Wednesday, January 22, 2020

Sinatra's Stock Market: Fly Me to the Moon

If today’s stock market had a theme song, it would be “Fly Me to the Moon.” It was written in 1954 by Bart Howard and recorded by lots of top singers. Frank Sinatra and the Count Basie Orchestra recorded a version of the song arranged by Quincy Jones in 1964. “Fly me to the moon / Let me play among the stars”: Those lyrics could as easily be about an investor frolicking in today’s stock market as a fellow smitten by love. Investors love the stock market these days! It has aroused their animal spirits. They are sending it to the moon, and going right along with it.

What’s not to love about the S&P 500, which is up 3.1% so far this year? It is up 41.6% since the Xmas Eve bottom on 12/24/18, 55.6% since Trump was elected president, and 392.2% since the start of the current bull market (Fig. 1, Fig. 2, and Fig. 3). The S&P 400 and S&P 600 are up 417.9% and 471.7% since the start of the bull market.

I reckon that the most recent meltup started last year on 10/2 (Fig. 4). That coincided with widespread expectations that the Fed would lower the federal funds rate for the third time in 2019 to a range of 1.50%-1.75% at the 10/29-30 meeting of the Federal Open Market Committee (FOMC), which is exactly what happened. Immediately after that meeting, Fed Chair Jerome Powell really aroused investors’ love for stocks when he said during his post-meeting press conference, “So I think we would need to see a really significant move up in inflation that’s persistent before we would consider raising rates to address inflation concerns.”

Those words were music to investors’ ears. Inflation has remained persistently below 2.0% since that became the Fed’s official target for the personal consumption expenditures deflator (PCED) measure of inflation during January 2012 (Fig. 5). Apparently, Powell’s soothing words convinced many investors that the federal funds rate could remain unchanged through the end of the current decade, or at least until the next inflation number confirmed that the Fed could remain “patient,” to use Powell’s lingo.

In his press conference, Powell said, “We entered the year [2019] expecting some further rate increases, we went to ‘patient,’ now we’ve done three rate cuts. It’s a very substantial shift, and the effects of it will be felt over time. So we feel like those shifts are appropriate to support exactly the outcomes you’re talking about, which are a continuing strong labor market, continued strong job creation.”

So the Fed is back to patient with the federal funds rate range at 1.50%-1.75%, down from 2.25%-2.50% at the start of 2019. What Powell didn’t say was that his renewed patience after the Fed lowered the federal funds rate three times has been wildly bullish for stocks, as evidenced by the meltup since Powell said what he said last October.

That’s only fitting. Recall that it was only a year before, on 10/3/18, that Powell triggered a meltdown in the stock market by saying, “Interest rates are still accommodative, but we’re gradually moving to a place where they’ll be neutral.” He added: “We may go past neutral. But we’re a long way from neutral at this point, probably.” The S&P 500 crashed nearly 20% as a result.

The refrain in the love song “Grease,” from the musical of the same name, is “Grease is the word.” For the stock market, “inflation” is the word. As long as it remains persistently below 2.0%, the Fed will remain on hold. So we need to watch the inflation indicators very closely and give them more weight in our thinking about the outlook for stocks. Low inflation should continue to grease the bull market. Now let’s review a few of the latest key inflation numbers:

(1) CPI. Last year, the core Consumer Price Index (CPI) rose 2.3% y/y through December. That’s above the Fed’s 2% target, but that target is for the PCED rather than for the CPI. In any event, the headline and core CPI inflation rates were up only 0.2% m/m and 0.1% during December. Over the past three months through December, the core CPI was up 2.0% (saar) (Fig. 6).

(2) PCED. The PCED inflation rate is available through November of last year, and its headline and core rates rose 1.5% and 1.6%, respectively. Over the past three months through November, the core rate is up just 1.3% (saar). If you are looking for more inflation, you’ll find it in the services component of the PCED, which was up 2.2% y/y through November (Fig. 7). If you are looking for deflation, you’ll find a bit of it in the goods component of the PCED, which was down 0.3% y/y through November.

