(Monday Market Open) It’s earnings time, and that means investors have something fundamental to get excited about. That’s in contrast to the last couple of weeks, when geopolitical drama dominated.
The S&P 500 Index (SPX) hasn’t fallen on consecutive days in more than a month. With major indices up in pre-market trading and stocks mostly higher across Europe and Asia as a Chinese trade delegation wings its way to the U.S., we’ll see if the positive pattern holds.
The last time the index fell two days in a row was Dec. 9 and Dec. 10. The SPX then resumed the rally that began back in October and is up nearly 4% since that two-day December losing streak. That’s pretty impressive, especially when you consider the geopolitical turmoil it had to struggle through at the start of the year. It speaks to the resilience of the market and investor willingness to keep putting money into equities. Now the big test starts as attention shifts to Q4 earnings.
Earnings, Inflation, Retail All Loom
A busy week is coming at us, but today’s schedule doesn’t hint at that. There really aren’t any earnings or data of major importance. Instead, it all starts tomorrow when JP Morgan (NYSE:JPM), Citigroup (NYSE:C), and Wells Fargo (NYSE:WFC) report, along with Delta (NYSE:DAL).
Other big banks follow with earnings reports of their own later this week, with Bank of America (NYSE:BAC), Goldman Sachs (NYSE:GS), and Morgan Stanley (NYSE:MS) all lined up. The banks seem to be doing a good job creating a positive picture despite everything that’s been thrown at them over the last two years, including a slowdown in business investment, a downturn in housing that now seems like it might be turning around, and a bearish rate picture.
Heading into tomorrow’s bank earnings, analysts expect JPM and C to do very well despite spending much of 2019 battling a tough yield curve, weak business investment, and trade issues. Along with their expertise in managing expenses, the big banks likely benefited from healthy U.S. consumers who reached into the wallet or purse for the credit card over and over last year, as well as low mortgage rates that appear to have the housing market in better shape.
Investors also receive their first 2020 look at consumer and producer prices this week, with the December consumer price index (CPI) report due Tuesday and producer price index (PPI) on Wednesday. Both of these inflation indicators came in kind of muted in November, so we’ll see if that continued. Retail sales for December take the spotlight Thursday, and could provide more insight into holiday spending.
On the cusp of another earnings season and 29,000 for the Dow Jones Industrial Average (DJI), markets took a breather Friday. The DJI peaked just above 29,000 early on and couldn’t hold that level, which might have helped spur a bit of-pre-weekend profit-taking. It was actually a bit hard to tell if the pressure on indices came from lack of buying or active selling. The market just seemed to lose energy as the day continued.
Fundamental economic news might have weighed on the indices Friday after the December jobs report showed 145,000 new positions added that month, a bit below the 160,000 consensus estimate of Wall Street. With the report in the books, it appeared that investors gravitated toward some of the risk-off part of the market, shedding high-flying Technology and scooping up Utilities and Real Estate.
Gold and bonds also got a slight lift to end the old week. The 10-year yield finished near 1.82%, still roughly in the middle of the 1.7% to 1.95% range it’s been in for months. Both gold and bonds slipped slightly early Monday, maybe a sign that the risk-off sentiment from Friday could be fading. Volatility has really calmed down since the geopolitical winds eased last week. The Cboe Volatility Index (VIX) is at a relatively low 12.75, down from highs of around 16 a week ago when tensions ran high.
Reconsidering The Jobs Report
Going back over the jobs report, it looks like one of those data points that’s just ho hum, nothing much to see. The question is whether it’s a blink in time or the start of a trend.
For instance, jobs growth of 145,000 was well below the three-month average of 184,000. If January growth is in the same ballpark as December, it might be time to consider whether that brief burst of strong job creation late last year has staying power. That said, it’s probably hard for the economy to keep adding nearly 200,000 jobs a month after 10 years of recovery, so anyone disappointed by 145,000 might want to consider resetting expectations. Still, some analysts said the tepid job growth might point to slow earnings growth, too.
