INVESTOR’S first read.com – Daily edge before the open
S&P 500: 2,888
Friday, April 12, 2019 9:13 a.m.
Yesterday, MarketWatch published an article, “Risk of earnings recession rises, as S&P 500 profits to fall for first time in 3 years.”
This is not news to readers here, I have warned of this for months, but now the Street sees it. Will they care ?
Yes, the market has been going up, possibly because of expectations of a trade deal or Fed rate cut, or even because they are looking ahead to 2020, but FactSet’s senior earnings analyst, John Butters notes that companies have been cutting guidance more than usual causing leading analysts to make bigger cuts to their forecasts.
He goes on to add, that more important for the outlook for the stock market is that blended EPS growth estimate for the second quarter slipped into negative territory on Wednesday, to minus 0.2% (that is news to me, FactSet had been tracking a plus 0.1%)
I think the trade deal and expectations of a rate cut to head off a recession before the 2020 elections are mostly built into current market prices, though a brief rally would accompany the news anyhow.
I do think the Street is ignoring 2019 earnings and focusing on 2020 when it expects a strong earnings rebound, which may push the market up in coming weeks. The key will be, will the BIG money use that push to sell ?
If the Street suddenly begins to revise 2020 projections downward, it spells bear market.
As noted below, the Shiller price/earnings ratio is calculated by the S&P 500’s price divided by a moving average of 10 years of earnings adjusted for inflation. At 31.13, it is higher than it was when the market plunged 20% in Q4 last year, higher than it was before the Great Recession’s 50% plunge, as high as it was in 1929, but not yet as high as the dot-com bubble burst high in 1999, which hit the S&P 500 for 51% (Nasdaq:78%), a time when high priced stocks with near zero earnings dominated the market. It is close to twice as high as its mean of 16.6.
All this at a time earnings are tanking, which will raise the P/E even more.
The Street, and corporate managements with a lot to gain, do not want this party to end. NOTHING CHANGES IN LATE-STAGE BULL MARKETS.
While it is unlikely today, a rally failure, where the market gives up the day’s gains, would suggest the risk of a correction has increased. The Street wants to run the market higher, the fever is rising, when will they ever learn ?
Major resistance now is DJIA: 26,487; S&P 500: 2,897; Nasdaq Comp.:8,103.
The new normal is the flash crash, or steep plunge that does not allow an investor to raise cash except at sharply lower prices. A cash reserve in advance helps reduce the carnage, and in some cases is necessary to avoid a disaster.
The size of a cash reserve depends on one’s tolerance for risk.
Generally, I think a cash reserve of 70% is reasonable at this time.
We are in the late stages of the longest bull market in 155 years and it will be hard to shut off. Speculative frenzy usually drives late stage bulls to absurd highs.
We are well into that stage. As noted below, the blue chips are overvalued given the outlook for earnings and a softening economy, worse abroad.
This is the point prudent investors get sucked in by the media headlines and others brag about their newly discovered genius as stock pickers, but eventually get their clock cleaned.
Most savvy traders know how to play it, quick to bail out before getting picked off second base. Major corrections and bear markets begin with a sharp sell-off that looks like a buying opportunity at first, since bull markets have relentlessly rebounded. Thinking this is a gift (never are in this business), investors jump in only to get ripped by the next down-leg.
One or several more tempting surges may occur – easy does it, one of these will be a “trap door.”
This bull market has two pieces of news that can move it up. A trade deal, which is mostly built in to current price levels, and a Fed rate cut, which I also think is built in.
Currently, the Street is looking beyond 2019 earnings slump to a stronger growth rate in 2020. If a recession hits late this year or in 2020, the Street will have to chop their estimates down drastically. With prices at these lofty levels, that spells bear market.
There is no fear on the Street of a bear market and that’s bearish. The only surprise now can be an ugly one.
For this reason, speculative sentiment can run stock prices higher, but it won’t be justified.
The Street and corporations with major stock buy-back programs would like to run the market up to new all-time highs. That would result in front page coverage in all major news media and a stampede of buyers.
This would offer the BIG money a chance to sell as much stock as it wants without depressing prices. It also fattens stock portfolios and options exercise perks of executives in the upper tier of corporate management.
The environment for sensible investing stinks. This kind of panic is typical of stock market tops, but investors simply can’t resist the temptation to go all-in.
Corporate earnings growth is projected to barely top 5% this year, but the Street is looking for 10% + next year. I am assuming they are not factoring a recession in their calculations.
The Street didn’t see the 50% plunge coming in 2007, it didn’t see the 20% break in Q4 and it won’t see the cascade of selling that will come at some point within the next two years.
Too busy counting their winnings.
Stupid ? Greedy ? Overwhelmed by confirmation bias ?
No – just human. No one wants the party to end.
The market is driven by expectations of a cut in the fed funds rate, a deal on trade between the U.S. and China and a fear of missing out on higher stock prices in a 10-year old bull market that racked up a 332% gain since it started in early March 2009.
The surge since December 26 has recouped nearly all the losses in the October-December plunge (DJIA: -19.2%, S&P 500: -20.2%, Nasdaq Comp.: 23.9%).
Most likely the surge will continue to new highs where the BIG money stands to use the euphoria to do some selling.
