Wednesday, March 4, 2020

Stock Market Fears Virus of Socialism Almost as Much as COVID-19

I’ve been asked several times since last week’s stock market correction whether the selloff might not be just about the COVID-19 virus outbreak. Might the emergence of Bernie Sanders as the Democratic party’s frontrunner—and the possibility that it will be a “democratic socialist” running against Donald Trump in the general election—in part explain the stock market rout? The S&P 500 peaked at a record high of 3386.15 on Wednesday, February 19. It plunged 12.8% to 2954.22 on Friday, February 28. There were lots of headlines about the spreading virus that coincided with the plunge in stock prices. However, also coincidently, Bernie won the New Hampshire primary on Tuesday, February 11.

Sanders took New Hampshire with the support of a majority of the voters aged 18 to 29, winning 51% of their votes. Former South Bend, Indiana, Mayor Pete Buttigieg trailed him with 20% of the youth vote, followed by Massachusetts Senator Elizabeth Warren at 6%. On Saturday, February 22, Sanders had another big win in the Nevada primary. Last week, Sanders had the momentum, and the market plunged.

But then on Sunday, March 1, Joe Biden handily beat Sanders and the other contenders in the South Carolina primary, with lots of support from black voters. CNN enthusiastically reported: “Former Vice President Joe Biden’s blowout South Carolina win reshaped the Democratic presidential campaign and positions him as the surging moderate alternative to Vermont Sen. Bernie Sanders in a 48-hour sprint to Super Tuesday.”

On Monday, March 2, Joe Biden welcomed former rivals Pete Buttigieg, Amy Klobuchar, and Beto O’Rourke into his camp in a show of force by the Democratic party’s establishment against frontrunner Bernie Sanders the night before Super Tuesday. Buttigieg and Klobuchar dropped out of the race and threw their support behind Biden, whose decisive win in South Carolina on Saturday appears to have cemented his status as the moderate alternative to Sanders’s democratic socialism.

On Monday, March 2, the S&P 500 jumped 4.6%. The DJIA soared 5.1%, the biggest such gain since March 23, 2009. The Dow’s 1,293.96-point gain was its largest one-day gain ever.

Is it possible that stock market investors may fear Bernie Sanders almost as much as they fear the coronavirus?! Yes, it’s possible. After all, the widespread view is that the virus pandemic will probably abate in coming months. Monday’s stock market rally might also have been fueled by news reports—such as Reuters’ March 1 report—that China’s efforts to halt the spread of the virus are paying off.

Socialism, on the other hand, is a virus that won’t go away even though extreme versions of it have immiserated and killed millions of people since it started to spread after infecting the French during the French Revolution. The philosophical founding father of socialism was Jean-Jacques Rousseau. He inspired Maximilien Robespierre, literally the first politician to execute socialist principles. He headed the Jacobin terrorist group that led the French Revolution during the eighteenth century. He was a big fan of the guillotine. Rousseau said lots of crazy things, but here is my personal favorite:

“There is therefore a purely civil profession of faith of which the Sovereign should fix the articles, not exactly as religious dogmas, but as social sentiments without which a man cannot be a good citizen or a faithful subject. While it can compel no one to believe them, it can banish from the State whoever does not believe them—it can banish him, not for impiety, but as an anti-social being, incapable of truly loving the laws and justice, and of sacrificing, at need, his life to his duty. If anyone, after publicly recognizing these dogmas, behaves as if he does not believe them, let him be punished by death: he has committed the worst of all crimes, that of lying before the law.”

Look it up; it’s in his seminal book The Social Contract (1762), which is appropriately posted on the Marxist Internet Archive. (Hat tip to Mark Melcher and Steve Soukup, my friends at The Political Forum. Read their excellent and provocative book, Know Thine Enemy: A History of the Left, Volume 1, 2018.)

Investors fear Bernie because he wants to cut off the head of capitalism by raising taxes significantly on the rich and using the funds to provide free everything to everybody else. He also wants to regulate everyone. On his website, he promises college for all. He will cancel all student debt and medical debt. He’ll expand Social Security. Medicare will be for all. His program includes housing for all and universal childcare and pre-K. He will embrace the Green New Deal: “Reaching 100 percent renewable energy for electricity and transportation by no later than 2030 and complete decarbonization of the economy by 2050 at latest.” In effect, he will either privatize or destroy the health care and fossil-fuel energy sectors. He will break up any company he deems to be a monopoly.