Manufacturing and warehousing jobs declined in December, possibly reflecting the soft manufacturing data seen lately. The manufacturing sector, in particular, is worth a close watch for job growth in coming months to see if businesses are starting to re-invest in operations now that there’s a Phase One deal with China. Lower manufacturing employment growth could also be weighing on wage growth, because these jobs tend to be high-paying. There was a lot of disappointment Friday over the 2.9% year-over-year wage increase, but keep in mind that it was a tough comparison vs. strong growth in the same month a year earlier.
Anyone paying attention to something besides football over the weekend might have caught this: Treasury Secretary Steven Mnuchin told Fox News that Boeing’s (NYSE:BA) 737 Max crisis could slow U.S. economic growth in 2020 by half a point. “Boeing is one of the largest exporters, and with the 737 Max, I think that could impact GDP as much as 50 basis points this year,” Mnuchin said.
Remember that BA’s problems might boomerang around a bunch of sub-sectors, including companies that make parts for BA, but also the airlines and even the hotel and restaurant industry. Late last week, Spirit AeroSystems (NYSE:SPR) said it plans to lay off more than 20% of its workforce as it grapples with halted production and uncertainty over when 737 MAX jets will return to service. The layoffs affect 2,800 workers.
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CHART OF THE DAY: TECH TACK: The Technology sector (IXT-candlestick) took a step back Friday amid what appeared to be some profit-taking, but it’s still easily outpacing the S&P 500 Index (SPX-purple line)) over the last six months, as this chart demonstrates. Data Source: S&P Dow Jones Indices. Chart source: The thinkorswim® platform from TD Ameritrade. For illustrative purposes only. Past performance does not guarantee future results.
Shades of 2018? As stocks rally early this year, it might make some people recall a similar rally in early January two years ago that ended with a big splat. That doesn’t necessarily mean we’re in for a repeat, because the market is in a different place and fundamentals have changed. Still, you could argue that valuations—now about 18.5 vs. projected earnings for the S&P 500 Index (SPX)—are looking a little high historically. Just over a year ago, the price-to-earnings (P/E) ratio was around 14, and the historic average is roughly between 14 and 16. So thinking back to January 2018, when a sharp early-year rally fizzled and the market ended up sliding 6% for the full year, what’s really changed? A lot, but rates are a big factor. The Fed raised rates four times in 2017 and four more times in 2018, and that really clipped the rally. Now it’s lowered them three times and seems likely to keep things steady. In an environment like that, sometimes investors are more likely to tolerate the kind of valuations we see now.
Putting the “E” in P/E: Speaking of valuations, the denominator (earnings) now starts getting updated as Q4 reporting season begins. The most recent FactSet projections are for a 1.5% decline in S&P 500 earnings in Q4, which would be the fourth-straight quarter of year-over-year earnings losses. The last time that happened was in late 2015 and early 2016, an era that became known as an “earnings recession.” To make matters worse, the projected 1.5% decline in Q4 is down from FactSet’s September projection for 2.5% growth in Q4. That arguably calls into question the EPS growth estimates people are making for 2020, which are generally in the mid-to-high single digits. Will they also start to sink as time goes by? We’ll have to wait and see.
Earnings Could Turn Positive: What’s the potential bright side when analysts see stretched valuations and declining earnings? Well, earnings projections typically start out low when earnings season begins but then start to creep up. For instance, FactSet believes there’s actually a good chance Q4 earnings may grow when all is said and done. It notes that from the end of the quarter through the end of the earnings season, the earnings growth rate has typically increased by 3.6 percentage points on average (over the past five years) due to the number and magnitude of positive earnings surprises. Another silver lining: FactSet expects revenue for S&P 500 companies to grow 2.6% in Q4. That’s low historically, but in the green.
Good Trading
TD Ameritrade® commentary for educational purposes only. Member SIPC. Options involve risks and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options.
TD Ameritrade® commentary for educational purposes only. Member SIPC. Options involve risks and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options.