Ah yes, the start of a new month – and August at that – the often ugliest month of the summer haze.
Every August 1st I always tell myself I will ignore everything in August – except the summer swoon.
I note again for this time of year: August is often the month where so few are paying attention that almost anything can happen. The noise is louder (to get your attention), the headlines are nastier (to get your attention) and the monsters seem to be bigger. August is also the home of the trailing end of the Q2 earnings season.
To kick that off, just a few headlines this morning – right on cue:
~ Gundlach, “Sell Everything…”
~ Trader: “This chart is a warning sign for all global traders.”
~ “Dog days could bite market in August”
~ “Goldman Downgrades Equities to “underweight” – For Three Months” (<–hilarious)
~ Fed’s Dudley: Rate hikes could come faster than the market expects
~ Trader: “No Chance Earnings to Rise Double Digits Next Year”
~ Earnings signal a bear market: ‘Sell the house, sell the car, sell the kids’ – Marketwatch
~ Wall Street stocks set to struggle as August kicks off
~”What Spells Trouble Ahead for US Banks?”
I could go on of course. That is just a smattering of headline articles for the poor, hapless bums who even threaten to tread into the investment world – all before 8:00am on a Monday mind you.
Preposterous waste of time. Terrible disservice to readers. But let’s hope we get that summer swoon nonetheless.
Headline writers have been scaring investors away from stocks since I started in this industry – nearly 34 years ago. Little has changed other than the style of delivery.
Here is one 1982 headline I never saw:
“Many Horrible Things Will Unfold Over Next 33 Years – While the Dow Rises to 18,000”
New Highs – Always Scary
As covered before, new highs are always terrifying. One can see quickly why hitting new highs on the closing day of July – just before the terrible summer haze of August – would evoke such an avalanche of frightening headlines.
Surely it comes down from here right?
Be assured, I feel jittery as well. The higher it gets, the dizzier one feels – all normal as well. Want something even scarier? Were someone to write about the same comedy of investing emotions 33.5 years from now – and the same basic theme of events have unfolded over that time – the DOW will be nearing 210,000. Sometime in the future, movement of thousands of points in a day will become normal.
Fearing higher numbers today is no different than fearing DOW 1,100 or even 100 when those were record both closing highs. Having witnessed the move to 4-digits and 5-digits, I have come to this conclusion: It’s just math.
We can be confident 6-digits are ahead in the decades to come. Crazy right? No crazier than suggesting the DOW would rise 18 times over – back in 1982.
Speaking Of Math
The GDP data in Friday’s headlines sure stunk up the joint.
As is often the case, the headline can be a bit misleading. Notwithstanding that it will now go through multiple revisions – some years from now – let’s dig a bit deeper:
Last week’s drop in orders was reflected in weak real capital spending and inventory investment during Q2 (still burning off the energy setbacks). Real GDP rose just 1.2% q/q (saar), and the same on a y/y basis. Indeed this is below the 2.0% “stall speed” to the slowest pace since Q2-2013.
A more upbeat thought is this: real final sales (i.e., real GDP without the drag of inventory investment – see below) rose 2.4% q/q (saar), and 1.9% y/y. Why?
Blame it on the consumer.
Their spending rose very nicely by 4.2% q/q, and 2.7% y/y. Like we often said, it took awhile to see the saved oil dollars show up – but after now amassing over $8 trillion in savings and hitting record higher personal incomes, pocketbooks are more flush than the fear-mongering suggests.
Sure – capital spending remained weak falling by 1.3% y/y.
Important details alert: Dr. Ed suggests we take a closer look – we agree:
A closer inspection of capital spending in real GDP shows that the following categories rose to record highs last quarter: industrial equipment, software, and research & development.
Transportation equipment fell but remained near its record high during Q3-2015.
Information processing equipment edged down a bit from its record high the previous quarter.
Spending on manufacturing, commercial, and health care structures rose to cyclical highs or remained close to the most recent such highs.
The big wipe-out was in the energy-related structures. This category is down 50% y/y. (allowing one sector – fully expected to be weak for many quarters now – to blind one to strength in most other areas tends to be unproductive.)
Old News = New Highs
I have a hunch the reason markets did not crater 6 minutes after the GDP numbers is simpler than we might imagine. The recession in the oil patch is not news – indeed, it’s old news.
