Did you miss yesterday’s post: DEEP INTO THE TWILIGHT ZONE
Conference Board’s Leading Indicators Index Rises Again The Conference Board’s leading economic index jumped again in January, a sign that the U.S. economy could continue growing in the first half of this year.
The Conference Board’s leading economic index rose 0.6% last month, accelerating from a 0.5% clip in December and 0.2% growth in November.
January’s gain was broad-based across the indicators. Ataman Ozyildirim, director of business cycles and growth research at The Conference Board, said the U.S. economy may accelerate in the near term.
The board’s coincident index—designed to reflect current economic conditions and made up of four data points including nonfarm payrolls—rose 0.1% last month after being up 0.3% in December.
The index of lagging indicators rose 0.3% in January after growing 0.5% in December.
- The Conference Board:
In the six-month period ending January 2017, the leading economic index increased 1.6 percent (about a 3.3 percent annual rate), much faster than the growth of 0.9 percent (about a 1.8 percent annual rate) during the previous six months. In addition, the strengths among the leading indicators have become more widespread.
While the absolute change in the Leading Indicator was certainly positive, we prefer to look at how the Leading Indicator performs relative to the coincident indicator index. The level of this reading isn’t particularly important but its direction is a very good advance warning of approaching recessions. As shown in the chart below, the ratio between the Leading and Coincident Indicators tends to drop sharply immediately before and during a recession. Over the last few months, the ratio has started to turn upwards again after a period of stagnation since the post-recession high print of 1.098 in June 2015. A new high print, which looks quite likely after the 1.097 level printed this month, would be an indicator that recession isn’t likely in the near term. With a number of other pieces of economic data suggesting a ramp up in business activity and consumer spending, the Leading/Coincident Indicator ratio adds to the case that a recession in US economic activity is still nowhere close.
Economic Outlook from Freight’s Perspective – Two Green Lights
Both the Shipments and the Expenditures Indexes have now turned positive. Throughout the U.S. economy, there is a growing number of data points that suggest that the worst is over and the economy is getting better. Some data points are simply less bad, but an increasing number of them are better, and even a few are becoming outright strong.
The 3.2% increase in the January Cass Shipments Index is yet another data point which strongly suggests that the first positive indication in October may have indeed been a change in trend. In fact, it now looks as if the October index, which broke a string of 20 months in negative territory, was one of the first indications that a recovery in freight had begun in earnest. (…) the overall freight recession which began in March 2015 appears to be over.
There is normal seasonality at work, and we are continuing to get daily reports of stronger shipment volume in almost all modes from both hard data sources and industry anecdotes. It also looks far less troubling when compared to the seasonality in 2013, 2014 and 2015. Not only was January 2017 higher than last year, but it was stronger than January 2014 and almost as strong January 2015, both of which fell further from higher summer/fall peaks.
The strength in European airfreight gives us increasing confidence that the improving trends in the freight economy are not confined to the U.S. We should also point out that historically, strength in this index has been followed by a stronger European PMI. Simply put, it looks as if the European economy is also improving.
The recent strong surge in Asia Pacific airfreight gives us increasing confidence in the technology segment of the global economy – not because everything that moves in this lane is a semi-conductor, but because the largest overall segment/type of good that is moved via airfreight in this lane has one or more semi-conductors in it. Hence, there historically has been a high level of correlation between Asia Pacific airfreight and semi-conductor billings.
INFLATION WATCH
From The Daily Shot:
Russia Overtakes Saudi Arabia as World’s Top Crude Oil Producer
Saudi Arabia Breaks Records on Oil Exports and Output for Year
EARNINGS WATCH
Overall, 82% of the companies in the S&P 500 have reported earnings to date for the fourth quarter. Of these companies, 66% have reported actual EPS above the mean EPS estimate, 11% have reported actual EPS equal to the mean EPS estimate, and 22% have reported actual EPS below the mean EPS estimate. The percentage of companies reporting EPS above the mean EPS estimate is below the 1-year (71%) average and below the 5-year (67%) average.
In terms of revenues, 53% of companies have reported actual sales above estimated sales and 47% have reported actual sales below estimated sales. The percentage of companies reporting sales above estimates is above the 1- year average (52%), but equal to the 5-year average (53%).
In aggregate, companies are reporting earnings that are 2.9% above expectations. This surprise percentage is below the 1-year (+4.4%) average and below the 5-year (+4.2%) average.