All we need to know is that Sanders is a fan of Fidel Castro. He said so in a town hall meeting on Monday, February 24:

“[W]hen Fidel Castro first came into power ... you know what he did? He initiated a major literacy program. It was a lot of folks in Cuba at that point who were illiterate. And he formed a literacy brigade ... [they] went out and they helped people learn to read and write. You know what? I think teaching people to read and write is a good thing.

“I have been extremely consistent and critical of all authoritarian regimes all over the world including Cuba, including Nicaragua, including Saudi Arabia, including China, including Russia. I happen to believe in democracy, not authoritarianism. ... China is an authoritarian country ... But can anyone deny—I mean the facts are clear—that they have taken more people out of extreme poverty than any country in history? Do I get criticized because I say that? That’s the truth. So that is the fact. End of discussion.”

Getting everything for free trumps freedom, according to Bernie. No wonder investors are reacting to him as though he is going to infect us all with the virus of socialism.

No wonder that stocks soared on Wednesday as Biden’s major victories during Super Tuesday sparked a massive rally led by the health-care sector

Wednesday, February 26, 2020

Government Measures To Stop COVID-19 Triggering Pandemic of Fear

Our rapid-response team at Yardeni Research first responded to the coronavirus outbreak in the Monday, 1/27 issue of our Morning Briefing, which was titled “Going Viral?” That was the next business day after the outbreak first hit the headlines on Friday, 1/24. Let’s review some of our initial assessments and the latest developments:

(1) Panic attack #66 could be the one that causes a global recession and a bear market. In our 1/27 analysis, we suggested that the outbreak had the potential to be added to our list of 65 panic attacks since the start of the current bull market: “Will the coronavirus outbreak that started in the Chinese city of Wuhan, Hubei turn out to be just the latest panic attack that provides yet another buying opportunity for stock investors? Fears that it could turn into a pandemic knocked stock prices down last week, especially on Friday.”

The S&P 500 peaked at 3329.62 on Friday, 1/17. It then fell 3.1% through the last day of January. Joe and I added the outbreak to our list of panic attacks on 2/3 (Fig. 1).

The S&P 500 proceeded to rally 5.0% to a record high of 3386.15 last week on Wednesday, 2/19 (Fig. 2). It dropped on Friday of last week, 2/21, by 1.1%, and plunged 3.4% on Monday, 2/24, as reports showed that the virus was spreading globally, particularly to Iran, Italy, and South Korea.

It plunged again, by 3.0%, on Tuesday after an official at the Centers for Disease Control and Prevention (CDC) that day said Americans should prepare for COVID-19 to spread in their communities and cause disruption after Iran, Italy, and South Korea reported a rapid uptick in the number of people who have been sickened.

“We really want to prepare the American public for the possibility that their lives will be disrupted because of this pandemic,” Dr. Nancy Messonnier, director of the CDC’s National Center for Immunization and Respiratory Diseases, told reporters. She said that Americans should talk to their children’s schools about contingency education and childcare plans and discuss tele-working options at work if community spread is reported in the US.

When asked by a reporter on a conference call if her tone had changed compared to previous calls, the CDC official said: “The data over the last week and the spread in other countries has certainly raised our level of concern and raised our level of expectation that we are going to have community spread here ... That’s why we are asking folks in every sector as well as within their families to start planning for this.”

Messonnier said that she herself spoke to her family over breakfast on Tuesday, and that while she feels the risk of coronavirus at this time is low, she told them they needed to be preparing for “significant disruption” to their lives. (See the Fox News article “Coronavirus disruption to ‘everyday’ life in US ‘may be severe,’ CDC official says.”)

We have come to the conclusion that even if the virus turns out to be no more dangerous to global medical and economic health than previous outbreaks (as we still expect), extreme government responses aimed at containing the virus, while effective, may be creating a pandemic of fear, increasing the risk of a global recession and a bear market in stocks.

(2) To be contained. We expect the coronavirus outbreak to be contained, as the previous three major viral outbreaks were. SARS (2003-04), MERS (2012), and EVD (2014-16) all were contained using traditional public health measures—e.g., testing, isolating patients, and screening people at airports and other public places. Eight months after SARS began circulating, for example, the virus died out. A 2/18 LA Times article explains how SARS, which had reached 29 countries at its peak, suddenly disappeared. The seriousness with which governments and health organizations around the world are taking the coronavirus suggests its spread likewise will be minimized.