By the way, a footnote in the FOMC’s February 2000 Monetary Policy Report to Congress explained why the committee decided to switch to the inflation rate based on the PCED:

“The chain-type price index for PCE draws extensively on data from the consumer price index but, while not entirely free of measurement problems, has several advantages relative to the CPI. The PCE chain-type index is constructed from a formula that reflects the changing composition of spending and thereby avoids some of the upward bias associated with the fixed-weight nature of the CPI. In addition, the weights are based on a more comprehensive measure of expenditures. Finally, historical data used in the PCE price index can be revised to account for newly available information and for improvements in measurement techniques, including those that affect source data from the CPI; the result is a more consistent series over time.”

The CPI continues to have an upward bias, as demonstrated by the ratio of this price index to the PCED (Fig. 8).

(3) PPI. Despite rising tariffs last year, the US import price index excluding petroleum was down 1.5% y/y through December, matching its slowest pace since June 2016 (Fig. 9). That helped to keep a lid on the finished goods Producer Price Index (PPI) excluding food and energy, which rose only 1.5%, the lowest since September 2016.

(4) AHE. Wage inflation, as measured by average hourly earnings (AHE) for production and nonsupervisory workers on a y/y basis, seemed to be making a big comeback last year when it rose to 3.6% during October, the fastest since February 2009 (Fig. 10). But it fell back to 3.0% during December.

I don’t view wage gains as inherently inflationary. On the contrary, I believe that wages tend to rise faster than prices, and don’t exert upward pressure on prices, when productivity growth is improving. That may very well be happening now. Inflation-adjusted AHE growth has been tracking a 1.2% per year trend since December 1994 (Fig. 11). Real AHE rose 1.9% y/y through November.

(5) Fed target. During the aforementioned press conference, Powell was asked by the WSJ’s ace Fed watcher Nick Timiraos how soon the Fed’s review of its inflation-targeting procedure would be announced to the public. Powell answered: “So we’re in the middle—we’re really quite in the middle of it now, and my thinking is still that it will run into the middle of next year. These are—you know, these changes to monetary policy frameworks happen—they don’t happen really quickly, let’s say. Inflation targeting took many years to evolve. I don’t think we’ll take many years here. I think we’ll wrap it up around the middle of next year, would be my guess. I have some confidence in that.” Odds are that not much will change.

Friday, January 17, 2020

Nothing To Fear But Nothing To Fear

Strategy I: Here Comes Another Earnings Season. First, the bad news: During the 1/9 week, industry analysts estimated that S&P 500 earnings per share fell 1.7% y/y in Q4-2019 (Fig. 1). They currently estimate that earnings rose just 1.1% last year (Fig. 2). That was mostly because the comparison with 2018 was tough, as earnings soared 23.8% that year thanks to Trump’s tax cut for corporations.

In addition, S&P 500 revenues per share growth was remarkably strong during 2018, rising 8.9% (Fig. 3). In other words, the S&P 500 profit margin jumped 14.9% during 2018 mostly thanks to the tax cut (i.e.,14.9% = 23.8% – 8.9%) (Fig. 4). That’s a hard act to follow, as demonstrated by 2019’s so-called “earnings growth recession.”

The good news is that the outlook for 2020, both from industry analysts and from Yardeni Research, calls for better earnings growth. Consider the following:

(1) Forward revenues at another record high. For starters, S&P 500 forward revenues per share—which is a great weekly coincident indicator of actual revenues—rose to a new record high during the 1/2 week (Fig. 5).

(2) Forward earnings uptick to record high. S&P 500 forward earnings edged up to a record high the following, 1/9 week, and the forward profit margin is holding up surprisingly well around 12%. The resilience of the margin is impressive given rising labor costs and tariff-related costs. Both cost pressures may actually ease this year if productivity makes a rebound, as I expect, and the Trump administration deescalates its trade wars.

(3) Upside surprise? By the way, forward earnings tends to be a great year-ahead leading indicator of actual earnings as long as there is no recession on the horizon (Fig. 6). Forward earnings rose to $178 per share during the 1/9 week (which will be the 1/7 week in 2021). I estimate that earnings totaled $163 per share during 2019. That implies that earnings will grow around 9% this year. That would be a nice rebound from last year’s near-zero growth rate. Joe and I still project that S&P 500 earnings will rise 5.5% to $172 per share this year, but I am considering revising our number higher (Fig. 7). (See YRI S&P 500 Earnings Forecast.)

