Retail Sales & Earnings Season Highlight An Expected Turbulent Week For Markets
Closing out the 1st week of earnings season found the major averages higher last week. In the wake of earnings results from Citigroup, Wells Fargo, Blackrock and JP Morgan Chase, however, investors found the earnings reports to be a sell the news type of event. The banks and financial institutions managed to beat results handily, but found their share prices under pressure shortly thereafter. While the bulk of this week’s reports are dominated by the Finance sector, other sectors will be dripping earnings reports throughout the week.
As it pertains to the financial sector’s earnings, they were only up +1.2% in FY17 and in the low single digits in the 3 years prior to that. Expectations have much improved for 2018 though and on the heels of an improving economy with benefits from tax reform and higher interest rates. Financial sector earnings are expected to be up some 25% in 2018 according to Zach’s Research.
So why did the likes of Citigroup, Wells Fargo and JP Morgan Chase sell-off after the release of their respective Q1 2018 results? One basic and understandable reason could be the simplicity of a “sell the news” event. There is also likely a comparability ground for the market’s lack of appreciation for the results, as 2 new accounting rules took effect this quarter. This week we’ll have a great more data and earnings reports from the financial sector. The sector’s earnings growth momentum is expected to continue in the coming quarters.
suggest that individual bank stocks may see some lift throughout the quarter, but only if the broader market finds investor appreciation. We believe it more optimal to participate with the Financial Sector Spiders (XLF) instead of trying to pinpoint which bank stock will appreciate with greater probability.
As it pertains to bank earnings, credit spreads continue to weigh on investor sentiment as a whole for the sector, although that factor is greatly improved when compared to early February as spreads hit their highs. The 10-year/2-year U.S. Treasury spread has been narrowing since the market sell-off in equities at the beginning of February. The spread hit a year-to-date high of 78 basis points on Feb. 9 but has since narrowed to 48 basis points.
With the financial sector in focus this coming week, we now take a look at the market as a whole under the context of valuation. According to data from FTSE Russell and Thomson Reuters, the U.S. stock market was recently trading at its most expensive levels since the dot-com era. This is not an “ah ha” moment as most investors understand the market’s historic valuation and readily justify it based on corporate earnings growth expectations for 2018.
The historic median S&P 500 PE ratio is about 15. The present PE ratio on the S&P 500 stands around 17 as depicted in the chart below.
Again, while valuation seems stretched and at levels not seen since the dot.com era some 20 years ago, it comes due in part to strong corporate earnings growth expectations. When we take into account that earnings are expected to grow between 16.5% and 18% for 2018, depending on the data tracking firm, one might draw the conclusion that the S&P 500 is somewhat undervalued. If we look at valuations using PEG ratio, based on this metric, stocks have a PEG of 1.2.
What this means is that the S&P 500 is not only trading one standard deviation below its long-term average of a little more than 1.3, but also at its cheapest level since 2012. That’s a very different consideration than the simplistic historic PE ratio noted above.
We are 3.5 months into 2018 and markets have had a rollercoaster ride like investors have not seen in more than a decade. Volatility has taken center stage with most investor classes citing great geopolitical uncertainty as the reason for increased market volatility. The increased levels of market volatility in 2018 have born out the 1st S&P 500 correction in roughly 2 years and an increased bearish equity sentiment among the investor classes. Institutional investors have indicated their views on the market by putting to work their hedging strategies that generally serve to elevate the VIX and with SPX options.
David Templeton, portfolio manager and principal at Horan Capital Advisors recently noted the bearish equity sentiment in his blog post. Templeton used the latest figures concerning investor sentiment from the American Association of Individual Investors to surmise a contrarian view on equities near term.
“Bearish sentiment jumped 6.1 percentage points to 42.8%, resulting in the bull/bear spread being reported at a negative 16.7 percentage points, the widest negative spread in more than a year,” he noted.
The AAII survey is often used as a contrarian indicator, meaning traders turn upbeat when its readings get gloomier. The chart below from AAII suggests a turning point for equities may be coming soon enough.
The weekend that was will give way to this trading week and continued earnings releases and as such we will briefly discuss the missile strikes on Syria from the coalition of nation states that included France, United Kingdom and lead by the United States. The strikes that occurred on the evening of Friday the 13th (EST) were declared successful by the coalition and evidenced as such in the media. The strikes and mission were designed to curtail or stop Syria’s government from using chemical weapons going forward.
The consternation about the missile attacks comes via Russia’s involvement in the Syrian war against the rebel forces in the region. Russia has enhanced the Syrian government’s capability and stands in alliance with the government of the war-torn nation. This brings Russia squarely into conflict with the United Nations and more obviously, the United States. With that being said, for all the bluster and conflict aimed at the U.S. and the UN over the years by Russia, it hasn’t amounted to more than that, bluster and threats.
