Jobs Data, Fed Shift Boost Markets U.S. stocks bounced back from their worst two-day start to a year since 2000, with the Dow gaining 747 points and the S&P 500 and Nasdaq rising more than 3% and 4%, respectively.
(…) Federal Reserve Chairman Jerome Powell said economic data suggest good momentum heading into the new year, but that the central bank is “prepared to adjust policy quickly and flexibly” if necessary. (…)
Allow me to retrace the sequence of events since Wednesday Dec. 19 post FOMC and Powell’s presser:
- The S&P 500 tanked 3.2% between 2:15 and 4:00pm on Dec. 19, as investors, 70% of which expected a rate hike that day, finally decided that “the Fed made a mistake in raising rates again in December amid credit-market cracks, a strong dollar, falling bond yields and commodity prices, and no signs of inflation. Mr. Powell had seemed almost cavalier at his press conference about rate increases and the steady decline in the Fed’s balance sheet.” (WSJ)
Many bears immediately started dancing on Hakuna Matata, seeing, as John Mauldin did, no signs of a Powell put in both the FOMC statement nor in Powell’s press conference:
He is also wicked smart, maybe even wicked brilliant. He didn’t stumble or mumble at his press conference. He was quite deliberate. He knew exactly what he was saying and I’ll bet you a dollar against 27 doughnuts he knew the market would react negatively. You cannot have his resume and not know exactly what the market would do given his quite careful press conference. (…)
This makes me think Powell is perfectly willing to walk away from that unofficial third mandate [safeguarding against financial asset declines]. Is he letting his inner Volcker show just a little bit? If so… damn, Skippy, it’s about time!
If Powell lets the markets fall and doesn’t crawdad on us without coming back and giving a speech essentially saying “I’m sorry, I really meant to be more dovish,”, then we will know he really wants to end the third mandate. That would make me stand up and applaud. Loudly and with enthusiasm. (…) (John Mauldin)
- The rout took another 6.8% off equities until 11:00am on Dec. 26 when an intra-day bear market (-20.3%) was registered.
- Equities erratically retraced 4.2% until Powell spoke again on the morning of Jan. 4 at the American Economic Association’s annual meeting, saying from prepared remarks that
- most of the data suggests that the U.S. economy remains quite solid
- rising wages are quite welcome and “for me, at this time, does not raise concerns about too high inflation”
- consumer spending was strong in December and U.S. data seems to be on track to sustain good momentum into the new year
- Chinese authorities are responding to the recent weakness with additional stimulus and China and the rest of emerging Asia should continue to expand at still solid pace this year.
He had said exactly the same on Dec. 19 save the Chinese part. Mauldin was standing up and ready to applaud.
Then, Powell crawdaded. The wicked brilliant Fed chair didn’t stumble or mumble confessing that he is indeed keeping an eye on financial markets which have “been sending different signals, signals about downside risks, about slowing global growth, particularly about China, about the on-going trade negotiations, about general policy uncertainty coming out of Washington…” The S&P 500 spiked 3.4% while John sank in his chair with his 27 doughnuts.
Powell explained that amid conflicting signals, monetary policy is “about risk management”:
- “as always, there is no preset path for policy, and particularly with the muted inflation readings that we have seen, we will be patient as we watch to see how the economy evolves. But we are always prepared to shift the stance of policy and to shift it significantly if necessary” as the FOMC did in early 2016 when it paused, watched the economy do a soft landing before getting back on track later in the year when normalization policy resumed.
In the Q&A, Powell reiterated that the Fed is “listening carefully and sensibly to markets concerns” and could go as far as altering the course of its balance sheet normalization process if the committee felt necessary.
In truth, Powell simply repeated what he had said on Dec. 19:
(…) our policy decisions are not on a preset course and will change if incoming data materially change the outlook. (…)
What kind of year will 2019 be? We know that the economy may not be as kind to our forecasts next year as it was this year. History attests that unforeseen events as the year unfolds may buffet the economy and call for more than a slight change from the policy projections released today. (…)
Powell admitted that the risk is clearly tilted to the downside, that the downside could be serious (“buffet”: to strike sharply) and would rapidly call for “more than a slight change from the policy projections”.
- I think we’ve reached the bottom end of the range of Committee estimates of what might be neutral. I think from this point forward, we’re going to be letting the data speak to us and form the outlook and form our understanding of what would be appropriate policy. So, there’s a fairly high degree of uncertainty about both the path and the ultimate destination of any further increases.
