Weekly Update: Earning it
With European central bankers acting to calm nerves over a Portuguese flare-up (more below), and with this morning’s better-than-expected jobs report keeping September tapering talk on the front-burner (more below), the next big catalyst for the market may be second-quarter earnings that kick off Monday with Alcoa. Thomson Reuters says the preannouncement period is on track to be the most negative in more than 12 years. Downward guidance also has lowered 2013’s second-quarter earnings growth rate to 3.0% from the 8.4% estimate at the beginning of the year. Estimates are even bleaker for top-line revenues. According to Thomson Reuters, the S&P’s aggregate revenue growth rate was 0.0% in the first quarter, and the consensus is looking for 1.8% growth in the second quarter, down from January’s estimate of 3.9%. Companies are compensating by actively buying back shares. But this does not compensate for real earnings. On a positive note, Bank of America says the three-month earnings revision ratio stands at 1.0 vs. the long-term average of 0.8, indicating analysts are revising up as many estimates as they are revising down. The three-month sales forecast revision ratio also improved a fourth straight month in June. Given that sales growth has remained anemic, a sustained improvement in this ratio would be very positive.
On the other hand, the three-month management guidance ratio suggests management is guiding below consensus more than twice as much as above. More concerning is management went silent last month—instances of guidance by S&P companies were the lowest ever for June. A lack of guidance is generally worrisome and suggests an environment of heightened uncertainty, though a similar situation occurred ahead of the last two earnings seasons, when earnings ultimately surprised to the upside and the S&P rallied to new highs. Uncertainty and volatility are common in thinly traded markets because big buyers or sellers can more easily move prices. Dudack Research notes the best and steadiest bull market trends are those with broad household participation, a characteristic that recent fund flows suggest is not the case. Markets driven more by external, or geopolitical, factors also tend to be more volatile than markets driven primarily by economics and fundamentals. The first half of 2013 was a relatively calm and non-political period of time. The second half has quickly become dominated by discussions of Fed policy and global issues.
The S&P gained 10% in this year’s first quarter and 12.6% in the first half—the best first-half performance since 1998, when the S&P gained 16.8%. 1998 was four years into a six-year bull market cycle that peaked in March 2000; we’re four years into this bull market. However, in the second half of ’98, the S&P lost 19.3% between July 17 and Aug. 31(just shy of a 20% “bear market” decline) before resuming its advance late in the year. Two important levels for the S&P are found at resistance marked by the 50-day moving average (1,624) and excellent support found at the 200-day moving average (1,512). We had a 6% pullback from mid-May through mid-June. Perhaps we’ll get more given this morning’s renewed sell-off in Treasuries. (Bond yields last week began to stall at their four-year/200-week moving averages, suggesting an oversold bounce may be underway. But RBC notes the longer-term technical outlook remains negative for this asset class.) Historical studies dating back to January 1980 find that when long-term bond prices fall around 15% year-over-year (10-year Treasuries were down nearly 8% the past 52 weeks before today's steep sell-off), the S&P has tended to decline by a median of 6% in seven out of eight such cases. This decline historically lasted about two months, but one-year later, the S&P has been higher in seven out of eight cases by a median of 9%, with the exception being the 1987 crash. In other words, a further pullback would be a normal and healthy part of a longer-term bullish cycle. The pain trade remains to the upside.
All roads lead to jobs This morning’s 195,000 increase in June payrolls, on top of upward revisions of 70,000 the prior two months, represented a surprisingly solid report. Household employment rose 160,000, the labor-force participation rate ticked up to 63.5% and average hourly earnings rose 0.4%. The increase in the “under-employment” rate—which includes discouraged workers—to 14.3% from 13.8% in May and the unchanged 7.6% official unemployment rate signaled there still is clearly slack in the labor market. But this could be good for stocks, ISI says, as going into today’s report, there were lots of worries that the rate could have a decent drop and get us close to the Fed tapering more quickly.
