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Earnings Better, but Weak Markets


The Week Ahead: Keep focused on earnings. There are plenty of distractions.

We thought markets may turn skittish and so it has been. This is what stocks and bonds must contend with: i) a U.S. election (enough said) ii) a divided Fed iii) a somewhat weaker economy iv) earnings v) weaker numbers from China and v) a post-Brexit world. We’ll jump right in.

1. Earnings Season: only 34 of the 505 companies in the index have reported. Expectations are for flat earnings but excluding energy, growth is closer to 3%. The biggest concern for companies was the strength of the U.S. dollar. Here’s the chart:

us dollar strength

The top line is the dollar, which is up 15% in the last year and recently ticked back up. S&P 500 companies get around 30% of their sales from overseas so the concern seems justified.

2. The Divided Fed: the FOMC minutes came out last week. We knew there were dissenters but the gulf seems pretty wide to us. Here’s an example. The subject is low rates. One member said that with low rates, investors save more, and depress growth. Others that the same conditions encourage excessive borrowing, which usually leads to growth. Now call us simple but it seems that both statements can’t be true. And anyway, big savers like endowments and pension funds, don’t save more, they just adjust their return assumptions up.

There are two decisions facing the Fed. One, inflation, which is mostly benign but has some serious medical inflation coming through the system. Two, the labor force. Despite the jobs numbers, unemployment is the same as it was a year ago, at 5%. This is why:

labor force

Over on the right you can see the monthly increases in the labor force. It’s been around 250,000 a month for the last year and at the same time labor participation grew. So the Fed’s dilemma is: will people come back into the labor force or not? If they do, wage inflation remains low. If not, it will accelerate. Meanwhile, the odds are above even of a rate hike in December. Fed Fund futures trade at a rate of 0.70% compared to 0.40% today. Also remember, next year’s FOMC will be less hawkish than 2016.

3. Make me care: Lest one thinks that the UK is a small island (it is), that it can go off on its own if it wants to (it has), sterling and U.K. Gilts remain one of the most important FX and bond markets in the world. Last week there was a classic ‘flash crash”. That means, for no particular reason, sterling, a market which trades around $500bn a day, or three times the U.S. stock market, fell 4%.

flash crash

And again, this week, Gilts rose 10bps. To put that in context, the price of the benchmark 40-year issue fell 17%. So markets are primed to over react.

Bottom Line:  The market is facing a lot of stress. The good news is that there is an earnings recovery underway. But other distractions may lead to a bumpy quarter.


Fibonacci is everywhere

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Using math to sound smart

Why Tinder charges double if you’re over 30


–Christian ThwaitesBrouwer & Janachowski, LLC


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