- We’re always data-dependent, but I think it has a particular meaning in this context.
What’s “this context”? Given the “robust economic backdrop and our expectation for healthy growth” amid “low and stable inflation”, “this context” can only be quickly slowing Europe and China, mainly due to Trump’s trade wars, and sharply lower oil prices, combined with high corporate debt and limited fiscal leeway. In reality, the Fed finds itself with really nothing to fight other than an economic contraction induced by sharply lower corporate spending amid trade wars and low oil prices.
He even went out of his way to proclaim that accelerating wages would not impact monetary policy:
- I do expect, and I think many forecasters expect, that wage increases will continue, and that would be a welcome development. Wage increases do not need to be inflationary. There’s plenty of evidence of situations, for example, in the very tight labor market of the late 1990s of a, I think in a mentioned in a speech a month or so ago, we had wage increases above productivity plus inflation. We didn’t have high inflation. So, it would be welcome. We hear a great deal of anecdotal information about labor shortages, along with other, you know, bottlenecks and things. So I would expect that wages will keep moving up, and it doesn’t necessarily mean inflation. We don’t think of it that way.
The only new info from Powell’s Atlanta complete crawdading is that the FOMC is fully prepared to stop shrinking its balance sheet, which many, like Mauldin, Rosenberg and Shilling, considered a worst evil than raising rates because it takes liquidity out of financial markets.
In a few minutes last Friday morning, the bearish story (Fed hiking, China sinking, liquidity sponging, excessive leverage) suddenly got an antithesis. Not only was December’s employment report totally bullish economically, but Powell announced his own put, wickedly clearly.
Now, let’s talk about this employment report which certainly also surprised Powell but not sufficiently to make him change the message he really wanted to make sure investors got right this time: the Fed still has your back, “particularly in this context”.
David Rosenberg also did not consider the “blowout job report” sufficient to make him shift “on any view, opinion, or forecast based on [Friday’s] report, as bullish as it looks on the surface”. In his usual thorough fashion, David more than scratched the surface and showed
a pretty wide divide between the headline and much of the details, which means this report does not pass the sniff test. Let’s wait to see any ratification in the January data before rushing to any conclusions in what looks like a spurious report littered with inconsistencies.
In all, we got the Powell put, loud and clear the same day that we learned that employment (+1.8% YoY) and wages (+3.2%) are accelerating, boosting nominal payroll earnings 5.1% when inflation is dipping towards 1.5%, pointing to real consumption expenditures in the 3.5% range during the most important period of the year, setting the stage for sustained manufacturing production during Q1’19 even amid trade wars.
However spurious December’s NFP report was, some facts remain rather encouraging:
- the last 3-month job gain averaged 254k, better than the 6-month (222k) and the full year (220k). There’s momentum there;
- revisions were quite positive, always a good sign;
- Markit’s U.S. PMI also revealed that “hiring also remains encouragingly buoyant. The December survey is indicative of non-farm payrolls growth of approximately 190,000, driven mainly by increased service sector job gains as firms boosted capacity in line with rising demand. (…) Despite a contraction in the level of outstanding business, service sector firms noted a solid rise in employment. The rate of job creation accelerated to a three-month high amid reports of shortages in capacity following a further increase in workloads.
Mr. Market will have to deal with conflicting thoughts in coming weeks:
- U.S. recession calls just became less credible, for now, thanks to strong employment data and a self-proclaimed benevolent Fed.
- Had equities not tanked in December, there is little doubt that the “data dependent” FOMC would have been even more determined to keep hiking given the latest data (strong Christmas sales, employment).
- Has Powell boxed the FOMC in Neverland? In both his Dec. 19 presser and on Jan. 4, he has been using the first person several times on some rather debatable issues.
- The “particular context” remains: trade wars, China, Brexit, Italy, leverage, shutdown, Mueller, etc…
To be clear, Powell did not say the Fed has or will soon pause. He said that the future course of policy is data dependent, which for now remains quite strong although “non-inflationary, for me, at this time”, but that “forward looking” markets must be listened too, especially in “this [complicated political] context” that requires the Fed to be carefully managing risks.
To try to be clearer 
, the recent good behavior of inflation and the decline in oil prices are providing unexpected “flexibility” to monetary policy while American, British, European, French, Chinese and Saudi Arabian politicians try to fix their respective globally reaching mess. Powell specifically mentioned the “general political uncertainty from Washington” just to be on the record and offset Trump’s attacks on the Fed. Nothing to secure investors in need of apparent coordination among policy makers and less uncertainty.
