On my paid site today, the missing volatility may be hiding in the bond market and where do stocks go from here now that 2100 is behind us
On my paid site JubakAM.com I aim for a mix of posts on macro trends and on individual stock picks. It’s a strategy I call tactical stock picking.
Today, though, I’m posting about two of the big macro questions in the current financial markets.
First question: Where’s the volatility from the uncertainty over Federal Reserve policy, the growth rate of the U.S.and Chinese economies, and minor details like the British vote on June 23 on leaving the European Union.
It’s sure not in stocks–the VIX fear index, which tracks volatility in the Standard & Poor’s 500, has been stuck at extraordinarily low levels since March. On May 31, on the Jubak.com paid site I posted suggesting that maybe the efforts of the People’s Bank of China to suppress speculation in Chinese stocks had actually contributed to a decline in volatility among global equities. Today, I look at the odd rise in volatility in the supposedly extremely stable market for short-term U.S. Treasuries. I try to explain why we’re seeing volatility in this part of the bond market that we haven’t seen since the global financial crisis. And I try to sketch out what this volatility might mean for investors and traders whether they have money in the Treasury market or not.
Second question: Now that the S&P 500 has broken through the top of the recent trading range at 2100, is an attack on the all-time high at 2135 next? I think it is–unless some unexpected negative news derails the effort–but I think the assault may well take as long as the six-week effort to break through 2100. Any successful move through 2135 will just give us a new question to answer, of course. Now what? How long can a rally that is already at the record high go on with such lackluster fundamentals? This second post lays some of the groundwork for a post later this week or early next, to be published on both the free and paid sites, that looks at what to do with short positions, like those I’ve got in my Jubak Picks portfolio, now.
That’s what I’m working on at my subscription JubakAM.com site. (I’m still, yes still, at work on what’s turned out to be a very complicated post on the robotics sector that should go up on JubakAM.com in the next day or two. After that a post on water stocks is already partially written.) I think there’s some value to you in passing on the direction of my thinking about the market on that site. Hope so anyway.
Of course, there’s an ulterior motive to sharing this with you: If you decide that you’d like more of my thoughts on the market in my JubakAM.com posts, I’m hoping that you’ll subscribe to my site at JubakAM.com for $199 a year. (By the way, you can get a full refund during the first seven days if you change your mind for any reason.)
The revision of fourth quarter GDP released last week showed just how dry the corporate earnings desert was at the end of 2015. Corporate earnings fell by 3.5% for the biggest drop in seven years.
That’s not a good lead in for first quarter 2016 earnings that begin to be reported beginning with Alcoa’s (AA) release on April 11. Earnings for the stocks in the Standard & Poor’s 500 are coming off a rare “earnings recession” of two quarters of negative year over year growth in 2015. Third quarter S&P 500 earnings fell 0.2% and fourth quarter earnings were lower by 3.1%.
Forecasts of estimates from Wall Street analysts put together by Yardeni Research show that Wall Street is looking for a huge 7.4% decline in first quarter 2016 earnings from the first quarter of 2015. Other research houses show a similar 7% or slightly greater projected drop. That would push the market from an “earnings recession” into an “earnings depression.”
That’s obviously not a good thing–especially with stocks trading near the May 21 2015 all-time record closing high of 2130.82 on the S&P 500. (The S&P 500 index closed at 2059.74 today, March 31.)
But how damaging is it likely to be, really?
It depends. And I say that not as your typical guru’s cop-out, but because it happens to be true. And to show you it’s not just a cop-out, I’m going to try below to spell out what it depends on.
1. I expect that first quarter earnings will be grim but not as bad as now projected. This quarter will follow the normal Wall Street pattern: Forecasts will be worse than the earnings actually delivered so Wall Street and CEOs will be able to claim victory from jumping those very low hurdles. If, for some reason and against pattern, results are worse than expected, then the market will be, indeed, in the soup since the indexes are near record highs.
2. I still expect earnings to drop this quarter–say 5% rather than the forecasted 7.4%–from the year ago first quarter of 2015–which will turn the current two-quarter earnings recession into three-quarter earnings depression. That certainly won’t be good news but how badly the market takes it will depend on guidance for the second quarter.
3. Right now projections for second quarter earnings call for a year over year drop of 1.9% from the second quarter of 2015. The worry here is that the projection has been creeping lower–1.9% for the week ended March 24 versus 1.7% for the week ended March 17. If company by company guidance for the second quarter, delivered with first quarter earnings results, points Wall Street analysts toward lowering their estimates, the market will increase its worry about the second quarter–and all of 2016. If on the other hand, guidance is even modestly positive (more positive than now expected) then Wall Street will start to look ahead to the positive growth in earnings promised for the last two quarters of 2016.
