'Do not be afraid'
I spent the week in Pittsburgh, where I enjoyed time with colleagues from all over who were in town for our annual Global Sales Conference. It was great fun and interesting. My bullish equity CIO shared that he sees a lot of reasons why 3,800 on the S&P 500 is possible this year (the official Federated Hermes call remains 3,500). Either would suggest higher valuations than the current forward P/E multiple of 19. It averaged 20 the past three market peaks. But the average 10-year Treasury yield in those periods was 7%. At this writing, it’s just 1.59%! How relevant can the multiple be in an extended low-rate, low-inflation environment in an economy with no signs of recession (except for maybe an inverted yield curve, which did occur again briefly last week)? The Mister asked me this morning about the inverted yield curve. “Isn’t it a recession indicator?” What’s an accountant doing in the weeds with the shape of the yield curve!?
With nearly three-quarters of the S&P market cap having reported, fourth-quarter earnings have been very solid. A majority of companies have beat on both the top- and bottom-lines, and earnings-per-share (EPS) is on track to grow 3% vs. the consensus for a 0.3% decline. Further, management guidance has been strong. Bank of America puts mentions of optimism on earnings calls at a 2-year high, and the negative-to-positive guidance ratio is the best it’s been since the second quarter of 2018. Easing of trade tensions is a factor. A move back above 50 in ISM exports, as occurred in January (more below), historically is associated with a pickup in earnings growth. This suggests the consensus forecast for 10% EPS growth this year may be too low (with eventual damage from the coronavirus a wild card). With 80% of S&P members’ cash yields higher than the 10-year, and with a record 64% with dividend yields above the 10-year Treasury, equities should be biased higher until a sustainable move up in rates. That doesn’t seem likely soon with the Fed firmly on hold, global short rates at record lows and the money supply expanding at a 7% annualized rate.
Even with equity indexes hitting new highs, investors keep building the Wall of Worry. The past week alone saw $13 billion flow into bonds and $10 billion flow out of stocks. January inflows into bond funds were the largest of any 4-week period the past 15 years! The average equity allocation in balanced stock-bond portfolios is 55.8%, according to Bank of America, well below the typical allocation of 60%-65% stocks. Leuthold Group theorizes extraordinarily low bond yields—many negative outside the U.S.—have elevated investor anxieties, leaving the impression of a high-risk, low-return world that’s pushing investors toward more conservative allocations even amid renewed indications of a globally synchronized expansion. Last week’s weakness and virus worries dropped Investors Intelligence bulls to their lowest level since early fall 2019. Noted bull David Tepper this week called the virus a “game-changer.’’ We’ll see. Otherwise, it’s hard not to be bullish. Do you know which command appears most frequently in the Bible? 122 times. “Do not be afraid.” Amen, brother.
- Job growth strong Nonfarm payrolls jumped 225K in January, surpassing estimates, and wage growth accelerated. ADP private payrolls surged an even higher 291K, their biggest gain since May 2015 and nearly double the consensus of 150K.
- ISMs surprise January’s manufacturing read rebounded into expansion territory to a 6-month high, with new and export orders, backlogs and supplier deliveries indicative of better growth ahead. On the services front, the gauge rose to a 5-month high and the separate Markit measure hit a 10-month high, with the improvement led by a big jump in business activity. This upside bump may prove temporary until disruptions caused by the virus finish working their way through the global economy.
- Capex is better than you think Instead of big buildings and massive equipment, capital expenditures (capex) increasingly are tech-oriented, i.e., software and artificial intelligence. This “new-era” investment spending, as Leuthold Group calls it, now comprises a record 55% of total business outlays and helps explain 2019’s strongest productivity performance of the entire recovery.
- The labor market is tight Challenger layoff announcements more than doubled last month to their highest level in nearly a year. Technology and retail trade led the job cuts amid continued downsizing in industrial goods manufacturing.
- A good year closes on a sour note Construction spending fell in December for the first time since June, mainly on a drop-off in public spending. Nonresidential private spending, a capex component, also continued its downward slide. A plus note: residential construction rose a sixth straight month.
- Virus hits commodities Commodity prices have plunged on concerns that large disruptions to manufacturing and supply chains could result from a demand shock in China, foreshadowing an upcoming detrimental effect on global data. It is believed this hit will prove temporary.
Lots of popcorn Trump’s probability of being re-elected hit a new high in the betting markets, with the caucus chaos and the Senate acquittal adding to momentum that saw his favorability rating hit a new high for his presidency.
ESG at work Worries about the carbon footprint associated with long supply chains and potentially problematic employment practices in some countries are helping drive “reshoring’’ among global companies based in North America, according to a Bank of America survey. This intent to relocate home was particularly true for high-tech sectors and industries for which energy is a key input, it said.
Lots of ESG work to do Almost all of the more than 8 billion tons of plastic ever produced are still with us, threatening ocean health and the food chain. A recent survey of 65K people suggests plastic pollution could almost be as big a concern as climate change. Packaging is the fastest-growing segment, with most of the demand coming from Asia.