Bob’s Journal for 1/24/19

Is all the bad news reflected in the markets, or are the markets still too optimistic?

It is early in earnings season, and we’ve received a mixed message so far. Last Tuesday, the stock indexes had nice rebounds following positive earnings reports from IBM, Procter & Gamble and United Technologies. The gains, however, were mostly focused in the Dow Jones Industrial Average to which the three stocks belong.

The other indexes had modest gains, and the Dow recovered only a little more than half the previous trading day’s losses.

Looking at the bigger picture, with about 14% of S&P 500 companies reporting earnings, almost 73% have beaten earnings estimates. But those estimates were revised steadily down leading into earnings season. In addition, the 13.2% increase in earnings for the quarter so far is the lowest growth rate since the fourth quarter of 2017.

An important change in this earnings season is the reported revenues. In recent quarters, the percentage of companies beating revenue estimates has been about the same or higher as the percentage beating earnings estimates. So far this quarter, only about 59% of companies beat revenue forecasts.

The earnings season so far is consistent with the economic data. The economy was growing in the fourth quarter, but at a slower rate than earlier in the year. The data also indicate growth is slowing further to start 2019.

Market pricing indicates investors believe this is as bad as it is going to get. They say the Fed will hold interest rates steady while inflation will be stable or decline. Investors also believe growth will be about 3% for the year.

I think the economic data is going to be worse than investors expect. Monetary tightening is felt first in the markets and then works its way through the economy. Based on how things progressed in the past, I think the economy will show more effects of tightening as the year unfolds. That slower growth will be reflected in earnings later in 2019.

The market indexes have had a nice rebound from the lows recorded on Christmas Eve. Stocks likely will have an additional strong rebound if there are announcements about a deal to end the partial government shutdown or resolve the trade conflict with China. But that won’t override the effects of the Fed’s tightening.

Despite the rally, most technical measures of the markets aren’t positive, and major changes are required for them to turn positive. The rally could continue for a while, but don’t be caught in panic buying. A fresh move down is likely in the coming weeks.

The Data

The Industrial Production report contradicted the other data we’ve been receiving on manufacturing in recent weeks. Most of the recent data has been negative. But production increased by 0.3% for the month, and the manufacturing component increased 1.1%. While a surge in motor vehicle production was partly responsible for the unexpected increase, a jump in business equipment also contributed. Business equipment production now is up 5.0% over 12 months. Manufacturing overall increased only 3.2% for 2018.

The Richmond Fed Manufacturing Index, however, reflected the negative trend of other recent surveys. It declined by 2, which follows a decline of 8 last month. This is the index’s lowest level in more than two years. As recently as September, the index was reported at 29.

The Kansas City Fed Manufacturing Index further complicates the picture. It came in at 5, and last month’s index was revised higher to 6 from 3. So, this month’s number was higher than last month’s initial report but lower than the revised level.

The PMI Composite Flash Index, however, showed manufacturing accelerated in the first half of January to 54.9 from 53.9. The service sector also increased to 54.2 from 53.4. The composite increased to 54.5 from 53.6.

Consumer Sentiment, as measured by the University of Michigan, declined sharply to 90.7 from 98.3. The result was well below expectations and the sharpest one-month decline in this expansion. Consumers said they were concerned about the government shutdown, trade conflicts and market volatility.

Existing home sales also tumbled. They were down 6.4% in December and 10.3% over 12 months. The annualized rate of sales for the month is the lowest in more than three years. Also, prices declined 1.4% for the month and are up only 2.9% over 12 months.

The FHFA House Price Index tells a better story, though it goes only through November. The HPI said prices increased 0.4% for the month and were up 5.8% over 12 months.

The index of Leading Economic Indicators from The Conference Board declined 0.1% for December. It rose 0.2% for November but had declined 0.3% in October. The Conference Board indicated that means U.S. growth should slow to about 2% by the end of 2019. Some of the measures used to calculate this index were estimated because official data wasn’t issued as a result of the partial government shutdown.

New unemployment claims decreased by 13,000, bringing the total down to 199,000. That’s the lowest number of new claims in the almost 50 years of the measure, and the labor force was about half its current size at that time. The decrease in claims occurred despite about 25,400 new claims from furloughed federal workers.

The Markets

The S&P 500 rose 0.93% for the week ended with Wednesday’s close. The Dow Jones Industrial Average gained 1.67%. The Russell 2000 added 0.06%. The All-Country World Index (minus U.S. stocks) increased 0.27%. Emerging market equities appreciated 0.19%.

Long-term treasuries rose 0.13% for the week. Investment-grade bonds gained 0.80%. Treasury Inflation-Protected Securities (TIPS) fell 0.25%. High-yield bonds gained 0.10%.

On the currency front, the dollar rose 0.08%.

Energy-based commodities were unchanged for the week. Broader-based commodities fell 0.13%, while gold lost 0.81%.

Bob’s News & Updates

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