Yesterday, May 25, U.S. stocks looked set to bust right on through the top of the recent trading range at 2100 after moving to 2090.54 at the close.
Today, May 26, not so much. The index stalled at 2090–and closed at 2089.25.
Yesterday, it looked like the markets–both in the U.S. and overseas–had decided that a rate increase from the Federal Reserve was no big deal and wouldn’t put a dent in the global economy. And, markets, seemed to believe, the U.S. economy looked like it was ready to rebound from a weak first quarter.
Today not so much. U.S. economic data was mixed with good news on initial claims for unemployment–down for a second week–and pending homes sales–ahead the most since 2010–but with unexpected negative news on orders for durable goods. Orders for non-defense capital goods–excluding aircraft–fell 0.8% while economists had forecast a 0.3% gain.
Maybe this is just a pause as the market gets ready for an assault on 2100. Maybe it’s just a bit of uncertainty ahead of a speech Friday by Janet Yellen, the head of the Fed, and the release of revised estimates of first quarter GDP.
…I can’t help thinking that the fundamentals don’t justify a breakout above 2100 right now.
I know, I know: Fundamentals how quaint. Just indulge me for a minute and look at where we stand in terms of the stuff that’s supposed to, eventually, justify what we pay for stocks.
The first quarter of 2016 showed a 6.8% drop in earnings for the stocks in the S&P 500. That marked the fourth consecutive quarter of lower earnings–the first such streak since the fourth quarter of 2009. The estimate for the quarter as of March 31 had been for an 8.8% drop in earnings so I suppose the actual decline was better than expected.
Estimates for the second quarter, the one that ends on June 30, are better, but still forecast negative growth. FactSet calculates the consensus forecast at a decline of 4.7% in earnings and 1.2% in revenue. Yardeni Research is looking for a 4.1% drop in second quarter earnings.
Hardly the stuff to drive stocks already near an all time high to new heights.
Current estimates for the third quarter aren’t exactly the stuff to set the heart a flutter. FactSec is calling for 1.3% growth in earnings for the S&P 500. Yardeni sees 2.8%.
Positive instead of negative, but still….
Part of the problem is that if the Fed raises interest rates it’s not a plus for company earnings–outside of the financial sector. And if oil prices hold at the recent $50 a barrel or head higher, that too will take a bite out of earnings for everybody but oil companies.
(A big recovery in energy sector earnings is behind the current estimates for 7.5% earnings growth in the fourth quarter (FactSet) or 8.4% (Yardeni Research.)
Right now, according to Yardeni Research, profit margins for the S&P 500 companies, at 10.6%, looked to have peaked in 2015 for this cycle. (A peak in profit margins would also explain at least some of the drop in orders for capital goods. You don’t invest in as much new machinery if you think profit margins are coming down.)
If these estimates of fundamentals are correct, it’s hard to see much headroom above 2100 no matter what markets believe today or yesterday about the effects of Fed interest rate increases on global economies.
On the fundamentals, that is.
Welcome back to December! Remember when the financial markets thought the Federal Reserve was going to raise interest rates three times or maybe even four times in 2016 and suddenly bank stocks were the thing to own? (At least until January when the Fed pulled back from its three or four times language and the market decided that one or none was more like it for interest rate increases in 2016 and sent the sector into a dumpster.)
Well, the positioning was back today–even if just for a day. After last week’s minutes from the April meeting of the Federal Reserve and after jawboning by half the Fed board of governors (it seems), financial markets have decided that a June interest rate increase could be back on the table–odds are now up to 36% from 4% before the release of the Fed minutes–and if not June then quite likely July–odds for a July increase climbed to 54% today.
That was more than enough to help the Standard & Poor’s 500 stock index to a gain of 1.4% as the index tacked on 28.02 points to hit 2076.06, comfortably, again, above the 2050 level that triggers worry that the S&P 500 is going to break through the bottom of its recent trading range.
The way upward was led by, you guessed it, banks as the SPDR S&P Bank ETF (KBE) climbed 1.86% led by stocks such as Morgan Stanley (MS) up 2.16%, JPMorgan Chase (JPM) up 1.7%, Bank of America (BAC), up 1.45%, and Capital One Financial (COF), up 1.37%. (Capital One is a member of my Jubak Picks Portfolio.)
The logic here is that bank earnings will climb if the Federal Reserve raises interest rates since that would increase the interest rate that banks can charge on their loans.
Of course, the growing conviction that the Fed will raise interest rates sooner rather than later (just two weeks ago you had to go out to February 2017 (and not July 2016) to find a Fed meeting that got better than 50% odds for an interest rate increase) took its toll on other sectors today. Gold fell another 1.8% to $1232 an ounce to set its longest losing streak since November. The dollar held near its recent two-month high against the euro.
There’s been precious little staying power to any market trend recently and today’s love affair with banks may prove to be short-lived as well. At an investor day event today Wells Fargo (WFC) lowered its projections for its 2016 return on assets to 1.1% to 1.4% from the 1.3% to 1.6% it projected at its 2014 investor day. For the full 2016 year the bank is now looking for a return on equity of 11% to 14%, down from 12% to 15%.
