March 31, 2016

The major stock market averages are flat in early trading. Biotechs are up nicely, as are most energy stocks. Materials and industrial sectors are sagging a bit. WTI crude oil is moving back up toward $39/barrel this morning, and not surprisingly, the dollar is weaker. I’d point out that the dollar is at its lowest point vs. a basket of foreign currencies since last October. Bonds are mostly unchanged; the 5- and 10-year Treasury yields are trading at 1.26% and 1.81%, respectively. And by the way, junk bonds are higher on the day, and are now up for the year. Remember, credit concerns were one of the main reasons bears were calling for a recession last month. So that situation is improving.  

We are approaching first quarter 2016 earnings announcement season. Yesterday, CNBC reported that Wall Street analysts are forecasting aggregate earnings growth for S&P 500 companies of -6.9% y/y; revenue is expected to fall 1.0% y/y. Of course, the energy sector is driving the decline in earnings. Energy sector earnings are projected to fall 99% y/y! (By the way, basic materials sector earnings are forecasted to decline 19% y/y.) Stripping out energy, S&P 500 earnings growth will fall 1.8% y/y and revenue will rise 1.8% y/y. Consumer discretionary sector earnings are expected to increase 14% y/y; telecoms sector earnings should rise 5.5%.

I think it’s worth noting that there are different ways of estimating Wall Street consensus earnings expectations. Zacks Investment Research says aggregate S&P 500 earnings are expected to fall 10% y/y in the first quarter. And excluding the energy sector earnings will fall 5%. Not only that, Zacks says Wall Street analysts have drastically reduced earnings expectations over the last month, so it’s a moving bogey. And I’d point out that if the recent trend holds, analysts will cut estimates too far and by the end of the reporting season something like 70% of companies will have beaten those lowered expectations. What we’d really like agreement on is when to expect earnings growth to turn positive again. Zacks says the third quarter of 2016 will mark the return to growth.  

We heard two very different calls on the market by a couple of experienced investment strategists. Tom Lee of Fundstrat Global says stocks are likely headed for fresh all-time highs. He cites “improving fundamentals” as corporate earnings will come in better than expected. Why? Oil is $40/barrel vs. $26 in February; and the strong dollar is no longer an issue. He understands central bank divergence, but says that’s already priced into the dollar. “…what’s moving currencies right now is relative inflation developments.” And since there’s not much inflation in the US, we won’t likely see the dollar strengthening into the summer. Mark Grant of Hilltop Securities, on the other hand, believes the 10-year Treasury yield could fall to 1.25%. He believes the economy won’t improve enough to ignite inflation expectations. And the Fed knows that lower interest rates abroad have the effect of monetary tightening here at home. So they won’t be raising rates. Consequently, he thinks stocks can’t possibly perform very well this year.   

Speaking of improving fundamentals, we got a couple of encouraging business activity reports this morning. The Chicago Purchasing Managers Index (“Chicago PMI”) improved to 53.6 this month from 47.6 in February. Remember, any reading above 50.0 indicates expanding business activity. Current production levels, as well as new orders and backlogs were stronger. The Chicago PMI covers both manufacturing and service businesses. Separately, the ISM Milwaukee rose to 57.8 this month vs. 55.2 in the prior month. Bloomberg’s take is that these reports suggest “US manufacturers have avoided falling into recession, and in fact may be gearing up for a stronger performance as demand for goods strengthens at the end of 1Q.” 

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