The U.S. earnings season started last week as it is likely to go on: Profits plunged, but came in higher than Wall Street analysts’ had forecast, and shares rose.
Analysts forecast a fall in earnings per share of 7.8% for the S&P 500, the third year-over-year drop in a row according to Thomson Reuters IBES.
Yet, investors don’t seem that bothered. Large U.S. stocks are up 1.8% this year. The perverse result is that big-company shares are getting more expensive, even as their prospects dim and the bond market suggests clouds are gathering over the economy.
Why are shares so high when bond yields are so low?
All the main valuation tools now show stocks are expensive compared with history. Wall Street’s favored valuation metric, price to estimated 12-month-ahead earnings, has been higher since 2004 only for a few months last year. This forward PE ratio stands at 16.7 times, higher than any time from 1985, when the data starts, until the dot-com boom really got going in 1997.
Students of bubbles should note that stocks are more expensive than when Alan Greenspan, then Federal Reserve chairman, warned of the markets’ “irrational exuberance” in December 1996.
Other widely used valuation gauges tell a similar story. Notably, price relative to the past 10 years of earnings—the cyclically adjusted price/earnings ratio popularized by Yale’s Prof. Robert Shiller as a way to smooth the economic cycle—is at the highest this year. It is back at the level of November 2007, just after the precrisis peak for U.S. stocks, and stands 50% above its average since 1881.
No, this isn’t exuberance. This is desperation. Fund managers are far more cautious than usual, and worries abound about negative interest rates, recession risk, possible British exit from the European Union, the U.S. election, Chinese debt and geopolitics.
Investors are more funereal than enthusiastic, and are reaching for the assets that usually accompany gloomy times: Treasury bonds, Japanese yen and German bunds.
But with bonds already pricey, they are also piling into anything that might pass as an alternative to a bond, offering a reasonably dependable income and perhaps a little growth. ...
it is not a justification for buying shares at these prices. In the past, buying shares because they appeared cheap compared with bonds sometimes worked, but sometimes proved catastrophic. Shares were supposedly very cheap relative to bonds shortly before the financial crash, for example, before becoming very much cheaper indeed.
Investors might get lucky. If the world is stuck in an era of slow but steady growth, shares in dull companies at high valuations might be the best bet out there, albeit still one offering low returns. But the crowd that has rushed into this trade is walking a fine line between recession on one side and growth on the other, either of which would leave investors wishing they had avoided the heady valuations of today’s bond-like stocks.
It is over a decade since the housing bust began, nearly seven years since the recession ended, and the U.S. housing market isn’t close to what historically would be considered normal. Last year, a combined 5.1 million new and used homes were sold in the U.S—not quite as many as in 1998, when the working-age population was one-fifth lower than it is now.
The conditions for improvement are there. The job market has continued to strengthen—there were 2.8 million more people working last month than in the same month a year ago, according to the Labor Department—bolstering one wrinkle in the housing-revival story is that warm weather over the winter may have made things look better than they actually are. Because housing data are adjusted to account for the big seasonal swings the sector is subject to—typically around 40% of annual homes sales are inked in the four-month period that starts in March—if only a little activity gets drawn into the dead winter months, it can have a pronounced effect
The Federal Reserve raised interest rates in December for the first time in nearly a decade. The Fed's liftoff from a zero interest rate policy was highly anticipated by a massive rally in the U.S. dollar that began in July of 2014.
On January 25, the dollar index (DXY), which measures the greenback against a basket of six major currencies, hit a short-term high of 99.52. Since then, it has dropped 6 percent to a low of 93.62. The decrease in the dollar was the primary contributor for the rebound in the major averages. Investors sold dollars because Fed Chair Janet Yellen backed away from her previously threatened four rate hikes during 2016.
A coordinated central bank attempt to depreciation the dollar is the last desperate hope to keep the bubble inflated because the overvalued stock market isn't being supported by earnings or GDP growth.
I think a stock-market sell-off of 25 percent or more will happen if the Fed can't get the dollar into a bear market. That is, a sustained decline from 94 toward 80.
The U.S. is not the only country suffering from secular stagnation. The slowdown in global growth has been fully acknowledged by the International Monetary Fund. First, the IMF just took down its outlook for U.S. growth to 2.4 percent, from 2.6 percent. And despite aggressive monetary policies implemented by the Bank of Japan, it has halved their forecast for Japanese growth this year to just 0.5 percent. In 2017, when a consumption tax hike takes effect, the IMF expects the Japanese economy to shrink actually shrink once again — as it has the habit of doing — this time by 0.1 percent. ...
All this bad news has led the IMF to cut its global growth forecast for the fourth time in the past year, this time from 3.4 percent, to 3.2 percent. Last year the global economy grew 3.1 percent, its slowest pace since the recessionary year of 2009.
