Posts tagged ‘S&P 500’
It is almost four months since Donald Trump won the US presidency but the shockwaves from his victory still reverberate. Coverage of supposed scandals, protests and presidential Tweets have continued to abound. Those who were delighted by November’s result, so polling suggests, remain so; those who reverted to hysteria continue their frenzy. Amid all the drama it is perhaps an odd expression to pick, but: Amercian politics has found an equilibrium.
Assumptions about the US economy have also become entrenched. It has long been obvious that a Trump presidency would be inflationary and the bond market reacted to the result accordingly: on the day of the election the ten-year Treasury yielded 1.85%, but by the end of November had hit 2.4%. It has stayed firmly in a range of 2.3%-2.6% ever since. The dollar likewise strengthened sharply after the election and has comfortably held its range against other major currencies. Eurodollar rates moved from pricing in two Fed hikes by the end of this year to pricing in three, and have held that view right up to the present.
While American politics has become energized, however – by the ambition of the new incumbent and the vitriol of his critics – financial opinion has become complacent. While markets and observers have in many cases settled on a static view, the ground since the election has shifted. Look away from fixed income and the currency, and towards risk markets and the data and this is easily clarified.
The US stock market found a secure range after the election, but only for a time. Last month it smashed it. From meandering around the 2,250 level throughout December-January the S&P 500 broke 2,300 in early February and 2,400 less than a month later. The index has now risen by more than 6% since the beginning of the year, comfortably beating other major bourses around the world.
It is not just the stock market that is optimistic, and setting new records. Consumer confidence hit a new high this week, eclipsing the levels reached prior to the credit crunch and threatening to visit territory last occupied during the go-go boom of the later 1990s. This is of a picture with earlier data on retail sales, showing the fastest annual rate of growth (+5.6% in January) since the early stages of the recovery in 2010-11, and buoyant numbers on existing home sales, which have reached a pitch last seen before the credit crunch in 2007. (Bear in mind that mortgage costs have actually been increasing at the same time, pushed up by higher long-term interest rates.)
Industrial indicators have strengthened too. Purchasing manager activity surveys out this week for both manufacturing and service sectors continued their sharp rise. The rotary rig count released last Friday showed that US oil production has continued to recover even though the price of crude has been no better than stable since December. Again, this is consistent with earlier data such as the NFIB survey of smaller firms and the “Philly Fed” report on the national outlook for business, both of which have been rocketing up, in the latter case to a 33-year high.
If one tries very hard to find them there are more equivocal releases. Monthly variability on jobs data, for instance, has been weak in some instances; then again, the broader context is one of effectively full employment, and short-term moves from 4.6% to 4.7% in the headline jobless rate are neither here nor there.
More seriously, while vague expectations of higher inflation have been priced in since November, underlying price indicators have started to move. Import price inflation, which had been negative since mid-2014, flattened out to +0.2% in election month and has since hit +3.7% (year to January). The price components of PMI surveys have also risen. Public statements from various Fed presidents and board governors has been preparing markets for a hike this month which leaves ample scope for those three rises this year, and more.
Put all the pieces together and it seems more and more obvious that there is no longer any broad backdrop of bad economic news, whatever one’s views of American politics. The credit crunch hit housing and the banking sector – all recovered. The oil price collapse hit the shale business – recovering nicely. A strong dollar dampened activity – that effect has fallen away.
On the other hand, sentiment and output indicators are on the up. The economy is at full employment. The core rate of CPI inflation has already been running above 2% for more than a year and in January posted its fastest monthly increase since 2006.
The US economy is catching fire. This will make a novel change from the sclerotic pace of recovery we have seen there to date. The question is: are markets properly discounting the eventual need to put the fire out?
One of the key themes this blog identified on the eve of 2014 was earnings growth. Equity valuations in the major markets had reached territory that needed to see a higher denominator in the p/e ratio or risk looking overvalued.
Since then we have seen a quarterly contraction in the US, patchy outcomes for GDP across the Eurozone and tax-related volatility in the Japanese economy. There has thus been reason to suspect that this growth would disappoint. And that is before considering any confidence impact from events in Ukraine, the Middle East and elsewhere.
So the Q2 US earnings season which opened in early July was arguably more important than most. When it opened, consensus expectations as followed by Bloomberg were for a 4.5% increase on the prior year, barely higher than the 4.2% increase in nominal GDP over the same period.
