Just New All-Time Highs

361 Capital Market Commentary | January 13th, 2020

The bears tried their best to break the market Tuesday night on the anticipated Iranian attacks but it didn’t last long. Iran quickly backed down once the news of a mistaken attack on a Ukrainian passenger jet surfaced. As geopolitical risks de-escalated, the markets quickly turned its thoughts toward the signing of a U.S./China trade deal, better-than-expected ISM Service numbers, good jobless claims, doable non-farm payrolls, and looking forward to the start of this week’s earnings season. The Chinese Yuan continues to move higher reaching five-month highs as optimism toward future trade climbs. A stronger Yuan not only helps the Chinese equity indexes, but as the largest component, it also gives emerging markets a big boost.

As earnings begin to be announced this week, we are seeing some confirming news in the pre-releases. In the semiconductor space, Microsemi pre-announced to the upside, while both Samsung and Micron hinted at positive flash memory demand. In the housing space, Lennar reported positive numbers helping the housing stocks offset volatile interest rates. Retail, meanwhile, remains difficult with Kohls, JCPenney’s and Walgreens announcing difficult trends sending all stocks sharply lower. With stock prices higher into earnings, the bar has been raised so the outlooks and tone of the conference calls will be important.

While stocks continue to make new all-time highs, you will notice the notes of caution and walls of worry building. This weekend’s Barron’s roundtable is a good barometer of this. Strategists, CIOs and Portfolio Managers have little incentive right now to advertise 100% long risk exposures when stocks are trading at 18-19x forward earnings. It’s much easier to be more cautious in times like this in the event that weaker earnings/economics, a geopolitical event or market psychology hits the market for 4-5 multiple points. I have included some of the warning flags and comments below for you to think through. This is no time to be a hero in stocks, but if you can pick the individual stocks, sectors of geographies correctly, you can still find buckets of returns to take home.


Morgan Stanley warns that concentrated returns can be reversed if the concentrated income does not keep pace…

We talked a lot last week about the narrow breadth at the top of the market indexes. Morgan Stanley wants us to consider that earnings at the top five companies must keep up with the stock price movements. Of course if the global economy heats up, it could lead to cyclical earnings accelerating faster than iPhone profit growth.

Share of Top 5 Companies in S&P 500

Plenty of market warning flags to consider in Barron’s this weekend…

Meryl Witmer (Eagle Capital Partners): The consumer is in good shape; consumers will continue to spend, and the Fed looks like it will be very cooperative. We usually say slow growth is nirvana for the market, but with valuations this high, I would not expect a robust year for the market. Everything I look at is trading where it should trade in 1½ or 2 years from now, which means valuations are 15% to 20% too high. We could have a really sideways-to-down market; if something happens to cause fear, it could really topple. Then, maybe we’d get some good valuations again. It’s good to have some cash around. Cash levels for retail investors are still kind of high, but down from last year.
(Barrons)

More high probability warning flags thrown on Twitter from RenMac…

@RenMacLLC: WARNING: Only Strong Swimmers Beyond this Point. In January 2018 the CBOE Composite P/C ratio reached similar levels. Unlike today, the Fed was tightening and contracting its balance sheet. That liquidity difference may give this more room, but understand these waters.

S&P 500 vs CBOE

Meanwhile, the very big risk parity fund managers look like they are all in on equities…

Which is fine as long as equity volatility stays low. But if volatility increases, they will take their exposure down and the markets will feel the impact when this big strategy shifts.

Exposure to equities

Also, other equity PMs are also quite long equity futures right now…

Which in the past has been an early indication of future volatility.

Investors are Very Bullish on US Stocks
(WSJ/DailyShot)

In the great news camp, the China Yuan breaking higher = good for global trade…

USD/CNY inverted
(WSJ/DailyShot)

A higher Chinese Yuan is also likely tied to global economic growth which should lead to cyclical outperformance…

Cyclicals should outperform
(Goldman Sachs)


Samsung and Micron indicated last week that flash memory demand is in short supply…

Great news for this highly cyclical segment of the semiconductor industry, as well as for all things tech that these chips go into.

