The two underpinnings of this rally — the Trump Rally, and the Reflation Trade — are both very much intact. » Read More
Oil is likely to remain in the low $50s for the rest of the year. » Read More
Stocks rallied this morning as President Trump, meeting with retail CEOs at the White House. » Read More
The first wave of earnings reports has rolled in, and they are "good enough," with Bank of America, PNC and JPMorgan all beating on the bottom line, while Wells Fargo at 96 cents was a bit shy of the $1 consensus.
As expected, commentary on what the investment community really wanted to hear — 2017 guidance — was light. JPMorgan CEO Jamie Dimon did say, "The U.S. economy may be building momentum. Looking ahead, there is opportunity for good, rational and thoughtful policy decisions to be implemented, which would spur growth, create jobs for Americans across the income spectrum and help communities, and we are well positioned to play our part."
On the conference call, Dimon, when asked about signs of that "building momentum," characteristically downplayed forecasting, saying "we don't react that much to the weather." But he said he was basing his observation "on a broad range of things, and it looks like growth may have done a little better in the fourth quarter, plus if you take a walk around the world, Japan's doing a little bit better, Europe's doing a little bit better. ..."
As for the issue on everyone's mind — tax cuts and fewer regulations — Dimon said that regulatory relief may help banks open new branches and seek out clients they don't have "so I'm hoping you'll see a little bit of that." A lower tax rate would be "good for growth in the country in general."
The bottom line on the impact of lower taxes and less regulation: "You have to see the whole package before you can see what the net impact is, but ultimately ... it's good for our franchise broadly."
CFO Marianne Lake said the bank would provide details on 2017 guidance at its Investor Day, which is scheduled for Feb. 28.
Bank of America's CFO Paul Donofrio said, "While the recent rise in interest rates came too late to impact fourth-quarter results, we expect to see a significant increase in net interest income in the first quarter of 2017."
While they did not give guidance about how the combination of lower taxes and less regulations might impact earnings, Mr. Donofrio said they expected a similar tax rate of 31 percent for the average for 2017 excluding unusual items.
Markets are weak Thursday going into earnings season for very good reasons. Until this week, stocks, the dollar, and 10-year yields have mostly moved sideways since mid-December. But this week the 10-year yield has slid to the lowest level since the end of November, and the dollar has slid back to its early December levels.
I have called the market a "coiled spring" several times in the past week because markets are priced for perfection: stocks are at highs, investor sentiment is at highs, and consumer sentiment is at highs.
On top of that, there are high — VERY high — expectations that earnings will expand in 2017. Some are anticipating the S&P 500 could put up a 20 percent increase in overall earnings. That is a LOT to ask.
Throw in the now well-known "Trump tweet risk" and the difficulty of knowing the final impact of the Trump campaign promises of lower taxes/less/regulation/fiscal stimulus, and you've got plenty of reason for the markets to take a pause.
The markets, for a short while, had a hiccup around President-elect Donald Trump's press conference. The big question: why?
Drug stocks dropped as Trump said drug companies will "not get away with murder."
Lockheed Martin dropped when he said he would bring the cost of the F-35 fighter jet "way down." Defense names in general dropped.
The answer lies in where we are in the markets right now: priced for perfection. The market is a little like a coiled spring, ready to break out one way or the other. Stocks are near historic highs. Consumer confidence is high. Investing sentiment is very bullish and volatility is low.
That's all good news, but it's a volatile mix. That's because stocks have moved on expectations that earnings in 2017 are going to be much higher than 2016, partly on a better economy in general but it's been turbocharged by Trump's promises of lower taxes, less regulation and fiscal stimulus.
That's where the risk lies, in the very real possibility that there is going to be some kind of disappointment. And the market is not in the mood for any disappointment.
We saw this in the third quarter when slight misses in earnings expectations caused a notable drop in stocks.
With markets nearly 10 percent higher since then, the nervousness is even greater. Evercore ISI said it perfectly this morning: the "bar on earnings has risen as expectations for growth have increased."
What we need, as my colleague Jim Cramer mentioned this morning, is a bridge. We need a bridge between the current market mentality that has high expectations for a 2017 earnings boost and the likely guidance we are going to get: an attempt to lower expectations.
Here's what needs to happen: the bridge is a belief by market participants for the next few months that better numbers will be coming down the road and that expectations for much higher revenue and earnings growth are not wildly inflated.
If that mentality takes hold, the markets can look forward to a relatively peaceful few months, with lots of mostly sideways action.
If the market stops believing that mantra, it's going to be a rocky winter.
Bank earnings kick off on Friday, and analysts are urging caution ahead of those results.
Today, Citigroup downgraded Goldman Sachs and Comerica to "sell," saying "We view the banks as trading stocks and following the recent run, we don't really see a compelling risk/reward for the group." Regarding Goldman's fabled trading platform, Citi said: "While we expect GS will see improved trading revenues going forward, the path is relatively uncertain and the bar is relatively high."