In early August, however, just as the S&P 500 had fallen back towards 1900, things were looking rather better. By this time the first 200 companies had reported their results. The increase in EPS was averaging 12%. The analyst consensus began to catch up, and the final outcome for Q2 was then expected to reach 8.2%.
Now the season is essentially over with 499 companies having reported. Index earnings for the S&P rose by 10.3% over the prior year. In price terms the 500 is up by more than 18% over the last 12 months, but supported by that bottom line growth the exuberance does not appear irrational – especially if most of the momentum can be maintained, as is expected.
There was an interesting story out this morning on European earnings growth too. With the sovereign debt crisis and the double dip recession, the outcomes for reported EPS on the Stoxx 50 have been dire. But for the first time since April 2012, there are now more positive than negative earnings revisions coming from analysts covering European stocks. In the words of one such:
“There are signs that the pressure on European companies … is beginning to abate. We’re beginning to see small upgrades in earnings estimates overall for the first time in absolutely ages.”
There is a connection here to recent euro weakness, and a further connection to the open mouth operations of the ECB. There is also a lot of ground to make up: simply stripping out reported losses reduces the historic p/e on the Stoxx to 16.1x from over 23x. For the S&P 500 this makes almost no difference – 18x drifts lower to 17.8x.
These markets are not a steal any more – in isolation, certainly. (Relative to bond markets they still look very cheap, but that says just as much about poor value in rates.) It has been a long wait for many to see real, underlying growth actually return to growth assets. What it needs to do now is continue.
The US shutdown is over. Japanese inflation for the year to September reached its highest level for nearly 5 years. And UK GDP data showed signs of a strengthening recovery. The S&P 500 has risen 4% since the beginning of the month, the FTSE 100 has done likewise and the Euro Stoxx 50 is up by a little more.
At the same time, the Norwegian sovereign wealth fund – the world’s largest with $810bn under management – announced that it is waiting for a correction before increasing its equity exposure. (See the widely-read Bloomberg story here.)
Developed-world equity markets have had a strong 2013, to the point where it is difficult to argue on some measures, such as p/e ratios, that they offer value. Are we entering the territory of over-exuberance?
As a starting point let’s have a look at what the CEO of that Norwegian fund actually said:
Our share in the stock market has been stable or falling even though markets are rising, and that means in practice that we’re not using inflows to buy stocks … In general, we see market corrections more as opportunities than as threats, so it’s not something that worries us. If they come, that’s just a positive sign for us as an investor.
According to the interview he did say the fund was “preparing for a correction”. But this is a fund whose rapid growth is underpinned by sizeable petrodollar inflows. They are not selling the market, and in the event of a correction – should it come – they intend to start buying again. In fact this sounds like the Norwegian central bank is offering the market a put!
In addition it is always worth looking at what reported earnings are doing. US news has been dominated by political and monetary goings-on, but the S&P is almost half way through the latest quarterly earnings season: 243 companies have reported an overall EPS increase of 8.4% on the previous year so far, significantly ahead of expectations. If that growth rate can be sustained as predicted the current price level would soon look much easier to bear.
Finally, the rally in risk pricing has not been universal. We took a look at India a few weeks back when the rupee was coming under heavy pressure for instance. Indeed, emerging market equity in general has underperformed its developed-world equivalent by a margin of 23% over the year to date. Selective exuberance may be irrational in some ways but it is not so terrifying as indiscriminate (and price insensitive) optimism.
The Norwegian view looks sensible: no panic, nor any excitement over the major markets at current valuation levels, and a preparedness to buy again should prices come down.
The markets which have performed the most strongly – as ever – may not be offering the most obvious opportunities. But the steady stream of positive data on earnings and economies is encouraging for their investors nonetheless.
The S&P 500 index has roared through 1700 for the first time ever. US GDP for Q2, expected to come in at 1.0% annualised, hit 1.7% on the advance estimate instead. Jobless claims reached a new five-year low. It is clear in some quarters that “the US is the engine of global recovery“.