If the Fed can’t rekindle strong economic growth with a combination of hype and rate cuts, we will slide into a recession. In that case stock prices are at risk for a 30% + correction, more if new negatives hit the market after it has declined significantly.
Even if economic growth is rekindled by the Fed, the market is pricey. But, in a market where speculative frenzy is on the increase, going against the tide goes against human nature.
The Shiller price/earnings ratio is calculated by the S&P 500’s price divided by a moving average of 10 years of earnings adjusted for inflation. At 31.13, it is higher than it was when the market plunged 20% in Q4 last year, higher than it was before the Great Recession’s 50% plunge, as high as it was in 1929, but not yet as high as the dot-com bubble burst high in 1999, which hit the S&P 500 for 51% (Nasdaq:78%), a time when high priced stocks with near zero earnings dominated the market. It is close to twice as high as its mean of 16.6.
All this at a time earnings are tanking, which will raise the P/E even more.
Of the last 13 Fed credit crunches, 12 resulted in a recession. The sole exception occurred in 1998 when the Fed cut its discount rate in face of the Russian financial crisis that had global repercussions. Its move delayed a recession until March 2001 but triggered a speculative blow off in stock prices led by dot-com companies and a bear market with a 50% loss by the S&P 500 and 78% loss in the Nasdaq Comp..
So, let’s assume we get a recession, what can the Fed and the administration do to pull us out of it?
Cut taxes ? No, we did that with a 40% slash in corporate taxes (1% for individuals). Corporations now account for 5% of the tax monies the federal government receives, hardly adequate considering all the benefits they receive.
Cut interest rates ? They are still too low to make a difference.
Borrow ? It’s too late for that, individual, corporate and government debt is already too high.
BOTTOM LINE: When a recession comes it will be ugly and long.
As I explained last week, I believe the Fed will lower its fed funds rate this summer (May 31 or June 19) to head off a recession ahead of the presidential election year.
However, a cut in the fed funds rate preceded the last four recessions, so a move like this is ominous, unless it heads off a recession, i.e. a soft landing.
I have said for months that I believe we are in the early stages of a recession, that a bear market started last October with the first leg coming in Q4 of DJIA: 19.2%, S&P 500: 20.2%, and the Nasdaq Comp. of:23.8%.
If the market averages reach new highs, that forecast will be wrong, but won’t change my belief a bear market is imminent.
EARNINGS: For 2019, FactSet expects a gain of 3.7%. Currently, it tracks 2019 earnings gains/losses at Q1: -3.9%, Q2: +0.1%, Q3: +1.7%, and Q4: +8.3%;
A Morgan Stanley study shows a downturn in S&P 500 earnings growth has consistently triggered a plunge in stock prices. Analysts have been slashing 2019 earnings projections, however he Street is betting on a rebound in 2020. If they start slashing projections for 2020, we have the next leg of the bear market.
What No One on Wall Street Wants to Hear
>We are in the late innings of an economic expansion, so a recession is a good bet. The current expansion started in June 2009, has lasted 116 months, the second longest on record and twice as long as the average length of 11 cycles since 1945.
> Of the 10 recessions since 1950, the average time between the low point in the unemployment rate and the start of a recession was just 3.8 months. The unemployment rate hit a low of 3.7 percent in November, jumped to 3.9 percent in December and to 4.0 percent in January. Now, averages include months below and above 3.8. What’s more, we won’t know when the current recession if we have one begins because that conclusion is reached by the Nat’l Bureau of Economic Research (NBER) long after the fact.
>Bear markets lead the beginning of recessions by 3 to 12 months. The current bull market at 119 months is four times the average of the last 15 bulls going back to 1957
>Nine out of the last 10 recessions have occurred with a Republican in the White House.
> While Q4 corporate profits are very impressive, analysts are dramatically slashing estimates for 2019. FactSet now sees Q1 this year at minus 3.2% down from minus 2.7% a week ago; Q2 at plus 0.3% down from plus 1.0%; Q3 at plus 1.9% down from plus 2.4% and Q4 at plus 8.5% down from plus 9.9%. For the year they see an earnings gain of plus 4.1% down from plus 4.8% a week ago.. The Street may be looking beyond 2019 to 2020 when it sees a rebound in earnings. That’s sheer insanity. By then, a recession will be underway. When the Street sees its folly, it will slash 2020 earnings like it is slashing this year’s.
>The current economic expansion has lasted 123 months. That’s 65 months (2.1x) longer than the average expansion (58.4 months) going back to 1945.
>Of the 10 recessions since 1950,the average time between the low point in the unemployment rate and the start of a recession was 3.8 Months.
> Of the 10 recessions since 1950, the average time between the low point in the unemployment rate and the start of a recession was just 3.8 months.
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Investor’s first read, is a Game-On Analysis, LLC publication for which George Brooks is sole owner, manager and writer. Neither Game-On Analysis, LLC, nor George Brooks is registered as an investment advisor. Ideas expressed herein are the opinions of the writer, are for informational purposes, and are not to serve as the sole basis for any investment decision. References to specific securities should not be construed as particularized or as investment advice as recommendations that you or any investors purchase or sell these securities on their own account. Readers are expected to assume full responsibility for conducting their own research pursuant to investment in keeping with their tolerance for risk.