Bob’s Journal Update for 1/17

We’ll soon know if the recent rally in the markets will continue, because fourth-quarter earnings reports are being rolled out.

Most markets had a dismal fourth quarter of 2018. But markets turned a corner after Christmas and the subsequent rallies are impressive.

While the S&P 500 still is down 4.28% for the last three months, it is up 3.63% so far in 2019. The Russell 2000 index of small company stocks declined 6.12% in the last three months but is up 7.30% for the year to date.

The results are similar for most international stock markets, commodities and currencies. Corporate bonds, high-yield bonds and leveraged loans also have recovered a lot of the ground that they had lost in the last quarter of 2018.

Government bonds are the main asset that have been left out of the rally. They did well in the fourth quarter while other assets declined. But they’ve been flat or down so far in 2019. Long-term treasury bonds are up 6.02% for the last three months but down 0.48% for the year to date.

The stock market rally has been very strong. The S&P 500 had its largest 10-day percentage gain since 2009. Percentage gains of this magnitude in 10 days are very unusual.

But that doesn’t mean we’re beginning an extended new rally. The latest rally was triggered by Fed Chairman Jerome Powell’s remarks that the U.S. central bank might not raise interest rates as much in 2019 as previously indicated. That was enough to change the views of many investors who were concerned that the Fed would raise rates too high.

The enthusiasm could be premature. The actions the Fed already took still are moving through the economy. Also, even if the Fed doesn’t raise rates, it seems determined to continue shrinking its balance sheet by not replacing some bonds and mortgages after they mature. That’s another way of tightening monetary policy.

So, the economy is likely to continue slowing. Plus, an indication that the Fed might not raise rates any higher is a long way from reversing course and beginning a new period of easing.

More importantly for stock investors is that earnings estimates continue to decline, and companies aren’t beating the estimates the way they did over the last couple of years.

The percentage of stocks that beat earnings, revenue estimates or both shot well above the long-term average beginning in mid-2016. Those consistent “beat rates” were a major factor in the stock market surge the last couple of years.

But the beat rates peaked in the third quarter of 2018. It probably is not a coincidence that is when stock indexes peaked as well.

Another feature of the market rally was that the percentage of companies providing more optimistic guidance about future earnings and revenues as part of their earnings reports shot well above the long-term average. That also peaked in the third quarter of 2018. Now, more companies are lowering future expectations than are raising them.

Likewise, stock analysts have become more likely to reduce their earnings estimates during a quarter than increase them.

Over the last month, stock analysts raised earnings forecasts for 321 companies but lowered them for 711 companies, according to Bespoke Investment Group. That makes this the most negative period of revisions since July 2016.

Energy and materials companies received the highest percentage of negative revisions. Utilities were the only sector that had net positive revisions.

We’ll soon know if earnings and revenues for the fourth quarter declined as much as investors initially feared and what the outlook is for 2019. The number of companies reporting earnings for the fourth quarter in one day will peak on Jan. 31 but will continue at a high daily rate for most of February.

Remember that the economy responds to changes in Federal Reserve policies with lags that are often very long. I think we’ve only seen the first effects of tighter monetary policy and that more negative surprises are on the way.

The Data

There continue to be signs that manufacturing is slowing. The latest indicator is the Empire State Manufacturing Survey, which was reported at 3.9 compared to 11.5 last month. This still indicates growth even though it marks the lowest rate of growth since May 2017.

But the Philadelphia Fed Business Outlook Survey deviated from the other manufacturing surveys. It rose to 17.0 from 9.4. The Philly Fed survey often is stronger than the other surveys, but this month’s result is a significant contrast.

Inflation remains in check and might have peaked for this cycle. The Consumer Price Index (CPI) declined 0.1% for the month and is up 1.9% over 12 months. Excluding food and energy, the CPI rose 0.2% and is up 2.2% over 12 months.

The Producer Price Index declined 0.2% for the month and increased 2.5% over 12 months. Excluding food and energy, producer prices declined 0.1% for the month and increased 2.7% over 12 months.

While we usually worry about inflation becoming too high, these days we also have to worry about the potential for deflation, which is likely to lead to a declining economy.

Interest rates have declined since their highs of late 2018, and that is helping the housing market. The Housing Market from the National Association of Home Builders increased to 58 from 56. That’s only been the second increase since May 2018.

New unemployment claims declined by 3,000 to 213,000. Overall claims declined despite an increase in claims filed by federal employees as a result of the partial government shutdown.

In the last two weeks, housing starts, factory orders and retail sales weren’t reported because of the partial federal government shutdown.

The Markets

The S&P 500 rose 1.17% for the week that ended with Wednesday’s close. The Dow Jones Industrial Average gained 1.23%. The Russell 2000 added 1.13%. The All-Country World Index (minus U.S. stocks) increased 0.53%. Emerging market equities appreciated 1.30%.

Long-term treasuries declined 0.89% for the week. Investment-grade bonds lost 0.09%. Treasury Inflation-Protected Securities (TIPS) fell 0.25%, while high-yield bonds gained 0.24%.

On the currency front, the U.S. dollar jumped 1.15%.

Energy-based commodities fell 0.07% for the week. Broader-based commodities gained 0.50%. Gold had no change.

Bob’s News & Updates

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