Q1 Earnings Season Set Up For Positive Surprises

April 11, 5:00 pm EST

As we came into the week, the economic, political and corporate calendar was relative light.  With that, I suspected markets would be relatively quiet.

Of course we have had an ECB meeting and minutes from the Fed.  Often, these would be market moving events.  Not this week.  As we discussed yesterday, we clearly know where they stand.

So, what’s next?  Earnings.

First quarter earnings season kicks off next week.  We’ll hear from the major banks.  Earnings will be the catalyst for where stocks go from here – and banks will set the tone.   The building theme has been “earnings recession.”

After 20%+ earnings growth in 2018, following a historic corporate tax cut, anyone would expect earnings growth to be less hot than last year.  Some were even predicting that the hot numbers of last year would be a peak in earnings growth.  After all, under ordinary circumstances (in a stable economic environment) we’re very unlikely to see the U.S. stock market grow earnings by excess of 20%.  That’s not much of a story .

But the media loved the shock value of the phrase “peak earnings” last year, and ran it in headlines, conveniently excluding the word “growth.”  Peak earnings is very different than peak earnings growth.

Still, the broad market sentiment on future corporate earnings eroded through the end of 2018, and has continued to erode through 2019.

And both Wall Street and corporate America are more than happy to ride the coattails of lower sentiment by lowering the expectations bar on earnings.  When sentiment is leaning that way already, there is little-to-no penalty for lowering the bar.  That just sets the table for positive surprises.  They did it for Q4 2018 earnings.  And they beat expectations.  And they have set the table for positive surprises for Q1 2019 earnings.

Just how low has the bar been set for Q1?

Before stocks unraveled in December, Wall Street was looking for 8.3% earnings growth for 2019.  Now they are looking for less than half that.  Moreover, they have projected earnings to contract in Q1 compared to the same period a year ago (i.e. at least a short-term peak in earnings).
Will they be right?
Well, the Atlanta Fed’s real-time model for estimating GDP has Q1 GDP coming in at 2.3%.  The economy added on average 173,000 jobs a month over the first quarter.  Both manufacturing and services PMIs expanded in the quarter, and stocks fully recovered the losses from December. That’s a formula for earnings growth, no contraction.

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Global Central Bank Policy Is Back To Pinning Down Rates, Driving Up Asset Prices

April 10, 5:00 pm EST

The minutes were released from the March Fed meeting today.  But we already know very clearly where they stand.

Remember, they spent the better part of the first three months of the year marching out Fed officials (one after another) to give us a clear message that they would do nothing to kill the economic recovery.

Just in case there was any question, Jay Powell stepped in just ahead of the March Fed meeting with an exclusive 60 Minutes interview, where he spoke directly to the public, to reassure everyone that the economy was in good shape, and that the Fed was there to promote stability (i.e. rates on hold and even prepared to act if the environment were to turn for the worse).

As expected, the ECB echoed that position today, following their meeting on monetary policy.  As we’ve discussed, the major global central banks have again coordinated both messaging and policy to ward off an erosion of confidence in the global economy.   No surprises.  And I’m sure managing the U.S. 10-year yield has been part of that coordinated response.  In addition to the speculative flows that have pushed yields lower, I suspect there has been a healthy dose of central bank buying (Bank of Japan and others through sovereign wealth funds).

With that, even though stocks have bounced back, commodities are on the move, and we’ve had improvements in global economic data, we still have European 10-year yields (Germany) at zero and U.S. yields at 2.50%. That is promoting the global central bank stability plan.

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Stand-Down By The Fed Has Put The Bottom In For Emerging Markets

April 4, 5:00 pm EST

The slowdown in China spooked global markets late last year, and have since spooked global central banks. 

Given the current recession-like growth in China (6%ish), and the prospects that it could keep sliding, especially if a U.S./China trade deal doesn’t materialize, the major central banks in the world have positioned for the worst case scenario.

In the process, we may have discovered the real drag on the Chinese economy.

Here’s the latest look at the Shanghai Composite, up 33% since January 4th (which not so coincidentally is the day the Fed walked back on its rate hiking path).

Maybe the easiest message to glean from this chart, and that turning point, is that the biggest culprit in the China slowdown has been the Fed, not tariffs.

