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.”