4. Actually even if first quarter earnings are as bad as expected and second quarter guidance is worse than expected, Wall Street would probably be perfectly happy to look past those results to the happy quarters ahead. Right now, according to Yardeni Research, expectations are for 5% year over year earnings growth in the third quarter and 9.3% earnings growth in the fourth quarter. Those projections serve as an important foundation for current stock market valuations.
5. But remember those are projections and not guarantees. The big year over year increase in earnings is predicated on a recovery for the energy sector and for financials. If instead of stabilizing at $45 a barrel or better, oil looks like it’s headed back to the low $30s or worse, then a good part of the growth in third and fourth quarter earnings will disappear. Same with earnings in financials, where analysts are looking for Federal Reserve rate increases and stability in the fixed income markets to restore earnings to 2015 levels (not the greatest of years, I grant you) at the big money center banks such as JPMorgan Chase (JPM) and Goldman Sachs (GS). I’d even go so far as to argue that what the big banks say about second quarter guidance may be the most important guidance that we’ll hear in the upcoming earnings period. (Partly that because no one really has anything other than a guess at oil prices in the last half of the year.) Many of these big banks have warned in the last few weeks of truly terrible revenue and profits from their fixed income and other business segments for the first quarter. For the market to feel confident in the third and fourth quarter earnings growth recovery, it needs to get some signals from these banks that they see their business getting better in the second half.
And that, in my estimation, is what the degree of earnings danger depends on.
The Standard & Poor’s 500 stock index closed today at 1986.45. That’s quite a run from the February 11 close at 1810.
The 2000 level is in sight with the promise that the market is finally ready to break out of a trading range that has capped the upside at 1950 to 1975.
So what’s next? Are we about to get that tantalizing breakout to the upside? Or is this a trap designed by a malevolent market to suck us into putting money in near a temporary top before sending the averages back down to the lower end of the trading range?
My best estimate is that the market will move a bit higher from here–and maybe take a run or two or three at 2000–but that the rally has an automatic check to its upside called the Federal Reserve. Every bit of good news just makes it more likely that the market will raise the odds for an (following December 2015) interest rate increase in 2016. That’s a big deal since this rally has been fueled by a growing consensus that the Fed will raise rates only once more in 2016–late in the year–or maybe not at all until 2017.
For example, the Fed Funds futures market now prices in a 38% chance of an interest rate increase in June–that’s up from 26% a week ago. Similarly the odds for a December increase have climbed to 66% from 42% a week ago.
I think the central bank calendar here gives us some parameters for judging the market’s short term trend. The European Central Bank meets on March 10. The market now anticipates that the central bank will do something more to stimulate the economy in the EuroZone and to weaken the euro after what was essentially a promise to do just that from bank president Mario Draghi. I think it’s likely that the bank will deliver something that at least gestures toward meeting Draghi’s promise. Whether what it delivers–an increase in monthly asset purchases or a slightly more negative rate on bank deposits with the central bank–will impress the market is, of course, the key question. I think it’s very likely that whatever the bank delivers will strike the markets as disappointing.
The Open Market Committee of the Federal Reserve itself meets the following week on March 16. I think it is extremely unlikely the the Fed will raise interest rates at this meeting–it is so far outside market expectations now that the Fed would know that a move like that would be a shock to the financial system. More likely the Fed will attempt to manage expectations for a June increase so that the central bank has the room to make that move without traumatizing financial markets. Any signal of serious consideration for a June increase would put a damper on the current rally.
The current market moves look like a classic bear trap–a strong rally in a continuing bear market that sucks money into stocks before then knocking them back. We’re still looking at a weak quarter for earnings for the period that ends of March 31; we’re still looking at a slowing Chinese economy despite stimulus measures by the People’s Bank; and despite the rally in oil prices, we’re still looking at a glut of oil on the market with more oil scheduled to come from Iran.
Of course, just because it looks like a bear market trap doesn’t mean it is one. Global central banks–with the exception of the Fed–are once again doing their best to pump cash into financial markets. That could work again. I just think the odds are that it won’t work for very long–maybe just long enough to wash shorts out of this market–with a continued move upward as they cover–over the next couple of weeks.
The Standard & Poor’s 500, closing at 2015 on October 9, is within spitting distance of the 2020 level that marked the high point before a hefty decline ended the August and September rallies.
