You've got to ask yourself one question
[The subject matter of my calls this week took a stark turn. Now everyone is focused on the election. “What should I do if my guy doesn’t win,” I was asked. My response—I don’t need to know who your guy is, because for the market, it doesn’t matter who wins. In a few weeks, the Mister and I will go on vacation, and I will offer you my Election Special to explain.]
“‘Do I feel lucky?’ Well, do ya, punk?” This is Clint Eastwood’s infamous question to an injured criminal in the 1971 movie, "Dirty Harry." This week the S&P 500 closed at a new record high, taking just 103 trading days to erase its 35% decline, the fastest-ever recovery to a new high after a drawdown of at least 30%. Breadth, however, remains underwhelming. Decliners are outnumbering advancers by about 2.5 to 1, with the median stock roughly 28% away from all-time highs. A mere 6% of S&P constituents are at 52-week highs, vs. 25% at February’s peak. Not the best. Also, the 12-month forward earnings yield (per-share earnings divided by market price) is at its lowest on record, even with significant increases in estimates among beaten-up cyclicals. Gulp. Since late May’s bottom, sector earnings for Energy, Consumer Discretionary, Materials, Industrials and Financials have been revised up a respective 239%, 26%, 11%, 10% and 9.5%. Still, the valuation gap between yields on forward earnings and bonds has narrowed, suggesting investors may have bid stock prices far above what’s justified. At $4.6 trillion, money market cash represents 14% of the stock market, a zone where Ned Davis says gains historically have been below average. The only other times when the Dow’s price-to-book value topped 4, as it did this month, were in 1929, 2000 and 2007. Hmm.
To be sure, rate suppression is a boon for cyclicals. Renaissance Macro sees the current environment as being almost exactly opposite that of late summer 2018. Back then, the news was almost unambiguously good with the exception of China trade tensions. Manufacturing was running hot, producer prices were subdued, the 10-year Treasury yield was approaching 3% and the Fed was in the midst of a rate-rising cycle, hiking the target rate a quarter point that September and indicating another increase was likely by year-end 2018. Almost immediately, cyclicals vs. defensive names signaled the Fed was overstepping, resulting in one of the worst fourth quarters for equities ever. Today, this cyclical vs. defensives trade indicates rates are low enough to spark a recovery, despite a challenging news cycle, Covid or no Covid, Democrat or Republican in November. Yardeni sees the Fed embracing the analysis of influential French economist and MIT Professor Olivier Blanchard, a senior fellow at the Peterson Institute for International Economics. His conclusion: Don’t tighten until you see “the whites of inflation’s eyes.” Chair Powell on June 10 essentially stated he doesn’t care if the Fed is creating an equity market bubble. It doesn’t get more bullish than this for stock investors. The danger to the market is unlikely to be economic data, Ren Macro says, but rather the sensitivity assets will have to monetary policy when it eventually begins to tighten at some point well down the road. In an email to its future self, it says, “Remember to sell assets when the Fed tightens, no matter how good things are or how smart you think you are.’’
Q3 GDP is expected to jump at annual rate of at least 20% on the initial surge in activity, with goods demand likely back at pre-pandemic levels. Applied Global Macro Research sees a quick earnings recovery and says that while service activity may continue to lag, it’s less important for profits than it is for GDP. (Fundstrat shares that social-distance spending at bars and restaurants and for take-out represents $717 billion, just 4% of the $17 trillion consumer wallet.)! Applied Global thinks profit growth over the next 12 months will be the strongest in decades and is forecasting a 60-80% increase in nonfinancial corporate profits from Q2’s low through Q2 2021 and nonfinancial corporate profits to reach a record high in next year’s first half. Yes! And because recessions tend to lead to rising profit margins and sustained multiyear profit cycles, it expects profits and earnings to be higher in 2022 than they would have been even in the absence of the Covid recession. Woo-hoo! Outside of housing, the economic data appears to be softening, signifying a shift from a “V” to what Cornerstone calls a “wavy” recovery pattern—moderating improvement, with ups and downs on Covid flare-ups and pauses in reopenings. The overall economic trend remains solidly up, however. So, therefore, you’ve got to ask yourself one question. “Is this a bubble? Well, is it, fellow investment professional?”
- Don’t count out a ‘V’ July existing home sales shot up to a 14-year high, while housing starts jumped the most in almost four years and housing permits soared the most since January 1990. August home builder confidence also beat expectations, matching its highest level on record.
- Don’t count out a ‘V’ Markit’s initial read on August business activity jumped to early 2019 levels as both the manufacturing and services sectors saw a resurgence in new orders. Its flash composite PMI rose to 54.7, its highest since February 2019, with the manufacturing component its highest since January 2019 and services its highest since March 2019. Regional manufacturing data was less robust, as gauges in the New York and Philly partially retraced recent gains but remained expansionary.
- Don’t count out a ‘V’ Conference Board leading indicators rose a third straight month in July by a robust and better-than-expected 1.4%, with six of 10 components contributing.
- Jobs recovery slows New jobless claims no longer are collapsing—they rose above a million again in the latest week. Although continuing claims fell, they too remain at extreme highs on a historical basis.
- Consumers want their stimulus Retail sales have flattened the past nine weeks, and Bloomberg’s monthly survey shows consumers remain deeply negative as pessimists outnumbered optimists a sixth month in a row. Bloomberg’s weekly consumer comfort gauge also slipped and, while off May’s recession low, is 23.8 points below January’s pre-recession high.
- Benefits cliff Fiscal stimulus is starting to fade with the economy less than halfway back to full health. Congress and the White House remain at loggerheads, and Trump’s executive orders aren’t expected to have much impact and won’t kick in until September. The lack of action comes as mortgage delinquencies spiked in Q2 to a 9-year high and credit card delinquencies hit a 7-year high.
Cash still king Covid revealed people will hoard paper money despite the availability of other payment media and still use coins and low-denomination bills to make low-value purchases. Indeed, a shortage of coins emerged in June, when the Fed's inventories plunged as shutdowns froze coins in cash registers of closed businesses. Meanwhile, demand for $20s and $50s soared more than 30% annually.
It doesn’t matter who wins Trend Macro notes that, amid a broad discussion of all the risk factors holding back business spending, the word "election" wasn’t mentioned even once in July Fed meeting minutes.
Life is like a box of chocolates In the 1994 movie, Forrest Gump bought a stake in Apple worth $100,000. Bank of America says that today, that share would be worth $60 billion.