As we witnessed over the weekend, the Caribean and Florida took a beating from Hurricane Irma, and its impact is going to be a major source of weakness in the economy for the current quarter. Paired with the impact of Hurricane Harvey, we’re looking at one-two punch to the GDP gut and we expect existing GDP forecasts for 3Q 2017 will be revised sharply lower in the coming days. That’s enough to rattle the market, but there are other reasons investors should be increasingly cautious. Last week, when speaking at a conference in Germany, Goldman Sachs (GS) CEO Lloyd Blankfein shared that he was “unnerved” by things going on in the stock market. As we’ve been analyzing the economic data and watching the political landscape in Washington, we here at Tematica have been talking about a growing sense of unease in the market over the last several months. Yet, the market has at least thus far managed to shrug these mounting concerns off its proverbial shoulders.
In today’s increasing frenetic society, short attention span filled society sometimes it takes a “voice from on high” to catch people’s attention and wake them up. All it took was a short comment from Blankfein during the question and answer session of his presentation at a conference in Germany:
We certainly share Mr. Blankfein’s concerns and have been hammering the points home weekly in our Monday Morning Kickoff report and the Cocktail Investing Podcast. To fully understand the source of Mr. Blankfein’s current unease let’s explore his statement:
#1: “Things have been going up for too long.”
While there have been modest pullbacks in the market, like the ones in late 2014 and the second half of 2015, a longer view shows the major averages have moved sharply higher over the last five years, with the S&P 500 in the upper range of its long-term upward trend. Before factoring in dividends, the S&P 500, a key benchmark of institutional investors, is up more than 70% since September 2012.
More recently, the S&P 500 has gone more than 300 trading days without a 5% or more pullback, the longest such streak since July 19, 1929. For those wondering, the record still sits at 369 trading days per Dow Jones data. Historically speaking periods of suppressed volatility tend to be followed by periods of heightened volatility, as market volatility reverts back to its mean. Given the extended period of low volatility, the probability of entering a period of heightened volatility moves higher.
As the stock market has moved higher, so too has its valuation. As we write this, the S&P 500 is trading at 18.7x expected 2017 earnings versus the 5 and 10 year average multiples of 15.5x and 14.1x, respectively. In 2015 and 2016, we saw earnings expectation revised lower during each year until annual EPS growth was nil. With economic data that is once again leading the Atlanta Fed to reduces it GDP forecast, we’re seeing downward earnings revisions to EPS expectations in the back half of 2017. We at Tematica classify that as “unnerving.”
#2: The Current “Recovery” is Now Over 100 Months
If we look back to when the stock market bottomed out during the Great Recession, the timeframe for the current “recovery” has been over 100 months. By comparison, the average economic expansion over the 1945-2009 period spanned 58.4 months. In other words, the current expansion is rather long in the tooth and a variety of data points ranging from slowing growth in employment to peak housing and auto to a flattening yield curve support this assessment. While the length of expansion has likely been affected by the Fed’s aggressive monetary policy, the bottom line is at some point
While the length of expansion has likely been affected by the Fed’s aggressive monetary policy, the bottom line is at some point it will come to an end. As the Fed looks to unwind its balance sheet and gets interest rates closer to normalized levels, we’re reminded that the Fed has a track record of boosting interest rates as the economy heads into a recession. Let’s not forget that every new presidential administration coming in after a two-termer going all the way back to 1900 has experienced a recession within the first twelve months. Yep, we color that as “unnerving.”
#3: The Market’s Post-Election Euphoria Has Worn Off
Coming into 2017 there was a wave of euphoria surrounding newly elected President Trump with high hopes concerning what his administration would accomplish. Over the last few months, a number of executive orders have been administered, but we have yet to see any progress on tax reform or infrastructure spending. The risk is that expectations for these initiatives are once again getting pushed out with tax reform that was slated for August now being expected (don’t hold your breath) near the end of 2017. The risk is the underlying economic assumptions that powered revenue and EPS expectations in the second half need to be reset, which will mean those lofty valuations are even loftier.