Here’s how the Dallas Fed put it in a report from October 3rd (which happens to be the high in stocks, the day stocks turned):

“Emerging economies have suffered a general decline in forecast GDP growth, and inflation rose in a handful of countries. The tightening of monetary policy in advanced economies, both through rate hikes and other policy actions such as forward guidance, results in capital outflows from emerging economies with low reserves relative to their foreign debt.”  

Higher U.S. rates has meant a stronger dollar.  With the economy moving north, the dollar moving north and rates moving north, global capital flows to the U.S. — and away from riskier emerging markets.  It’s not that the U.S. economy can’t handle a 3.25% ten-year yield or a 5% mortgage rate in the domestic economic environment.  It’s the EM world that can’t handle it (at the moment).

China has responded to the growth slowdown with an assault of monetary and fiscal stimulus.  But the most powerful stimulus appears to have been the move by the Fed to stand-down.

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Lyft And Uber IPOs Mark Euphoric Stage Of Internet 2.0

April 3, 5:00 pm EST

We’ve talked about the prospects that Lyft and Uber, dumping shares on the public at a combined $140 billion plus valuation, may mark the end to the Silicon Valley boom cycle.

This uber-exuberant valuation reflects the regulatory and policy advantage Silicon Valley has enjoyed for the past decade (which is ending).  It shows the displacement of capital from Wall Street to Silicon Valley (as a result of those advantages).  And arguable, it shows the euphoric stage of a bull market for internet 2.0.

Bull markets are said to be born on pessimism, grown on skepticism, mature on opitimism and die on euphoria.  For the euphoria stage, as Paul Tudor Jones describes it, there’s typically no logic to it and irrationality reigns surpreme.  Given that markets have bought the notion that a hand full of apps would destroy enduring industries, millions of jobs, and life will be great (?) —  It’s fair to say that irrationality is (and has) reigned supreme.

With this in mind, we talked about the beginning of the end, last year, when the regulatory screws began to tighten on the untouchable tech giants (namely, Amazon, Facebook and Google).

As I said back on September 4th, when Amazon crossed the trillion-dollar valuation threshold, “at 161 times earnings, the market seems to be betting on the Amazon monopoly being left to corner all of the world’s industries. That’s a bad bet. Much like China undercut the compeition on price and cornered the world’s export market, Amazon has undercut the retail industry on price, and cornered the world’s retail business. That tipping point (on retail) has well passed. And as sales growth accelerates for Amazon, so does the speed at which competition is being destroyed. But Amazon is now moving aggressively into almost every industry. This company has to be/will be broken up.”

A day later, Facebook and Twitter executives visited Capitol Hill for a Congressional grilling.  Here’s an excerpt from my note that day:  “If you listened to Zuckerberg‘s Congressional testimony in April, and today’s grilling of Jack Dorsey (Twitter) and Sheryl Sandberg (Facebook), it’s clear that they have created monsters that they can’t manage. These tech giants have gotten too big, too powerful and too dangerous to the economy (and society).”

In short, they are too big to manage, and Zuckerberg said just that in his Op-Ed this week, calling for global regulation.  Remember, the irony is, regulation only widens the moats for these companies.  The higher the cost of compliance, the smaller the chances that there will ever be another Facebook developed in a dorm room.

 

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Lyft IPO Is Exposing The Valuation Gap Insanity

April 1, 5:00 pm EST

Last week we talked about the buildup to the Lyft IPO.

Lyft, “lifted” to a valuation of close to $25 billion when shares started trading on Friday.  Today, it’s down as much as 20% from the Friday highs.

The last private investment valued the company at $15.1 billion.  That gave them a paper gain of over 60% on Friday, for just a 9-month holding period. Good for them.

For everyone else, remember, you’re looking at a company that did a little over $2 billion in revenue, while losing almost a billion dollars. Most importantly, over the three years of data that Lyft shared in its S-1 filing, revenue growth has been slowing and losses have been widening.

So, you’re buying a company that hopes to be profitable in seven years, to justify the valuation today.  This is a company that has only existed seven years.  And to think that we can predict what the next seven will look like, in the ever changing technology and political/regulatory environment (much less economic environment), is a stretch.

For some perspective on these valuations, below is what it looks like if we compare the three largest/dominant car rental car companies (Enterprise, Hertz and Avis) to the two largest/dominant ride sharing companies.

