The S&P 500's YTD Rally Is More A Function Of Liquidity Than Earnings Results And Sentiment
The S&P 500 (SPX) and its peer indices have had quite the bullish move off of the Christmas Eve 2018 lows and finished last week with it’s strongest daily move of the week. Technically speaking, the S&P 500 has repaired a good deal that had broken during the 20% drawdown, which occurred during the Q4 2018 period. With the rally from the week that was, the S&P 500 is officially out of bear market and correction territory, but still within a period of “correcting”. As far as the technical perspective of the S&P 500 is concerned, until the benchmark index achieves a new high it is defined as lingering in a corrective period within a cyclical bull market. So let’s take a look at what drove the markets in the week that was.
On Tuesday, the Brexit vote failed, but equities closed out the day with a 1% advance and closed near the highs of the day. A no-confidence vote was held by the British Parliament the next day, for which Prime Minister Theresa found favor and remains driving the Brexit path forward, but without consensus and in a state of flux.
There are only a few options that seem to be in reach for the U.K., but more importantly is the coordination and agreement with the European Union. An agreement between the U.K. and the European is the biggest sticking point and impetus for increasingly signaling a second referendum. A no-Brexit scenario is the most feared by global markets and in order to stave off such a scenario, a second referendum may be the only rational path forward for the Prime Minister and the nation.
With Brexit issues in search of new and more favorable headlines some weeks out, equity markets have side-stepped concerns in favor of potential trade deals. Let’s face it; trade has been the biggest worry for investors throughout 2018 and remains as such given the uncertainty that comes without resolving trade disputes between China and the United States. On Thursday, headlines surfaced on the trade front and proved favorable despite the dueling narratives.
Trade Headlines Boost Equity Appetites
U.S. officials have been reportedly debating lifting tariffs on Chinese imports to give Beijing a reason to make deeper concessions in ongoing trade talks between the two countries. Treasury Secretary Steven Mnuchin proposed lifting all or some of the tariffs, The Wall Street Journal reported on Thursday, citing people close to the matter. The goal is to push forward trade talks and get China’s support for longer-term reform.
Shortly after the Wall Street Journal reported on the subject matter, White House officials refuted the idea of lifting tariffs. A senior administration official told CNBC’s Eamon Javers that “there’s no discussion of lifting tariffs now.” The official, who participated in a trade meeting at the White House on Wednesday, told CNBC that President Donald Trump “has no interest in making decisions now.”
President Donald Trump said on Saturday there has been progress toward a trade deal with China, but denied that he was considering lifting tariffs on Chinese imports.
“Things are going very well with China and with trade. If we make a deal certainly we would not have sanctions and if we don’t make a deal we will. We’ve really had a very extraordinary number of meetings and a deal could very well happen with China. It’s going well. I would say about as well as it could possibly go.”
Finom Group is of the opinion that the initial reporting from the Wall Street Journal is closer to the truth than what is being refuted by the White House. What we’ve seen in the past is that news breaks on trade initiatives that are played down by the White House officials thereafter and then the original trade initiatives actually take place (for better or for worse). We’ve seen this type of “good cop-bad cop” commentary from headlines and White House officials throughout the trade saga. A thoughtful analysis would suggest that the initial reports are accurate, but the White House desires to maintain the upper hand in trade negotiations. In order to achieve this goal, whereby a tough façade on trade is maintained, the White House either refutes or lowers the temperature of the positive trade headline. Additionally, should the potential offering (lowering/removing tariffs) prove a failed negotiation, disappointment won’t find new depths from equity market participants.
What makes the analysis above that much more compelling is the fact that not more than 24 hours later there was headlines from the other side of the trade negotiation. China has reportedly offered a six-year boost in imports during its ongoing talks with the United States. Chinese officials made the offer during negotiations in Beijing earlier in January, Bloomberg News reported. China would increase its annual import of U.S. goods by a combined value of over $1 trillion, the officials told Bloomberg, which was first to report on the import boost offer. China pegged its proposal to buy more U.S. goods through 2024.
