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It's not like there's a panic. There has not been any intense selling pressure, but there has also been no buying interest. There's just been no real interest in the market, and you can see it in the volume: many days it has been 10-20 percent below normal levels.
What's going on? Several factors have combined to create a dangerous "stew" of uncertainty for stocks. There is not one issue, but throw them all together and you get a slow-motion, low-volume drift downward:
1) Fiscal reforms pushed out. Did you notice Trump, while in Milwaukee Tuesday, made a point of saying that, "[W]e're in very good shape on tax
2) Weaker "hard" economic data. From retail sales to the Consumer Price Index to the Producer Price Index, economic data has been weaker than anticipated. As a result, the odds for a Federal Reserve rate hike in June are now down to 44 percent, from close to 60 percent a little more than a week ago.
4) Bond yields trending downward. This wasn't supposed to happen. The core principle of the "reflation trade" was, well, reflation. Commodity prices up. Bond yields up. Not now: after hitting multi-year highs of roughly 2.6 percent in December and March, 10-year yields dropped below 2.20 percent yesterday. True, shorter term rates have not dropped as much, but that has only flattened the yield curve, a big problem for banks who profit when the yield curve steepens. The cause is hotly debated, but it certainly reflects concerns about weaker data and geopolitical issues, and weaker bond yields in Europe have also put downward pressure on our yields as well.
5) Earnings. This is the most recent risk. Here's why: stocks are expensive. Valuations are high. The risk is to the downside. This leaves stocks very vulnerable to a selloff, particularly if there is even the slightest hint of an issue. If you don't believe me, look at what happened to Goldman Sachs yesterday, and to IBM today. IBM beat on the bottom
I have nothing against Goldman, but I am primarily interested in how the U.S. economy is doing through the eyes of banks. Goldman is not a good candidate for this. The company gets 40 percent of its revenue outside the U.S., and it relies on trading for a large part of its revenues.
Regional banks do not have trading operations and operate solely in the U.S.
Regions has a huge retail operation: nearly 60 percent of their revenues are on the consumer side. Comerica is slightly more focused on corporate lending. Both have substantial wealth management divisions — they manage money for wealthy people. It's more than 10 percent of revenues for both companies.
Both beat on the top and bottom line, but the full year guidance for both is very similar — and very telling.
Let's start with Regions Financial. What we care about is guidance. What matters about these banks are: 1) loan growth, both consumer and commercial, 2) net interest income and net interest margin, which is how much money the banks are making between what they are paying out on deposits and lending out in the form of loans, and 3) how well the loans are performing (credit conditions). To a lesser extent, fee income is also important — it's been growing as a percentage of bank revenues — but it tells you more about how much banks can charge for things like bank withdrawals than it does about the state of the economy.
I kept saying the IPO market would open up. It's finally happening.
There were six IPOs last week (seven if you include a blank check company), tied for the busiest week of the year.
Then, I came in this morning, and six — count 'em, six — IPOs announced terms.
Finally. The floodgates are opening. If all goes as planned, there will be at least seven IPOs next week (there's only one scheduled for this week), making next week the busiest week of the year.
As of now, there should be at least 18 companies going public in April, the busiest month since October of last year, when we had 19.
The offerings are amazingly diverse. Two companies are scheduled to trade on Thursday, April 27th:
Five companies are scheduled to trade on Friday, April 28th:
All will trade at the NYSE with the exception of Zymeworks, which will trade at the NASDAQ.
There's not just more IPOs going public, those that have gone public are performing better. The Renaissance Capital IPO ETF, a basket of the last 60 IPOs is up 10 percent this year, twice the gain of the S&P 500.
April's strong numbers comes off a strong first quarter for IPOs. There were 25 IPOs in the first quarter that raised $10 billion, that is way above the first quarter last year when there were only 8 IPO that raised a measly $700 million.
What's next? There's a few energy companies like Tapstone, and more airlines like low cost carrier Frontier Airlines, and many more Energy companies.
But the big story -- if Cloudera is successful -- may be the long-awaited emergence of unicorns from hiding.
If Cloudera does indeed go public, this would be the fourth tech unicorn of the year (after Snap, Mulesoft, and Okta). That doesn't sound like a lot, but there were only three last year: Twilio, Coupa Software, and Nutanix. We will now have four in just two months.
There are no additional unicorns (companies with valuations in excess of $1 billion) in the pipeline for the moment. Blue Apron still floats out there.
Here's the issue: do unicorns need a higher threshold to go public? Seems to me they do. After all, these companies have held off going public because they can raise money privately and they have such a high valuation there is a real risk that value-conscious investors will not pay the high prices.
Look at Cloudera. It looks like it will go public with a market cap of $2.2 billion, but it was valued at about $4.1 billion almost three years ago.
Yikes. Fast-growing, high losses and very highly valued. That's an issue for any unicorn.
Is the market willing to pay up for that combination?
"Last year, it would not have been a good combination," said Matt Kennedy, who analyzes IPOs at Renaissance Capital. "We'll see if this year is different."
Bank earnings are upon us. Optimism on the economy is running high, and banks are supposed to be able to demonstrate that. More demand for loans! Steeper yield curve!