Elsewhere, enthusiasm about the growth data in particular has been tempered. After all, the number for Q1 this year – which began life estimated at 2.5% and was later cut to 1.8% – was revised down further to 1.1%. And the figure for Q4 2012 was cut to an almost flat 0.1%. In fact, in real terms the American economy expanded by a rather torpid 1.4% over the full year from Q2 2012 to Q2 2013.
Which brings us on to the stock market. The S&P 500 is 25% higher than it was a year ago but reported earnings per share for the quarter so far (393 index members) are up by only 3.6%, and have actually fallen by 2% for non-financials. So over the last twelve months the p/e ratio has jumped back to its pre-recession level – about in line with the long run average for the index. US stocks are not yet expensive by this measure but they are no longer cheap.
This is not to knock the rally. There is a bigger gap between rhetoric and reality than there is between reality and market behaviour. Confidence and activity indicators are consistent with continued, solid growth, albeit at a sub-trend pace, and that’s always better than the alternative. There was a marked correction across equity markets in May-June, which slowed the pace a little, and there will doubtless be more volatility to come. It does not look as if there should be much reason to argue with a measured, patchy uptrend in the US stock market. That’s what’s happening to growth and earnings too.
It is instructive to compare the lie of the land this year with the immediate aftermath of the credit crunch. In 2009 confidence began to improve way before the Great Recession ended. It became clear that capital losses and writedowns in the banking system had peaked in Q4 2008, and that was enough for the S&P to return 50% over the year to 31 March 2010. It was not until the Greek crisis that the scale of contagion began to be more widely understood, and market confidence has still not fully recovered from the demeaning misery of having to absorb fixed income ephemera such as what a “Fitch” is and how one might go about swapping a credit default.
So US equity has shown about half the exuberance in price terms since last summer as it did over the 12 months from Q1 2009. Again, let us stress that this does not appear unreasonable. But back in ’09 of course it was not just a select group of developed-world stock markets that embraced the transformation in morale.
Over the same 12-month period – from Q1 ’09 to Q1 ’10 – the MSCI Emerging Markets index returned 82%. The yield on the ten year Treasury rose by 1.4%. The trade-weighted dollar fell by over 8%. Investment grade credit spreads in Europe fell by 95bp. Brent crude futures were up 68%, COMEX copper futures up 93%.
Much of this seemed absurd at the time, and in hindsight seems especially so. What is useful, perhaps, is to note what a really abandoned recovery in confidence looks like, and to compare these numbers and others with the very much more tentative present upturn.
The move in Treasuries has been similar, with the ten year yield up 1.2%. Compared to ’09, therefore, bond bearishness has outpaced stock market optimism. And that optimism has been much narrower: the MSCI EM equity index has returned only 4%. Credit markets have broadly kept in step with Treasuries, tightening by most but not all of what they managed back in 2009-10 (80bp so far). On the other hand oil has gone nowhere and base metals have fallen.
There are always risks and always fundamental changes to consider. So there were four years ago. What differentiates markets today is that they are less certain – more confused – than they were back then. If the confidence felt on Wall Street is justified, and if this confusion should diminish, there are a number of dots which need to be joined before the picture across asset classes looks composed once again.
This was a phrase very commonly heard in relation to the financial crisis. From a number of perspectives it had merit: various key elements of the disaster were explicitly transatlantic (the sub-prime mortgage market) and several had distinctly American roots (rating agencies, structured credit products). Of course we shouldn’t lay all the blame at America’s door. Nonetheless, from fraudulent originators through hedge funds to investment banks and beyond, the detonators which set off the global explosion were made in the USA.
The release of the advance estimate of Q4 GDP data for the US this week reminded us that this huge economy, which remains the behemoth of the financial world, has lost none of its power to shock. Of the more than seventy economists tracked by Bloomberg, none expected output to fall. The consensus was for a 1.1% (annualised) rise. Since the data came out, reaction has been muted. Stocks have drifted lower. The dollar is a little weaker. But observers in America and around the world are broadly united in their dismissal of the release as a temporary blip.
They might well be right, but this was hardly the attitude taken when US GDP last disappointed back in the summer of 2011. Sentiment was more fragile, to be sure. The Greek crisis was weighing rather more heavily on the market then than it is today. And of course there were down-to-the-wire budget negotiations in Washington that tantalised with the prospect of an American sovereign default, prompting S&P to downgrade the country’s credit rating all the way from AAA to AA+.
