The markets have had a big run, up about 6 percent since the elections.
Industrials in particular have been strong on a mix of expectations for tax cuts, lower regulations and a big infrastructure spending program some time in 2017. But two big industrial companies — Honeywell and United Technologies — have just released earnings guidance for 2017 that is below expectations, and a third — Caterpillar — said earlier this month that earnings expectations were "too optimistic."
It's not that they think business will be terrible — they are reasonably optimistic — but the implication is that the stock prices have run up a bit too much on expectations that earnings would strengthen dramatically. They are trying to damp down unrealistic expectations, and with good reason: We don't know what the size of a corporate tax cut will be, and we don't know what an infrastructure program will look like, or how we will pay for it.
And even if we do get an infrastructure program, it's unlikely money will start flowing until 2018.
Honeywell forecast 2017 earnings at $6.85 to $7.10. The midpoint is $6.98. Analyst expectations are $7.08. And the analysts haven't even raised the numbers yet. Again, Honeywell is not pessimistic: Darius Adamczyk, president and chief operating officer, talked on the conference call about better organic growth (1 percent-3 percent) and higher margins. The earnings guidance would represent a gain of 6 percent-10 percent over 2016.
Those are good numbers, but when asked about specifics around the Trump proposals, Thomas A. Szlosek, chief financial officer and senior vice president, declined to comment: "We're waiting to see a little bit more clarity in terms of some of that tax and trade policies, which would obviously impact our cash."
But the questions kept coming. When pressed about how their $8 billion cash hoard that is outside the United States and how it might be impacted by tax cuts, Szlosek said the current discussions about tax cuts were "very constructive" but wouldn't commit to anything specific: "You're making too many assumptions, but we think it's going to provide some opportunities for us certainly on the cash mobility side and the capital allocation side."
Then there is just the boring reality that the rest of the world isn't exactly on fire. United Technologies talked about decent organic revenue growth of 2 percent-4 percent, but noted weak demand at its Pratt & Whitney unit's commercial aircraft engines. And look at their assumptions for the year: 2 percent GDP growth in the U.S., slower China (6 percent GDP), and continued slowness in Europe post-Brexit. Then there's the stronger dollar: The dollar could be a $600 million headwind on the top line, $125 million on the bottom line.
Despite the weak earnings projections, both United Technologies and Honeywell are up today.
What does all this mean? There is a battle going on — instead of "bulls versus bears" let's call it "pragmatists versus optimists."
The pragmatists are saying, in essence, "We have no data on how tax reduction and fiscal stimulus will impact earnings."
The optimists are saying, in effect: "Use your imagination! We don't have to have all the numbers, we know it's going to be positive!"
This may be a very flimsy foundation for a stock rally, but that is where we are now.
And that flimsiness may be why the market is starting to look a bit trendless. Market leaders like banks are mostly weaker today, market laggards like industrials are mostly higher. When you get daily leadership changes, it's a sign the market is starting to question certain assumptions.
For the moment, though, the optimists still have the momentum.