Tuesday, September 29, 2015

What Will It Take to Revive the Bull? (excerpt)

In the past few days, I’m being asked more frequently: “What will it take to revive the bull market?” Yesterday’s decline was the fifth consecutive daily drop. The S&P 500 may very well retest its August 25 correction low, which was 12.4% below the record high on May 21. The recent low nearly matched last year’s mini-correction low on October 15, which was attributable to fears about the termination of QE4 at the end of that month. There were also concerns about the impact of plunging oil prices and the soaring dollar on earnings.

Yet stocks managed to rally 14.4% from last October’s low through this year’s record high on May 21. It was yet another relief rally as investors concluded that outside of the Energy sector, earnings were holding up surprisingly well. Nevertheless, here we are again, right where we were about a year ago. The correlation between the S&P 500 and the Fed’s holdings of bonds is working all too well.

During the current bull market, many of the relief rallies were triggered by central bank moves to provide more liquidity into financial markets. As I observed yesterday, the central bankers may be starting to lose their credibility. In my opinion, investors would have favorably greeted the widely expected Fed rate hike following the September 16-17 meeting of the FOMC. It would have demonstrated the Fed’s confidence in the strength and resilience of the US economy.

Instead, the FOMC passed on doing so, emphasizing for the first time concerns about the global economy and financial system. Yet on Thursday, Fed Chair Janet Yellen said that she still expected a rate hike before the end of the year. Yesterday, FRB-NY President Bill Dudley said the same. The Fed’s transparency makes it transparently clear that Fed officials are clueless. That’s not good for investor confidence.

Yesterday, Dudley said that the US economy is “doing pretty well.” Notwithstanding the recent puzzling hawkishness of the Fed’s two leading doves, they and their colleagues on the FOMC will continue to confront a weak global economy when the committee meets on October 27-28 and December 15-16. They will have to be concerned that combined with the strong dollar, the US economy won’t continue to do so well.

That’s what’s unnerving investors right now. Yesterday’s implosion in Glencore’s stock price was the latest confirmation that the global commodity industry is in a major bust, which is also depressing capital goods producers of mining equipment. In addition, yesterday we learned that profits at Chinese industrial companies plunged 8.8% y/y in August, with losses deepening even after five interest-rate cuts since November and government efforts to accelerate projects. Leading the losers were Chinese coal companies.

I am starting to think that getting a relief rally this time might be more challenging than in the past, when central banks had more ammo and more credibility. If the market’s main concern is the slowdown in global economic growth, there’s not much reason to expect any upside surprise anytime soon. If the US economy remains strong, it is unlikely to be strong enough to lift global growth. Meanwhile, investors may continue to fear that the poor economic performance of the rest of the world will increasingly weigh on the US.

So what will it take to revive the bull given this assessment of the global economic situation? As long as it doesn’t all add up to a global recession, the bull should find comfort in good companies that can continue to find growth in a world of secular stagnation. Commodity users should continue to benefit from the woes of the commodity producers. Valuation multiples are also more attractive now than they were earlier this year. Needless to say, earnings have to keep growing and US consumers have to keep consuming for the secular bull to survive this latest challenge.

Today's Morning Briefing: What Will It Take? (1) The fourth FAQ. (2) No bull with stocks basically flat y/y. (3) No bull since end of QE. (4) Fed is transparently clueless. (5) Hawkish doves. (6) A sensible message from the trenches. (7) “Doing pretty well.” (8) Glencore’s meltdown. (9) China’s profits are MIA. (10) Seeking growth in a world of stagnation. (11) Forward revenues and earnings remain on bull market’s uptrends. (12) Buybacks and M&A will likely continue to shrink supply of equities. (13) Stocks are cheaper. (14) Consumers of last resort. (More for subscribers.)

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