Strategy II: Stocks Priced for Good News. Stock prices have continued to soar to new highs ever since the S&P 500 last exceeded its 9/20/18 high of 2930.75 on 10/10/19 (Fig. 8). As of Tuesday’s close, it was up 12.0% since 9/20/18 and up 39.6% from the Christmas Eve 2018 massacre low of 2351.10. It’s definitely been a meltup since then, led by the forward P/E multiple, which rose from a low of 13.5 back then to 18.5 on Tuesday (Fig. 9).

Investors have concluded that there is nothing to fear but fear itself. Last year’s worries about Trump’s escalating trade wars have abated dramatically as he deescalated them, especially the one with China. The Phase 1 trade deal with China was signed on Thursday. Additionally, the Fed reversed course last year. Instead of raising the federal funds rate three or four times, it was cut three times. Trump undoubtedly will claim bragging rights for this pivot since he harangued the Fed to do just that.

When Trump took executive action against the top Iranian general on Friday 1/3, the stock market flinched on Monday 1/6, but then resumed its climb to record highs. Therefore, I am NOT adding this event to my diary of panic attacks during the current bull market, for now. (See my Table of S&P 500 Panic Attacks Since 2009 and the related chart book.)

The Iranians did retaliate with a missile attack on a US military base in Iraq. However, no one was killed, though there were a few injures, contrary to preliminary reports. Trump may have convinced the Mullahs that he is willing to obliterate their regime if they attack Americans and America’s allies anywhere in the world. Meanwhile, pro-Mullah demonstrations in the streets of Iran have been followed by widespread anti-Mullah protests. The Mullahs are cornered. In the past, they might have unleashed chaos in the Middle East to deflect attention from their internal crisis, which has been greatly exacerbated by Trump’s sanctions on Iran. Now, they might be loath to pick a fight with Trump, maybe.

While roughly half the country hates Trump, nearly all Democrats hate him, believing that he is the Devil incarnate or at least deranged. (The President also has an uncanny ability to trigger “Trump Derangement Syndrome” among his adversaries.) His supporters see him as a great dealmaker, using the economic and military power of the US to make trade and geopolitical deals that benefit the US.

Love him or hate him, the question for those of us who invest is whether Trump is bullish or bearish for the financial markets. The answer is obvious: The markets believe that there is method in his madness. The S&P 500 is up 53.4% since Trump was elected president (Fig. 10). It helps that the President keeps talking up the stock market, which he seems to view as his most important popularity poll.

I think it’s reasonable to assume that the markets expect that Trump will be reelected. If so, that will be bad news for his opponents. For investors, it could be good news. However, I am concerned that there is nothing to fear but nothing to fear. If the meltup continues, then the stock market’s valuation multiple will rise toward nose-bleed levels. If that sets the stage for another meltdown correction like the one during Q4-2018, it would probably be yet another buying opportunity and not the end of the bull market. It’s credit crunches, which lead to recessions, that cause bear markets.

So for now, we have nothing to fear but nothing to fear.

One final note on this subject: My job is to be an investment strategist. I do “bullish” or “bearish.” I’m not a preacher. I don’t do “good” or “bad.” So all I am saying is that Trump has been bullish for the stock market and is likely to remain so. If you would prefer not to give him any credit for the bull market, you can give it all to the major central banks. I have been predicting since last fall that the latest round of easy money being provided by the major central banks could cause a meltup in the US stock market. See for example the 11/3/19 CNBC interview with me titled “A ‘market melt-up’ is becoming a real risk as stocks hit new highs, Wall Street bull Ed Yardeni warns.”

Recall that President Barack Obama also was not loved by all. However, anyone who stayed out of the stock market because of their political antipathy for the President missed a great bull market. The S&P 500 rose 140.3% under Obama mostly because the Fed pursued ultra-easy monetary policies (Fig. 11).