As mentioned above, the China trade offering came less than 24 hours after the U.S. trade offering headlined on Thursday. Both headlines were met with a favorable response from equity markets. It’s logical to assume the chronology of the headlines is fitting with purposeful leaks from both trade camps that are aimed at stabilizing economies around the world that are seemingly slowing. Additionally, with equity markets already boosted by ample liquidity injections since the New Year, the impetus to falsely leak trade information would seem unnecessary to boost markets unless accurate. In short, with global equity markets already rising in 2019 and China already upping their purchases of soybeans from the U.S., why offer such a long-term, six-year commitment on imports if the U.S. hadn’t also offered something substantial regarding China’s exports/tariffs? Logic dictates!
S&P 500 Performance, Precedence, Stats, Flows
For the week that was, the S&P 500 weekly expected move was roughly $45/points. It moved much more than that with the benchmark index finishing the week higher by $74/points, to 2,670. So what does this mean? In short, it means that we are back in the S&P 500 BOX (See Chart Below) that developed during Q4 2018.
The S&P 500 BOX is defined with an upper level of 2,800 and a lower level of 2,581. While the BOX has carried a negative bias/connotation as the SPX triple topped before breaking below support and cascading lower in December 2018, it now has a more favorable connotation as we’ve trended higher in 2019 and broken through resistance levels on the way up.
The S&P 500 is up 6.5% year-to-date. Statistically speaking, the S&P 500 has gone up more than 1.5% 4 weeks in a row. Along with many other signal posts like breadth and A/D line, the stretch of positive weekly moves of greater than 1.5% suggests the depths of the Q4 2018 market drawdown were largely without merit and/or overdone, expressing deep value in the market. Along with this assessment, let’s take a look at what happens to the S&P 6-12 months later and after moving higher by greater than 1.5% for 4 consecutive weeks. (Table from Troy Bombardia)
The statistics don’t lie and are overwhelmingly favorable. As depicted in the table above, from 1950 - present, this situation has been 100% bullish for the S&P 500 6-12 months later. Will 2019 find the trend remaining on par or will it prove a deviation from perfection?
What I like about the current market action is that it is attempting to repair itself from a technical perspective. What don’t like about the current market action is that it is repairing during earnings season and with earnings coming in mixed, with respect to results being positive or negative. Ideally, I would like to see strength in earnings and revenues, but the results have been all over the place with beats and misses and on both top and bottom lines. Very few companies that have reported within the early reporting season (financials largely) have beaten on both top and bottom line. We are more commonly seeing a beat on bottom line, but a miss on the top line or visa versa. Given the dynamics thus far, I'm being forced to recognize the market is operating under the guise of greater liquidity and pricing in the fundamentals for the next 6 months. As I shall discuss earnings a little later in this weekly research report, let’s take a look at what to expect in the coming week from the S&P 500.
So here’s the deal, right? I have talked about what I would like to see from the market and why. Are the earnings bad, no! Is the economic data bad, no! But neither is improving to the degree we saw in 2018 and that dampens the mood of the market rally and calls into question how long it can last. Given the aforementioned, I am forced to conclude this is more a technical move, driven in part by an increase in liquidity and less about economic fundamentals.
Moreover and for the shortened trading week to come, the S&P 500 weekly expected move is $41/points, down from last week’s expected move of $46/points.
Market Liquidity
Earlier in the trading week that was, Finom Group subscribers were privy to some insightful research reporting from J.P. Morgan’s quant team, led by Marko Kolanovic, CFA. The report discussed volatility and liquidity and how the two go hand-and-hand in many respects. Additionally and what may prove of great consideration is the notion of liquidity with respect to the actions of the Federal Open Market Committee and central banks around the globe. As the U.S. has embarked on Quantitative Tightening, many conclude that such activity drains or reduces market liquidity. However, nobody has yet to formulate or indicate the mechanism for which such liquidity is drained outside of sentiment.