 

With Uber now expected to be valued at around $120 billion when it goes public (possibly this month), the ride sharing industry is valued at about 14 times the car rental industry.

The rental car industry has been priced as if ride-sharing industry has destroyed it.  Ironically, if the ride sharing movement is to succeed in the long-run, and is to fully reach the potential that is being priced into the valuations, then they will need these car rental companies to supply and manage the fleet of vehicles required for Uber and Lyft to scale.

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Why The White House Wants The Fed Spigot Open

March 29, 5:00 pm EST

We’ve talked about the prospects of a repeat of 1995, when the Fed flip-flopped — cutting rates, following an overly aggressive tightening cycle. Stocks soared.

With that in mind, in addition to the about-face the Fed has done over the past three months, verbally managing down expectations on rates, we’ve since heard from (effectively) the White House, calling for “an immediate 50 basis points cut.”

Trump has selected Stephen Moore as an nominee for the Fed.  He publicly called for the 1/2 point cut this week.  And today, Larry Kudlow, the White House Chief Economic Advisor, said the same.

The Fed wants ammunition if a U.S. slowdown occurs (as damage control).  The White House wants a cut to “protect” the current growth — i.e. to pre-empt a slowdown (prevent the damage).

This comes following a weaker final Q4 GDP number, which dropped full year 2018 growth just below 3% (2.9%).  And the reality is, Q1 won’t be a big number (thanks in part to the sentiment scars from the Q4 stock market decline). It looks like 1.5% at the moment.  That would be the slowest growth since Q1 2016.

Are the calls for a cut from the White House coming because they don’t think a China deal will happen?  Possibly.  More likely, the Trump administration wants the spigot open, to fuel economic momentum into the 2020 election.  Why not press the accelerator, given the continued tame inflation environment and softness in Europe and China?

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Lyft: Hyper-growth valuations unlikely to give investors hyper-growth

March 28, 5:00 pm EST

Earlier this month, we talked about the big IPO agenda this year.

We have some big Silicon Valley “disrupters” set to go public this year, including Lyft, Uber, WeWork and Airbnb.

Lyft will IPO tomorrow.  The expectations is for a $20+ billion valuation.

The company has raised $4.9 billion in the private market since launching in 2012.   A little more than a year ago, it raised money at an $11 billion valuation.  If you were the investor at that stage, you’re looking at a double when it goes public (just 15-months later).

Now, if you are joe-average investor, as a buyer of Lyft shares, you’re about to pay these early private market investors at a $22 billion valuation.  This is a company that did about $2 billion in revenue last year, and lost about a billion dollars.

Remember, while the founders of these companies will become celebrated billionaires, the investors that buy these shares in the public market don’t tend to get rewarded very well.  Of course, there are exceptions, but remember, the IPOs this year are coming into a far less friendly regulatory environment than their “disrupter” predecessors of the past decade.

The reality:  The hyper-growth valuations are unlikely to get hyper-growth, as the regulatory advantages Silicon Valley has enjoyed over the past decade are now being scrutinized by Washington.

Here’s how the big “disrupters” of the past two years have fared, after much anticipated IPOs.

Dropbox:  Dropbox was priced at $21 per share.  It started trading at over $28.  Today it trades at $22.

Spotify:  Priced at $165.90 per share.  It started trading at $164.  It currently trades at $137.

Snap: Priced at $17 per share.  It started trading at $22.  Today it trades at $10.80.

After Lyft, Uber is on deck.  Uber last raised venture capital at a $68 billion valuation.  They are expected to go public at a $120 billion valuation.

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Fed’s Flip-Flop Leads Us To This 1995 Chart

March 27, 5:00 pm EST

We’ve talked this week about the yield curve inversion.

In response, the market is now pricing in a better than 70% chance of a rate cut in June.  And Trump’s new pick to join the Fed, Stephen Moore, has said the Fed should cut by 50 basis points immediately.We’ve talked about the comparisons between 2019 and 1995.  In 1994 the Fed aggressively tightened into a low inflation, recovering economy (as they did in 2018).  By the middle of 1995, they were cutting.  Stocks finished the year up 36%.

