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A positive start to the trading day, and boy do we need it. We are in some very rare oversold territory. Consider:
1) The S&P 500 has dropped five days in a row. It's the first five-day losing streak since January, but before that, the last five-day losing streak was December 2013;
2) The S&P 500 materials sector is down nine days in a row, which hasn't happened since May 2012;
3) The NYSE Advance/Decline line has declined seven days in a row, an equally rare event. The NYSE Composite Index has also been down seven days in a row.
4) There were 467 new lows on the NYSE, or nearly one in five of the stocks, a very high number.
Even though the S&P 500 is only 3 percent from its recent high, this decline in the Advance/Decline line indicates the leadership is becoming much more selective.
The Shanghai Composite closed down 8.5 percent Monday, the biggest single-day loss in eight years, while the Shenzhen was down 7 percent.
On the Shanghai, there were 75 stocks declining for every one advancing. Ouch.
It's not clear what caused the decline. There are the usual rumors that the government would either not continue to support the market or that such support would be ineffective.
What is clear is it's becoming impossible to make an investment decision on China right now. It's a complete wild card. Chinese stocks could be down another 8 percent tomorrow, or up 8 percent. There's no way to know.
China's weakness is spilling over into the rest of Asia:
And it's spilling over into the commodity markets. Copper is down 1 percent to its lowest level in 6 years. Crude is weak, with West Texas Intermediate down 1.6 percent to $47.38. We are getting very close to the March 17 closing low of $43.46, which was the lowest close since 2009.
So much for the idea that China doesn't matter much for the U.S. investor. It does, because it impacts commodity prices, as well as materials, industrials, and energy stocks.
This is creating some very strange statistics. For example, the S&P materials sectors is almost 2.8 standard deviations (SD) below its 50-day moving average, the energy sector is 2.42 SD below, and the industrials are 2.38 SD below, according to our partners at Kensho.
This is very rare territory. Standard deviation of 3, for example, means the sample is within all observable samples 99.7 percent of the time. These are not yet 3 SDs, but they're close. We are in 98 percent territory, surely. In other words, these sectors are very stretched on the downside. A typical quant would look at this as a potential buy signal.
The focus will again be on earnings next week, but, as always, a small number of companies will be in focus.
There's a lot riding on Facebook, which reports Wednesday, because the stock is up 20 percent in the last month on expectations of a strong report. Investors have piled a lot of money into a small group of big-cap tech names. Good news dramatically boosted Amazon and Google, but even the smallest disappointment hurt Apple.
Traders will also be scrutinizing big international companies for the impact of the strong dollar. Procter & Gamble, for example, gets 65 percent of its business outside the U.S. They'll be reporting Thursday. Other multinationals that have already reported have noted significant impact from the strong dollar.
The two biggest energy companies, Dow components ExxonMobil and Chevron, will report at the end of the week, and we all know it's going to be a disaster. Chevron's earnings will probably be down 55 percent. Still, estimates have been coming up a bit recently for themm and they will be scrutinzed for any indication of when the oil slide may stop.
And remember, it's not so much the earnings, it's the guidance for the third quarter that matters. Earnings growth was expected to be positive in the second half of the year, but the expectations for the third quarter are now also expected to be down 2.4 percent, according to Factset. With 40 percent of the S&P reporting, that number should be stronger.
And revenues are even worse, expected to be down 2.8 percent for the third quarter. That's one reason the markets have had so much trouble this week.
What's the problem? Slow growth in China and Latin America is one issue, but also the dollar strength and weak oil has continued into the third quarter. The Fed told us that a strong dollar and weak oil might be transitory, but that hasn't been the case.
Bottom line: growth is proving to be very elusive this year, particularly overseas.
Aside from earnings, watch the market leaders next week. A lot of money is in a small group of banks and biotechs. Banks are holding up, but today is one of the worst days we have seen in a long time in biotechs on the Biogen disappointment. The NASDAQ Biotech ETF is down 4.2 percent today.
What a difference a day makes. Yesterday, investors expected Amazon report earnings per share of 46 cents this year, which led to a comical price-to-earnings ratio of almost 1,100.
Today, expectations are for a profit of $1.21, a 220 percent increase, and the P/E is now down to roughly 475, even though third quarter operating income guidance is very wide, from a loss of $480 million to a gain of $70 million.