To more succinctly state the aforementioned, the Fed or central banks did not create a new button, lever or instrument to drain liquidity and named them QT. Marko Kolanovic mirrors this sentiment in the following paragraph.
“To our knowledge, there is no broadly accepted understanding of the exact mechanics and magnitude of QT’s impact (e.g., how much it is a signal to the market, vs. mechanical supply/demand and price impact). There is a significant relationship between the Fed’s balance sheet changes and the market, but the big drivers of this relationship are points when the large QE programs were announced such as March 2009 (e.g., when this point is taken out, the relationship no longer appears statistically significant; Figure 7 shows the weak contemporaneous relationship since the start of 2010). Whatever the real mechanical impact is, likely the impact on market sentiment is much larger (i.e., self-fulfilling impact). In support of that are recent intraday movements on balance sheet mentions, as well as the price action of the S&P 500 during Q4 shown in Figure 8. While there may be little or no mechanical impact on equity prices, most macro traders are not ‘fighting the Fed’ – when liquidity is added they are buying assets, and when liquidity is removed they are selling assets.
Investors have assigned a value to risk assets along the lines of Fed activity. When the Fed is easing this assumes a higher value on risk assets. When the Fed is tightening, investors assume less value on risk assets. In both Fed conditions noted, the investor is sentiment driven, not mechanically driven. Investors are drawing conclusions or end results from Fed activity and as such, the self-fulfilling prophecy is commenced.
Given the topic of market liquidity and as we’ve mentioned it several times throughout this report, we are forced to understand that even as the Fed has paused future rate hikes, it’s balance sheet is still contracting. The Fed remains with its selling of Treasury’s, balance sheet run-off activities. Given the facts about the Fed still draining liquidity from the market, I'm forced to question where the excess market liquidity has come from. Why is the economy more heavily flushed with cash/USD?
The chart above speaks volumes. The U.S. debt ceiling is approaching on March 1, 2019. Therefore, the U.S. Treasury will not be allowed to have as much excess cash at its account with the Federal Reserve. As the U.S. Treasury draws down this account in January, this liquidity will enter the banking system. This >200bn liquidity addition will overshadow the scheduled liquidity drainage from maturing Treasuries (40bn). The drawdown can happen in different ways, such as via less tax revenues or via less bill issuance, but the end result will still entail greater dollar liquidity in the banking system. The greatest impact from the liquidity injection occurs when the USD weakens. With a weakened USD from excess liquidity risk assets tend to gain. By and large, this is what has and is continuing to happen in the month of January. It’s not the fundamentals; it’s the technicals that are juxtaposed with improving liquidity given the U.S. Treasury’s forced activity ahead of the debt ceiling. In fact, the U.S. Treasury has added $50bn of excess USD to the system so far this year? Another $100bn+ is likely over the next 4 weeks
I can’t just stop here with respect to defining what has produced this injection of market liquidity, the U.S. Treasury. It’s unlikely that the U.S. Treasury by itself could produce a global equity market resurgence.
When we dig that much more deeply into the global money supply trends we’ve come to find that global money supply has ticked higher in late 2018 and into 2019, as depicted in the chart above. While the U.S. Federal Reserve is tightening, most other central banks are still pumping liquidity into their system, especially China and Japan. (Chart of central bank balance sheets from around the globe, below)
Some of the excess liquidity being pumped into the global money supply finds its way to the U.S. markets obviously. So when we suggest that the equity market rally of late is one of increased liquidity and technical repair, we urge investors and traders to refer to these research points in the future. Certainly, we don’t project that liquidity is all that matters, but as we understand, it is an important factor for market performance.
