Will Strong Earnings Confirm an Economic Rebound?

Once again, Juan Luque provides us with some words of wisdom from the Incline trading desk:

The S&P ended the week on the rise after being in the red territory briefly on Wednesday. The Consumer Discretionary and Information Technology led the performance being up over 2% each despite being in the weakening quadrant. The Consumer Staples sector was up and continued its move along the improving quadrant, while Real Estate declined and moved backwards in the quadrant. The Health Care and Energy sectors continue in a downtrend both being down on the week with no signs of improvement both shown in red arrows. The Industrials sector remains the strongest one overall as it remains green in the leading quadrant.

Here is a bit more detail at the industry level.

Comment

The “official” market range was a bit smaller than the chart suggests since we only consider movement during normal trading hours. The market gained 0.2% for the week with a trading range of only 3.2%. This is pretty quiet action, as you can see from the volatility summary in my Indicator Snapshot, featured in the Quant Corner.

Personal Note

As regular readers will notice, I have made some changes in both format and content for WTWA. I am focusing on the most important good and bad news rather than attempting an exhaustive compilation. I am adding my own summary of the current economy. My goal is to make the news section more valuable and easier to read while leaving out less important news. My focus on the best charts and sources is unchanged. The overall article will be shorter but will include (I hope) your favorite segments.

I am emphasizing evidence that readers can evaluate readily. If I have done my job well, you will find charts and data that help you reach your own conclusion, all organized in a logical sequence.

I welcome comments and suggestions about these changes.

Noteworthy

The Visual Capitalist provides an interesting analysis of advertising spending, including this angle:

Interestingly, changes in advertising spend tend to fall closely in step with broader economic growth. In fact, for every 1% increase in U.S. GDP, there is a 4.4% rise of advertising that occurs in tandem.

The same phenomenon can be seen among the biggest advertising spenders in the country. Since 2000, spend has seen both promising growth, and drastic declines. Unsurprisingly, the Great Recession resulted in the largest drop in spend ever recorded, and now it looks as though history may be repeating itself.

Check out the table listing the top advertisers. The top ten would be a challenging “Family Feud” question.

The News Overview

Each week I break down events into good and bad. For our purposes, “good” has two components. The news must be market friendly and better than expectations. I avoid using my personal preferences in evaluating news – and you should, too!

My continuing assessment is that many of the normal economic indicators are not helpful in the wake of the COVID lockdown decline. Too many sources are focused on a change in direction, even if very modest. Looking at indicators that show the level of activity paints a different picture. Consumer spending remains high, aided by government assistance programs. Employment has improved (although less than the numbers seem to show), but those gains have stalled.

The other bright spot is the housing market, which has the tailwind of record low mortgage interest rates.

Good

The consumer

Retail sales improved 1.9% in September, beating expectations of a 0.6% gain and August’s 0.6% increase. The improvement “ex-auto” also beat expectations, 1.5% versus 0.3%. Jill Mislinski has the report, perspective and many useful charts.

Sentiment

The NFIB small business optimism index improved to 104.0 from August’s 100.2 David Templeton (HORAN) covers the story, emphasizing the small business hiring plans.

Michigan consumer sentiment (Oct. preliminary) registered 81.2, up slightly from September’s 80.4. (Jill Mislinski).

Earnings

Q320 reports have started. With 10% of the S&P reporting the early indications are pretty good. Eddy Elfenbein comments on the strength in bank earnings and the chance that permission for dividends and stock buybacks will resume. John Butters (FactSet) provides this comment on the early results:

…(T)he index is reporting higher earnings for the third quarter today relative to the end of last week and relative to the end of the quarter. Despite the increase in earnings, the index is still reporting the second largest year-over-year decline in earnings since Q2 2009, mainly due to the negative impact of COVID-19 on numerous industries within the index. However, the S&P 500 is projected to report year-over-year earnings growth starting in Q1 2021.

Overall, 10% of the companies in the S&P 500 have reported actual results for Q3 2020 to date. Of these companies, 86% have reported actual EPS above estimates, which is above the five-year average of 73%. In aggregate, these companies are reporting earnings that are 21.7% above the estimates, which is also above the five-year average of 5.6%.

Bad

Employment

Initial jobless claims increased to 898K versus expectations of 830K and the prior week’s 845K. The claims remain stubbornly high, calling into question the claims of a big employment rebound.

It is important to look at new jobs as well as job losses. Job postings represent one such indicator. I also like to consider private sources as well as government data.

Industrial production

September’s decline of 0.6% missed expectations of a 0.6% gain and was also lower than August’s 0.4% increase.

Government

Despite agreement that more fiscal stimulus is needed, policymakers have been unable to reach a compromise.

