reserve has been expanding the size of its balance sheet and is maintaining interest rates at a very low level. The policy interest rate in the United States is below the various inflation rates, which means that the use of money (in real terms) is free. When that happens, asset price momentum is upward and will likely continue to be upward as long as money expands and the cost of money is next to zero.

In Europe and Japan, policy is expansive, and the cost of money is free or subsidized by negative interest rates. Remember, when the interest rate is negative, the theoretical asset price can go to infinity. With the usage of cross-currency interest-rate swaps, there is a clear transmission mechanism such that the negative rates in Europe and Japan end up raising asset prices in the United States.

In sum, this stock market is driven by momentum, and it is a force that must be respected. The market could go higher or much higher. It could stumble into a serious correction. We saw a 20% correction within the last two years. To be sure, this stock market could go both much higher and much lower in the coming year.

Meanwhile, we have some cash in reserve, and we are worried about the extended market behavior of FAAMG and its secondary effects on the broader indexes. Our ETF selection is defensive. Our quantitative strategies hold cash or defensive and lower-beta positions.

Twenty years ago, we faced a problem with the NASDAQ market top and the tech stock bubble. At that time (April 1, 2000), we wrote a piece entitled “Will the NASDAQ sell-off become a crash? A Value Perspective.” Here is a link to our archive. https://cumber.com/pdf/Cumberland-Advisors-April-2000-Will-the-NASDAQ-sell-off-become-a-crash.pdf. The circumstances today are different, and history never repeats itself exactly, though it often “rhymes.” We shall see.

All in one year:

U.S. Satisfaction Surpasses 40% for First Time Since 2005

Forty-one percent of Americans are satisfied with the way things are going in the U.S., a level not seen in nearly 15 years. (…)

The higher level of satisfaction measured in the Jan. 2-15 Gallup poll comes at a time when Americans’ evaluations of the U.S. economy are the best they have been in nearly two decades, perhaps because of continued low unemployment and record stock values. (…)

Consistent with this pattern, 72% of Republicans are currently satisfied with the way things are going in the U.S., compared with 14% of Democrats. Thirty-seven percent of independents are satisfied.

The five-percentage-point increase in overall satisfaction this month is primarily attributable to higher ratings among Republicans. Since last month, there has been a 14-point increase in Republicans’ satisfaction. Meanwhile, the percentage of independents who are satisfied is unchanged since December, and Democrats show a statistically nonsignificant two-point increase.

Since Gallup began measuring national satisfaction in 1979, 37% of Americans, on average, have been satisfied, meaning the current figure is just above the historical average. The highest satisfaction level Gallup has measured was 71% in February 1999.

The prolonged slump in satisfaction ratings since 2005 — with an average 27% satisfied — has brought the historical average down six points from where it stood in 2004.

One reason satisfaction readings have been lower in recent years is that those who identify with the party that does not occupy the White House have been extremely reluctant to say they are satisfied with how things are going in the country. Since 2005, on average, 11% of the opposition party’s supporters have said they were satisfied. Between 1992 (the earliest year for which Gallup compiled party data) and 2004, the opposition party’s satisfaction levels were three times higher, at 34%.

However, reflecting a broader discontent that has taken hold in the country, supporters of the sitting president’s party have also expressed lower satisfaction since 2005 (45%) than they did before (57%).