#4: Precious Metals Are Gaining Strength
Since August 1, Gold, Silver and the Utilities sector have significantly outperformed financials and consumer discretionary stocks – never a positive sign. The KBW index of regional banks has fallen below is 50-day, 100-day and 200-day moving averages and is down over 18% from its March 1st
#5: The Breadth of Current Rally Isn’t Looking So Hot
The median Dow stock is down more than 4% from its 52-week high and the median S&P 500 stock has dropped nearly 7.5%. Only 44% of Nasdaq members are trading above their 50-day moving average.
#6: Another Contra-Indicator Has Reared its Head — Individual Investor Confidence
TD Ameritrade’s (AMTD) Investor Movement Index (IMX) has continued its month-over-month rise. For those unfamiliar with this, it’s a behavior-based index created by TD Ameritrade that aggregates Main Street investor positions and activity to measure what investors are actually doing and how they are positioned in the markets. The higher the reading, the more bullish retail investors are. In August, the IMX hit 7.45, up from 7.09 in July, to hit an all-time high.
Why is that unnerving you ask?
While TD Ameritrade opted to put a rosy spin on the data, saying, “Our clients’ decision to continue buying reflects the resiliency of the markets.” Institutional investors, however, see this continued surge higher as a warning sign. Here’s why: Historically speaking, retail investors have been late to the stock market party. Not fashionably late, but really late, which means they tend to enter at or near the point at which things start to go seriously awry.
Complicating things a bit further, over the last month CNNMoney’s Fear & Greed Index has slumped from a Neutral reading (52) to Fear (38). Taking stock (pun intended) of these two indicators together at face value sends a mixed message on investor sentiment. Not a hardcore piece of data like the monthly ISM data, but one institutional investors and Wall Street traders are likely to consider as they roll up their sleeves and revisit the last few weeks of data.
How to Know What’s Next
These are just some of the points that could be unnerving Blankfein. Generally speaking, the stock market abhors uncertainty and anyone of those points on their own would be a cause for concern. Taken together they are reasons to be cautious as we move deeper into September, which is historically one of the most tumultuous months for stocks.
Whether you’re a subscriber to Tematica Investing or not, we would recommend you subscribe to both our Monday Morning Kickoff and Cocktail Investing Podcast to get our latest thoughts on the economy, the stock market as well as thematic signals that power our 17 investing themes.
Despite yesterday’s move higher in the stock market, March to date has seen the Dow Jones Industrial Average move modestly lower with a larger decline in the Russell 2000. Only the Nasdaq Composite Index has climbed higher in March, bringing its year to date return to more than 9 percent, making it the best performing index thus far in 2017. By comparison, the Dow is up 4.75 percent, the S&P 500 up 5.35 percent and the small-cap heavy Russell 2000 up just 0.75 percent year to date.
So what’s caused the move lower in the stock market during March, bucking the upward trend the market enjoyed since Election Day 2016?
Despite the favorable soft data like consumer confidence and sentiment readings, investors are waking to the growing disconnect between post-election expectations and the likely reality between domestic economic growth and earnings prospects. Fueling the realization is the move lower in 1Q 2017 earnings expectations for the S&P 500, per data from FactSet, as well as several snafus in Washington, including the pulling of the vote for the GOP healthcare plan. These have raised questions about the timing and impact of President Trump’s stimulative policies that include infrastructure spending and tax reform.
We’ve been steadfast in our view that the earliest Trump’s policies could possibly impact the US economy was late 2017, with a more dramatic impact in 2018. On a side note, we agree with others that would have preferred to have team Trump focus on infrastructure spending and tax reform ahead of the Affordable Care Act. As we see it, focusing on infrastructure spending combined with corporate tax reform first would have boosted confidence and sentiment while potentially waking the economy from its 1.6 to 2.6 percent annual real GDP range over the last five years sooner. We’d argue too that that would have likely added to Trump’s political war chest for when it came time to tackle the Affordable Care Act. Oh well.