This is amazing, considering Amazon's profitability has been erratic and the company does not appear to have any new product launches (Remember the Fire phone?) scheduled for 2015.
And it doesn't stop there. Expectations are now for a big gain of $4.21 in 2016, which would bring the P/E down to roughly 140.
The source of this enthusiasm isn't hard to spot: Amazon Web Services, its cloud storage business, and Prime membership, the key to its North American retail operations.
Both are growing. Fast. Revenues for Web Services were up 81 percent. Amazon hasn't broken out details for Prime membership, but everyone seems to believe it has at least 30 million members paying $99 a year, and that it will likely exceed 40 million by the end of the year.
1) Slowing economies: China, Latin America
2) dollar strength
The slowing economies are leading to declines in commodity prices and a slowdown in capital spending.
No surprise multinational are feeling the pain:
Multinationals this month
United Tech down 9.1%
Caterpillar down 9.0%
Emerson Electric down 6.7%
MMM down 2.6%
Caterpillar reflects all of the concerns. They are seeing declines in their commodity business (mining), in their oil business, and in construction (China):
(Q2 revenues year-over-year)
Resource: down 12% (mining)
Energy/Transportation: down 12% (oil)
Construction: down 18% (China)
The downbeat commentary is taking some analysts by surprise. For example, 19 of 21 analysts who cover Emerson Electric lowered their full year estimates in the last month.
Sixteen analysts who cover United Technologies—almost the entire universe of analysts who cover the stock—have dropped their full year earnings outlook for the year this month, most in the last couple days.
The largest of the Latin America ETFs, the iShares Brazil ETF, is seeing very heavy volume today and is poised to break through a 6-year low.
Watch for any signs that this is spreading past the commodity and industrial names. For example, food giant Unilever (Ben & Jerry's ice cream, Knorr stock cubes, Hellmann's mayonnaise, etc.) said consumer demand was weak, with what it called "negligible" growth in Europe and North America. Sales were flat in the second quarter.
The main concern of the trading community right now is, how long will the stalwarts remain the stalwarts?
The stock buyback craze has continued into the second quarter, and the cumulative effect of that craze—now almost two years old and counting—is really mounting.
First, one clarification: Many companies buy back stock, but they use it to pay out options they give out to employees. What investors care about is when there is an actual share count reduction, because that increases the earnings per share and decreases price-to-earnings levels.
By that measure, the reduction in share count has been notable for the last five quarters, and is continuing into the second quarter.
The trend is up. Twenty percent of S&P 500 companies have reduced their share count by at least 4 percent year over year in each of the last five quarters, and that appears to be continuing into the second quarter, according to Standard and Poor's.
As of last night, 92 companies have reported; 20 have reduced their share by at least 4 percent year-over-year.
That means earnings is 4 percent higher and P/E is 4 percent lower than a year ago for those companies.
One shining example is Apple, which has reduced its share count by 4.7 percent year-over-year, and 10.3 percent in the last two years, meaning earnings are 10 percent higher than two years ago, regardless of whether sales were higher or costs were lower!
Pretty cool, huh?
It's happening again. In Q1, the two most relevant drags on revenue and profits for multinational companies who got a big chunk of their profits and revenues overseas were: 1) slow global growth, particularly China, and 2) the strong dollar.
Both are resurfacing as issues in Q2.
The dollar finally began to weaken in April, and many were hopeful that multinationals would finally get a break. But after bottoming in mid-May, the dollar has begun strengthening again.
Take United Technologies, which lowered 2015 guidance due to softness in Aerospace, softness in Europe (particularly hurting Otis Elevator) and softness in China. That enough softness for you?
But they also went out of the way to note how the strong dollar was impacting them. Like many multinationals, they are again breaking out earnings and revenues in two form: excluding the impact of foreign exchange, and then including the impact.
Take Otis Elevator. Look at this:
(2015 operating profit, YOY)
Excluding forex impact: down $25-$-$75 million
Including forex impact: down $300-$350 million
That is a lot of coin for the impact of the dollar!
How serious an issue is the strong dollar?
UTX said earnings would have been 6 cents higher than the $1.73 reported if the effects of the stronger dollar was excluded. That's not trivial.
How serious is this for other multinationals? It's hard to break out the effect, since not every company breaks out currency. But you can get a hint if you divide the S&P 500 into two groups: those that get at least half their sales outside the U.S. (meaning they are very exposed to the stronger dollar) and those that get less than half outside the U.S.