The blended (combines actual results for companies that have reported and estimated results for companies that have yet to report) year-over-year earnings growth rate for Q4 2016 is 4.6% today, which is above the estimated earnings growth rate of 3.1% on December 31. The downside earnings surprise reported by AIG was mainly responsible for the decline in the overall earnings growth rate during the past week.
The blended sales growth rate for Q4 2016 is 5.0% today, which is slightly above the estimated sales growth rate of 4.9% on December 31.
At this point in time, 90 companies in the index have issued EPS guidance for Q1 2017. Of these 90 companies, 61 have issued negative EPS guidance and 29 have issued positive EPS guidance. The percentage of companies issuing negative EPS guidance is 68%, which is below the 5-year average of 74%.
On guidance, IT companies provided 31 of the 90 warnings with 17 of the 31 being positive. Ex-IT, 47 of the 59 companies providing guidance have guided negatively (80%).
AIG’s Q4’16 results included a huge $5.6 billion charge from “prior year adverse reserve development”. Given AIG’s business, this is clearly an operating loss but investors and aggregators need to consider it company-specific. It is not a one-time charge: AIG reported a $60 billion charge in Q4’18 which totally blinded many people in 2009 if they failed to consider it company-specific. Remember that AIG’s losses then subtracted $5.13 to S&P 500 quarterly earnings even though AIG only represented 0.02% of the Index (this is partly why the CAPE valuation model, still to this day because it uses trailing 10-year earnings, significantly underestimated earnings throughout the bull market (The Shiller P/E: Alas, A Useless Friend).
I calculate that AIG’s latest charge reduces S&P EPS by $0.65 per share; this only 2.1% of the quarterly total, a far cry from 2008 when it shaved some 10% off the index “normalized” EPS. Some aggregators will treat this charge as operating which is technically correct but rather useless when valuing the entire S&P 500 Index. The ultra conservative S&P Capital IQ now has total 2016 EPS at $106.86, 10.2% lower than Factset and Thomson Reuters/IBES which carry $119.04 and $118.47 respectively. I have been using TR’s numbers during the last 2 years because I think they best represent fundamental Index trends. Estimates for 2017 are all converging to $130.
Goldman: ‘Cognitive dissonance exists in the US stock market’
Goldman Sachs analysts believe investors and traders in the stock market are acting irrationally.
“Cognitive dissonance exists in the US stock market,” Goldman Sachs’ David Kostin said. “S&P 500 is up 10% since the election despite negative [earnings per share] revisions from sell-side analysts.”
Earnings and expectations for earnings growth are the most important drivers of stock prices in the long run. In the short run, however, earnings and prices will often diverge.
“Investors, S&P 500 management teams, and sell-side analysts do not agree on the most likely path forward,” Kostin continued. “On the one hand, investors, corporate managers, and macroeconomic survey data suggest an increase in optimism about future economic growth. In contrast, sell-side analysts have cut consensus 2017E adjusted EPS forecasts by 1% since the election and ‘hard’ macroeconomic data show only modest improvement.” (…)
“Sell-side analysts appear hesitant to incorporate potential tax reform and deregulation into their estimates given elevated policy uncertainty,” Kostin said. (…)
“We are approaching the point of maximum optimism regarding policy initiatives,” Kostin said. “We expect investors will soon de-rate their expectations of potential 2017 EPS growth as they face the reality that the accretive impact from tax reform will not occur until 2018.” (…)
Hedgopia has this chart showing elevated price to sales on the S&P 500 Index:
Rising price/sales is not necessarily a bad thing, as long as profit margins are also rising. Since the 2014 peak in margins, the P/S ratio has lifted 8% while margins declined also 8%. This 16% gap will need to be closed somehow…
SENTIMENT WATCH
Morgan Stanley Says Markets Are Underpricing the Risk of a Plunge and Surge
Investors might have forgotten that in any given year, there’s almost a one-in-five chance of a 15 percent tumble in American stocks, according to Morgan Stanley. (…)
“The risk of a severe equities decline over the next 12 months is about average,” the Morgan Stanley analysts wrote in a Feb. 20 note. “Many assume it is lower. At the same time, we also see a credible bull case centered on more greed, and animal spirit, in the near term. Credit underprices the former, while equity volatility underprices the latter.” (…)
The analysts looked at a variety of indicators to determine the risk of a significant sell-off in U.S. stocks, including economic indicators such as jobless claims and housing data along with market prices including the cost of oil. Analyzing data since 1950, the chance of a 15 percent drop of the S&P 500 within a 12-month period is 18 percent, they wrote.