That said, it is obviously still weighing on capital spending on structures and probably accounts for the weakness in some of the other equipment categories.
The Other Shoe:
Another source of weakness was a significant swing from inventory accumulation during Q1 to slight liquidation during Q2 as companies once again are learning to adapt to quicker seasonal adjustment. Data show the inventory cuts were mostly in manufacturing and among wholesalers.
Any Good News Mike?
Barring a recession showing up quickly in the summer hurricane season still to come, inventory accumulation is likely to resume over the rest of the year and into the ’17-’18 period as Gen Y moves further into the system and the Boomers continue to change retirement as we know it.
Consumers Feeling OK?
As the summer back-to-school push begins, retail experts are suggesting growth YOY is in order. Hence, the consumer is likely to keep spending. Recall this: While many will fret over industrial weakness still trickling in from the oil patch, the consumer’s health and the health of our services industries are the much larger drivers of our economic growth.
The latest on their sentiment shows some good news – it is dropping!
Consumer confidence slipped to a three-month low in July, though sentiment was slightly better during the second half of the month than the first half. The Consumer Sentiment Index (CSI) dropped for the second month from an 11-month high of 94.7 in May to 90.0 last month–above the mid-month reading of 89.5.
Richard Curtin, chief economist for the consumer survey stated, “Uncertainties surrounding global economic prospects and the presidential election will keep consumers more cautious in their expectations for future economic growth.”
The expectations component slipped from 84.9 to 77.8 the past two months; the present situation component remained near June’s cyclical high of 110.8, edging down to 109.0 last month. (The mid-July readings of the expectations and present situation components were 77.1 and 108.7, respectively.) We can likely blame this chiller on the chilling news about Brexit, terrorism and global unrest in recent weeks.
Why is this good news? Lower sentiment readings on this front have a contrary effect. The worse we feel – the more we shop. Sounds nutty – but history shows lower consumer sentiment readings mesh well with lows in stock values.
It reminds me of what a very smart investor once taught me about investing in big drug stocks: buy them when their pipeline is light…sell them when they are full.
More Math – and Earnings
Even though we have seen many quarters of pressure brought on by the energy mishaps in pricing (not a surprise to clients/readers here), the earnings number are on an upward trend – comparably speaking.
With 73.5% of the S&P 500’s total market cap reporting already, total earnings are down 3.3% from last year at the same time – on .09% lower revenues. If we assume for Q2 as a whole by combining the actual results so far with the estimates for those still-to-come in the index, total S&P 500 earnings are expected to be down -3.4% on -0.4% lower revenues.
The Q2 growth pace has ‘improved’ as companies have come out with improved results, but the quarter is still on track to be in the negative for the 5th quarter in a row. Don’t fret – we expect that to remain the case next quarter as well for reasons already noted.
The Energy sector remains the biggest drag on the aggregate growth picture, with total earnings for the sector expected to be down -84% on -26% lower revenues.
Excluding the Energy sector, earnings for the rest of the index would be up +0.3% right now – we suspect that number expands as the rest of the companies report.
We stand by the idea that too much is wasted by fretting over the blended world picture. We remain confident (see stats at top) that the Barbell Economy is all one needs to focus on in the years ahead. The rest will be noise, taking too many off track, blinding them to the new horizon.
Change is what we need to accept. Gen Y and the Baby Boom have all the power. Their sectors are the workhorses of the economy of the future.
Simple – basic – math.
Remember the current underneath – no the surface waves.
Let’s keep this even more simple:
Ignore the noise.
An important, basic fundamental issue is repeating itself today in our economy.
We have seen it before. Focus on people – waves of them.
It is wonderful news that GDP data show inventories continue to tighten. A greatly misunderstood wave of demand is approaching. The demands of the Barbell Economy are very positive trends – but fear has left us unprepared for them.
Get ready for the birth of the next monster: probably inflation if I were to guess, all the while, overlooking the rising market.
So, stay focused –
If this latest GDP “weakness” does not trigger the August summer swoon, I say the same thing I did way back in the early 80’s:
The market is telling you something more important than the headlines.
The underlying current is moving strongly.
Staying focused on today’s news does not prepare you well for what’s next.
Until we see you again, stay safe – may your journey be grand and your legacy significant.