With the daily debate on what’s been priced in to stocks, now spurred on by Steve Mnuchin’s comments Tuesday on the stock market and what the impact of no tax reform would have, I’ll just give some stats and a chart as a form of chiming in. I’m going to strictly use the Russell 2000 here with the assumption of course being that its components will benefit the most from a lower corporate tax rate. The Russell 2000 rallied 12 days in a row from the day after the November 8th election (and after being up 3 straight days prior) for a gain of 12.7%. The size of the gain over the full 15 straight days of higher closes was 16%. Since the day of the election the Russell 2000 is up 26%. Next, here is a chart of the Russell 2000 since the beginning of 2017 in yellow with earnings estimates for the components (I believe they leave out those companies that lose money) in white. Thus, while earnings estimates are not yet pricing in tax reform, the performance of the index certainly assumes it happens.
RUSSELL 2000 in YELLOW, EARNINGS ESTIMATES for 2017 in WHITE
Bottom line, obviously only in retrospect will we know for sure what’s been priced in and what’s not but anyone thinking that nothing has been priced in I hope these figures were instructive.
I couldn’t believe my eyes this morning when I saw the S&P futures down double digits. It was September 5th the last time the S&P 500 closed down by more than 10 pts and with the VIX at 11+ this morning, go back to September 8th the last time we saw that handle. There was a modest change in the AAII individual investor survey where Bulls fell 1.8 pts to 37.9 while Bears rose by 1 pt to 27.9. The volatility of this index makes it less relevant unless there is an extreme read and this wasn’t one of them. For those that follow the Daily Sentiment Index, there are 85% bulls in the S&P 500 and NASDAQ.
The selling that lead to red in Europe and in the S&P futures began in Asia where most markets closed down, particularly the Hang Seng which fell almost 2% and the H share China index which was weaker by 2.4%. The Shanghai index was lower by .3% after a slew of economic data reported in the midst of the Party Congress. And with the Party Congress in full bloom, you didn’t think China would have reported any disappointing economic numbers did you? Their economy grew by 6.8% y/o/y in Q3 right as forecasted while September retail sales (goosed by a 34% rise in online sales) and industrial production rose a hair above expectations and up from August. Fixed asset investments ytd y/o/y though grew less than expected and at 7.5% it’s the slowest rate since 1999. Maybe the market selling overnight in China was a sell on the news response now that the Party Congress is underway and there really is nothing new or maybe it was what PBOC head Zhou said.
We got some interesting comments from the head of the PBOC Zhou who said “When there are too many pro cyclical factors in an economy, cyclical fluctuations will be amplified. If we’re too optimistic when things go smoothly, tensions build up, which could lead to a sharp correction, what we call a Minsky Moment. That’s what we should particularly defend against.” He particularly warned of the large credit and debt build up. It’s refreshing to hear a central banker actually warn about the risks of excessive credit growth that cheap money perpetuates. The question from here for the Chinese economy is whether they get serious with needed deleveraging at the risk of slowing growth or will they continue on the hamster wheel of constant stimulus in order to reach some made up GDP growth figure.
The Japanese September trade data was a bit less than expected as exports grew by 14.1% y/o/y (driven by rail car engines and semi’s/electronics) vs the estimate of up 15% while imports were higher by 12% vs the forecast of up 14.7%. On a merchandise volume basis, exports were up by 4.8% y/o/y with strength in Asia, particular China, and the US. Exports to the EU declined. Volume imports of merchandise outright fell by .3% y/o/y. Notwithstanding the slight data miss, the Nikkei closed up for a 13th straight day. Not only has there been an earnings recovery for Corporate Japan but they’ve gotten some religion on improving ROE’s and corporate governance where giving money back to shareholders has become a more welcome option for capital use. Moody’s today laid out its Japanese growth forecast with 1.5% in 2017 and 1.1% in 2018.
Lastly out of Asia, Australia a China proxy saw better than expected job growth in September of 19.8k vs the estimate of up 15k. Their unemployment rate fell one tenth to 5.5% which is the lowest since early 2013. The Aussie $ is up in response and its stock market bucked the broader regional weakness with a slight .1% gain. It was the very early 1990’s the last time the Australian economy experienced a recession.
In the UK, falling real wages caught up to the September retail sales data. Sales ex auto fuel fell .7% m/o/m, well worse than the estimate of down .2% and the y/o/y gain slowed to 1.6%. For perspective on the slowing rate of growth in sales, the average y/o/y gain in 2017 ex fuel is 2.5 vs 4.6% in 2016 and 3.7% in 2015. The ONS said it was primarily non food stores that contributed to the negative growth for both value and volume sales. Online sales as it is everywhere was the bright spot. As for the contribution of retail sales overall in Q3, it will give only a very modest lift according to ONS. Yields are falling in the UK in response with the 2 yr note down by 3 bps and the pound is also weaker. It’s the knee jerk reaction to think that weak data means the BoE will buckle in raising rates but if its higher inflation that is causing the weaker retail sales, then it’s all more the reason to control inflation via a rate hike.
Finally, I’m going to include these comments from the Fed’s Beige Book yesterday as it highlights why they will hike again in December and follow thru again in 2018 (depending on where the S&P 500 and broader data is) because many still firmly believe that a tight labor market leads to faster wage growth which then in turn leads to higher consumer prices as companies try to protect profit margins. The underline is mine.
“Labor markets were widely described as tight. Many Districts noted that employers were having difficulty finding qualified workers, particularly in construction, transportation, skilled manufacturing, and some health care and service positions. These shortages were also restraining business growth. Firms in several Districts reported that scarcity of labor, particularly related to construction, would be exacerbated by hurricane recovery efforts.”
“Despite widespread labor tightness, the majority of Districts reported only modest to moderate wage pressures. However, some Districts reported stronger wage pressures in certain sectors, including transportation and construction. Growing use of sign-on bonuses, overtime, and other nonwage efforts to attract and retain workers were also reported.”