April 29th, 2019
As of the close of April 29th the S&P 500 is +3.8% MTD and +17.4% YTD, and the MSCI World is +3.1% and +15.4% YTD.
- The S&P 500 is currently at a new all-time-high of 2943 on the back of generally strong corporate earnings. The NASDQ is also having a strong month, +5.5% MTD and +23% YTD. Amid index level bullish price action across US equities, it is no longer possible to say that positioning in US equities is still light. While not yet ‘full’, exposures are approaching average for HFs, futures, and systematic strategies.
- On the data front, the US employment data was strong earlier in the month, with a buoyant jobs market beating the expectations of most economists with 196,000 new jobs created in March. This data was important, as it comes after an unexpectedly weak February, where only 20,000 new jobs were created. More importantly, the initial report on 1Q19 GDP surprised to the upside (+3.2% annualized vs 2.3% expected), though this was mostly driven by transitory factors related to trade and inventory. At the end of this week the April unemployment numbers will be released, with estimates expecting a creation of 180,000 jobs and the unemployment rate at 3.8%. This number will be important as it will confirm (or not) the weak February number as an aberration.
- The 2Q headline GDP number may appear lower without the transitory boosts, but core domestic economy growth should be solid. That being said, the weak IFO print out of Germany this week could be cause for concern across the pond, as it indicated that business confidence remains weak in Germany. Data letdowns from Germany have certainly lowered the desires to wave the all clear flag on EU growth in the near term.
- Still, among all of the macro and geopolitical noise that continues to dominate headlines, global investors are turning their focus to more micro drivers and business fundamentals as we get into the heart of earnings season. Putting it all together, it hasn’t paid to overthink earnings this quarter. Stocks that beat and raise / point to short cycle signs of improvement are rallying, while companies that miss / do little to instill confidence in outlooks are sold.
- More importantly, we are starting to see signs of real dispersion and differentiation. In the S&P 500, dispersion is above the median level within each sector. This is particularly the case for Energy, Communication Services, and Healthcare where dispersion over the last two weeks is in 99th, 95th and 94th percentiles respectively. This begs the question—is stock picking really starting to kick in ?
- Yet, with US Tech earnings continuing to drive markets this month, we ask ourselves whether this is just a continuation of the sector Barbell strategy that has dominated client positioning thus far, or if we are in fact seeing idiosyncratic stories start to matter. Within Tech most recently, it appears to be the latter, as we’ve seen both beats and misses across the space. Microsoft (MSFT), Amazon (AMZN), Facebook (FB), and Twitter (TWTR) all beat numbers, while Intel (INTC), Texas Instruments (TXN), and Xilinx (XLNX) had more negative results, at a minimum casting some doubt on the 2H recovery. Yesterday’s Alphabet (GOOG) numbers missed analysts’ estimates sparking concerns that advertisers are shifting spending to digital rivals. Revenues from Google advertising rose +15% (the slowest since 2015) contrasting with Facebook’s (FB) which last week reported a +26% in ad sales.
- More broadly, earnings so far have shown an above average beat trend with 77% of the S&P 500 beating estimates (above the average of 68% since 2004) and 3.5x more companies beating on Sales and EPS than have missed on both metrics. Notably, earnings day performance trends reveal a more positive market reaction than historically has been the case, and the market appears to be both rewarding and punishing companies by a greater degree based on EPS and Sales results vs historical average. Thus far, the reported 1Q19 EPS y/y growth rate is tracking positive (+2%), though the overall blended growth rate remains negative for the quarter. The full year 2019 S&P 500 EPS estimates have been revised higher by some while EBIT margins have been revised slightly down. While margin concerns persist, companies have delivered positive margin guidance across a variety of sectors and investors seem ready to give a pass to those companies spending offensively—Amazon (AMZN), Netflix (NFLX), Disney (DIS).
- In line with this theme, Tech remains the best performing sector YTD, with Software being a major contributor to this outperformance. With many questions remaining around the outlook for global growth, investors have been flocking to one of the few areas where the trajectory of earnings growth has been historically steeper vs. other sectors.
- Despite strong headline numbers, we have seen some few trends that could be cause for concern, especially surrounding capex. Across some of the US’s largest companies, we’re seeing hits to capex spend. Tech giant Microsoft (MSFT) cut capex by 30% and even Facebook (FB) cut capex by 10%. While their 1Q results were taken positively on the whole, these trends should at least give investors a reason to pause and ask themselves why some of the market’s biggest earnings growers are cutting spending if fundamentals still remain so strong. Maybe these are just blips in an overall strong market, but the US economy doesn’t look like it did in 1Q2016. Today, labor (tight), inventory (high) and capex (coming off a boom) are in a much different place.
- Companies are jumping over a lowered bar in the 1Q earnings season, keeping hope alive for now, but the risk to 2019 EPS is still significant. In fact, Morgan Stanley Chief US Equity Strategist Mike Wilson, who correctly predicted the slowdown in the 4Q 2018, estimate S&P 500 EPS consensus estimates are approximately 8 percent too high. These observations tie into Wilson’s view that an earnings recession in the US is just beginning. He believes that this quarter is likely to be the first negative YoY growth quarter in three years, and is monitoring margins closely to see if there are signs of either stabilization or deterioration. Labor, inventory, and excessive capital spending are the greatest areas of excess causing corporate margin pressure.