They're not the only ones worried about bank valuations. Nomura, in a note today on regional banks, said,"[W]e believe share prices already discount the upside for most regional banks" though they highlight KeyCorp, Wells Fargo, Huntington Bancshares, and US Bancorp as possible outperformers.
None of this is surprising, but it is refreshing hearing caution from normally upbeat analysts. Banks were huge outperformers in the fourth quarter: the SPDR Bank ETF, a basket of large banks, was up 30 percent in the fourth quarter and 25 percent since the election.
Here's the problem: banks have moved so fast that there is a risk that we could have a pullback before we move higher. They are already reflecting much of the upside from higher interest rates and the potential for lower corporate taxes and less regulation, as Citi and Nomura have noted.
Fourth-quarter earnings season starts soon, but everyone is focused on 2017 guidance. The big problem: no one knows how to model the Trump rally.
Here's the good news: fewer companies are guiding down for the fourth quarter.
Now the bad news: what we care about is 2017 guidance, and there's a good chance that most companies will not be doing any dramatic fist pumps about earnings in the new year.
Here's Lindsey Bell, CFRA's Investment Strategist and chief wizard of earnings, on what she thinks will happen: "We expect guidance will be unlikely to move higher in the near term and could even be reduced from the current estimate... disappointing investors and potentially causing a pullback or pause in the market."
Huh? How could that be? All this gushing optimism is for nought, at least for the time being?
The question is, how much will earnings improve? How much will this magical potion of tax cuts/less regulation/fiscal stimulus really impact earnings?
We don't know and that's why analysts have been reluctant to raise 2017 earnings estimates. Current estimates for S&P earnings in 2017 are at roughly $131, about an 11 percent improvement over 2016, but essentially unchanged for the past several months.
That's an important point: no one is raising 2017 estimates, at least not yet.
More importantly, because the stock market has risen roughly 6 percent since the election, but 2017 earnings estimates have not risen. Stock multiples have expanded, from roughly 16 times 2017 earnings for the S&P 500 to a little over 17 times. This is high by historical standards, but optimists insist it is justified because earnings will be improving later in the year.
Maybe. There's plenty of back-of-the-envelope guesses, just not many facts. Leon Cooperman, on our air Thursday, noted that current 2017 earnings for the S&P 500 is at $131 or so but "We could see earnings at $140" if the full package of tax cuts and infrastructure come through.
Lighten up on last year's winners, buy the losers? Maybe not this year. There's a very timeworn pattern that usually emerges in the first few trading days of the year: Investors rotate. They tend to buy the losing sectors last year and lighten up on the biggest gainers. This is the simplest kind of value trade you can make, and it makes some sense as a strategy for a portion of your portfolio.
It's very early, but it's interesting that this pattern is not playing out, at least not so far.
With the S&P 500 up 1.2 percent in 2017, here's how some of the best performers last year are faring so far:
2016 Leaders in 2017
Not bad at all — they are all holding their own and even outperforming. Here's how some of last year's worst performers have done in the first two days of trading:
2016 Laggards in 2017
Hm. The losers are also doing well! This may be speaking to the underlying trader mentality of the moment: I am bullish, but I don't want to keep buying too much because the market is expensive. I really want the market to drop five to 10 percent so I can buy more.
That's why a lot of traders, like Cannacord Genuity's Tony Dwyer, are neutral on the market at the moment. Dwyer said in a note this morning that the key drivers are in place for a rally to continue — the improving global economy, a steeper yield curve, improved jobs/consumer confidence and the hopes for lower taxes/less regulation/and stimulus.
But the market is expensive, so he's neutral now and "looking to buy any fear-based weakness as it develops." He has a 2017 target of 2,340 on the S&P 500 but admits it "may be conservative."
That's why we keep getting these days where the markets struggle to advance, but the market never drops. Everyone is looking to get more aggressive as market works off its overbought condition, but no one wants to sell!
"I want to get bullish, but we've got to get lower prices," Dwyer told me this morning. "We've got to rid of some of the excessive optimism."
My friend Jim Stewart of The New York Times was just on our air. After briefly chatting about 2016, he concluded with this observation: "What really stands out is how the smart people are almost always wrong."
Amen to that! It's been a wild year for trader sentiment...what's amazing is how wrong sentiment has been this year.
We started out with a stomach-churning drop of nearly 2,000 points in the Dow in January — sentiment was, we were heading for a recession. Wrong!
Then in June, Brexit. Sentiment was solidly on the side that the vote would be to stay and that if there vote was to leave it would be a disaster for the markets. Wrong on both counts!
Then the election. Most felt a Donald Trump victory was unlikely and that if it happened volatility would rise and stocks would suffer. Wrong again...at least so far.
