The Week Ahead: Stick with the strong earners
Low growth confirmed. More ambling by the Fed. Some decent earnings and another package from Japan. So nothing really new except that U.S. stocks hit a new high with small and mid caps outperforming large caps by nearly two to one. The big move in the week was the Yen, which strengthened 2.6% against the dollar and gold, up around 3.5%. It was generally quiet and earnings season chugged on. But here’s what caught our eye.
- Growth: first report for Q2 U.S. GDP was 1.2%. Yet, again, we’re stuck in this not-so-great recovery where anything above 2.5% never seems to last. Most estimates for Q2 were in the 2.5% range so there was some disappointment. Also, Q1 growth was revised down to 0.8%. Here’s what growth looks like:
It’s below the post recovery trend. Most of the story was in the inventories, which subtracted 1.2% from growth. For the last 15 months, inventories have contracted. The way to think about inventories is a simple confidence indicator. If a company thinks demand is growing, they build inventories. If not, they cut them back. Recent economic data show a very mixed bag of slightly better or slightly worse than expected. In other words, low expectations.
- The Fed: met and held. No surprises. It’s a group that wants to raise because that would vindicate policy and prove the economy is in better shape. But it doesn't and it isn’t. The so called “dot plot” (here it is on page 16), where the Fed guesses what rates will be two years from now, is so way off as to be laughable. Their last estimate for 2016 GDP growth was for 2.0%...way below what we’re seeing. So with the Fed on hold, U.S. 10-Year yields dipped down to 1.45%.
- Japan: the Bank of Japan held rates and the 10-Year bond fell to -0.29%. Remarkable. But then, "Japan rates have to rise” will remain a meme longer than anyone can remain short. But what surprised us was the decision to increase purchases of $70bn to $90bn worth of bonds a month. This is about 30% more than the Fed ever did in peak QE. The Bank of Japan’s balance sheet is roughly $4 trillion (so 12 zeros there) or 85% of GDP (U.S. is around 20%). All this activity meant a lower stock market and stronger yen.
So what? Does Japan matter anymore? Yes. If we continue to have slow growth in two out of the three biggest economic blocks, the U.S. cannot power ahead. At least not without fiscal action. Don't hold your breath.
Bottom Line: Now all that sounds pretty bad. But we’re about halfway through earnings season. Companies have so far reported negative growth of 3.8% with about half the industries reporting negative growth and half positive. But the outlook is way better and markets remain well supported. No rush to buy.
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Apple borrows to return cash
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--Christian Thwaites, Brouwer & Janachowski, LLC
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