BAML’s Hartnett Sees Additional “Melt-Up” In Stock Prices
(…) To develop its thesis, Hartnet and his team note foundational pillars of analysis:
1. Structural market changes are more important than ever. Flow and positioning data help identify the impact of new market entrants, newly active participants (e.g. risk parity and quantitative funds), and the increasing prevalence of cross-asset mandates
2. It’s better to be buying. Our research shows that measuring fear is easier than measuring greed, and that market tops tend to be a process, whereas market bottoms form quickly. As a result, “buy” conditions are often more visible than occasions to “sell short” in our view.
Point #1 suggests that this time is different…yeah! Sure.
Point #2 advises to “keep buying; we can’t really measure the extent of the current overvaluation but we do understand the process and we will surely tell you when to get out.”
In the meantime, you could take read DEEP INTO THE TWILIGHT ZONE to look at measures of greed and fear and analyse these charts to acquaint yourself with the “process” in case your friendly broker is away on a cruise at the crucial time.
There are alternate ways to measure greed and fear as these Yardeni charts show:
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Trump Team’s Growth Forecasts Far Rosier Than Those of CBO, Private Economists The Trump administration has drafted preliminary economic growth forecasts in its federal budget planning that rely on assumptions that are far rosier than projections made by independent agencies and most private forecasters, according to several people familiar with the discussions.
(…) The deliberations show the challenge the administration faces as it tries to reconcile the competing goals of cutting taxes, boosting military and infrastructure spending, preserving Medicare and Social Security programs and keeping budget deficits from soaring. (…)
The economy has grown around 2% on average over the past decade. Many economists believe sustained growth at more than 3% will be difficult to achieve without a sharp rebound in productivity growth and a reversal in the slowing expansion of the U.S. labor force, developments few are projecting. Worker productivity growth has slowed to 0.7% a year since 2010, a sharp slowdown from rates exceeding 3% in the late 1990s and early 2000s.
The internal Trump projections are at odds with other assessments of the economy’s long-run growth prospects. The Congressional Budget Office, a nonpartisan agency that provides analysis to Congress, estimates the economy will grow 1.9% annually between 2021 and 2027. The Federal Reserve forecasts growth of 1.8% over the long run. (…)
“It is awfully hard to get to 3%. I don’t know where a number like that would come from,” said Dale Jorgenson, a Harvard economics professor who specializes in such projections. Mr. Jorgenson’s most recent forecasts show an economy growing by 1.8% annually over the next decade. That’s in part because the labor force is aging, meaning there are fewer workers to produce goods and services, and because the educational attainment of the workforce has plateaued, meaning workforce skills aren’t advancing. Major policy changes such as a tax-code overhaul could boost growth to 2.4%, he said.
Trump officials believe a regulatory rollback and a tax-code revamp will unleash growth that drives a recovery in productivity, sends business investment higher and draws idled workers back to the labor force. They also assume interest rates would remain low because the U.S. would become a more attractive place to park money. (…)
Republicans in Congress won’t be able to rely on such estimates when they produce a budget resolution for the coming fiscal year because they use estimates from the CBO. (…)
Republicans and Democrats in prior administrations said presidents have typically been hesitant to produce implausibly glowing projections because it could weaken their credibility with Congress and the public. (…)
- From Politico
(…) Ryan spent at least a half-hour explaining why the border adjustment is essential. But multiple GOP senators told POLITICO they felt his talk was too wonkish and hard to follow. Some bristled at being told to keep their “powder dry” while Ryan is aggressively campaigning for the tax.
“I heard ‘keep your powder dry’ as, ‘Don’t articulate your cogent arguments against our bad idea,’” one senator said. “I have not yet talked to a single senator who’s enthusiastic about it. Ryan and [Ways and Means Chairman Kevin] Brady seem to have a near-theological commitment to it.”
At the Senate GOP lunch a week earlier, former Sen. Phil Gramm of Texas blasted the border adjustment tax idea. His arguments were easier to follow and resonated with many of his ex-colleagues, attendees said.
“To me he made more sense,” said Sen. Jim Inhofe (R-Okla.), contrasting Gramm’s presentation with Ryan’s. (…)
(…) the prospects in the Senate, at this point, appear grim.
TREAT YOURSELF
- Warren Buffett documentary on HBO: video
- Snapchat analysis: I don’t normally get into specific stocks but here’s a well done, informative and impartial analysis by Aswath Damodaran, Professor of Finance at the Stern School of Business at NYU: My Snap Story: Valuing Snap ahead of it’s IPO!
787: Made in USA?
