Fed Rates - Stocks Rally On Election Day

With the 0.63% rally in the S&P 500 on Tuesday, the stock market is only down 6% from its September peak. It is up 3.06% year to date.

This rally continues to vindicate my short term bullishness. I’m still bullish in the short term. CNN Fear and Greed index is at 11 out of 100 which indicates extreme fear. That’s up from 9 on Monday.

One or two more positive days should take us out of the extreme fear category. That's as long as there isn’t volatility throughout the day. Then my intermediate term bearishness will determine my opinion on stocks

Nasdaq increased 0.64% and Russell 2000 increased 0.55%. VIX was down 0.25% to 19.91. Every sector increased.

Best performers were industrials and materials which were up 1.1% and 1.51%. Worst sector was energy which was up 0.34%.

That makes sense because oil plunged 1.4% on Tuesday. It is down 7 straight days and briefly entered a bear market.

Oil fell because America allowed Iran’s oil customers to keep importing its oil without violating American sanctions. Weaker sanctions on Iran combined with a weakening global economy spell doom for oil. Last month it peaked at $76.90. Now it is at $62.21.

As you can see from the chart below, the put to call ratio is the highest since the 2016 presidential election.

This is partially because of the correction and partially because of the midterm elections. I don’t anticipate any volatility after the election. But investors thought it was a good idea to hedge their portfolios just in case something negative happens.

Fed Rates - Zillow Stock Craters After Hours

With the weakness in the housing market, it’s no surprise Zillow had a disappointing report. It caused its stock to crash after hours. Zillow reported 17 cents in EPS. That's in the middle of the range of 6 estimates which were between 15 cents and 20 cents. That is down from 19 cents last year.

Catalysts of the 18.98% decline after hours were weak revenues and guidance. The firm reported revenues of $343.09 million which missed estimates for $344.19 million. It issued 2018 revenue guidance between $1.307 billion and 1.324 billion. That missed estimates for $1.34 billion.

Specifically, Q4 revenue guidance was between $340 million and $357 million. It was way below the consensus for $368 million. The company is in very bad shape. It just launched its real estate business where it will buy and sell houses.

That’s perfectly disastrous timing because. The home flipping market is showing weakness. And the overall housing market is slowing due to poor affordability.

It’s fair to say this decision is a signaling tool that the housing market is near its peak. The home building industry has had an oversold bounce recently. ITB index was up 9.07% from October 24th to November 5th. Zillow is at its lowest price since March 2017.

Fed Rates - Treasury Market Update

The 10 year yield increased 3 basis points to 3.23%. It is just 3 basis points away from its 52 week high of 3.26%.

Real yields have been increasing which is offsetting the decline in inflation estimates.

The chart below shows the 5 year breakeven inflation rate is down about 7 basis points from the high in early October. To be clear, in the past few days the breakeven inflation rate hasn’t followed oil prices lower.

Bloomberg CRB commodity ETF is down 1.37% year to date and 0.71% in the past year. I don’t think wage growth will drive inflation higher. It hasn’t in the past 2 cycles.

Tariffs might drive up inflation. But the commodity index has been weak this year despite the tariffs. It’s possible treasuries are selling off simply because increasing deficits have increased the supply of treasuries.

The 2 year yield increased 2 basis points to 2.93% which is the cycle high. CME Fed Watch Tool shows there is only a 6.5% chance the Fed raises rates at its November meeting.

There is an 80.8% chance of a rate hike by the end of the year. The main reason the market expects a rate hike in December instead of November is because the December meeting has a press conference.

Fed Rates - Great Q3 Earnings Reports But Terrible Guidance

Negative catalysts of a hawkish Fed, ending fiscal stimulus, and tariffs are finally starting to weigh on earnings estimates.

Q3 earnings season has been great, but future estimates have plummeted. Investors don’t care about the past; they only care about the future.

This means the 32.32% EPS growth rate in Q3 with 405 S&P 500 firms reporting can’t send stocks higher. To be clear, the 2 year stack of earnings growth with 405 firms reporting in Q2 was 38.07% and the 2 year stack in Q3 is 36.87%.

Strong Q3 growth is all about weak comparisons. Sales growth with 405 firms reporting fell from 10.31% in Q2 to 9.44% in Q3.

Those are all great numbers, but Q4 estimates have been falling sharply.

As you can see from the table below, the estimates for year over year growth have fallen from 15.51% on August 1st to 12.88% on November 6th.

Furthermore, the estimates for Q1 2019 have fallen from 8.79% growth on October 1st to 7.74% on November 6th. It wouldn’t be a surprise for growth to fall below 5% by the time firms report in a few months.

Fed Rates - Conclusion

Fed likely won’t raise rates in its November meeting. But it should provide clear guidance for a rate hike next month.

The Fed is very close to the neutral rate. This hike could put rates above the neutral rate, making policy hawkish.

That combined with the fiscal stimulus running its course and the tariffs make 2019 look bad for equities.

Declining estimates for Q1 earnings growth are a preview of the weak growth to come. I’m still not sold on there being a bear market.  Earnings need to fall for that to occur.

President Trump will probably make a trade deal before tariffs start to really hurt the economy.