- We remain constructive the equity market however we are aware that the market is not cheap and sentiment indicators also appear stretched. A recent Bloomberg article noted that speculative positioning of VIX hit its lowest level in 10 years, even as the VIX sits at a six-month low—meaning investors are heavily positioned for lower volatility even though it is already extremely low.
- Bloomberg noted that “large speculators … were short about 178,000 VIX futures contracts on April 23, the largest such position on record”. Aggressive bets against the VIX are evidence of either confidence or complacency. Against this backdrop, we think a pullback is not out of the question, but market timing is not our strength, so we prefer to maintain our market weight position.
- Consequently, the strong equity market returns this year have been entirely driven by expanding P/Es. For instance, the U.S. benchmark S&P 500 12-month forward P/E has risen to nearly 17x from a low of 14.5x at the turn of the year, compared against a 30-year average of around 15.5x. Valuations look less stretched at a global level – the 12-month forward P/E ratio on the MSCI ACWI index is now at 15.1x, actually a slightly below its long term average. Even in the U.S. this level of P/E is more appropriately classified as stretched rather than “crazy,” but we’d be wary of betting on further valuation expansion taking equity markets substantially higher, given how much uncertainty still surrounds the economic and earnings outlook. One obvious issue is analysts’ overly-optimistic outlook for 2020 earnings, which already flatters the 12-month forward P/E.
- Last month we noted that “while the global growth debate rages on, what is possible is that the Fed pivot opens the path towards significant USD weakness.” this has not been the case in the month of April as the USD strengthened to a current level of under 1.12 against the €/EUR. The weak European growth indicators and the better US ones, continue to favor USD assets. In addition, the continued interest rate differential in favor of the USD, as well as the negative news elsewhere, have made the USD very resilient.
- However, as stated last month two opposing US domestic forces support the view of —fiscal policy tightening (balance sheet normalization) and monetary policy getting looser—leading to a reversal in net US inflows. A weaker USD opens the door for investors to start paying attention as EM starts to outperform on the back of a weaker dollar.
- The yield curve flattened with the spread between 3-month treasuries and the 10-year narrowing to a fresh 12-year low. With Fed Fund rates at 2.5%, current 2 year rates are at 2.27%, 5 year rates at 2.28% and 10 year at 2.50%, the yield curve is now inverted up to the 5 year rates and slightly positive after.
- Also, outside of the US, the yield on Germany’s benchmark 10-year, remains at zero following weak German growth data, but slightly better than last month.
- As mentioned last month it is possible that quantitative easing (QE) has reduced the signaling capacity of the yield curve. QE was designed to purposefully depress long-term bond yields below an economically “neutral” rate. One way of gauging the impact of global QE is to consider term premia—the excess yield investors require to lock up money in a long-term bond. Even though the US Federal Reserve has started the process of quantitative tightening, term premia are still extremely low.
- For this reason the yield curve may have lost its predictive power if it no longer provides a signal about the stance of policy today relative to neutral. The curve could be flat even if interest rates remain stimulative to the real economy and thus are not serving to depress activity.
- Europe has been more of a mixed bag and generally “not as bad as feared.” Similar to the US, Europe started earnings season off in strong fashion – of the many companies tracked so far in Europe, 32% more have beaten earnings than missed (by 5% or more), which would be the strongest ever quarter up to now. In combination with EUR weakness and higher oil prices in the last week the Euro STOXX saw the strongest pace of earnings upgrades in 10 months.
- The Euro STOXX Saw Earnings Upgrades In The Last Week At The Strongest Rate In 10 Months
- While this may not seem an ideal backdrop to turn more positive on the region, our view is that the gloom has reached an extreme and Europe looks set to surprise on the upside. The equity markets seem to be ignoring the negative news, with the Eurostoxx 50 +16.7% YTD and the MSCI Europe +16.2% YTD. Our view is not the typical ‘EU has underperformed and is cheap relative to US’ thesis. From a macro standpoint, this year will mark the beginning of a swing from fiscal restraint to boost in Europe. While the past couple of years have seen a negative budget impulse, 2019 will benefit from a positive fiscal swing – amounting to 0.6% of GDP. As this spreads through the economy, it should support growth. And given Europe’s sensitivity to trade and exports, China’s inflection is an additional positive driver. Thus our constructive view on the EU is contingent on growth picking back up in China.
HIGHLIGHTS ASIA AND EMERGING MARKETS
- Looking at China, last week was a tough week with the CSI 300 down -5.35% from April 19th to 29th. Weakness was largely driven by the Politburo meeting last Friday, which concluded that 1Q growth was for the most part stable and took away the stimulus calls on the market (even though policy continues to be well underway). Bottom line, one can see this move as positive longer-term, where no surge = no crash. While the meeting takes away China’s stimulus-led beta play, given the rally YTD, this healthy consolidation isn’t surprising. It puts focus on a hopeful improvement in earnings/margins going into the second half.
- While EM underperformed (down -1.53% last week largely driven by a stronger USD and less dovish commentary from the Politburo meeting), the MSCI Emerging Markets Index is +11% YTD.
- Our views on the “rest of the world” EMs seem to probably benefit from the looser monetary policy in the DMs. The MSCI EM, +11% YTD, with Brazil +9.7% and China (CSI 300) close to +30% YTD in dollar terms. These moves support our view to remain bullish EMs towards the end of last year, which we believe is well-positioned to benefit from narrowing growth differentials, a weaker USD, and attractive valuations.
- One of the only exceptions is Argentina where the equity market is now -17.5% YTD as uncertainties over the political outcome of the coming October 2019 elections are now favoring a potential return of the Peronists to power.