Ugly

The coronavirus resurgence. The economic pressures to reopen the economy are evident both at the macro level and for the many who do not have jobs. Where do things stand in the U.S?

• Incidence and death rates are higher.

Source: STAT.

• Most states have significant uptrends.

Source: ProPublica

• Some cities are especially hard hit, including three cities where Mrs. OldProf and I once resided and where we have many friends and relatives. No place is really safe.

Source: New York Times

• Fatality rates are higher for old folks but significant for those in middle age.

Source: Conversable Economist

Calendar

We have a big week for housing data and not much else. Housing starts and building permits are important, as are the unemployment claims reports.

PMI’s and leading indicators are not meaningful. The NAHB index has some value. Many will try to squeeze something out of the Fed Beige Book, but it should not move markets.

Corporate earnings represent the most important real news. Political event, COVID-19 updates, and vaccine news will compete for attention.

Theme and comment

With 96 companies in the S&P 500 reporting earnings this week, we can expect a focus on this fresh source of data. There will also be housing data, unemployment claims, and a few other reports. Oh – there is also an upcoming election and the pandemic.

Despite this competition, investors should be asking:

Will earnings signal a strong economic rebound?

Current obsessions

Wall Street has reached the conclusion that a Biden victory is very likely. This has left many pundits with the need to reverse their field. In theory, the market should be reacting negatively to this news – higher taxes, more regulation, more spending, etc. Since it is important to pretend demonstrate that you understand every market move, I saw countless articles explaining this. Here is a small sample.

Wall Street Prepares for a Biden Victory, Higher Taxes and All

The Market Sees Blue

Does a “Blue Wave” = Higher Rates?

Understanding The Current Market Logic

And some see a Biden victory as better than an uncertain outcome.

Investors Once Feared a ‘Blue Wave’.
Now, They Fear Something Else.

Of course, this all depends upon polls, and whether they will be more accurate than in 2016.

What Pollsters Have Changed Since 2016 — And What Still Worries Them About 2020

Nuggets

Schwab’s Liz Ann Sonders provides a nice economic review with the appropriate emphasis on corporate earnings. Here are two key charts.

Fool’s gold

Here is a good chance to check out the underlying sources as just the start of evaluating this claim.

A 90x return in five years? Former Goldman hedge-fund manager says an ‘enormous wall of money’ is coming

Finding important information

Sometimes the most important information is out of the mainstream. This section is designed to highlight important concepts that might otherwise be missed.

Relevant facts for investors

CFO’s are pretty confident about their own companies. When it comes to other businesses, they are worrywarts who are consuming the news like everyone else. The article also has information about when companies expect to rebound to pre-COVID levels.

Most important unknowns

How many people will take a COVID vaccine? If it is 50% effective and only 50% take it, it will not help enough. Current estimates are for a vaccine early next year, but there will be production and distribution questions.

What to watch

Forward earnings estimates! All the other factors culminate in this metric, which is closely tied to stock market results. As we know from Brian Gilmartin, the estimate changes react to current results and discussion of the corporate outlook.

Business failures and births. This is not captured accurately in the monthly payroll employment report, so we should track some other sources as well.

Quant Corner

I have a rule for my investment clients. Think first about your risk. Only then should you consider possible rewards. I monitor many quantitative reports and highlight the best methods in this weekly update, featuring the Indicator Snapshot.

Indicators

For a description of these sources, check here. Here is an update of the Big Four from our key resource, Jill Mislinski.

Comment

Technical measures are reasonably strong. Trends remain intact and support levels have generally not been violated.

The Big Four indicators help us track the level of the economic rebound. Only real retail sales has regained the levels prior to the recession.

Corporate forward earnings show continued strength. Brian Gilmartin tracks this carefully. He is the source for our regular updates, using this table.

I blend the current quarter with the next to make the one-year forward earnings smoother and more consistent.

My continued bearish posture for long-term investors is based upon both valuation and continuing fears about a major economic pullback.

Guest ideas

The anticipated inflation is growing faster than the Fed’s measure of core PCE. Something must give!

And there is plenty of fear about the election season. The VIX, which captures market-based volatility expectations, remains elevated.

And expectations are for a near-term move higher. (Forbes).

Final Thought for Investors

In my revised format I am including specific economic worries as part of the good and bad news. In the Final Thought I hope to emphasize action that investors should consider taking – and especially what they should not do.

We are now more than seven years into a quest for yield. The traditional safe havens offer extremely low yields. I went into my bank last week to buy a CD and they said I had to give them a toaster as part of the transaction. (Young readers may not get that one so ask an older relative about their best CD inducement).

One result is that the quality of investment grade bonds has decreased. In my research I also find that bond funds are stretching a bit to include junk bonds as well.

© NewArc Investments, Inc.

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