See, the markets can indeed go down for a bit.
Man, I know I like praying for a correction - and I love getting deals - but I sure hate watching red ink. Here is the thing. It is very typical for a market which has risen hard into the heaviest part of the earnings season to then have a hiccup or two - or six - during the busiest weeks of the earnings season.
This week and next week are the two busiest of the Q417 earnings season and they represent the highest level of market capitalization in the list of companies reporting. Hence, they also represent the largest numbers of clashing opinions and short-term reactions to the earnings data. A real shocker huh?
Besides, after the first few weeks of this year - we really do need to see things cool off a bit. While I cannot bring out a crystal ball, seeing the markets go straight up for extended periods of time does not often end well.
This pause will do us all good in the end.
And the Data?
Strong as battery acid.
A couple of key thoughts to glean from the hail of information:
The Q4 earnings season has seen very strong revenue momentum, an above-average proportion of positive surprises and an extraordinarily-positive revisions trend for the current and coming quarters - partially thanks to the tax act.
For the 185 S&P 500 members reporting through last night, total earnings are up a huge 13.3% from the same period last year. Revenues are much higher as well, +8.2% higher than last year with 82.2% beating EPS estimates and 80% beating revenue estimates. Keep in mind, it is this strong momentum that likely fed some of the strength in the first few weeks - hence the pause as it gets reported (buy the rumor, sell the news in short-term trader land).
Recall we noted in advance that this season would be filled with many new pieces of data. Companies are announcing big one-time charges related to the tax law change which is doing two things: a) causing a gigantic amount of confusion for many - and unnecessary selling, and b) driving the gap (pun intended) between adjusted operating earnings and GAAP earnings to some of the highest levels seen in recent years.
When the dust settles, it is expected that total earnings for the S&P 500 index will rise 11.9% from the same period last year on +7.6% higher revenues. Earnings growth is expected to be positive for 14 of the 16 sectors.
Clearly, along with the Q4 data, estimates for the current period (2018 Q1) and following quarters have been going up in big steps, with tax law changes as the most notable reason for those positive revisions. These revisions are broad-based, with estimates for 15 of the 16 sectors up since over the last few weeks.
This data is shown for you below in a couple of helpful charts from Zacks (the Thomson data will be updated again over the weekend with the latest reports).
Net, net: For the full-year of 2017, total earnings for the S&P 500 index are expected to rise 7.5% on +4.8% higher revenues, which would follow +0.7% earnings growth on +2.6% higher revenues in 2016.
The bigger plus ahead? The on-going impact of the tax changes shows larger impact in out years: Index earnings are expected to be up +17.9% in 2018 and +9.5% in 2019.
Note the contrast between the last 5 quarters in dark green on the second chart above - and the next 5 quarters. These are all YOY compounding numbers. I think the market will continue to be surprised by the trickle-down effect of the growth embedded in these numbers.
Outside of Earnings?
Well, that data remain strong as well.
The Conference Board released the latest Leading Economic Index (LEI) - and it rose 0.6% in December. Naturally, this bodes well for the fourth-quarter GDP estimate seeing increases over the first estimate which came out on Friday. The Commerce Department announced its first flash estimate for annual fourth-quarter GDP which came in a little low - at 2.6%.
The culprit? They burned down inventories - which is good - and a bigger trade deficit reduced GDP growth by 0.67% and 1.13%, respectively. The bigger positives were clear though: consumer spending grew at a 3.8% annual pace and business investment grew at a very fast 11.4% annual clip.
Don't fret when you see inventories fall - that is a good thing - and they are usually rebuilt in the following quarter or two. Hence, do not be surprised to see the fourth-quarter GDP revised higher as those inventory and trade figures are adjusted in the upcoming months.
Finally, the Commerce Department reported that durable goods orders have risen nicely now for four of the past five months and bode well for continued strong GDP growth.
Rates are rising a bit as people fear all this growth must lead to inflation. While jitters may spread a little bit we think the surprise continues to be lighter pressure than feared on the inflation front. Blame the kids - and there are millions of them coming into the work-force. The deeper they rise into management over the years, the more technology will be used to but fat.
Keep in mind that the quarterly GDP price deflators in the GDP releases don’t get nearly as much press as do the monthly CPI and PCED readings. They sell way more headline ads with the latter two.
