Stocks Ignore - Were Mixed On Thursday

S&P 500 was down 0.27% on Thursday, but that should be considered an amazing performance when context is given. The stock market came into the day overbought and the retail sales disaster report was released. 

You would think an overbought market would worry about the declining Q4 and Q1 GDP estimates, but it completely ignored that. It’s obviously not fair to say that stocks priced in this negative report with the decline in December because most of the bear market move has been rescinded.

It’s possible that the stock market decline caused the weakness in retail sales. But consumer sentiment was weak in January which was after the volatility ended. There was a modest pickup in last week’s consumer comfort report, but that might not be a new trend. 

On the one hand, consumers being nervous about the stock market, even after the rally, could be positive. It signals there’s more room to the upside.

 On the other hand, it could mean the political uncertainty and bear market could have a long tail effect on the economy. I might be overanalyzing the retail sales report from 2 months ago. However, I’m still curious about Q4 GDP growth.

The Nasdaq and Russell 2000 outperformed the S&P 500 as they were up 9 basis points and 14 basis points. The worst 2 sectors were the financials and consumer staples which fell 1.16% and 1.22%. 

This clearly wasn’t a risk off day as the utilities and consumer staples fell, while technology and communication services rallied. The 2 best sectors were real estate and healthcare which increased 0.45% and 0.23%. Finally, the industrials underperformed as they fell 0.55%.

Stocks Ignore - Earnings Results Aren’t Great

Q4 2018 earnings results have been bad and estimates for the next 3 quarters have fallen sharply. The only positive is Q4 2019 estimates are increasing. However, they are increasing for a bad reason as Q4 2018 results haven’t been great. 

As you can see from the chart below, with 386 firms reporting earnings results, EPS growth has only been 13.18% which is much less than half the growth rate in Q3 which was 34.41%. 

The 2-year growth stack fell sharply as it was down from 39.41% to 30.91%. The sequential weakness is partially due to weaker comparisons, but also due to global economic weakness. In Q4 tech earnings growth was only 5% which was down from estimates of 6.7% at the end of last year.  

The second chart above shows revenue growth is 6.36%. Even though this is lower than the 9.79% growth rate in Q3, the 2 year growth stacks are about the same. Q3’s stack was 16.69% and Q4’s growth stack is 16.19%. Both are great results. 

This point shouldn’t be overlooked in the sea of bad data from earnings. 

Stocks Ignore - The biggest story the bears are hanging onto is the potential for an earnings recession. 

However, if revenue growth is in the mid-single digits in 2019, I don’t think it’s a real recession.

As of February 14th, estimates for Q1 earnings growth were 0.85%. Even if earnings estimates are beaten less than average, growth would be positive as of today. Estimates will likely fall in the next few weeks, but I don’t think they will fall as quickly as they did in January because there’s not as much new information to catalyze estimate changes. Weak guidance in Q4 results pushed down estimates. As earnings season winds down, this catalyst won’t exist.

Technically, a recession isn’t 2 consecutive quarters of negative GDP growth. However, it’s fair to say an earnings recession is 2 quarters of negative EPS growth. 

As I mentioned, I won’t take it seriously if revenues grow. Q2 EPS growth needs to be negative for there to be a recession. Currently EPS estimates call for 2.54% growth, so an earnings recession isn’t a guarantee. Q3 faces the toughest comparison. Currently, estimates are for 3.18% growth. 

That quarter should end up with negative growth based on the tough comp, but if economic growth rebounds, there’s hope for decent results. Finally, Q4 estimates are for 11.14% growth because Q4 2018 has been weak. 

Stocks Ignore - The economy needs to be in a recession for this quarter to have negative EPS growth.

It’s very important to understand that the extremely high EPS growth in 2018 made it almost impossible for 2019 to have trend growth. 

Estimates for 2019 growth that were in the low double digits or the high single digits were ridiculous. Analysts usually start with between 7% and 10% earnings growth unless the economy is in a recession. EPS falling modestly because of tough comps isn’t the end of the world for stocks. 

Clearly, it hasn’t been so far as stocks have soared this year.

Stocks Ignore - Moderate Jobless Claims

Jobless claims reports are no longer a source of strength, but they aren’t yet a source of weakness. Initial claims were up 4,000 to 239,000. Claims in the prior week were revised higher by 1,000 to 235,000. 

4 week moving average rose sharply because a great result was excluded from the average. The 4 week average increased from 225,000 to 231,750.

These results are nowhere close to recessionary, but it does look like claims bottomed in September. 

That perfectly correlates with the top in the stock market, but the latest results have been the opposite of stocks. The government shutdown’s effect is almost gone as claims from federal workers fell from about 5,500 to about 1,000. Since this pushed claims down, the fact that they increased looks a little worse.

Stocks Ignore - Conclusion

Negative argument for stocks is earnings growth is almost nonexistent in 2019 and jobless claims have bottomed. 

Positive argument is revenue growth in 2019 is still expected to be solid and jobless claims are still very low. Even with the terrible December retail sales report, I side with the bulls. I just wouldn’t buy stocks unless they pullback from the current overbought level. 

That makes me short term negative and intermediate term positive.