Obama certainly wasn’t as much of a cheerleader for the stock market during his administration as Trump has been during his. However, Obama was a great investment strategist. On 3/3/09, Obama told reporters: “What you're now seeing is [price-to-earnings] ratios are starting to get to the point where buying stocks is a potentially good deal if you've got a long-term perspective on it.” At the time, the forward P/E was 10.5. That was truly a great call. I came to the same conclusion later that same month.

Strategy III: Valuations Soaring. In my analysis above, I focused on the forward P/E. It’s at a cyclical high, though still well below the tech bubble high of 25.7 on 4/12/99. Nevertheless, if you are looking for trouble, then you’ll find it in the S&P 500 forward price-to-sales ratio (P/S) (Fig. 12). It is simply the S&P 500 stock price index divided by forward revenues. Previously, I demonstrated that it very closely tracks the Buffett Ratio, which is the US equity market capitalization excluding foreign issues divided by nominal GNP (Fig. 13).

The forward P/S rose to a record high of 2.2 during the 1/2 week. That exceeds the tech-bubble peak in the Buffett Ratio at 1.9 during Q1-2000. Here’s another outlier: The PEG ratio—which is the forward P/E of the S&P 500 divided by analysts’ consensus expectations for long-term earnings growth at an annual rate over the next five years—also soared to a record high during the 1/2 week (Fig. 14).

Again: We have nothing to fear but nothing to fear other than high valuation multiples.

Saturday, January 4, 2020

How to Get YRI’s App

Our website functions as an app across all digital platforms. Just follow these steps to add the YRI button to your cell phone’s home screen:

Apple devices:

(1) Open Safari and navigate to yardeni.com

(2) Click the share button on the toolbar (it looks like a box with an upward arrow coming out the top)

(3) Select "Add to Home Screen"

(4) Customize title if desired, then click “Add”

Android devices:

(1) Open Chrome and navigate to yardeni.com

(2) Select “Add to Home screen” on the toolbar

(3) Customize title if desired, then click “Add”

Sunday, December 29, 2019

Central Banks Likely to Keep Santa Claus Rally Going In 2020

Former Fed Chair Paul Volcker passed away on 12/8. He broke the back of inflation. Unfortunately, he had to cause a recession to do so, which broke the backs of lots of good hard-working people. He was widely viewed by them as the Grinch Who Stole Christmas. All of the Fed chairs who came after have preferred playing the role of Santa Claus, showering us all with lots of easy money. They were able to do so mostly because inflation has remained subdued ever since Volcker subdued it.

Actually, at the end of last year, Fed Chair Jerome Powell seemed more like a Grinch than a Santa. He roiled the financial markets by suggesting that the Fed would continue to raise the federal funds rate three or four times during 2019. He started to change his mind just around Christmas of last year and signaled that the Fed would halt rate hikes for a while. He completed his pivot by lowering the federal funds rate three times this year, on 7/31, 9/18, and 10/30 (Fig. 1).

As a result, the S&P 500 stock price index bottomed on Christmas Eve last year at 2351.10 (Fig. 2). It was up 37.8% to 3240.02 on Friday, 12/27 (Fig. 3). That’s a very long Santa Claus rally.

At the 7/31 meeting of the FOMC, the committee decided not only to lower the federal funds rate, for the first rate cut since 2008, but also to terminate quantitative tightening (QT) ahead of schedule: “The Committee will conclude the reduction of its aggregate securities holdings in the System Open Market Account in August, two months earlier than previously indicated.” From 10/1/17 through 7/31/19, the Fed’s balance sheet was pared from $4.4 trillion to $3.7 trillion (Fig. 4).

The Fed and the other major central banks are all playing Santa during this holiday season and are on track to continue doing so in the new year:

(1) Fed. In a 10/11 press release, the Fed announced that beginning on 10/15 it “will purchase Treasury bills at least into the second quarter of next year in order to maintain over time ample reserve balances at or above the level that prevailed in early September 2019.” More details were released in a separate New York Fed statement (and accompanying FAQs).

The initial pace of these “reserve management” (RM) purchases will be approximately $60 billion per month and will be in addition to ongoing purchases of Treasuries related to the reinvestment of principal payments from the Fed’s maturing holdings of agency debt and agency mortgage-backed securities. As the new holdings mature, the principal payments will be reinvested again into T-bills.