Will all the mess go away before March? 
Amid this circus, we must all hope that corporate America keeps delivering. Earnings really matter.
EARNINGS WATCH
Surprise! The Q4’18 earnings season has already begun. IBES/Refinitiv informs us that 17 companies have already reported their Q4 (October-November yearends): 94% beat rate and a +3.1% surprise factor lead to a +18.7% earnings growth rate. Very early but a good start nonetheless. Nine of the 17 companies are consumer-related, eight beat with a surprise factor averaging +6.1%.
IBES expects blended Q4 earnings up 15.5% (13.6% ex-Energy). Factset’s compilation shows Q4 earnings up 11.4%, noting that analysts cut the Q4 estimates by 3.8%, a larger cut than during the last 5 years (-3.1%) but less than in the last 10 years (-4.5%). But Factset then applies the average 4.8% beat of the last 5 years and calculates that the actual earnings growth in Q4 could be 16.1%.
Trailing EPS are now $162.62. They were $157.75 on December 30! To be closely monitored in coming days.
Refinitiv provides us with a nice detailed summary of S&P 500 earnings data. It calculates that the impact of the tax reform was to boost earnings by 9.5% to +23.8%. Pretax profits are seen up 13.1% in 2018 and are forecast up 6.3% in 2019 on a 5.6% revenue growth rate.
Note that analysts are incorporating a 100 bps gain in gross margins in 2019 which would protect pretax margins from rising wage and interest expenses. Wishful thinking? I would not hang my hat on that. Here’s Refinitiv’s David Aurelio’s conclusion:
Bottom-up EPS revisions data shows that analysts are slow to make revisions to annual estimates. This can be seen in the delayed upward revisions to 2018 and 2019 EPS estimates following tax reform and in the delayed downward revisions to 2007, 2008, and 2009 estimates. For example, analyst estimates for 2008 EPS declined by 0.4% from Jan. 1, 2007 to Dec. 1, 2007. Meaningful downward revisions did not occur until after companies started to report 2007 Q4 earnings. Over the course of that earnings season, 2008 earnings declined by 7.2% to $97.22 per share on Apr. 1, 2008, from $104.76 on Jan. 1, 2007.
Unfortunately, historical evidence that suggests analysts are slow to revise estimates combined with expectations for stable pre-tax profit margins and recent company guidance seems to favor the idea that the market is likely predicting the new year will see downward revisions to 2019 EPS estimates.
Add the cost minefields from trade wars, wages and the shutdown. Cases in point:
- The Apple miss blamed on the slowdown in China. Hmmm. Looks like a trade war prisoner to me (AMERICA CURSED). More to come?
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America’s Lost Markets The Pacific trade pact is up and running, and U.S. exporters are the losers.
The world turns even if America doesn’t. That’s certainly true on trade, where a rebranded Trans-Pacific Partnership has begun with the new year in 11 countries two years after President Trump withdrew. The biggest losers are American producers. (…) Despite the U.S. withdrawal, member economies still stand to make significant gains—some $147 billion in global income benefits, according to the Peterson Institute for International Economics. (…)
Canada is due for a larger GDP boost than if the U.S. had remained in the pact, and that comes largely at the expense of U.S. farmers who are likely to be edged out of Japanese markets. Tokyo’s regular 38.5% tariff on beef, which applies to the U.S., will fall to 9% for imports from Canada, New Zealand and Australia. Ottawa estimates total beef exports will increase 10% as a result.
U.S. Wheat Associates President Vince Peterson said in Washington last month that U.S. producers’ 53% market share in Japan risks “imminent collapse” upon implementation of the CPTPP. U.S. wheat exports to Japan will face an effective 40-cent a bushel price disadvantage with Canada and Australia.
The news isn’t much better for U.S. pork, as Europe exceeded American pork exports to Japan in dollar value in 2017 for the first time in a decade. An imminent EU-Japan free-trade agreement will increase the European advantage. U.S. pork exports to China also face a 62% duty from Beijing’s retaliation in response to Mr. Trump’s tariffs.