But it was the revisions to growth that triggered the pandemonium. The S&P 500 had already fallen by 8% when the downgrade came. And the talk that followed was all about double dips and engines failing. With Europe in crisis, the US had been the great hope. One methodological change to statistics on imported petroleum later and that hope was swiftly and very sharply abandoned.
The situation today is therefore eerily familiar. The European crisis is forgotten, but not gone. Hopes for growth in the US are riding high again, and the S&P is some 17% above its June low. At the same time, growth has disappointed and budget negotiations are ongoing in Washington …
This is not to suggest, and still less to hope that there will be another shock of the 2011 magnitude. As yet the possibility of real slowdown in the US looks remote. This year we should see an acceleration in global growth and could see greater normalisation of pricing within and between asset classes. That’s the kind of thing we surely want to see starting in America.
2013 has barely begun. With major stock indices some 3-5% higher already for the year to date it is obvious that it has begun with a bang.
Confidence has been improving for some time, taking valuations with it. At the end of the year the MSCI World Index of developed-world stock markets carried a historic p/e ratio of 16x. At the same time, consensus earnings growth for the index (based on analyst estimates aggregated by Bloomberg) is forecast to rise by 23% this year. If that can be delivered, current pricing doesn’t look too demanding.
Turning to the US in particular, as of today 67 S&P 500 index members have reported earnings for Q4 2012. Share weighted EPS are up 31% on the previous year. All that growth comes from financials: ex-financial EPS are currently down slightly (-0.4%).
Overall, earnings are forecast to have grown 3.8% on Q4 2011 by the time the last index constituent reports. Unsurprisingly that number has risen slightly since the data began to come in, and if the pace doesn’t slacken too suddenly will be revised up again.
There are a number of reasons why we might expect company earnings to do well – and to do better than nominal American GDP. Most obviously, there is room for margin improvement. Some of this may be attributable to manager brilliance; some is certainly attributable to new lows for corporate interest rates (with the BoA ML US Corporate Index recently yielding a record 2.7%), and lower effective tax rates over the last few years.
Whatever the reasons, however, EPS growth of 31% is remarkable. It appears highly unlikely to be sustained at that level as more reports come in. But even if we do see “only” 3.8% on the year to Q4, and similar data this year, robust earnings growth for the US and for the developed world as a whole begins to look perfectly plausible.
There are risks out there, as always. The sudden optimism over US politics and Japanese growth may be premature. It seems as if the European crisis is being disregarded now too. Though it has yet to push pricing into uncomfortable territory, there is the scent of complacency in the air.
After the disappointments of recent years we wish the relief rally well. Whatever happens to sentiment, sustained earnings growth would give it important support.
“We are seeing light recovery blowing in a spring wind.”
That was how the IMF’s Christine Lagarde – clearly more of a poet than her predecessor – described the Fund’s latest World Economic Outlook report, out this week. The big news was that its growth forecasts have been revised – gasp! – up.
Of course, the report is laden with the usual caveats, and understandably so. After all, the commentariat tells us solemnly that when it comes to bond yields, 6% is the new 7%, and that borrowing in Spain has thus become unaffordable. (This is moot. But having failed to bankrupt a country with no deficit problem – Italy – perhaps the market will succeed in respect of a country with no debt problem instead.)
Nonetheless, seeing an important economic forecast revised up is encouraging. Unsurprisingly, given the strong data, one of the key revisions was in the case of the US, where projected growth of 2.1% for this year is 0.3% higher than the IMF was forecasting in January. And that brings us on to another type of prediction.
Amid the gloom and woe of the second half last year, Wall Street analysts slashed their expectations for stock market earnings. At one point, reported earnings for the season that has just begun were expected to fall.
The consensus as reports began was less bearish, with average EPS growth across the S&P 500 anticipated to reach about 1%. But with a quarter of the index’s constituent companies having announced their results, the outturn so far is running at 7.2% (6.2% excluding financials – some of the big banks have been doing especially well).
Over 80% of reports have beaten expectations. Forecast earnings growth for the index as a whole this quarter has now risen to over 3%.
Mindless optimism is of no more use to the careful investor than the hysterical pessimism that has dominated of late. But it is surely not imprudent to observe that, even with renewed panic over Europe, proper gloom is becoming harder to sustain.