Many have commented that these actions look a lot like quantitative easing (QE). After all, the Fed is expanding its balance sheet sizably, possibly by up to $300 billion or more assuming $60 billion a month through March as a ballpark figure. The Fed’s balance sheet totaled $4.0 trillion during the 12/4 week, including $2.3 trillion in US Treasury securities, of which $420 billion are Treasuries maturing in one year or less (Fig. 5). This portfolio of Treasuries maturing in under a year is up $71 billion since the end of September.

(2) ECB. Mario Draghi’s term as president of the European Central Bank (ECB) ended on 10/31. Before leaving, Draghi put together a monetary stimulus package. It is designed to induce Eurozone governments to borrow at zero or negative interest rates to spend on stimulating their economies.

The package includes an open-ended commitment to buy as much as €240 billion per year of bonds issued by Eurozone governments. In other words, Draghi set the stage for the implementation of Modern Monetary Theory (MMT) in the Eurozone. According to MMT, governments should borrow as much as possible as long as inflation doesn’t heat up. All the better if the central bank enables such borrowing by lowering interest rates and purchasing government bonds—again, as long as inflation doesn’t heat up. Now it is up to the various Eurozone governments to take the bait.

The ECB terminated its QE1 program at the end of 2018. Under the program, which started 1/22/15, the ECB’s “securities held for monetary policy purposes” increased by €2.4 trillion to €2.7 trillion (Fig. 6). Draghi’s QE2 program will once again expand the ECB’s balance sheet to new record highs.

(3) BOJ. In an 11/18 Reuters interview, Bank of Japan (BOJ) Governor Haruhiko Kuroda said the BOJ has room to deepen negative interest rates, but he signaled there were limits to how far it can cut rates or ramp up stimulus.

According to Reuters, “Kuroda also said there was still enough Japanese government bonds (JGB) left in the market for the BOJ to buy, playing down concerns its huge purchases have drained market liquidity. After years of heavy purchases to flood markets with cash, the BOJ now owns nearly half of the JGB market.”

The BOJ’s QE program started in April 2013 and has yet to be terminated. This can be seen in bank reserve balances at the BOJ. They rose to a record high of ¥352 trillion during November, up 740% since the start of the program (Fig. 7).

(4) All together now. The total assets of the Fed, ECB, and BOJ rose $264 billion y/y during November to $14.5 trillion (Fig. 8). On this basis, they had been falling from December 2018 through September 2019. This total is on track now to rise to record highs in 2020.

That should be good for the stock market, which has been tracking the total assets of the three major central banks since the start of the current bull market (Fig. 9). Don’t fight the three major central banks.

The main near-term risk is a meltup that could set the stage for a correction. My S&P 500 forecast for year-end 2020 is still 3500. I just hope we don't get there well ahead of schedule. See CNBC: "A 10% to 20% pullback could strike stocks early next year, long-time bull Ed Yardeni warns."

Tuesday, December 10, 2019

Paul Volcker: The Great Disinflator

The following is an excerpt about Paul Volcker, who passed away on December 8, from my forthcoming book, Fed Watching for Fun and Profit.

When Volcker took the helm of the Fed, the Great Inflation was well underway. During the summer of 1979, oil prices were soaring again because of the second oil crisis, which started at the beginning of the year when the Shah of Iran was overthrown. Seven months later, in March 1980, the CPI inflation rate peaked at its record high of 14.8%. When Volcker left the Fed during August 1987, he had gotten it back down to 4.3%.

How did he do that?

Volcker didn’t waste any time attacking inflation. Eight days after starting his new job, he had the FOMC raise the federal funds rate on August 14, 1979, by 50 basis points to 11.00%. Two days later, on August 16, he called a meeting of the seven members of the Federal Reserve Board to increase the discount rate by half a percentage point to 10.50%. This confirmed that the federal funds rate had been raised by the same amount. Back then, as I previously noted, FOMC decisions weren’t announced. The markets had to guess.