After an excruciating year, makers of memory chips have reason to breathe a sigh of relief: The industry’s slide appears to have ended. The latest positive sign came from Samsung Electronics Co., the world’s largest memory-chip maker, which this week issued financial guidance that topped analysts’ estimates. That followed a declaration from rival producer Micron Technology Co. in December that its business was passing through a ”cyclical bottom.”

A big accelerant is the rollout of 5G mobile networks. The global deployment of the next-generation technology should re-energize smartphone sales and juice corporate investments in artificial intelligence, computing and data storage—all areas requiring significant memory capacity.

(WSJ)

Memory Boost

Microchip also had good news and since its chips go into so many end markets, it is another good sign for the broad-based semi manufacturers…

@cfromhertz: $MCHP *MICROCHIP RISES 4% AFTER PRELIM. 3Q SALES TOP HIGHEST ESTIMATE

Microchip Sees Third Quarter Net Sales

Earnings begin this week with an overdose of banking stocks to report…

Most Anticipated Earnings Releases
(@eWhispers)

Revenue growth should begin to accelerate going forward as global trade restarts with China…

On Tuesday morning a trio of big banks kicks off the fourth-quarter earnings season in the US. Analysts and investors are hopeful that corporate America will report its first quarter of earnings growth since the end of 2018 and that profits, and not a flood of liquidity, will power Wall Street in 2020.Last year the world’s biggest stock market notched its best annual gain since 2013, closing up 29 per cent, helped by three interest rate cuts over the course of the year from the US Federal Reserve. But valuations raced ahead of profits: over the course of the year the forward multiple of price/earnings rose from 14 times to 19 times. Multiple expansion accounted for 92 per cent of the market’s appreciation, according to Goldman Sachs.

Investors are hoping that the cheaper money now swilling around the system will begin to show up in companies’ income statements, said Jeff Kleintop, chief global investment strategist for Charles Schwab.

“Last year we saw a huge increase in valuations on the back of central bank support,” he said. “Now we’ve got to deliver on the promise.”

(FinancialTimes)

Tech revenues expected to rise

The stock market has moved to reward those companies who are investing in Capex and R&D…

In other words, the market is less rewarding to stock repurchasing and dividends.

GS Total Cash Basket
(WSJ/DailyShot)

We talked about Executive Office pessimism on our webcast last week…

Will this correct with an improving economic outlook? If so, will it cause CEOs and CFOs to greenlight new investments into their businesses?

Share of CFOs
(Axios)

Of course if manufacturers want to expand, the next step of hiring workers has become much more difficult…

Manufacturers are paying relocation costs and bonuses to move new hires across the country at a time of record-low unemployment and intense competition for skilled workers.

Half a million U.S. factory jobs are unfilled, the most in nearly two decades, and the unemployment rate is hovering at a 50-year low, the Labor Department said Friday. At the same time, Americans are moving around the country at the lowest rate in at least 70 years.

To entice workers to move, manufacturers are raising wages, offering signing bonuses and covering relocation costs, including for some hourly positions. They are betting that spending on higher wages and moving incentives will help them find workers to fill their backlogs of orders.

Rather than just extending these benefits as part of job offers, factories are also advertising them in postings to encourage farther-away candidates to apply. On ZipRecruiter Inc.’s job-listing site, 1.6% of manufacturing positions include a pledge to pay moving costs, up from 1% in 2017.

(WSJ)

More to Make

Some interesting thoughts from this weekend’s Barron’s Roundtable…

Do you expect inflation to rise?

Rupal J. Bhansali (Ariel Investments): Inflation is what breaks this feedback loop. We are so used to hearing that inflation is below the 2% target. It isn’t. It’s over 2% in the U.S., and wage inflation is running well north of that. Part of the reason the markets went up is because they always go up when you have real [inflation adjusted] negative interest rates, and that is what we are experiencing. That is the real canary in the coal mine. Higher-than-expected inflation will put an end to this party like nothing else would.