U.S. Q1 GDP, according to the Atlanta Fed model, is set to grow by a meager 0.3 percent. The Atlanta Fed's model doesn't include an estimate for nominal growth, but using last quarter's GDP deflator, we can glean that Q1 nominal growth (inflation + real growth) will be about 1.2 percent. Nominal GDP growth of just 1.2 percent is beyond pitiful. And since S&P 500 earnings tend to grow with nominal GDP, we can make the same sorry assessment about the health of U.S. corporations.
Hence, according to Zack's Financial Research, total earnings for Q1 are expected to be down 11.1 percent on negative 2.3 percent revenues. Earnings growth is expected to be negative for 11 of the 16 sectors that Zack's covers. The negative earnings growth in Q1 will be the fourth quarter in a row of earnings declines for the S&P 500 index.
The weak dollar may provide some temporary relief to the stock market. However, the major averages are still extremely overvalued and overleveraged:
Margin debt as a percent of the economy is higher today than both 2000 and 2007.
The median price-to-earnings ratio that sits at 22.6, is at a higher level than the market peak in 2007. And at 22.6, the S&P 500 index is currently 25.3 percent above its median fair value.
The price-to-sales ratio is now not only higher than in 2007; but also at any other time in history with the exception of the top of the internet bubble in 2000. And finally, the total market cap of corporations in relation to the economy is also higher than any other time in history outside of the Nasdaq craze.
All things being equal, the combination of falling corporate earnings and revenue, along with peak market valuations and leverage is what could trigger a bear market in stocks.
This is why the Fed has decided to hold in abeyance future rate hikes, in hopes the falling dollar will continue to bail out the global financial system.
But a falling dollar isn't a long-term or viable strategy to generate economic prosperity. All you have to do is look at Japan to realize that growth doesn't come from a crumbling currency. The yen has dropped 35 percent in the past few years and Japan's economy and has been mired in a perpetual recession. At best, the U.S. dollar breaking 94 on the DXY will provide only temporary relief for the major averages.
But inflation and currency destruction is the bane of viable growth and will lead to yet a further dislocation between asset prices and underlying economic growth … and that means the eventual day of reckoning will be much more pernicious.
According to economists at Goldman Sachs Group Inc., the Federal Reserve just delivered one of its most dovish decisions of the new millennium....
Markets had little doubt that the FOMC would leave the funds rate unchanged at yesterday’s meeting—futures markets implied only about a 5 percent chance of an increase before the announcement," wrote Pandl and Struyven. "Yet the decision was clearly a major dovish surprise for markets, with interest rates declining across the curve and the dollar falling against other developed market currencies."
The Japanese yen climbed to a near 18-month high against the U.S. dollar on Monday, as traders resumed bets that authorities won’t be allowed to weaken the currency through direct intervention amid pressure from the nation’s key allies.
The yen strengthened as much as 1.4% against the dollar, sending other Asian currencies broadly lower on renewed risk-aversion concerns, given the yen’s safe-haven status, while a sharp fall in crude-oil prices also hurt demand for regional currencies.
The yen, last at ¥108.02, will notch a new 18-month high against the dollar if it surpasses the ¥107.61 mark recorded on April 11
The Obama administration has obviously decided to restart the war in Syria. Thousands of tons of new weapons have been purchased and delivered to the Jihadists including anti-air MANPADs of U.S. (full text) and Chinese origin. Half of the weapons the "rebel" mercenaries are given by their sponsors regularly end up in the hands of Al-Qaeda in Syria. We will not be surprised when a few weeks from now a civilian passenger plane will be hit and come down in Turkey or elsewhere.
Two week ago the foreign supported "rebels" already broke the ceasefire when they took part in a large al-Qaeda attack south of Aleppo city. Several "rebel" attacks took place against the Kurdish quarter in Aleppo city with over a hundred civilian death. Other attacks took place in north Latakia.
Today the "rebels" announced a full return to open war and more fronts were reopened including in north Hama where Uighur "Turkmen" Jihadis used two suicide bombers against the Syrian government positions...
It seems that another round of the cycle is now necessary. Iran has deployed regular ground troops in Syria and these, even while not yet battle-tested, will have some effect. The Syrian air force has been reequipped and its older planes have been updated. Russian helicopters are active on the Syrian front and new short range (200 km) "Iskander" ballistic missiles were recently seen. The Russian air force can additionally engage with long range flights from Russia against fixed targets in Syria within hours. Russia cruise missile carrying ships are near the Syrian coast.
It is foolish to believe that MANPADs and TOW anti tank systems can decisively change the situation on the ground. I expect that a few week of heavy fighting will now follow after which the "rebels" will again be exhausted and again on the border of defeat.