Wednesday, February 12, 2020

With Immunity to Coronavirus, US Stocks Melt Up with Impunity

I discussed the possibility of a meltup in stock prices in my 12/18/19 Morning Briefing titled “2020 Vision.” I wrote: “Another risk is that investors could conclude that there is nothing to fear but fear itself. That could lead to a meltup. When the S&P 500 rose to our 3100 target for this year on 11/15, we started to consider the possibility of a meltup scenario involving an advance to our 3500 year-end 2020 target well ahead of schedule in early 2020. We may be experiencing that meltup now given that the S&P 500 is getting close to 3200 already!”

I reiterated this view in my first commentary of 2020, dated 1/6 and titled “Nothing to Fear But Nothing to Fear (and Iran).” As it turned out, the crisis with Iran didn’t last long enough to merit adding it to our Table of S&P 500 Panic Attacks Since 2009. However, we did add the coronavirus outbreak as #66 on our list with a 1/24 date, when the outbreak news first hit the tape. So far, it has turned out to be among the very short and minor selloffs, as the S&P 500 dropped only 3.0% from 1/23 through 1/31 (Fig. 1). The index is up 4.6% ytd, closing at a new record high of 3379.45 on Wednesday. A gain of just 3.6% would put it at our 3500 target for year-end!

That’s quite a remarkable development. Recall that there were a couple of panic attacks in 2018 and again in 2019 triggered by Trump’s escalating trade war with China (Fig. 2 and Fig. 3). One of the big worries was that the trade frictions would disrupt supply chains and force companies to spend money to move them out of China. It seems to me that the coronavirus outbreak in China poses a more immediate and greater threat to supply chains. Yet here we are at record highs in the S&P 500, DJIA, and Nasdaq.

There was also a minor panic attack when the yield curve inverted last summer (Fig. 4). But the Fed reversed that problem by cutting the federal funds rate for a second and then a third time last year on 9/18 and 10/30. The yield curve since has flattened again and may be about to invert again too. Yet this story is getting no play in the financial press as a pressing concern about an imminent recession the way it did last year.

The markets must figure that the coronavirus outbreak will be contained soon and go into remission, as did SARS, MERS, and Ebola. If that doesn’t happen, then there will be a vaccine that will make us feel better. It won’t be a miracle cure coming from a drug company. Rather, it will be injections of more liquidity into the global financial markets by the major central banks.

On Tuesday, Fed Chair Jerome Powell implied that the Fed is on standby to do just that. In his testimony on monetary policy to Congress, he said, “Some of the uncertainties around trade have diminished recently, but risks to the outlook remain. In particular, we are closely monitoring the emergence of the coronavirus, which could lead to disruptions in China that spill over to the rest of the global economy.”

Meanwhile, I continue to monitor the weekly fundamental indicators for the S&P 500 for signs of the viral infection:

(1) Forward revenues & earnings. It’s too soon to tell whether the virus outbreak is starting to weigh on S&P 500 revenues and earnings. S&P 500 forward revenues remained at a record high during the 1/30 week. Forward earnings edged down 0.3% during the 2/6 week from its $179.01 record a week earlier (Fig. 5). The forward profit margin remained at 12.0% during the 1/30 week.

(2) Q1-Q4 earnings. Nevertheless, industry analysts may have just started to cut their Q1-Q3 earnings estimates during the 2/6 week to reflect the possible negative consequences of the virus on the companies they follow (Fig. 6). They seem to be doing their best to offset those cuts by boosting their Q4 estimates, by which time the virus problem should have passed, in their collective estimation.

Wednesday, February 5, 2020

Fed on Hold as Inflation Remains Stubbornly Below Fed’s 2.0% Target

I believe that the 1/29 Federal Open Market Committee (FOMC) statement and Federal Reserve Chair Jerome Powell’s same-day press conference suggest that the Fed is likely to stay on hold through the end of this year. Furthermore, the Fed’s next move, whenever that comes, is likelier to be a rate cut than the start of more hikes. That’s because Fed officials remain concerned that inflation has stayed stubbornly below their 2.0% target.

Last year, the FOMC cut interest rates three times—on 7/31, 9/18, and 10/30—by a total of 75 basis points, from the 2.25%–2.50% range to 1.50%–1.75%. The committee voted to keep the range unchanged at both its 12/11/19 and 1/29 meetings. So far this year, comments from voting Fed officials indicate that the FOMC is likely to hold rates where they are for now.

During his 1/29 presser, Powell stressed that he is concerned that persistently low inflation might continue to weigh on interest rates. In that case, the Fed would have less room to reduce the policy rate “to support the economy in a future downturn, to the detriment of American families and businesses.” He added: “We have seen this dynamic play out in other economies around the world, and we are determined to avoid it here in the United States.” It’s not clear how he intends to do so.

Here are more takeaways from Powell’s 1/29 presser:

(1) Word game. Only two words were meaningfully changed in the FOMC statement released on 1/29 from the one on 12/11, according to the WSJ’s Fed Statement Tracker. It noted that “household spending has been rising at a moderate pace” rather than a “strong” pace and that inflation is “returning to the Committee’s symmetric 2 percent objective” rather than “near” the objective. So both the pace of household spending and the outlook for inflation were downgraded.

(2) Still pushing for more inflation. During the Q&A, Powell explained that the change in inflation language was to prevent any misinterpretation, specifically the impression that “near” the Fed’s goal might suggest that officials are comfortable with the inflation rate as it is running now. Au contraire, officials wanted to “underscore” their “commitment” to 2.0% inflation as a target to be achieved “symmetrically,” not as a “ceiling” to an acceptable range. That’s especially so now, when we are well along into an economic expansion with very low unemployment, a time “when in theory, inflation should be moving up.”

Powell cited November inflation figures as measured by the headline and core PCED (i.e., the personal consumption expenditures deflator) at 1.5% and 1.6%, respectively. December’s readings, released on 1/31 (two days after the presser), were similar at 1.6% for both measures.

In his opening remarks, Powell said the Fed expects inflation to move closer to 2.0% “over the next few months as unusually low readings from early 2019 drop out of the calculation.” But he suggested that moving closer to 2.0% may not be enough to cause the Fed to hike rates; he’d prefer to see inflation overshoot the Fed’s 2.0% “symmetric” target to boost confidence that inflation can be sustained at that rate. Powell had made the same point last year at his 10/30 press conference: “[W]e would need to see a really significant move up in inflation that’s persistent before we would consider raising rates to address inflation concerns.”

(3) Six major uncertainties. Powell said the Fed expects “moderate economic growth to continue” with supportive monetary and financial conditions, but “uncertainties about the outlook remain.” He listed six areas of concern: weakness in business investment and exports, declines in manufacturing output, sluggish growth abroad, trade developments, and the new outbreak of the coronavirus. “We are not at all assured of a global rebound,” he cautioned, “but there are signs and reasons to expect it. And then comes the coronavirus which, again, it’s too early to say what the effects will be.”

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:

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(3) Select "Add to Home Screen"

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

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