(3) People get sick. According to a Live Science article written last week (“How does the new coronavirus compare to the flu?”), the virus, officially “COVID-19,” infected more than 75,000 people and killed 2,000, primarily in mainland China. Not to minimize the suffering behind those numbers, in the US alone, the flu has already caused an estimated 26 million illnesses, 250,000 hospitalizations and 14,000 deaths this season, according to the CDC.

In the largest study of COVID-19 cases to date, China’s Center for Disease Control and Protection analyzed 44,672 confirmed cases and found 80.9% to be mild, 13.8% severe, and 4.7% (2,087) critical. They estimated the death rate at 2.3%; that’s much higher than the death rate from US flu cases, at around 0.1%—but both rates are extremely low. According to the article cited above, nobody under 10 years old has died of this coronavirus to date.

What’s unknown about the new virus is the problem. Nobody knows exactly how it will spread or how many serious cases will develop. “Despite the morbidity and mortality with influenza, there’s a certainty … of seasonal flu,” Dr. Anthony Fauci, director of the National Institute of Allergy and Infectious Diseases, said in a White House press conference on 1/31, according to the Live Science article. The course of the flu is predictable, he said, down to the number of hospitalizations and mortalities to expect before cases drop off in spring. “The issue now with [COVID-19] is that there’s a lot of unknowns.”

(4) The asymptotic difference. Unlike with previous headline-making viral outbreaks, asymptomatic people can have and spread the new coronavirus; that’s less likely with the flu, which spreads mostly from persons with symptoms. Cases have been reported on every continent but South America and Antarctica, most recently in Europe, East Asia, and the Middle East, according to the CDC’s website.

A 2/24 article in The Atlantic quoted Harvard epidemiology professor Marc Lipsitch saying he doesn’t think COVID-19 will prove containable. His “very, very rough” estimate was that 100-200 people in the US were infected (versus 35 cases confirmed cases as of Sunday, 2/23), which would be enough to spread the disease widely. The article observed that Chinese scientists reported an apparent case of asymptomatic spread of the virus from a patient with a normal chest CT scan. If this finding is not a bizarre abnormality, the scientist stated, “the prevention of COVID-19 infection would prove challenging.”

(5) Will warm weather kill the virus? Might the coming warm weather months halt COVID-19’s spread? David Heymann of the London School of Hygiene and Tropical Medicine, who led the global response to the SARS outbreak in 2003, says not necessarily. The MERS coronavirus spread in Saudi Arabia during August, he pointed out. The flu might spread less readily in summer simply because people spend less time together in confined spaces in summertime, per a 2/12 NewScientist article.

Drug manufacturers are rushing to develop a vaccine. On Monday, drug maker Moderna delivered its first experimental coronavirus vaccine for human testing, with a clinical trial scheduled for April.

The bottom line is that we aren’t too afraid of the virus right now. While we are not virologists, our take is that there are two sanguine outcomes: (#1) the virus spreads to lots more people, but most cases are mild, and we learn to live with the threat; and/or (#2) public health efforts and less togetherness during warmer months cause the virus to die out.

(6) Fear going viral. More fearsome than the virus itself is the global contagion of fear it could spawn as governments continue to react with extreme measures and the media continues to hype the threat up. Governments’ responses have been drastic, as discussed in a 2/24 WSJ article; they include China’s quarantine of 60 million people in Hubei province, halting economic activity, and the US’ travel warnings and ban on entry of any non-American who has been to China in the past 14 days. As noted above, just yesterday, the CDC warned Americans to prepare for a severe disruption to everyday life in the US in the event of an outbreak here.

We hope that people soon will have good reasons to conclude, as we have for now, that this too shall pass.

Wednesday, February 19, 2020

Powell Says Economy Is ‘In a Very Good Place.’ Time To Worry?

Fed I: Balanced MPR. My colleague Melissa Tagg and I read the Federal Reserve’s 71-page semi-annual Monetary Policy Report (MPR) to Congress dated February 7. We concluded that Fed officials believe the US economy is well balanced and that they will keep the federal funds rate in the current range of 1.50%-1.75%. Nevertheless, they are concerned about several global issues, which they are monitoring closely.

Federal Reserve Chair Jerome Powell emphasized during his MPR congressional testimony on February 11 and 12 that the “US economy is in a very good place.” The threat from the coronavirus is something to watch, he said, but too early to understand. Nevertheless, he affirmed that “there is no reason why the expansion can’t continue.”

Below, we review reasons that Fed officials are sanguine about the US economic outlook, followed by the concerns they are monitoring. Most of the issues discussed in the MPR have been around since the current expansion began. The two new exceptions are trade tensions, which started in 2018 but have recently diminished, and the coronavirus, which has been a global risk to health, economic growth, and stock markets only since the start of this year.