The big culprit is the bank’s large portfolio of energy loans and the company told investors it was taking steps to reduce the size of its portfolio of those loans. Wells Fargo said it had cut credit lines on 68% of the energy companies it had reviewed.
But it’s what the bank said about its net interest margin that might have the most impact on a continued bank stock rally. Because Wells Fargo, like many banks, has moved to reduce risk in its portfolio, it now expects that a 100 basis point upward shift in the yield curve after a Federal Reserve interest rate increase would add 5 to 15 basis points to its net interest margin. Previously the bank had estimated that a 100 basis point shift in the yield curve would add 10 to 30 basis points to its net interest margin. (100 basis points equal one percentage point.)
The speeches, interviews, and presentations from members of the Federal Reserve keep on coming. And they all say, “We’re prepared to raise rates soon.”
Over the weekend Eric Rosengren, head of the Federal Reserve Bank of Boston, told the Financial Times that he’s ready to back a rate increase.
The heads of the St.Louis, San Francisco, and Philadelphia Federal Reserve banks are due to speak today. (Update: In his remarks today Patrick Harker, head of the Philadelphia Fed, said he could see as many as two or three interest rate increases in 2016.)
Fed chair Janet Yellen is on tap for a speech on Friday.
All this speechifying has driven the odds for an interest rate increase at the Fed’s June 15 meeting to 32%, according to Bloomberg’s calculation, from as low as 4% before the release last week of the Fed’s minutes from its April meeting.
And all this talk makes Friday’s announcement of revisions to first quarter GDP growth even more important. Right now economists are looking for the revision to increase the growth rate to 0.9% from 0.5%. That would be a “fact” to back the Fed’s argument that the economy is strong enough to take an interest rate increase in stride. And that the first read on first quarter growth would be succeeded by stronger growth in the second half of the year.
The Standard & Poor’s 500 finished down a slight 0.21% for the day, against dropping below the 2050 level that has been support for this market recently.
Yesterday’s release of the minutes from the Federal Reserve’s April meeting has produced a massive change in market sentiment. Monday before release of the minutes financial markets were giving odds on a June interest rate increase of just 4%. After the meeting those odds soared and they continued to move up today to reach 26%. Odds for an interest rate increase in July have climbed to 47%.
Today has brought new remarks from Federal Reserve members, including the heads of the New York and Richmond Federal Reserve banks, pointing toward a move by the Fed at its June or July meeting.
That has all led Wall Street to jump on the sooner rather than later bandwagon. This morning Jeffrey Gundlach of DoubleLine and Rick Rieder of BlackRock both advised bond investors to note a major shift in Fed plans. Whereas the Fed had been saying, Gundlach told Bloomberg, that it will raise rates if the economic data improve, now the Fed is signaling that it will move if the economic numbers don’t weaken.,
Stock have continued to move down modestly on the change in sentiment. The Standard & Poor’s 500 fell about 0.37% today to close at 2040. That’s a relatively small decline but it puts the index solidly below the 50-day moving average at 2059.
Secondary indexes such as the small cap Russell 2000, which had already moved below support, continued to decline with the Russell 2000 dropping another 0.74% to 1095. The 50-day moving average for this index is at 1111 and the 200-day at 1118.
The U.S.dollar continued to firm with the Bloomberg Dollar Spot Index gaining 0.1% today after picking up 0.8%yesterday.
Stocks in emerging markets, which are sensitive to gains in the dollar, fell. The iShares MSCI Emerging Markets ETF (EEM) dropped 0.96% to $31.58 today. The 50-day moving average for that ETF is at $33.64 and the 200-day is at $33.01.
Important upcoming dates for figuring out the Fed’s June and/or July timetable include May 27, when we’ll get a second estimate on first quarter U.S. GDP (the first estimate showed the economy growing at just 0.5%, which led financial markets to conclude that the Fed would not raise rates this summer); June 3, when we’ll get May jobs numbers; and May 27 and June 6, when Federal Reserve chair Janet Yellen gives speeches in Cambridge and Philadelphia.
It didn’t take much to put an interest rate increase at the Federal Reserve’s June meeting back on the table today.
Just minutes from the Fed’s April meeting indicting that most Fed members thought a June hike would be appropriate if the economy continued to improve…
…and statements from the head of the Atlanta and San Francisco Federal Reserve banks saying that they were still looking for two or more interest rate increases in 2016…
…and data on wages and prices showing stronger than expect income and inflation growth.
Odds of a June increase priced into the financial markets have gone from 4% on Monday to 12% yesterday to 32% after the release of the Fed minutes this afternoon.
The release of the minutes took the Standard & Poor’s 500 stock index from plus 0.55% at 1:45 p.m. New York time to minus 0.49% as of 2:25 p.m.
The odds for a July increase climbed today to 48.3% and for a September increase to 64.2%. That 64% chance of an increase is in the range of what the Fed likes to see in the way of market preparation for an interest rate move.