For companies that get MORE than half their sales outside the U.S., Q2 blended earnings are estimated to be UP 10.5 percent, according to Factset.
For companies that get LESS than half their sales outside the U.S., Q2 blended earnings are estimated to be UP 1.7 percent.
That is quite a difference!
This is what the combination of slower growth and a strong dollar will do for earnings!
The strong dollar is another reason currency-hedged ETFs have seen increasing volume in the past month, particularly the two largest players, the WisdomTree Europe Hedged ETF, and the WisdomTree Japan Hedged ETF.
These ETFs are a way for the average investor to protect against currency fluctuations, and there are more coming. Tomorrow, IndexIQ is launching a whole family of 50 percent currency-hedged ETFs that's a further refinement of the same idea.
There's something strange going on in Tech Land.
Huh? Historic highs for the Nasdaq, but more stocks declining than advancing?
That is a weird divergence, and there's a reason for it.
The leadership is very narrow. A small group of tech stocks are pushing the indices higher. And that is worrisome.
But technology really matters. It's 20 percent of the market cap of the S&P 500, the largest sector.
Right now, there are four technology stocks that really matter.
Honeywell is a good example of the problems facing multinational corporations.
The strong dollar is really hurting multinationals. Even Honeywell.
Honeywell is one of the most-praised multinationals, and with good reason. It has strong management, and it plays in all the right spaces. Aerospace. Environmental controls. High performance materials.
Yet all three major segments saw declines in revenues year-over-year, largely because of the impact of foreign currency.
Here are the year-over year stats for Honeywell:
A 9.4-percent rise in earnings is fantastic, but revenues down 4.5 percent while organic sales are up 3 percent? That's strange.
Most, but not all, of that mismatch was unfavorable currency.
I don't want to blame everything on currency problems. The bigger picture is most multinationals—including Honeywell—have had a tough time growing revenues. Honeywell has seen almost no growth for several years.
It's been another decent day for the markets, but even as major indices approach historic highs, the field is littered with the corpses of those on the wrong end of the global growth slowdown.
The good news is there's a bit of a global boomlet in stocks in the last week or so, and it's easy to see why. With Greece moving toward some short-term resolution, and China stabilizing, global markets have rallied in the past 6 or 7 trading sessions:
Global rally (since July 8)
Germany up 9.3%
Shanghai up 9.0%
Australia up 3.5%
S&P 500 up 3.6%
Not bad for a few day's work. On this, volatility has collapsed, with the CBOE Volatility Index (VIX) poised to close at a new low for the year.
But even a cursory look at the markets will reveal that there is some very big divergences going on.
Specifically: the rally is mostly in defensive names. Consumer Staples. Utilities. Telecom. Healthcare.
OK, there's also a few Technology stocks doing well, like Google.
But the sectors most exposed to the global economy—energy, materials, and industrials—are having a really rough time:
Sector laggards (one month)
Energy down 4.5%
Materials down 4.1%
Industrials down 0.7%
These are the companies exposed to China and the slowing growth story. And it is NOT a pretty picture.
Just look at what four companies have said in the past 24 hours or so:
1) Alpha Natural Resources, a coal company, is in talks for bankruptcy financing and has just been de-listed from the NYSE;
2) Anglo American, a global mining company, is writing down $3-$4 billion in iron ore and coal assets;
3) Allegheny Tech, a steel company, has issued a profit warning, noting the world is awash in Chinese steel exports;
4) Car maker Audi said it may abandon its China car sales target due to slowing growth.
The stock market, of course, has not been waiting for these companies to issue a press release. The weakness is well known, and investors have been aggressively shedding global industrials.
These are the companies that operate in dozens of different countries and sell a wide variety of products, from flow control valves, power components, pumps, heating & air conditioning, all the stuff that goes into modern buildings and vehicles, the stuff that is behind the walls.
Look what's happened to some of these companies in the last few weeks:
Global Industrials (one month)
Emerson down 8.9%
Dover down 7.7%
Fluor down 7.8%
Eaton down 6.3%
Textron down 4.2%
And remember...the overall major indices have been in an uptrend! We need growth, and it's not materializing!
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New Barclays Chairman John McFarlane will wield the axe even more quickly at the bank, it emerged Wednesday.
The Fed is expected to point to a growing U.S. economy and stronger job market as it sets the stage for a possible interest rate hike in September.