Fed II: In a Good Place. Powell first used “in a good place” in reference to inflation during his 9/26/18 press conference. In his 1/30/19 presser, he said, “The US economy is in a good place.” He used “in a good place” to describe the economy and Fed policy four times during his 3/20/19 presser. The four-word phrase appeared again at the following pressers: 5/1/19 (once), 6/19/19 (thrice), 7/31/19 (once), 9/18/19 (nope), 10/30/19 (thrice), and 12/11/19 (once). At his 1/29 presser this year, he said that “household debt is in a good place, a very good place.” In his latest congressional testimony, he upgraded his assessment of the US economy as being in a “very good place.”

We wish he would stop using that expression. Our contrary instincts come out every time he says it. Nevertheless, he is right: The US is currently in a very good place compared to China. Let’s review what’s so good in the good old USA according to the Fed:

(1) US manufacturing slump not severe. After increases in 2017 and 2018, manufacturing output declined in 2019. But do not be alarmed; the report dismissed the decline as too small to “initiate a major downturn for the economy.” The MPR observed that mild slowdowns are not atypical during business-cycle expansions; to signal a broad recession, manufacturing would need to be experiencing a severe downturn. Every recession since 1960 included some months when the 12-month change in industrial production was at least 7 ppts below trend. The recent US data are well above that threshold: 2019 growth averaged 2 ppts below trend (Fig. 1).

(2) Solid labor market gains. Overall, the Fed has been pleased with the pace of gains in the job market. The MPR noted the following supportive data: The average monthly pace of payroll gains in 2019 of 176,000 was slightly below the pace of 2018 but faster than required to allow for net new labor force entrants as the population grows. During December 2019, unemployment fell to the lowest level since 1969, 3.5%, down from 3.9% a year ago. It ticked up just slightly m/m during January to 3.6% (Fig. 2).

Labor force participation increased, including for prime-aged individuals. Wage gains remained moderate. Powell indicated he was pleased to see labor force participation picking up as a result of stronger labor market conditions forcing employers to hire and train less skilled employees (Fig. 3).

(3) Residential investment moving up. “Financing conditions for consumers remain supportive of growth in household spending,” the Fed reported, observing that housing starts and permits for new construction rose to the highest levels in more than 10 years (Fig. 4). Sales of new and existing homes also increased during 2019 despite home price appreciation, reflecting reduced mortgage interest rates.

(4) Consumer spending strong. Strong consumer spending last year was supported by the “relatively high level of aggregate household net worth” as both house prices and US equity prices increased.

(5) Growth for advanced economies stabilizing. Growth in several advanced foreign nations has shown tentative signs of “steadying.” Brexit risk has lessened, but the final resolution of the UK’s divorce from the EU remains to be settled. Economic growth in Japan has deteriorated, but that’s expected to be a transitory effect of the October consumption tax increase. Following the report, Japan’s Q4 GDP was released at an annualized rate of -6.3%, largely attributable to weak private consumption given the sales tax increase to 10% from 8% (Fig. 5). For the US, fewer Fed officials “judged the risks to the economic outlook to be tilted to the downside” in their projections made in December versus last June, observed the report.

(6) Trade policy progress made. Uncertainty around trade policy recently “diminished somewhat,” the report highlighted, reflecting progress in the US–China trade negotiations.

(7) Global monetary policy accommodative. The current stance of monetary policy and low level of interest rates remain supportive of global growth. “Amid weak economic activity and dormant inflation pressures, foreign central banks generally adopted a more accommodative policy stance,” according to the report. Long-term interest rates in many advanced economies remained low. Indeed, central bank balance sheets continue to grow, as we discussed yesterday. For example, China’s central bank has moved aggressively to combat the coronavirus on the economic front by injecting more liquidity into the credit markets.

(8) Financial stability solid. The Fed believes that the US financial system is “substantially more resilient than it was before the financial crisis,” primarily because leverage in the financial sector and total household debt have moderated.

(9) Fiscal policy boosting growth. Current fiscal policy is expected to continue to boost growth. The Tax Cuts and Jobs Act of 2017, which lowered personal and business income taxes, and the recent boost in federal purchases have added to growth, the report said—a point Powell reiterated in his testimony. Following the report, news broke that the Trump administration is planning another possible US fiscal stimulus package—including middle-class income and capital-gains-tax cuts—should Trump be reelected.