The President’s trade supporters say his tariffs are merely short-term costs that will lead to better trade deals. But withdrawal from TPP is a deadweight economic loss because it has led to no other trade concessions from anyone. (…)
(…) In the meantime, there are the really practical concerns of trade uncertainty, many of them very unpleasant, that are felt at the business and entrepreneurial levels. Markets and businesses prefer certainty in order to chart the future and to make plans. Uncertainty slows down business and puts people and markets into a wait-and-see mode of operation focused on risk management and capital preservation. Adding tariffs or even threatening more tariffs has specific short-term consequences, creating disruptions and costs that will ultimately reach the consumer in real ways. There are hundreds of anecdotes of the personal costs playing out now across many industries as a result of these trade uncertainties. (…)
Adding to the equation, the government shutdown means that Homeland Security agents are not able to perform their surveillance checks on the containers. Product is sitting in port (refrigerated, obviously), creating further delays in the resolution of the situation. This is a case where the government shutdown has actual business costs that are not just inconveniences to consumers and government workers. These types of anecdotes are stacking up across the spectrum of businesses with international and trade connections. (…)
Given the most recent jump in trailing EPS, slowing inflation and a major drop in equity prices, the S&P 500 Index now trades at 17.6x on the Rule of 20 scale (15.5x trailing “normal P/E”). The 15% undervaluation (compared to a 21.7% overvaluation in January 2018) from the “20” fair value of 2910 (was 2400 in January 2018 when the S&P 500 was 2850) is the highest since February 2013. The Rule of 20 P/E has been below 17.6x less than 25% of the time since 1957.
TECHNICALS WATCH
From CMG Wealth’s Trade Signals:
13/34–Week EMA Trend Chart
Volume Demand vs. Volume Supply
S&P 500 Index 200-day Moving Average Trend
A sell signal occurs when the 200-day MA price line drops from a high point by 0.5% or more. Current: –0.9%
NDR Crowd Sentiment Poll
NDR Daily Sentiment Composite
Source: Ned Davis Research
Bank of America Merrill Lynch’s Bull & Bear Indicator fell to 1.8, indicating “extreme bear,” triggering a buy signal for risky assets like stocks for the first time since June 2016 when markets were battered by Brexit headlines.
Lowry’s Research sees low odds for a real bear, saying that the “latest drop is little different from the S&P 500’s 16% loss in 2010 or the 19.4% drop in 2011. The bears also
cite the percentage of S&P Large, Mid and Small Cap stocks down 20% or more from their 52-week highs as evidence of a bear market. But, the percentages at the Dec. 24th 2018 low closely matched those at the Aug. 2011 market low. There were slightly more Large Caps down 20% or more on Dec. 24th, 70.08% vs. 66.6% in Aug. 2011, but fewer Mid and Small Caps, 77.25% vs. 85.35% and 83.35% vs. 85.51%. Yet, with losses similar to the recent percentage declines in the S&P 500 and in Large, Mid and Small Caps, few now define the 2011 decline as a bear market.”
Let’s not get stuck in semantics.
China’s central bank pours US$218-billion into the economy as growth slows
The People’s Bank of China on Friday said it would cut the amount of cash that banks must hold as reserves by 1 percentage point. The move will essentially free up 1.5 trillion Chinese renminbi (about US$218 billion), for an economy experiencing weaker factory output and consumer confidence while it weathers a trade war with the United States.
Market Swings Push Analysts to Revise 2019 Wall Street Forecasts With volatility showing no signs of letting up, some companies are reconsidering their projections for where major indexes will stand at the end of the year.
(…) Citigroup’s chief U.S. equity strategist, Tobias Levkovich, cut his year-end S&P 500 forecast to 2850 from 3100, citing a December selloff that dragged the broad index onto the edge of a bear market. BMO Capital Markets’ chief investment strategist, Brian Belski, also trimmed his forecast: He now sees the S&P 500 ending the year at 3000, down from 3150 previously. Similarly, Credit Suisse ’s chief U.S. equity strategist, Jonathan Golub, lowered his target to 2925 from 3350. (…)
2012 again? Looks like the American consumer is supporting the global manufacturing sector.
This a.m. from the 
Total nonfarm payroll employment increased by 312,000 in December, and the unemployment rate rose to 3.9 percent. The change in total nonfarm payroll employment for November was revised up from +155,000 to +176,000, and the change for October was revised up from +237,000 to +274,000. With these revisions, employment gains in October and November combined were 58,000 more than previously reported. After revisions, job gains have averaged 254,000 per month over the last 3 months (full year average: +216k).