Carty Capital Management
CFP | Fiduciary



That'll Leave a Mark

Good Morning,


All weekend, I was getting little comments from advisors and investors alike, long-time readers and new parties to the morning notes - all with the same theme:  Is this "it"?


The "it" being referenced of course of the all-feared other shoe dropping.  So many waited so long to wade back into the stock market waters.  Oddly, it has only been in recent weeks where we saw the three-year run of non-majority bullish sentiment ended.  I suspect that will not be the case after last week's events - though we will need to wait for Wednesday night's data to see how quickly the rose petals fade.  I still suspect we find that the beauty of all those bullish feelings remains only skin deep.  


That said, the reason for the panic attack on Friday was not for any bad news.  It was, again, over something which not only is not yet existent - but, importantly - will be good news if it actually arises:  wage growth inflation. 


The crowd has been told for so long it is wise to fear wage growth, that we have apparently lost our ability to actually dissect the question with logic and not emotion.  


A whiff of inflation would be a good thing.  You don't want deflation.  Earnings are surging and we have not even had a quarter or two of that to build on itself after the tax cuts and repatriation flows. 


Think for a moment - with a few trillion new dollars to spend, what do you think companies will do with stocks falling?  I have two likely answers:


a) buy back more of their own stock on the cheap during panic and,


b) go hunting in the M&A world....just look at Broadcom adding a few billion more to the offer for QCOM as a hint


The outcome? 


Who knows if a Black Monday awaits as a follow-up to one ugly week.  I suspect not but for many who have just arrived to the idea that stocks are ok, it will feel just as bad.  But hey, we did get a good glimpse of what happens when everyone and their brother thinks ETF's are the new "easy route"...they work just like everything else does - only worse - when the crowd panics. 


And know this - they will always panic eventually.  


Earnings Reboot


Hard to believe but forward earnings have surged even more than bulls expected a as the results and impact of the tax changes drip into the Q4 conference calls and reports.  Let's take a look at the latest data from Thomson's:


With Thomson Reuters data out this Friday showing forward earnings exceeding $155 a share now, note the 2018 "estimated" S&P 500 earnings growth rate is now 17.7% (rounded off to 18% for this note).  This is a real step up from last week's 16% - which was a giant leap from just last NOV when it bumped above 10% for the first time in a decade.  


Interestingly, with the drop in the key indices this week, many will overlook that the P/E for the S&P 500 as a whole is now 17.8(x) - almost a direct hit for a 1X the market's expected growth rate this year.  This suggests the entire S&P 500 Index is now priced at roughly 1 times growth - a PEG ratio of 1.0 - not an unreasonably-valued market at all.


Keep in mind that the latest Thomson reports also show that 80% of the S&P 500 companies already reporting Q4 '17 financial results have beaten REVENUE estimates - well ahead of the more normal 60% (or so) beat rate.


Last item to note for now on this is that the S&P 500 earnings yield actually rose as the market took a beating.  It jumped from 5.35% in last week's note to over 5.60% this week.


Bottom line here?  A pause was badly needed - and should not be feared.  It is perfectly normal - what has not been normal is to see no setback at all as we climb this mountain. 


For now, note the latest expected S&P 500 earnings growth rates for the next two years:


2019: +10%

2018: +17.8%


It' not just earnings...the underlying data remain steady and overall positive:


Factory orders were revised upward in NOV and the DEC data matched that bump - also ahead of estimates.  


This is a long game friends.  Even when it is ugly short-term, as investors, we must stay focused on the long-term trends.  Essentially, one can disagree with demography but you are hard-pressed to ignore it all together.  Like it or not, we are going to get a lot busier in the years ahead - far more so than current pricing expectations assume. 


Speaking of Fear


It did not take long to rally back.  I stand by the idea that the largest bubble since 2008-2009 had nothing to do with stocks. 


It was instead in the overlooked emotion channel - and the culprit was all fear.  The recent converts after a rally of over 16,000 points were quick to retreat in a week of ugliness.  


Check the latest from CNN's Money Sentiment:



I have stated for months - if you are afraid that the crowd is too bullish, just wait for an ugly week (or three) and watch them move right back out.


The second chart above is just a few years of the data shown in the colorful dials above it.  Note how quickly we steered toward the lows in bullishness in just one ugly week.  A week guys - expect more and feel good about it long-term.  


Remember, after big annual surges, it is not abnormal to go for months and months without making a lot of headway.  As much as it might not feel good watching it, I would not be at all surprised if we find ourselves in a neutral-zone for a bit.


Thank your lucky stars - and be grateful if we can get more of a corrective wave to drive away all those good feelings again.  


Pauses and chop are good things along the way - even when they stink up the joint a little. 


In Closing


It is never a good feeling to write about bad near-term news and suggest to the reader that it is a good thing.  But alas, we must.  Readers of these morning notes recognize this is that ugly feeling we suggested we need to expect. 


As stated, "it will cause one to doubt all they knew before..."  The thing is, history proves to us a fairly consistent reality:  corrective waves ultimately transfer stock holdings from the hands of short-term traders to long-term investors.


There is a very long way to go on this pathway.  A significant number of companies don't even yet have a good sense of just how much their cash flows, investment capacity and earnings will increase from the tax and repatriation changes.  Stack that along with the economic forces aligning around the globe as powerfully as they are coming together now - and you get positives. 


It is just what we have defined in the globally-leading, powerful and steady Barbell Economy effect embedded in the US economy for the next 30+ years. 


Be patient and disciplined friends.  These forces are real and they give a solid 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 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. 


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 - many of which will feel like the world is ending.


But Just Remember.....


Patience and discipline are your very best friends.  It's a week folks - it might even be several more - and could lead to a trade range that will be awfully boring given the last few years of upswing.


This is what markets do to weed out those participants not focused on the proper horizon.  


Besides, I prefer that we focus on what happens after every single panic attack....


Long-term thinking always wins out over short-term trading.  Worrying about the next setback leads too many to think it can be outwitted.  History proves this to be untrue.  Patience works better.  


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.

InvestingMike Williams