So here we are and the enthusiasm for the Trump Trade is being unraveled as growth slows once again. As depicted above, the most recent forecast for 1Q 2017 GDP from the AtlantaFed’s GDPNow sits at 1.0 percent compared to 1.9 percent for 4Q 2016 and 3.5 percent in 3Q 2016. Even a grade school student understands the slowing nature of that GDP trajectory. Despite all the upbeat confidence and sentiment indicators, the vector and velocity of GDP forecast revisions and push outs in the team Trump timing has led to to the downward move in S&P 500 EPS expectations for the current quarter and 2017 in full.
With Americans missing bank cards payments at the highest levels since July 2013, the delinquency rate for subprime auto loans hitting the highest level in at least seven years and real wage growth continuing to be elusive, the outlook for consumer spending looks questionable. Factor in the aging of the population, which will have additional implications, and it looks like the consumer-led US economy is facing more than a few headwinds to growth in the coming quarters. These same factors don’t bode very well for the already struggling brick & mortar retailers like Macy’s, Sears, JC Penney, Payless and others.
Now here’s the thing, currently, the S&P 500 is trading at 18x 2017 expectations —expectations that are more than likely to be revised down than up as the outlook for U.S. economic growth in the coming quarters is revisited. In three days, we close the books on 1Q 2017 and before too long it means we’ll be hip deep in corporate earnings reports. If what we’ve seen recently from Nike, FedEx, General Mills, Kroger and Target is the norm in the coming weeks, it means we’re more likely to see earnings expectations revised even lower for the coming year.
While it’s too early to say 2017 expectations will be revised as steeply as they were in 2016, (which started the year off with the expectation of a 7.6 percent increase year over year but ended with only a 0.5 percent increase following 4Q 2016 reporting), but any additional downward revisions will either serve to make the market even more expensive than it currently is or lead to a resumption of the recent downward move in the market. Either way, odds are there is a greater risk to the downside than the upside for the market in the coming weeks.
Buckle up; it’s bound to get a little bouncy.
While higher interest rates might be a positive for financials, at the margin, however, it comes at a time when credit card debt levels are approaching 2007 levels according to a recent study from NerdWallet. The bump higher in interest rates also means adjustable rate mortgage costs are likely to tick higher as are auto loan costs, especially for subprime auto loans. Even before the rate increase, data published by S&P Global Ratings shows US subprime auto lenders are losing money on car loans at the highest rate since the aftermath of the 2008 financial crisis as more borrowers fall behind on payments. If you’re thinking this means more problems for the Cash-strapped Consumer (one of our key investment themes), you are reading our minds.
In 4Q 2016, the rate of car loan delinquencies rose to its highest level since 4Q 2009, according to credit analysis firm TransUnion (TRU). The auto delinquency rate — or the rate of car buyers who were unable make loan payments on time — rose 13.4 percent year over year to 1.44 percent in 4Q 2016 per TransUnion’s latest Industry Insights Report. That compares to 1.59 percent during the last three months of 2009 when the domestic economy was still feeling the hurt from the recession and financial crisis. And then in January, we saw auto sales from General Motors (GM), Ford (F) and Fiat Chrysler (FCAU) fall despite leaning substantially on incentives.
Over the last six months, shares of General Motors, Ford, and Fiat Chrysler are up 8 percent, -2.4 percent, and more than 70 percent, respectively. A rebound in European car sales, as well as share gains, help explain the strong rise in FCAU shares, but the latest data shows European auto sales growth cooled in February. In the U.S., according to data from motorintelligence.com, while General Motor sales are up 0.3 percent for the first two months of 2017 versus 2016, Ford sales are down 2.5 percent, Chrysler sales are down 10.7 percent and Fiat sales are down 14.3 percent.
In fact, despite reduced pricing and increasingly generous incentives, car sales overall are down in the first two months of 2017 compared to the same time in 2016.
