foxex: Tug of War

The Market Sum | INVESTOPEDIA

Insight after the bell

By Caleb Silver, Editor in Chief

Wednesday's Headlines

1. Stocks Rise, but Political Uncertainty Prevails

Markets Close

Dow
24,404.48 -1.22%

S&P
2,632.90 -1.42%

Nasdaq
7,020.36 -1.91%

VIX
20.8 +16.85%

INV Anxiety Index
99.8 Neutral

US 10-Yr Yield
2.73 -1.94%

Markets Today

Stocks rebounded from Tuesday's selloff, as strong earnings reports from IBM (IBM), United Technologies (UTX) and Proctor & Gamble (PG) led to optimism for the Dow Industrials.

But, there is a tug-of-war of sorts happening in the markets right now. On one side, investors are looking for bright spots in corporate earnings to bring them back to the buying table. On the other is political dysfunction, which is creating a blinding haze of uncertainty. This is not the first time this has happened in history, and it won't be the last. But it's pervasive right now and it's making a mess.

Corporate Earnings

We knew they wouldn't be as strong as prior quarters given that the residue of the 2017 tax breaks would be fading around now. But, they are not too bad, and in some cases, they are terrific.

Here is a good summary, via Credit Suisse:

Companies representing 17.0% of the S&P 500's market cap has reported 4Q. Earnings are beating expectations by 1.5%, with 70% of companies that have reported having exceeded their bottom-line estimates. This compares to 4.9% and 70% over the past 3 years.
4Q expectations are for revenues, earnings, and Earnings Per Share (EPS) growth of 5.5%, 11.3%, and 13.3%, respectively. EPS is on pace for 16.5%, assuming EPS rates beat market expectations at typical rate for the remainder of the season.
Essentially, the recent tax breaks are adding 6.8% to the bottom-line. Ex-tax changes, trend EPS growth is on pace for 6.5 %. It's on pace for 13.3% when you include the tax breaks.

In summary, earnings growth is lower by about 3.5% compared to the past three years, but it's not negative by any means.

Take IBM, for example. Big Blue reported a blow-out fourth quarter on Tuesday and raised guidance for 2019 as its cloud and software services businesses are growing faster than expected. Shares of IBM ripped 9% higher today, and are up 25% in the past month. No drama...just a legendary company focusing on its growth businesses and crushing it.

The Government Shutdown

Our regular readers know my disdain for this embarrassment of governance, and all parties are culpable. But, with no end in sight, it has become a very serious threat to economic growth in the U.S. As we know, growth is already slowing as we are in what economists like to call the 'late cycle' of economic growth. (Read more about those cycles here.)

This is the stage before a recession where we've already experienced the benefits of fiscal stimulus (tax cuts), monetary stimulus (low interest rates), robust earnings growth and expanding multiples. With no artificial or policy winds at our backs, companies are growing organically or through acquisitions, or they are not.

A simplified sketch of the economic cycles looks like this:

We are somewhere near the top of the first hump, if not on the right side of it.

It's a vulnerable time for the economy, the stock market and investors. So, on the 33rd day of the partial U.S. Government shutdown, Kevin Hassett, an economic adviser to the White House, tells CNN that the damage to the U.S. economy has been 'worse than expected'. He then goes on to say that if the government remains in partial shutdown until the end of the first quarter, which is March 30th, we may get, 'zero growth for the quarter'.

Why it Matters

Obviously, zero growth is not healthy for any economy. Sometimes, things happen outside of policy makers' control that can affect growth. Terrorist attacks, weather disasters like hurricanes and floods, health epidemics...you get the point. But the fact that the shutdown - which is being used as a political football by both Democrats and Republicans - could wipe out economic growth entirely is nothing short of shameful.

What's remarkable is that the shutdown has not impacted the stock market - at least not yet. There is a reasonable case that the markets will rip higher if this is resolved quickly, as we wrote about today.

Shutdowns typically don't impact the stock market because they usually don't last more than three weeks. Investors can see beyond the bipartisan battles and focus on fundamentals like earnings and sales growth. While we saw evidence of that today with IBM and United Technologies, the more growth is threatened by extended uncertainty, the more companies will start reigning in their forecasts, cutting back on expansion plans and hiring, and accelerating a slowdown. It's the part after the peak in the late cycle that begins with the letter "R" that will become the narrative much faster than we expect.

Todays Headlines:

5 Red Flags to Watch As Recession Anxiety Rises (See Above)
Why Buying Gold Makes Sense Right Now - Always good to have a little Ag in the mix
Why Markets Could Rip Higher if Shutdown is Resolved Soon
Tesla slashed staff for Model S and X Staff in Recent firing (CNBC)
Ford Grows Sales, but Profits and Margins Miss
Einhorn's Greenlight Hedge Fund hit by Redemptions (WSJ) The harder they come...

Chart of the Day: British Pound Surges to New High

The British pound surged against the US dollar on Wednesday, extending its rebound and establishing a more than two-month high. In the process, GBP/USD reached back up to its key 200-day moving average, which the currency pair has not touched since May of last year. Recent Brexit pressures have threatened to weigh heavily on sterling, but the pound has generally been on the rise even since the UK Parliament voted down Prime Minister Theresa May's Brexit deal just last week. The GBP/USD currency pair actually bottomed out earlier than that with a double-bottom pattern in mid-December and early January, and has been on a sharp rebound and recovery since.

Helping to fuel sterling's recent rise well ahead of the March 29 Brexit deadline have been a few different factors. The prospect of a 'no-deal' Brexit is getting dimmer and optimism is rising over a "soft" Brexit, both of which have helped to boost the pound. There's also even a possibility of a second EU referendum, which would be another public vote on whether or not the UK should leave the European Union. In the event that this happens and the public chooses instead to stay in the EU, sterling could get a very substantial boost. All of this still remains up in the air, though, at least until Parliament meets again early next week to vote on Theresa May's revised plan and amendments.

Meanwhile, jobs data out of the UK turned out better than expected on Tuesday with wage growth beating estimates and employment rising to a record high. This helps open a potential path to higher interest rates, which would also be supportive of the pound. The Bank of England makes its interest rate decision in two weeks. There is a possibility of a rate hike then to help combat further sterling weakness and rising inflation, especially after the positive jobs report.