On September 18, 1979, Volcker pushed for another discount-rate hike of 50 basis points to 11.00%. However, this time, the vote wasn’t unanimous; the Board was split four to three. In his memoir, Volcker wrote that market participants concluded that “the Fed was losing its nerve and would fail to maintain a disciplined stance against inflation.” The dollar fell and the price of gold hit a new record high.

Volcker, recognizing that the Fed’s credibility along with his own were on the line, came up with a simple, though radical, solution that would take the economy’s intractable inflation problem right out of the hands of the indecisive FOMC and the Board: The Fed’s monetary policy committee would establish growth targets for the money supply and no longer target the federal funds rate.

This new procedure would leave it up to the market to determine the federal funds rate; the FOMC no longer would vote to determine it! This so-called “monetarist” approach to managing monetary policy had a longtime champion in Milton Friedman, who advocated that the Fed should target a fixed growth rate in the money supply and stick to it. Under the circumstances, Volcker was intent on slowing it down, knowing this would push interest rates up sharply.

On October 4, Volcker discussed his plan with the Board. In his memoir, he noted, “Even the ‘doves’ who had opposed our last discount-rate increase were broadly supportive, having been taken aback by the market’s violent reaction to the split vote.” A special meeting of the FOMC was scheduled for Saturday, October 6. Holding an unprecedented Saturday night press conference after the special meeting, Volcker unleashed his own version of the Saturday Night Massacre. He announced that the FOMC had adopted monetarist operating procedures effective immediately. He said, “Business data has been good and better than expected. Inflation data has been bad and perhaps worse than expected.” He also stated that the discount rate, which remained under the Fed’s control, was being increased a full percentage point to a record 12.00%. In addition, banks were required to set aside more of their deposits as reserves.

The Carter administration immediately endorsed Volcker’s October 6 package. Press secretary Jody Powell said that the Fed’s moves should “help reduce inflationary expectations, contribute to a stronger US dollar abroad, and curb unhealthy speculation in commodity markets.” He added, “The Administration believes that success in reducing inflationary pressures will lead in due course both to lower rates of price increases and to lower interest rates.”

The notion that the Fed would no longer target the federal funds rate but instead target growth rates for the major money supply measures came as a shock to the financial community. It meant that interest rates could swing widely and wildly. And they did. The economy fell into a deep recession at the start of 1980, as the prime rate soared to an all-time record high of 21.50% during December 1980. The federal funds rate rose to an all-time record high of 20.00% at the start of 1981. During 1980, the discount rate was raised to 13.00% on February 15, then lowered three times to 10.00%, then raised again two times back to 13.00%, on the way to the all-time record high of 14.00% during May 1981. The trade-weighted dollar index increased dramatically by 56% from 95 on August 6, 1979, when Volcker became Fed chair, to a record high of 148 on February 25, 1985.

The public reaction to Volcker’s policy move was mostly hostile. Farmers surrounded the Fed’s headquarters building in Washington with tractors. Homebuilders sent Volcker sawed-off two-by-fours with angry messages. Community groups staged protests around the Fed’s building. Volcker was assigned a bodyguard at the end of 1980. One year later, an armed man entered the building, apparently intent on taking the Board hostage.

At my first job on Wall Street as the chief economist at EF Hutton, I was an early believer in “disinflation.” I first used that word, which means falling inflation, in my June 1981 commentary, “Well on the Road to Disinflation.” The CPI inflation rate was 9.6% that month. I predicted that Volcker would succeed in breaking the inflationary uptrend of the 1960s and 1970s. I certainly wasn’t a monetarist, given my Keynesian training at Yale. I knew that my former boss [at the Federal Reserve Bank of New York] wasn’t a monetarist either. But I expected that Volcker would use this radical approach to push interest rates up as high as necessary to break the back of inflation.

Volcker must have known that would cause a severe recession. I did too. Back then, I called Volcker’s approach “macho monetarism.” I figured that a severe recession would bring inflation down, which in turn would force the Fed to reverse its monetary course by easing. That would trigger a big drop in bond yields. Arguably, the great bull market in stocks started August 12, 1982, when the Dow Jones Industrial Average dropped to 776.92. On December 6, 2019, it was 27,677.79.

Thank you, Paul Volcker.