With early results from earnings season at Monsanto (MON), Yum! Brands YUM), and now Alcoa (AA) all falling disappointingly short of Wall Street expectations, there’s good reason to think that third quarter earnings will result in another retreat from the highs.
On the plus side, none of these three stocks are the kind of bellwether stocks that determine the tone of the entire market. Alcoa, which was once an industrial stock to conjure with, isn’t very good at predicting the course of the entire market anymore.
On the down side, some of the trends even in these early returns are exactly the sort that should worry the overall market. Monsanto disappointed on weakness in developing economies; Yum and Alcoa showed slower than expected growth in China. Alcoa downgraded its estimates for China and now predicts a 22% to 24% drop in demand for aluminum for the manufacture of heavy trucks in China. That’s especially important because, Zack’s points out, a decline in truck production has often preceded recession in China.
There is some hope in Alcoa’s guidance, though.The company sees the current surplus in aluminum switching to a deficit in 2016 as global aluminum demand grows by 6.5% in 2015. Aluminum prices are down 40% from their peak in 2011 and down 11% this year.
Not everyone agrees with Alcoa. Morgan Stanley, for example, sees aluminum remaining in surplus in 2016 and Bloomberg sys the glut might even get worse as capacity grows in China.
And there we have the make or break question for this rally. So far commodities and emerging market stocks have moved up on a weak dollar, and speculation that we’re about to see the end of a supply glut in oil, iron ore, copper, and aluminum among other commodities. Speculation was enough while stocks drove toward the old highs, but now that we’re at those highs I think investors are going to need some evidence that the supply/demand balance is about to shift in producers’ favor.
Freeport McMoRan Copper and Gold (FCX) is a prime example of this shift in dynamic. As of the close on October 9, the shares were up 51% from the September 28 low. But with the stock up 50%, investors and traders are looking for some evidence of a sustainable recovery. Shares of Freeport McMoRan copper up just 0.22% at the close on Friday. Alcoa’s shares were down 6.81% on its earnings news. Freeport McMoRan reports earnings on October 22. Think we might see some profit taking before that report?
Spread that profit-taking across the market and you’re looking at an end to the current rally.
I’m going to use the current five-day (and counting) weak dollar rally to sell the Greenbrier Companies (GBX) out of my Jubak’s Picks portfolio. The stock is up 14% from September 28 to the close today at $35.18.
Greenbrier has bounced so hard in this rally because the maker of railroad cars is doubly leveraged to the U.S. energy boom. Oil and natural gas liquids from the country’s shale geologies have had, frequently, to travel by rail since these new production areas aren’t well served by the existing pipeline system. That had meant soaring demand for the tank cars that Greenbrier builds (and for the new, safer cars that government regulations are gradually phasing in.) And with the railroads making a very nice dollar from transporting this oil they had placed so many orders for new cars that Greenbrier’s backlog soared.
With a recovery during this rally in oil prices, Greenbrier has felt double upside leverage.
But this same double leverage that led the shares to bounce so strongly in this rally is exactly the double leverage that took Greenbrier down to $30.86 on September 28 from a 52-week high of $67.45. With oil producers in shale regions cutting back on production—even if not significantly until lately—that meant less oil to ship. With those same companies reducing capital spending there was less gear and fewer supplies headed to the oil fields. And with the railroads seeing their own revenue drop, they slowed the pace of capital spending on new cars.
Greenbrier has a huge backlog of orders—even with the slowdown in the pace of new orders—to work through so the company is in no danger of succumbing to financial pressures. And the stock is very cheap on a trailing 12-month basis with a price of earnings ratio of just 6.58 on last year’s earnings.
The problem, though, is that despite the current rally, I don’t see a turn in the company’s business happening nearly as early as some Wall Street analysts do. For 2016 the consensus estimate is now at $6.27, a solid pick up from the $5.79 of 2015 and one reason that the forward multiple is a very low 5.11.
But that consensus estimate hides a huge disagreement about earnings for 2016. The high estimate for that year is $6.95 per share, but the low estimate us just $4.91. That’s a $2.00 a share swing and the trend in the consensus estimate for 2016 has been downward, going from $6.32 90 days ago to $6.20 seven days ago (before a rebound to $6.27 in the current rally.)
I think what we’re seeing is a gradual coming to terms by Wall Street that the energy bear in U.S. share regions is deeper and longer than many forecasts still project.
I’d like to revisit Greenbrier once those lower estimates are in the Wall Street forecast. But right now I’d like to watch from the sidelines.
As of the close on October 5, I’ve got a 43.9% loss in Greenbrier since I added it to the Jubak’s Picks portfolio on November 18, 2014.