Brouwer & JanachowskiJuly 15th, 2016
In one line: market highs but some technical support might drift away.
Well, good news. The U.S. stock market broke through its all-time high set in the spring of 2015. As of writing on Thursday, the market is up 5.8% year to date and 18% since February lows. Small and Mid Cap stocks are even better at +10% and +25% over the same periods. And Treasuries? They’re up 15% since the beginning of the year. But underneath the news, it’s a mixed bag. Here’s what we’re seeing.
- Earnings Season: this was never going to be a great report because energy stocks, particularly Oil and Gas, will show very bad numbers (down over 50%) along with Telecoms. Overall earnings for the market will probably be down 5%. But remember the cycle of how Wall Street works? Management guides low, frownie face to analysts, analysts agree with low estimates, publish and then management beats. So the “beat” rate is always high. It’s happening so far with only 30 of the 505 companies in the S&P 500 (don't ask) reporting. Earnings growth is at -2.5% compared to -2.9% guidance. Expect more of this and a generally healthy season.
- The strange world of Bonds: the relentless downward drift in yields continues. Here’s the chart of major sovereign yields.
From top to bottom it shows U.S. Treasuries, U.S. Treasury Inflation Bonds and German, Japanese and Swiss Bonds. The blue line is zero. As we’ve mentioned this is a new world. For one, it makes valuing other assets extraordinarily difficult as most financial models run off a “risk free rate”. But now the risk free rate loses money. More important, it means bonds change from an investment with cash flow to more a source of capital appreciation. And that takes a lot of care.
Japan and Europe: two items this week. One, Japan revised growth down. Investors now expect more stimulus but we have no details yet. The Yen weakened a bit (expected). Stocks moved higher (also expected). The puzzle is why the Yen is so strong given the rate differential with the dollar. The answer, we think, is because of the huge current account surplus and lower imports (they are down 38% since 2014).
The other is that the ECB is fast running out of bonds to buy. They initially said they would not buy i) bonds yielding below the deposit rate of 0% and ii) more than 33% of the outstanding float of a bond. They will have to extend the eligibility. Meanwhile, we all thought that QE was great for equities. Not so fast:
Both Europe and Japan are down between 9% and 11% this year. And that’s with no competition from bonds.
Bottom Line: U.S. stocks are doing well partly because they have the best immediate outlook but also because i) buy backs, a sort of leveraged trade, are still at the fore and ii) the Fed will apparently not move on rates at all for the next few months. It’s a good time. But not without some concerns.
How capitalism works
Bear gets stuck in a Subaru
Beige Book sees inflation as “pretty benign”
Another month with a budget surplus (yes, the U.S.)
--Christian Thwaites, Brouwer & Janachowski, LLC
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