Stocks Fall Slightly As Tobacco Has A Bad Day

On Thursday, the S&P 500 closed down 0.57%. American Express was up 7.6% and Amazon was up 1.9%, but the consumer staples stocks were slammed as they were down 3.14%. The sector had a rough day because Phillip Morris reported a weak quarter as the heat not burn cigarettes didn’t sell as well as expected in Japan. The stock fell 15.6% which was the biggest decline in a decade. The other consumer staples stocks outside of tobacco where hit by rising long bond yields. This is because they have high dividends; yields on the long bond compete with them. The consumer packaged goods sector had extremely high multiples in the summer of 2016 when the long bond yields were the lowest in history. I think most of the declines in the sector are done because they now have multiples below the market.

Worries About iPhone Sales Dog Apple

The other reason the market fell is because Apple stock declined 2.8%. I don’t like this name as the stock is only off 4.91% from its all-time high despite the very real worries that iPhone sales will disappoint. The latest source of concerns came from Taiwan Semiconductor as the firm stated its revenue guidance range for the second quarter is between $7.8 billion and $7.9 billion which is way below the consensus for $8.8 billion. The main reason for the weakness was high end smartphone demand which analysts expect is caused by Apple. Apple’s earnings are May 1st. Wall Street expects it to sell 42 million to 43 million iPhones.

The company has transition to a services firm because the smartphone market has peaked. This is a smart move because people still use their devices often, they just buy them after longer periods (longer replacement cycle) and the market is saturated. All this points to selling products at lower prices yet Apple raised the price of the newest iPhones. Margins will be hurt if the firm needs to reverse course and lower them next fall, but that could be the most sustainable option.

Long Bonds Selloff Steepening The Curve

The 10 year bond yield increased about 3 basis points to 2.91%. This is a day after the yield increased 5 basis points, so there has been a pretty large increase in yields. The 10 year yield is almost at the previous peak of 2.95% in February which supposedly scared stocks. As you can see from the chart below, this increase has caused the 10 year 2 year differential to increase from below 42 basis points to above 46 basis points. This pushes back the next potential recession. Rising yields could be good news because it means fixed income investors either believe the economy is rebounding or they are worried about inflation.

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Considering the fact that oil has been increasing lately and economic reports are weak, this might be a selloff due to inflation worries. That could be bad for equities. The 10 year breakeven inflation increased to 2.16% on Wednesday. This is the highest level since 2014. This is still 47 basis points below the cycle peak. The correlation between the CRB Commodities ETF and the long bond yield is high in the past couple weeks. The index was down 0.55% on Thursday, but it went up 1.8% on Wednesday. It’s was at 201.86 on Thursday which is up from 192.25 on April 6th. Since I’m bearish on oil, it’s fair to say, I’m not all-in on the reflation trade. A few days of action doesn’t mean much and won’t cause the Fed to change its stance. Obviously, it’s possible for commodities to increase with a weak economy, but the increased supply of oil from frackers and weaker than expected economic growth doesn’t present a positive case for oil in the next few months.

Great Earnings Weak Economy

My thesis for the next few weeks is the economy will weaken and earnings will be great. The great earnings will push stocks up, but the weak economy will keep them in the recent range. I will do a complete update of the earnings season on Monday. The latest data is that out of the 74 S&P 500 firms which have reported earnings, the average sales growth rate is 10.3%. That’s amazing results so far. The fact that the S&P 500 isn’t up more is disconcerting. The hope is when the big tech firms report great results, the market gets some momentum.

The chart below shows a great overview of the economy. This coincident index is created by ECRI which is projecting a weak economy in the next few months. As you can see, this is about to be the 4th economic slowdown since the 2008 recession. This is clearly not a leading index because it went negative in late 2008. This slowdown is starting at a lower peak than the prior 3. The slowdowns have lasted a year or more which could mean the economy could be weak for all of 2018. There might be a bounce in Q3 followed by more weakness. If the next recession is in the 2nd half of next year, this slowdown could lead the economy right into one just like 2006. The weakness in 2015 and 2016 led to an earnings recession. Any earnings recession in this slowdown would need to occur in 2019. However, if earning growth was exclusively driven by the tax cut this year, investors would see through the façade and sell stocks.

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Conclusion

With the weakening economy just getting started, it will take great earnings from the FAANG names to push the market up. Netflix has reported great results; the hope is the other members follow in its footsteps although I’m not optimistic about Apple’s prospects. The good news is the earnings season’s results have been great so far after about 15% of firms have reported. The bad news is this hasn’t pushed stocks up much.