Why do we keep making predictions when everyone is so bad at it? Because humans want to know about the future. It makes us feel like we're a little more in control of events.
Is there anything we can do to improve forecasting? Here's hoping machine learning and big-data analytics will help. Wouldn't it be something to find out machines were just as bad at predicting the future as humans are?
I'm not against forecasts. Let's keep doing it...but did you ever notice how often the people with the strongest opinions are the ones who are most wrong?
So, here's to more forecasting. Let's just be cautious when we're reading them, and a bit more humble when we're writing them.
Happy New Year, and here's hoping 2017 is a prosperous one for you and your family.
I noted yesterday that the market debate was between "pragmatists" and "optimists" over two 2017 issues:
1) Will consumer confidence remain high and, specifically, will the Trump rally translate into more consumer spending?
2) How much will expectations for tax cuts and fiscal stimulus impact earnings in 2017 and 2018?
Here's my concern: Investors seem wildly optimistic. Consumer sentiment and business sentiment surveys have all popped after the election. The recent National Federation of Independent Business survey, for example, found dramatically different attitudes among small business owners before and after the election.
Investors are not just expecting a rally — we've already had that — they are expecting some kind of global reflation to occur.
I'm wondering where it will come from. Let's look at the evidence presented so far.
1) Consumer spending will increase. Will it? We could get a cut in the personal income tax, or consumers may simply feel better and begin spending more of their savings.
Let's put aside the personal income tax cut, since we have almost nothing to go on. PIMCO's Tony Creszenzi visited the New York Stock Exchange recently. I asked him for a back-of-the-envelope calculation of how simply spending more and saving less might help the economy.
He noted there was roughly $15 trillion in personal income each year. A roughly 6 percent savings rate produces savings of $900 billion a year. Consumers can spend more by drawing on the existing stock of savings or can boost spending by simply reducing how much they save.
So let's assume consumers spend 1 percent more by reducing their savings rate from 6 percent to, say, 5 percent. That's an additional $150 billion of spending. Annual consumer spending is roughly $5.2 trillion, so we're talking about a boost of about 3 percent.
That may not seem like a lot, but a 3 percent boost is significant.
Impact on earnings: moderate. This could definitely produce an increase in earnings, but as we saw this year the benefits are likely to accrue to a small group of retailers and potentially automotive stocks as well as restaurants and travel stocks.
2) Corporate tax cuts: Of all the "hopium" the market has been trading on, this is the one that has the best chance to move the dial on earnings.
Even before the election, analysts were anticipating a roughly 9 percent increase in earnings for the S&P 500, from roughly $118 in 2016 to $131 in 2017. But I noted back on Dec. 1 that Thomson Reuters estimated that every 1 percentage point reduction in the corporate tax rate could "hypothetically" add $1.31 to 2017 earnings. So with a full 20 percentage point reduction in the tax rate (from 35 percent to 15 percent), that's $1.31 x 20 = $26.20.
That implies an increase in earnings of close to 20 percent, or $157. Of course, this is a hypothetical and because most corporations do not pay the top rate, we won't get this kind of boost. No matter: Even a modest boost to, say, $140, would bring the S&P to 2400 at the current 17 multiple, nearly 7 percent above where it is now.
Impact on earnings: potentially significant. Analysts have not yet begun to incorporate the effect of tax cuts because they lack sufficient data to input into their models. That will change soon.
3) Fiscal stimulus: Trump can talk all he wants about a $1 trillion stimulus, but that is unlikely to happen without massive deficit spending that would be resisted by many Republicans. Most estimates I have seen are far more modest. Goldman's Jan Hatzius said a couple weeks ago he had "penciled in" a mere $25 billion per year for infrastructure, which would amount to $100 billion in four years. Let's assume the number is far bigger, in the $200 billion to $300 billion range.
That is not peanuts, but it certainly pales in comparison to Trump's election claims and to the fiscal stimulus the Federal Reserve has given us since 2009.
And as we get into 2017, you're going to hear a lot more about the downside of the massive deficits we will run up with any large fiscal stimulus program. You will hear about higher inflation and the stronger dollar. You'll hear whispers the Fed may have to hike rates more aggressively.
Sure, you'll hear about lots of public-private partnerships and tax credits to keep the cost of the infrastructure program down, but don't kid yourself. Trump is talking really big numbers. If that is going to happen, some kind of deficit spending is highly likely.
Impact on earnings: negligible for 2017. This is industry-specific, mostly around industrials and materials, and most agree this is a 2018 event.
4) Repatriation of profits overseas: That worry about massive deficits is why you hear so much about using the money from repatriation of profits overseas for an infrastructure program.