The reasons for being both bullish and bearish on the economy are that the consumer is very strong, but the manufacturing sector is not. So, it is a two-speed economy. The consumer is very strong, partly because employment is at record lows and partly because wage inflation is very strong, much higher than the consumer price index. It is running at 3.2%, compared with the headline CPI of 2%, and that’s a very healthy increase. Consumer credit is running at a 4% growth rate, while lending to small and medium-size enterprises is flat. If you look at manufacturing globally, it is in a tailspin. [The ISM Manufacturing index is at a 10-year low.] The auto industry is at the vortex, but aerospace is following suit because production cuts are about to happen in 2020. Surveys show consumer confidence is strong, but CEO confidence is at its lowest since 2009.

Will the industrial side get bad enough to have an impact on consumers?

Bhansali: It inevitably does, because the two are linked. Though manufacturing accounts for only 11% to 13% of gross domestic product, when it contracted in the first and second quarters of 2019, the Fed lowered rates despite inflation hovering at or above its stated target of 2%. If inflation rises well above 2%, it may force the Fed to raise rates. This may eventually end up hurting the consumer and the economy. In short, the economy may do fine, but the stock market won’t. Given how richly valued the markets are, if you have any hiccups in the credit markets, it will have a disproportionate effect on the equity markets because of the amount of corporate leverage and underfunded pension liabilities. It would not surprise me if we go into bear market territory because of those two starting points.

(Barrons)

Checking in on TIPS prices, it looks like others also want to bet on higher inflation…

Inflation is typically a trigger for investors to step back from standard government bonds. The interest payments on those bonds are fixed, so higher inflation eats away at the value they promise for the future. Now, bonds are not weakening, supported in part by the latest outbreak of geopolitical stress. But Treasury inflation-protected securities, or Tips, are climbing, reflecting a thirst among fund managers for instruments that are indexed to inflation and that provide a hedge for times when inflation takes hold.

Big investment firms including Pimco, BlackRock and Franklin Templeton are among those that have been snapping up the inflation-linked bonds.

“The notion that inflation is gone is a heroic assumption,” said Sonal Desai, chief investment officer at Franklin Templeton Fixed Income Group. Tips offer value, she said, because market participants are “too sanguine” about price rises.

(FinancialTimes)

iShares TIPS Bond ETF

Bank (relative) EPS momentum says it’s time to buy EU banks…

Higher inflation will lead to higher interest rates which will also help this move.

European Banks

If you are a high earner and you needed one more reason to move to Florida…

“I have to admit that I was surprised by how much of a financial savings” is achieved by moving to Florida. “It is crazy money,” says Connor Lynch, chief executive of Plastridge Insurance Agency based in Delray Beach, Fla.

Escaping state income taxes is a big part of the reason, but the federal Tax Cuts and Jobs Act of 2017 also plays a role. The law limits deductions on state and local taxes as well as the mortgage-interest deduction on federal tax returns. Factor in Florida’s lower cost of living relative to high-tax states, and the decision to move gets even easier.

(WSJ)

Florida Tax Savings

Some people still believe that changes in power generation will occur slowly…

@iain_staffell: 100 years of electricity generation in Great Britain… Just look how rapidly things have changed over the last decade! More to come in the next @Draxnews Electric Insights.
(https://electricinsights.co.uk )

Britain's electricity generation mix

After 25 great years, wine consumption hits a change in trend…

Americans drank less wine last year, the first such drop in a quarter of a century, as millennials opt for alternatives like hard seltzers, cocktails and nonalcoholic beer.

The volume of wine consumed in the U.S. declined 0.9% in 2019, the first time it has fallen since 1994, according to industry tracker IWSR. The trend was ascribed to a generational shift as the number of millennials surpasses baby boomers, who drove strong demand for wine in America.

“Millennials are just not embracing wine with open arms compared to previous generations,” said Brandy Rand, IWSR’s chief operating officer for the Americas. “With the rise in low and no-alcohol products and general consumer trends toward health and wellness, wine is in a tough place.”

(WSJ)

Glass Half Empty

I am a big believer in sleep science, but good luck getting people to turn off their Netflix and spend 2-3x the inflation rate on bedroom furniture…

@eliotwb: Casper says the “Sleep Economy” is growing 6.3% a year. Take that, US GDP!

Global Sleep Economy

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