S&P 500 Earnings
For the current earnings season, estimates have consistently been revised lower. Thus far, 11% of the S&P 500 members have reported results. In the coming week, another 56 members from various sectors will report results. Total earnings for the 55 index members that have reported are up +16.9% from the same period last year on +9% higher revenues. Earnings and revenue growth for the same members of companies had been +22% and +9.7% in the previous earnings season. The comparison chart below puts this growth deceleration in a historical context for these 55 index members.
Keep in mind that the earnings growth slowdown was to be expected and has been forecasted for the Q4 2018 period.
What might be of more concern to investors is that the EPS blended growth estimate for the first quarter has dropped to 1.3% through Friday, from 1.9% a week ago and from 6.7% on Sept. 30, according to FactSet Data. The first quarter is shaping up to witness the slowest growth since it rose just 0.3% in the 2nd quarter of 2016 to snap a five-quarter streak of declines. The following table shows what analysts expected through Friday in terms of year-over-year EPS growth for the S&P 500 and each of the S&P 500’s 11 sectors for the fourth and first quarters, as well as the change in estimates since Jan. 11 and Sept. 30.
As I source earnings forecasts from various data trackers and economists, Thomson Reuters remains the most objective and with the best track record. Here is what Reuters is forecasting for the Q4 2018 reporting season:
Aggregate Estimates and Revisions
- Fourth-quarter earnings are expected to increase 14.2% from Q4 2017. Excluding the energy sector, the earnings growth estimate declines to 12.2%.
- Of the 55 companies in the S&P 500 that have reported earnings to date for Q4 2018, 76.4% have reported earnings above analyst expectations. This is above the long-term average of 64% and below the average over the past four quarters of 78%.
- Fourth quarter revenue is expected to increase 5.6% from Q4 2017. Excluding the energy sector, the revenue growth estimate declines to 4.7%.
- 2% of companies have reported Q4 2018 revenue above analyst expectations. This is below the long-term average of 60% and below the average over the past four quarters of 72%.
- The forward four-quarter (19Q1 – 19Q4) P/E ratio for the S&P 500 is 15.4.
The real question posed to analysts and investors remains centered on FY19 EPS. A great many variables will play a role in corporate earnings and revenues going forward. Here is a list of some of these variables below:
- USD Index
- Global trade feud resolution
- Capital spending
- Housing sector trends
- Government Shutdown
- Consumer spending trends
- Fed remains dovish
For the current week, below is a table of expected earnings reports by day:
All of the bullet-point issues have the potential to be a headwind or tailwind in 2019. The consumer has remained buoyant throughout 2018 and as the trade feud wagered on. But signs of a slowing consumer may be on the horizon if consumer sentiment is any indicator.
Consumer sentiment dropped to its lowest level since before the U.S. presidential election in 2016 amid growing concerns over U.S. economic growth, according to data released Friday. The University of Michigan consumer sentiment index fell to 90.7 this month, its lowest since October 2016, from 98.3 in December, preliminary data showed. Economists polled by Refinitiv expected the index to fall to 96.4.
“The loss was due to a host of issues including the partial government shutdown, the impact of tariffs, instabilities in financial markets, the global slowdown, and the lack of clarity about monetary policies,” said Richard Curtin, chief economist for the Surveys of Consumers. “Aside from the direct economic impact from these various issues on the economy, the indirect effect meant that half of all consumers believed that these events would have a negative impact on Trump’s ability to focus on economic growth.”
The consumer data set will go through one more revision for the stated period. Nonetheless, the survey showed that the manmade issues of 2018 have finally impacted consumer sentiment to some negative degree. The good news is that the issues of concern are, in fact, manmade and therefore can be reversed. The biggest near-term threat to consumer spending and economic growth in the U.S. centers on the government shutdown, which is now the longest shutdown in history and seemingly without near-term resolution in sight.
Over the weekend, President Donald Trump stood before the nation in efforts to put forth a deal of compromise that would grant DACA residents temporary status in exchange for border wall funding. Unfortunately, the opposing side has already issued the compromise as being a “non-starter”.