No summer slump for manufacturing The ISM Manufacturing Index improved to a better-than-expected 50.9 in June from May’s slight dip into contraction territory, with two-thirds of industries reporting growth. May factory orders also rose an above-consensus 2.1%, led by a 10.9% jump in transport goods. The increase was driven by expanding inventories and new orders, depicting further strengthening in key manufacturing and transport sectors abetted by Americans’ rising appetite for new cars (more below). The global manufacturing PMI also marked a sixth straight month of expansion in June though at a slower pace, largely on a decline in China to its lowest level since September 2012 (more below). Still, all breadth indicators remained positive, suggesting broad-based improvement in the global economy and supporting the continuation in the current cyclical bull in equities.
U.S. auto sales picking up They reached an annualized rate of 16 million units in June, well above the 15.5 million forecast, putting sales at levels last seen in 2007. Moreover, since December 2008, U.S. domestic vehicle sales (i.e., vehicles assembled in North America) have increased 56%, while sales of imported vehicles have increased just 24%. Why? Cheap energy, low transport costs and restrained labor costs are all long-term supports. As the first hard data on June consumer spending, June’s auto sales represent a strong start to the month.
Services disappoint June’s ISM Nonmanufacturing Index declined 1.5 points to 52.2 (the consensus was for an increase to 54.0) as the forward-looking new orders component dropped the most since November 2008 to its lowest level since July 2009 and at a level historically consistent with contraction. Overall business activity and new export orders also fell. But the employment component rebounded after four months of decline, and a majority of survey respondents indicated “growth has been slow and incremental; however, it is still better year over year.” This is consistent with moderate economic growth.
This won’t help Q2 GDP The trade deficit widened in May by the most in two years—economists had expected the deficit to narrow, resulting in a 1.5 standard deviation miss. The wider deficit was all on the goods side as all major categories posted higher imports with cell phones and the like recording the largest gain. Construction spending in May also fell short of forecasts, rising 0.5% with April revised down sharply to an increase of just 0.1%.
China a worry Its official manufacturing PMI decreased to a four-month low of 50.1 in June, its HSBC manufacturing PMI came in at 48.2, down a full point from May, and its services PMI fell a third straight month, dropping its three-month average to levels last seen in the 2008-09 meltdown. The falloff comes amid an effort by Chinese authorities to toughen lending standards at its banks, prompting a credit crunch in June. Whether the Fed can hold firm and taper and whether China continues to be more disciplined with its banks will likely be the key stories and asset performance drivers of the second half.
Another summer, another European crisis European equities sold off early in the week on news the Portuguese government might be on the brink of collapse. The worry is that a new election would mean the Socialist party takes over, rejects austerity and gives us a Greek-style showdown like we saw last summer. (BTW, the New York Times recently noted that, for all the hoopla, Greece “has yet to fire a single government employee.”)The especially worrying part is Portugal seems ahead of the game on the reform front, so how will the countries in a worse position feel if Portugal rejects reforms? While both the European Central Bank and the Bank of England on Thursday signaled rates will remain low a long while, the developments in Portugal highlight the political risk still lurking in Europe. The increased uncertainty could diminish the risk appetite of foreign investors whose capital flows have been instrumental in reducing broad European tail risk the past year.
Delay in employer mandate a respite, not a cure The White House’s decision to push back mandated employer coverage a year to January 2015 removed a short-term headwind to employment, but the long-term net effect remains the same, ISI says. It notes the Affordable Care Act’s look-back provision means employers have to start cutting employee hours down six months before the enactment of the law in order to have them qualify as part time. The impact likely would have been seen in this year’s third quarter had the mandate started in January; now we may see a gradual decrease in hours worked instead of a huge drop-off six months before the provision is in force. Still a major issue and one that has more of an economic effect is the significant rise in premium costs to the individual.
My summer vacation will be a riverboat cruise on the Danube The Mister and I love cruising because you don’t have to pack and unpack, you’re seeing wonderful sights around the world, and you can just sit and drink while the music plays and the boats tool along in the evening. It seems we’re not alone. The Wall Street Journal reported this week on a new under-construction residential ocean liner—the Utopia—that will cost $1 billion to build, have 200 units ranging in price from $700,000 to $10 million and in size up to 6,200 square feet, plus an annual fee of 4% of the list price to cover the staff, maintenance and such. Sure beats a Winnebago!