So what’s an investor in these auto shares to do, especially if you added GM or FCAU shares in early 2016? The prudent thing would be to take some profits and use the proceeds to invest in companies that are benefitting from multi-year thematic tailwinds such as Applied Materials (AMAT), Universal Display (OLED) and Dycom Industries (DY) that are a part of our Disruptive Technology and Connected Society investing themes.
Currently, GM shares are trading at 5.8x 2017 earnings, which are forecasted to fall to $6.02 per share from $6.12 per share in 2016. Here’s the thing, the shares peaked at 6.2x 2016 earnings and bottomed out at 4.6x 2016 earnings last year, which tells us there is likely more risk than reward to be had at current levels given the economic and consumer backdrop. Despite soft economic data that shows enthusiasm and optimism for the economy, the harder data, such as rising consumer debt levels paired with a lack of growth in real average weekly hourly earnings in February amid a slowing economy, suggests we are more likely to see GM’s earnings expectations deteriorate further. And yes, winter storm Stella likely did a number of auto sales in March.
Subscribers to Tematica Pro received a short call on GM shares on March 16, 2017
As the stock market continued to get further and further out over its ski tips last week, as investors we have a split mind on the current state of things. On the one hand, we’re certainly enjoying the higher stock prices. On the other hand, we are mindful of the increasingly stretched market valuation. One of the common mistakes see with investors is they all too easily enjoy the gains, but tend not to be mindful of the risks that could wash those gains away.
Over the last few weeks, we here at Tematica have been pointing out the growing disconnect between the stock market’s valuation and the current economic environment. We have a snootful of data points that underscore our cautious stance in this week’s Monday Morning Kickoff, but we wanted to share two charts from our weekend reading that caught our cautious eye.
There have been some who call into question the use of Robert Schiller’s Cyclically Adjusted Price to Earnings (CAPE) ratio, but Tematica’s Chief Macro Strategist Lenore Hawkins does a pretty good job handling that criticism. Exiting last week the CAPE to GDP growth of 19.77 has far surpassed the 1999 peak and all points back to at least 1950. As we like to say when looking at data, context and perspective are key to truly understanding what it is we’re looking out. So here’s that context and perspective for the current CAPE to GDP reading — it is over three times the average for the last 66 years. Going back to 1900, the only time today’s ratio was eclipsed was in 1933 and that reflected the Great Depression when GDP has been running at close to zero for nearly a decade.
Students of CAPE will point out that in order for the CAPE to GDP to fall back to more normalized levels, we either need to see a dramatic increase in GDP (not likely in the near-term) or we need to see a pullback in the CAPE. Here’s the thing, as Michael Lebowitz of 720 Capital points out, “if we assume a generous 3% GDP growth rate, CAPE needs to fall to 18.71 or 35 percent from current levels to reach its long-term average versus GDP growth.” Based on the data we’re seeing, there is a rather high probability 2017 GDP is more likely to be closer to 2.5 percent than 3.0 percent per The Wall Street Journal’s Economic Forecasting Survey of more than 60 economists, which means to hit normalized levels, the CAPE would need to fall further than 35 percent.
As you ponder that and think on why it has us a tad cautious, here’s more food for thought:
Coming into 2017, forecasts called for the S&P 500 group of companies to grow their collective earnings more than 12 percent year over year, marking one of the strongest years of expected growth in some time. Granted energy companies are likely to be more of a contributor than detractor to earnings growth this year, but we as can be seen by the graph above, earnings expectations for the S&P 500 are already coming down for the current quarter. Those revisions now have year over year EPS growth for the collective at up just over 10 percent.
Are we getting data that shows the current quarter isn’t likely to break out of the low-gear GDP we’ve been seeing for most of the last few years?
Are earnings expectations for 2Q-4Q 2017 still calling for 8.5 to 12.5 percent earnings growth year over year?
Is it increasingly likely that President Trump’s fiscal policies won’t have a dramatic impact until late 2017 and more likely 2018?
Yep and yep.