Given the contrast of where the Fed has positioned themselves now, compared to just three months ago, they have effectively eased — and we can see it clearly manifested in the interest rate market.  The 10-year U.S. government bond yield has gone from 3.25% to under 2.5% since just November.  I would argue we already have a repeat of 1995.

Here’s a look, in the chart on the left, at what stocks did in 1994-1995, when the Fed transitioned from overtightening (into a low inflation, recovering economy) to easing.  And, on the right, this is how things look now, with similar context. 

 

Within a few quarters of the ’95 rate cut, U.S. growth was printing above 4% and did so for 18 consecutive quarters.  Stocks tripled over that period.

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Fed’s 1995 Script Playing Out Again

March 26, 5:00 pm EST

Yesterday we talked about the yield curve inversion.

It was driven by the Fed walking up the fed funds rate (i.e. “normalizing rates”) over the course of the past three years.  As we discussed yesterday, with global central banks pinning down the long-end of the yield curve through QE (now led by the BOJ), there were few things better telegraphed than the U.S. yield curve inversion.

The market is now pricing in a 66% chance of a rate cut by the end of the year.  The market is arguing that the rate hike the Fed made in December, was a mistake.

When have we seen this script before?  1995.  As we discussed coming into the year, 2018 was the first year since 1994 that cash was the best producing major asset class (among stocks, real estate, bonds, gold).  And the culprit was an overly aggressive Fed tightening cycle in a low inflation recovering economy.

The Fed ended up cutting rates in 1995 and spurring a huge run up in stocks (up 36%).  That’s the bet people are making again.  But I suspect we’ve already seen the equivalent of a cut through the Fed’s dovish posturing since early January.  Remember, they went on a media blitz the first several days of January, dialing down expectations that there would be any more tightening.

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Should We Be Concerned About the Yield Curve Inversion?

March 25, 5:00 pm EST

There was a big technical break in the interest rate market on Friday.   And the yield curve inverted.

What does it mean, and should we be concerned?

First, when people talk about the yield curve, they are typically talking about the yield on the 3-month Treasury bill versus the yield on the 10-year government bond.  The latter should pay more, with the idea that money will cost more in the future (compensating for inflation and an “uncertainty about the future” premium).

When the 10-year is paying you less than you could earn holding a short term T-bill, the yield curve is said to be inverted.  And this dynamic has predicted the past seven recessions.  Why?  Because it typically will be driven by a tighter credit environment, namely banks become less enthused about borrowing in the form of short term loans, to lend that money out in longer term loans.  Money dries up. Unemployment goes up. Demand dries up. Economy dips.

With this in mind, today the 3-month treasury bill pays 2.44%. And the 10-year government bond pays 2.41%.  The spread is negative which makes for an inverted yield curve.

Now, while an inverted yield curve has preceded recessions with a good record, we’ve also had inverted yield curves and no recession has followed.

What isn’t talked about much, is why the yield curve is inverting this time.  It sort of spoils the drama to talk about the “why”.  Unlike any other time in history, we have an interest market that has been explicitly manipulated by global central banks for the past decade (via global QE).  And we have one major central bank (the Bank of Japan) remaining as a buyer of unlimited global assets (that includes U.S. 10 years, which pushes the 10-year yield lower).

Remember, the Bank of Japan’s policy of targeting their 10-year government bond yield at zero, means they will be a buyer of unlimited bonds to push JGB yields back toward zero (price goes up, yields go down).  And when the tide of global rates is rising, pulling UP their yields, they will be a buyer of whatever they need to, to push things back down (and they’ve done just that).

What does that mean?  It means, as the Fed has been walking its short-term benchmark rate higher, the “long-end” of the interest rate market (the 10-year yield) has been anchored by central bank buying – buying by all major central banks for the better part of a decade, and now led by the BOJ.  That has kept a lid on the U.S. 10-year government bond yield, and global government bond yields in general.

With this at work, there have been few things better telegraphed than a U.S. yield curve inversion, as the Fed has told us for years that they will march their short-term rate beyond the anchored 10-year yield.
It’s often dangerous to say “this time is different”, but I think it’s fair to say that the past yield curve inversion/recession analyses don’t compare, when you have both components (the front-end and the long-end) completely controlled by global central banks for more than a decade.  Join me here to get my curated portfolio of 20 stocks that I think can do multiples of what broader stocks do, through the end of the year.