So what do the coalition strikes mean for equity markets and volatility in the coming week? Finom Group believes that most investors understood the missile strikes were an inevitability as President Trump had previously tweeted, “They’re coming”. As such, we see little equity market reaction to the strikes forthcoming. This belief or forecast can be juxtaposed with the more recent missile attack from the United States that occurred on April 6, 2017.
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As depicted in the chart above, provided by Chart IQ, the April 2017 missile attack did result in an increase in market volatility, with a roughly 1% negative move for the S&P 500 that began in the following trading week. The actual response to the April 2017 missile attack was, on the subsequent trading day, mostly void and with the S&P 500 virtually flat on the April 7, 2017 trading day.
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On April 6, 2017 the S&P 500 closed at 2,357 and on April 7, 2017 the index closed at 2,355. To reiterate, however, the VIX was sharply higher post the missile strikes in 2017, up some 27 percent. It remains to be seen if volatility will spike again in response to this particular geopolitical issue, especially as volatility tends to become desensitized to like stimuli, which this would be categorized.
Geopolitical concerns will seemingly continue to weigh on investors for months to come and there is no shortage of geopolitical issues to consider. They confront investors from all sides and regions of the world presently. Some of the concerns surround trade with China and NAFTA terms. While the China-U.S. trade and tariff dispute remain at heightened levels, a deal on NAFTA may prove promising for investors in the not too distant future, as suggested in a recent statement from U.S. Vice President Mike Pence. Pence told reporters it was possible that a deal would be reached in the next several weeks.
"As the president said very recently, we think we are close, we are encouraged at the progress of our negotiations and we are hopeful that we can conclude a successful renegotiation of NAFTA that will result in greater prosperity and a more fair and reciprocal trade between Canada the United States and Mexico," Pence told reporters in a separate news conference with Justin Trudeau on Saturday.”
As we risk getting long-winded with our latest research report we have to recognize the latest uptick in the forecast for Q1 2018 S&P 500 earnings. Last week, according to Thomson Reuters, Q1 2018 earnings were expected to grow 18.4% when compared to the same period a year ago. This was articulated in Finom Group’s latest research reported titled Geopolitical Concerns Weigh Heavily Against Earnings Season. But after the most recent outperformances from bank earnings, Thomson Reuters has revised its Q1 2018 earnings forecast higher by .2 percent.
Aggregate Estimates and Revisions
- First quarter earnings are expected to increase 18.6% from Q1 2018. Excluding the energy sector, the earnings growth estimate declines to 16.9%.
- Of the 30 companies in the S&P 500 that have reported earnings to date for Q1 2018, 70.0% have reported earnings above analyst expectations. This is above the long-term average of 64% and below the average over the past four quarters of 75%.
- First quarter revenue is expected to increase 7.4% from Q1 2017. Excluding the energy sector, the revenue growth estimate declines to 6.7%.
- 7% of companies have reported Q1 2018 revenue above analyst expectations. This is above the long-term average of 60% and above the average over the past four quarters of 69%.
- For Q1 2018, there have been 73 negative EPS preannouncements issued by S&P 500 corporations compared to 61 positive, which results in an N/P ratio of 1.2 for the S&P 500 Index.
- The forward four-quarter (2Q18 – 1Q19) P/E ratio for the S&P 500 is 16.4.
- During the week of Apr. 16, 60 S&P 500 companies are expected to report quarterly earnings.
The focus on earnings season should increase in the coming weeks, although investors will keep an eye out for geopolitical and Fed-related news via the Beige Book on Wednesday. Monday will likely prove to deliver the most impactful economic data of the week via monthly retail sales. The last few reporting cycles have shown MoM declines although YOY retail sales have been relatively strong, growing above 3.5 percent. The report will give clues on not just the state of retail in the United States, but also consumer spending trends, consumer credit and household debt and any reversion in consumer spending trends to name a few.
For better or worse, Finom Group continues to trade this volatile marketplace. Seth Golden is the firm's Chief Market Strategist and has been a featured trader to chronicle by many media outlets including the New York Times last year and this year. In 2017, the New York Times featured Golden in an article titled Day Trading in Wall Street’s Complex ‘Fear Gauge’ Proliferates. Golden believes, despite the increased levels of equity market volatility found in 2018, the major averages are likely to recapture all-time highs later this year. His belief is rooted in the fundamental and historical understanding that despite the "white noise" which accompanies equity markets in 2018, the earnings picture and results will trump geopolitical rifts and other macro-headwinds currently confronting the investing landscape.
Just last week, Finom Group and Seth Golden put out several trades for subscribers as depicted in the screenshot from Finom Group's private Twitter feed below.
Here's to a great trading week for all and a strong earnings season, as it is expected to be.