The bottom line is we have the stock market melting higher, pulling a Stretch Armstrong-like move in terms of valuation even though earnings expectations for 2017 are starting to get trimmed back.
Yep, you can color us cautious at least for the near-term. While we continue to use our thematic foresight to ferret our companies poised to ride several of our thematic tailwinds, the current market dynamic has us being far more selective.
If you’ve missed our weekly Monday missive that is the Monday Morning Kickoff, we’d encourage you to pursue it later today as it offers both context and perspective on last week, including much talk about the Fed, and sets the stage for this week. We’ve got a lot of data coming at us, more corporate earnings that prominently feature our Cash-strapped Consumer and Fattening of the Population investing themes. There are a number of events and conferences as well, and before too long we’ll have some thoughts on this week’s Mobile World Congress, an event that meshes very well with our Connected Society, Disruptive Technology and Cashless Consumption investing themes. We expect to see a number of announcements ranging from new smartphone models, connected as well as autonomous vehicle developments, voice digital assistant initiatives, drones, and payment systems to name a few. We’ll be watching these with regard to a number of positions on the Tematica Select List,
As Mobile World Congress gets underway, however, we have another event that should capture investor attention. After presenting what’s called a “skinny budget” today, (which we view as the “opening bid budget”) tomorrow night, President Trump will be speaking to a joint session of Congress. Typically this is referred to as the State of the Union Address, but it’s not called that for a newly elected president. Trump has already shared that he will be talking about health care reform – “We’re going to be speaking very specifically about a very complicated subject…I think we have something that is really going to be excellent.”
As we’ve said before, we’re optimistic and hopeful, but thus far it seems Republicans have yet to find common ground on which to move forward on this. In addition to healthcare reform, investors, including us, will be listening for more details on Trump’s fiscal policies. The issue is speeches such as this tend to be lacking in specifics, and we would be rather surprised to see Trump deviate from that tradition. Moreover, we’ve already seen the Treasury Secretary push out the timetable for a tax report to late summer, and Trump himself suggested that we are not likely to see his tax reform proposal until after the healthcare reform has been addressed.
As we shared in this morning’s Monday Morning Kickoff, with the S&P 500 trading at 18x expected earnings, it looks like the stock market is out over its ski tips. Two drivers of the market rally over the coming months have been the improving, but not stellar economic data and the hope that President Trump’s policies will jumpstart the economy. We’ve been saying for some time that the soonest we’d likely get any meaningful impact from Trump’s policies would be the back half of 2017. That’s been our perspective, but as we know from time to time, the stock market can get ahead of itself, and we see this as one of those times. The stock market’s move reflects expectations for an accelerating economy – it’s the only way to get the “E” that is earnings growing enough to make the market’s current valuation more palatable.
One of the common mistakes we see with investors is they almost always only focus on the upside to be had, without keeping an eye on the downside risks. If Trump is successful when it comes to the domestic economy, and we’d love nothing more than to see acceleration here, earnings will likely grow materially.
One of the potential risks we see this week is the market being disappointed by the lack of details that Trump will share tomorrow night, which might be read as a push out in timing relative to what the stock market expects. As we said on last week’s Cocktail Investing podcast, resetting expectations is a lot like children that open presents on Christmas morning to find something other than what they expected — it’s far from a harmonious event and more like one that is met with mental daggers, confusion, and second guessing. In short, not a fun time at all.
Again, our thought is better to be safe than sorry given where the market currently sits. Some investors may want to utilize stop losses across positions like Universal Display (OLED), CSX Corp. (CSX), Skyworks Solutions (SWKS), Activision Blizzard (ATVI) and others that have been robust performers thus far in 2017 in order to preserve gains should the stock market get its post-Trump speech jiggy on. More aggressive investors may wish to utilize inverse ETFs, such as ProShares Short S&P500 ETF (SH), ProShares Short Dow30 ETF (DOG), or ProShares Short QQQ (PSQ), while traders implement call options on those inverse ETFs or employ the use of select puts.