Nevertheless, it helps to glance at the more stable quarterly inflation data, even though they are largely determined by the monthly inflation indicators, which focus on consumer inflation rather than economy-wide inflation. Of course, since the consumer accounts for so much of GDP, consumer inflation has a big weight in the GDP deflator.
The bottom line - as the charts from Dr. Ed will show you below - on the broadest inflation measure for our economy is that inflation remains subdued at 1.9% (y/y through Q4) for the overall GDP deflator. Excluding food and energy, the figure is 1.8%.
In the second chart, the PCED in the quarterly GDP shows inflation of 1.7% total and 1.5% core. The market-based core PCED inflation rate was notably subdued at 1.2% last year.
Net result? There is no runaway inflation - and the black boxes I added to the data are designed to help you focus on the fat part of the bell curve of data. Most of the data points - going back over 25 years - fall into those boxes...and we are nowhere near either extreme.
The Cat's Out of the Bag
This is a long game friends. Pauses and chop are good things along the way - even when they stink up the joint a little.
While S&P forward earnings are already well passed $150 per share for 2018, we suspect we look for something closer to $162 - $170 per share in 2019.
Surprisingly, what analysts are unlikely prepared for is that free cash flow growth is also likely set to be even stronger than earnings growth - allowing for more debt paydown, additional share buybacks and increases in dividends.
The tax law changes are not just about more earnings at the bottom line. It will also drive capital spending as plans unfold over the next few quarters. I suspect by mid-summer or so we will see that this channel will also grow more than currently expected, well into 2019 as we get even more signs of an improving, global economic cycle.
The Bottom Line?
After years of being harnessed as covered so often in the Obama years, America is open for business again. With all the excitement over tax benefits, many have forgotten there is more to do. Look for the U.S to put together a significant infrastructure investment program. This should be a solid boost for 2019, adding again to steady growth.
To cap it all off, as these positive domino effects flow cohesively together and work down into the system, I suspect we will see more M&A activity as well - likely accelerating across all borders.
I repeat - pray for a correction.
It is rare indeed that we see the economic forces align as powerfully as they are coming together now. This is all on top of the globally-leading, powerful and steady Barbell Economy effect we have embedded in the US for the next 30+ years.
Be patient and disciplined friends. These forces are real and they give us a positive foundation for steady and continued long-term upside in global stock markets.
So yes - a correction in this type of environment is a gift.
The world we live in is changing - rapidly. Its' pace of change will likely be far more forward-looking than the crowd can be - hinting at analysts remaining well behind the 8-ball, just as they have been since 2009.
Get comfortable with larger numbers. A 100-point move today means almost nothing. In market terms, we are not too many years away from a normal day's move in our markets having 4 digits in it.
If that makes you nervous - tighten your seat belt and maybe learn yoga.
Stay focused. We are seeing the unfolding symptoms of the undercurrents we have covered for years. They have not changed - they merely get stronger over time as the generational Barbell Economy moves ahead.
The long-term horizon trends remain productive, strong and steady. Even better for long-term investors able to remain patient and disciplined during the storms?
They are still being grandly and profoundly misunderstood.
Alas, that makes better markets for the long-term investor.
And for the new readers fretting over the media chatter about this being the "9th inning...", try not to fret too much.
This is tough to wrap one's mind around - as tough as it was in the very early dawn of the 80's - the really important stage of this game has not even begun.
Far from the 9th inning, picture yourself arriving at the stadium early, walking in and the stands are still mostly empty. You hear the crack of batting practice echoing in the seats and see the net still covering the home plate area.
Players are stretching in the outfield and the managers are in the dugout playing with the line-up cards.
The pitchers are still warming up in the bullpen.
Strap in folks....the ride is still ahead of us.
Of course, there will be lots of stops, rests and short-term setbacks along the way - all the way up this mountain - where it will feel like the world is ending.
But Just Remember.....
Patience and discipline are your very best friends in a secular bull market.
Long-term thinking always wins out over short-term trading. Worrying about the next setback sells lots of ads but makes almost no money for you. History proves it.
Forget economics - think demographics.
It's the bigger picture - the latter drives the former.
It's the current under the emotionally-driven, short-term waves.
Demogronomics keeps us on the leading edge of that long-term direction - but it also demands a much larger, far more patient view of the economic elements at work....including this upcoming earnings season.
Until we see you again - may your journey be grand and your legacy significant.