Fed III: When China Sneezes. The coronavirus has led to unprecedented quarantines throughout China’s Hubei province and several of the country’s major cities. In effect, China has been quarantined from the rest of the world, as international flights have been suspended until the virus stops spreading and goes into remission. As a result, supply chains that go through China are being disrupted. China’s overall GDP, along with consumer demand, could either stop growing or actually turn down as a result of the epidemic. All this was confirmed by Apple’s warning on Monday that it does not expect to meet its quarterly revenue forecast because of lower iPhone supply globally and lower Chinese demand as a result of the coronavirus outbreak.

Not surprisingly, therefore, the MPR includes the coronavirus on the Fed’s worry list. The report was released to the public on February 7, two weeks after the outbreak hit the headlines. Let’s review the Fed’s worry list:

(1) Weak pace of inflation. According to the Fed, low readings in the US inflation rate were attributed to possible transitory influences, specifically “idiosyncratic” declines in “specific categories such as apparel, used cars, banking services, and portfolio management services.” After briefly rising toward the Fed’s 2.0% inflation goal during 2018, the pace of inflation during 2019 dropped well below that target again. The 12-month change in the PCED (personal consumption expenditures deflator) for both the headline and the core rates were just 1.6% as of December 2019, below year-ago readings for both (Fig. 6). Global inflation also remains subdued. Powell expects US inflation to move closer to 2.0% over the next few months, according to his testimony.

(2) Declines in business investment. The report voiced concerns about the stalling of business investment in structures, equipment, and intangibles last year. Private nonresidential fixed investment in real GDP was flat y/y during Q4, the weakest growth rate since Q1-2016 (Fig. 7). That reflected trade policy uncertainty and weak global growth, according to the Fed’s report, among other factors (including the “suspension of deliveries of the Boeing 737 Max aircraft” and “the continued decline in drilling and mining structures investment”). Going forward, the Fed expects business investment to remain subdued.

(3) Weak productivity trend growth. Wage gains remained moderate despite solid job market improvement. The Fed attributed this to weak productivity growth, partly as a result of “the sharp pullback in capital investment … during the most recent recession” and the slow recovery that followed. “While it is uncertain whether productivity growth will continue to improve,” the Fed said, “a sustained pickup in productivity growth, as well as additional labor market strengthening, would support stronger gains in labor compensation.” Powell said in his testimony that boosting productivity “should remain a national priority.”

Following the report, data covering last year’s productivity growth was released showing a 1.7% gain (Fig. 8). As we see it now, GDP has been growing at a little over 2.0%, so we are getting more of our economic output from productivity, which bodes well for real wages and profit margins (Fig. 9). In other words, we may be able to cross this one off the Fed’s worry list soon.

(4) Weak emerging markets growth. Growth in many Latin American and Asian economies (e.g., China, Hong Kong, and India) has slowed markedly. Social and political unrest in Hong Kong and Latin America have resulted in severe economic disruptions. In India, the “ongoing credit crunch continues to weigh on activity.”

(5) China spillover potential. In China, GDP growth slowed further in 2019 against the backdrop of “increased tariffs on Chinese exports, global weakness in trade and manufacturing, and authorities’ deleveraging campaign that continued to exert a drag on the economy” (Fig. 10). “[S]ignificant distress in China could spill over to U.S. and global markets through a retrenchment of risk appetite, U.S. dollar appreciation, and declines in trade and commodity prices,” the report stated.

(6) Coronavirus possible contagion. Coronavirus was mentioned eight times in the report, including “[M]ore recently, possible spillovers from the effects of the coronavirus in China have presented a new risk to the outlook” and “The recent emergence of the coronavirus … could lead to disruptions in China that spill over to the rest of the global economy.”

(7) Corporate debt & asset valuations elevated. “[A]sset valuations are elevated and have risen since July 2019, as investor risk appetite appears to have increased,” the report observed. Business debt remains elevated as well, whether viewed as a ratio of business assets or growth measures. In addition, that debt has gotten risker: The lowest investment-grade category (triple-B) represents about half of investment-grade-rated debt outstanding; that’s near an all-time high. Economic deterioration could lead to a liquidity crunch in the credit markets.

(8) Uncertainty in setting monetary policy. The report dedicated a box to discussing the Fed’s concern about the future effectiveness of its current approach to conducting monetary policy. The US economy has “changed in ways that matter for monetary policy. For example, the neutral level of the policy interest rate appears to have fallen in the United States and abroad, increasing the risk that the effective lower bound on interest rates will constrain central banks from reducing their policy interest rates enough to effectively support economic activity during downturns.”

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

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