But there are concerns. Investors are trying to reconcile a more optimistic outlook on the economy with troubling trends in bond yields and loan growth.
Here's the problem: a lot is expected to go right with bank earnings. Financials are expected to see a 15 percent gain in earnings in the first quarter. That is a lot. The gain is based on expectations that interest rates would be moving up, loan growth would improve, and credit risks would remain low.
But it's not quite playing out that way. Here's what's happening.
Total loan growth up 0.4%
Commercial/Industrial up 0.1%
Consumer up 0.5%
Commercial Real Estate up 2.0%
Mortgages down 0.1%
These are disappointing numbers, because loan growth trends were stronger last year. What happened? Susquehanna's bank analyst, Jack Micenko, believes part of the problem is that banks are simply changing the way they borrow money: many banks are paying off their bank loans and going to the bond market for money. He also believes there is continuing deleveraging in loans in the energy sector.
But Micenko admits these reasons can account for only part the disappointing numbers. Here's another alarming statistic: bank deposits are up 0.7% in the first quarter.
Deposits are up, but loan growth is flat. That is not a good sign, Micenko notes. "In an expansionary environment, you see deposits go down and loan growth going up. The opposite is happening."
Micenko's conclusion: "Corporate America is sitting on their hands, and we don't know why. The optimism has not found its way into corporate behavior."
So who's right, the bulls or the bears? We don't know yet, and that is why there is so much interest in bank earnings and particularly in the management outlook. They will avoid talking about Trump tax cuts but they can't avoid talking about loan growth and why bond yields are moving down and what the impact of a flatter yield curve will mean for them.
For the moment, the optimists are still in charge. Bank stocks (KBE) are 10% off their recent multiyear highs in early March but still nearly 20% above where they were on the eve of the election (the S&P 500 is up only 10%).
There's several reasons bulls still have the upper hand, for the moment:
Bottom line: a lot is riding on the commentary of a couple dozen bank CEOs in the next few weeks.
There's been a lot of excitement about the U.S. earnings season, and with good reason: S&P 500 earnings are expected to grow roughly 10 percent, led by roughly 15 percent gains in the two largest sectors, Technology and Financials.
But the slow improvement in the global economy has analysts even more bullish on investing outside the U.S. Goldman Sachs is anticipating first-quarter earnings will be up 17 percent for the STOXX Europe 600, which represents a basket of stocks across 17 European countries, and 16 percent for Japanese stocks. Even Emerging Markets are seeing an improving earnings picture.
The picture is the same for the full year: across the board, overseas earnings estimates look better than the U.S.:
Global earnings 2017
S&P 500: up 10.0 percent
Japan: up 12.1 percent
Europe: up 14.4 percent
Emerging Markets: up 19.3 percent
Source: JPMorgan Cazenove
Investors have responded. Overseas markets have either performed in-line or outperformed U.S. markets year-to-date:
Global markets 2017
S&P 500: up 5.5 percent
Europe (STOXX 600): up 5.5 percent
Phillipines:up 11.3 percent
Indonesia: up 6.5 percent
Japan (Topix): down 2 percent
Source: JPMorgan Cazenove
The exception to the outperformance--Japan--has had problems because of a stronger yen.
What's behind the spurt in earnings?
Stronger growth and better pricing power alone will be a boost to corporate margins. But
What could go wrong?
Currency fluctuations are big issues when dealing with global stock flows. Japanese stocks have suffered due to a stronger yen. The biggest risk is a sudden surge in the dollar, which would hurt the reflation trade and likely lead to more capital outflow from Emerging Markets. The weaker euro has recently acted as a help for earnings in Europe, though it's doubtful that will continue.
Once again the markets have demonstrated what they care about the most: the Fed and how aggressive it may be on interest rates, and any threat to the Trump agenda.
Midday, the Fed's William Dudley told a luncheon crowd that the Fed may begin the process of shrinking its $4.5 trillion bond portfolio later this year and that there might be only a "little pause" in the Fed's rate hike plan.
That was viewed as mildly hawkish by the markets. The dollar and 10-year yields rose. Bank stocks rose modestly, as did the S&P, though the gains have not lasted. This is not surprising, since Dudley's comments mostly affirm what had come out of the Fed minutes, though the "little pause" comment is slightly more hawkish.
Contrast this to the past 24 hours, where we've had a series of high-drama events that haven't done much to move the markets for even a short period. We have had a high-stakes meeting between President Trump and President Xi of China, a Syrian missile strike, and a disappointing jobs report.
And the market reaction? The S&P 500 is flat.
True, the 10-year yield has had a rather wild 24-hour run, going from 2.34% last night, then down to 2.29% on the Syrian missile strike, then rallying back early in the morning to 2.33%, then plunging to 2.27% right after the disappointing jobs report (the lowest level since mid-November) — and now rallying back to 2.36% on the Dudley comments.
But all this is small potatoes compared to what happened Wednesday, when the Dow plunged 200 points after the Fed said they would be moving to reduce their balance sheet later this year and House speaker Paul Ryan said tax reform could take longer than health-care reform.
The bottom line: geopolitical risk is definitely back on the radar of stock traders, but other factors are much higher up on the risk list. The Trump agenda and the Fed are the two top risks, with — for the moment — the economy and geopolitical risk much further down.
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