Even a cursory glance at the roughly $2.5 trillion warehoused overseas will show that the numbers are concentrated in a small group. Roughly 40 percent of the money is held by five companies: Apple, Microsoft, General Electric, Pfizer and IBM. Let's be wildly optimistic and assume $1.5 trillion of that comes home if the corporate tax rate is reduced to 20 percent from 35 percent. The Treasury will capture $300 billion in revenues.
That may be just enough to run a modest infrastructure spending program, but not much more.
Impact on earnings: limited to a relatively small group of companies. I'd love to tell you that there will be a massive increase in capital spending from the money returned to company coffers, but most strategists believe the primary use of the money will be to buy back stock. More financial engineering! More of what we have had for the last several years!
Bottom line: A genuine boost in consumer spending and even a modest corporate tax cut could have a significant impact on earnings. But the market is already anticipating that. The debate is over the extent of the boost in consumer spending and the size of the tax cut.
It's important to note that some sectors may see a significant impact from several different areas. Tony Crescenzi, for example, specifically pointed to the impact on banks. He estimates that a steepening of the yield curve will boost earnings 15 percent to 20 percent. A cut in taxes will add another 15 percent to 20 percent. Lower regulation, he figures, will add another 5 percent.
Put it all together, you are talking about earnings boost of roughly 35 percent to 45 percent for banks. Given that financials are the second largest sector in the S&P 500 (after technology), and you are talking about a potentially significant impact.
The year 2017 will have lots of fireworks!
The markets in January: What's next?
Forget about Dow 20,000 — for the moment. Forget about the lack of leadership, the lack of volume. The trading community is focused on what will drive markets higher in 2017 — and what speed bumps will occur along the way.
Two topics dominate the conversation:
1) Will consumer confidence remain high and, specifically, will the Trump rally translate into more consumer spending?
2) How much will expectations for tax cuts and fiscal stimulus impact earnings in 2017 and 2018?
Rather than "bulls vs. bears," I've recently suggested that these issues should be framed as a debate between "pragmatists" and "optimists."
The pragmatists insist that:
1) Investors are wildly optimistic about translating improving sentiment and tax cuts/infrastructure programs into improved consumer spending and higher earnings.
2) Investors are not only pricing in higher earnings, they are also pricing in a large-scale global reflation that is unlikely to occur.
The pragmatists certainly have some support in the trading of global equities. While U.S. equities have rallied since the election, European equities have been flat, and emerging markets have generally been down, including China.
The optimists insist that:
1) Consumer sentiment/business sentiment surveys are already improving. The recent National Federation of Independent Business survey, for example, found dramatically different attitudes among small business owners before and after the election. Optimists say that will soon translate into more business spending.
2) Even modest tax cuts could increase earnings 10 percent or more. I looked at some early predictions here. Optimists say that because of the boost from tax cuts, stocks are not wildly overpriced. The S&P 500 is currently trading at roughly 17 times estimated 2017 earnings. These estimates were done before analysts factored in any effect from tax cuts. That's slightly on the high side, but optimists also argue that a multiple expansion is justified, because earnings are going to expand.
Who's right? I'll give you my thoughts tomorrow morning.
Stock rally? Oil rally? Everyone's bullish now, but that will get tougher in 2017. But maybe investors who abandoned the market a decade ago will come back.
Here are three predictions for 2017.
First, the stock rally will continue ... but will hit major headwinds. The S&P 500 will hit a series of historic highs again within the first 100 days of Donald Trump taking office, but that will be it. The problem: Market participants are anticipating MUCH higher revenues and earnings due to tax cuts and fiscal stimulus, but actual company guidance will not match those high expectations. A stronger dollar, higher rates, inflation and possibly trade policy will emerge as potential headwinds.
Second, the oil rally will be a bust. As oil heads toward $60 a barrel, American producers will ramp up production, keeping prices down. The much-discussed agreement between OPEC and non-OPEC members to cut oil production will collapse among charges of widespread cheating.
Finally, 2017 will be the year stock ownership expands. The American public has seen declining levels of stock ownership for years. A Gallup poll earlier this year found that only 52 percent of households own stocks, tied for the lowest level on record. An earlier study found that 82 percent of all stock is owned by the top 10 percent of households. But rising GDP and greater optimism on the economy will finally reverse those trends in 2017, and households that abandoned the market after the financial crisis in 2008 will return and start buying stocks again.
Wouldn't it be great if that last prediction really happens? Wouldn't it be nice if more households owned stock? Stock ownership has becoming concentrated in a narrower and narrower group ever since the financial crisis.
Wouldn't it be great if that trend reversed in 2017?
America's largest banks are to propose a complete overhaul of how financial institutions investigate and report potential criminal activity.
It's the "Buffett Effect": Berkshire Hathaway has nearly quadrupled its Apple stake. USA Today reports.
Active managers have been taking a beating through the bull market, and Munger thinks the pain isn't going to stop soon.