Perhaps the biggest head-scratcher in all markets is how U.S. equities are able to continually reach new heights in the face of slower economic growth and the turmoil in Washington while supporting sky-high valuations. The short answer has been the expectation for strong profits growth. The bulls are about to find out whether that optimism is justified.
Earnings season is now in full swing with almost 20 percent of the Standard & Poor’s 500 Index’s members reporting this week, including market leaders Amazon.com and Facebook. With President Donald Trump’s pro-growth fiscal agenda seemingly sidelined for the time being, there’s not much for bulls to hang on to other than the prospect for decent earnings. Those that disappoint have been swiftly punished by investors, as General Electric Co. found out on Friday. Signs of fading investor enthusiasm abound. Consider the SPDR S&P 500 Trust, the biggest exchange-traded fund tracking the benchmark. Investors pulled $3.8 billion out of it in July through Thursday, according to Bloomberg News’ Oliver Renick. That puts the fund on pace for a fourth consecutive monthly outflow, which would be the longest streak since the start of the bull rally in 2009.
But what if the market is operating under a new paradigm when it comes to valuations and maybe this earnings season isn’t so crucial? That’s a question posed by Leuthold Weeden Capital Management Chief Investment Strategist Jim Paulsen. He notes that in the last quarter-century, the market’s price-to-earnings ratio has averaged more than 25, or about two-thirds higher than its average between 1880 and 1990. Here’s Paulsen in his own words: “The U.S. economy — and thus earnings flows — has become far less cyclical, recession risk has diminished markedly, inflation has been far more stable, the composition of the U.S. stock market has become much more growth-oriented, participation in the stock market has broadened significantly, less valuation-focused index funds have gained considerable popularity, and finally, the world has enjoyed a massive technological advance and witnessed a ballooning of functioning capitalistic economies in all corners of the globe.”
WHAT ABOUT THE DOLLAR AND U.S. BONDS?
Both are suggesting a much different outlook than equities, at least in the short term. Commodities Futures Trading Commission data show that bets against the dollar are at their highest since early 2013, while bullish wagers on the 30-year Treasury bond are about the highest since mid-2016, according to Bloomberg News’ Liz McCormick. One wouldn’t expect to see such extreme positioning if investors were confident in the outlook for the economy and the prospect for much higher interest rates. It’s even more remarkable given that Federal Reserve policy makers will wrap up a two-day meeting on Wednesday. The expectation is that they will keep their outlook for gradual rate increases, but the positioning suggests that the potential for a surprise could cause big moves in the dollar and in bonds. Nervous currency traders are paying the most in eight years for insurance against a plunge in the dollar against the euro, according to Bloomberg News’ Lananh Nguyen and Robert Fullem. The Fed will likely be as “vague and flexible as possible” because “if they catch the market on the wrong foot, we’d have some pretty big moves,” Max Kettner, a cross-asset strategist at Commerzbank, said on Bloomberg radio.
CANADA IS HAVING A MOMENT
Prime Minister Justin Trudeau must be doing something right. The International Monetary Fund said in the quarterly update to its World Economic Outlook that Canada will lead the Group of Seven countries in economic growth this year, expanding at a 2.5 percent clip, up from 1.9 percent in its April forecast. As if on cue, government data Monday showed that wholesale sales rose in May by more than forecast, adding to higher-than-forecast growth in retail and manufacturing sales, as well as a surge in new jobs that capped the best quarter since 2010, according to Bloomberg News’ Maciej Onoszko. The country’s economic strength can be seen in its resurgent currency. The loonie, as it’s known, strengthened to 80 U.S. cents on Monday for the first time in more than a year. Hedge funds and other speculators flipped their wagers on the loonie to net long less than two months after amassing record short positions against the currency, according to Commodity Futures Trading Commission data released July 21. Now, if only the stock market would cooperate. S&P/TSX Composite Index is one of the world’s worst performers this year, falling about 1 percent, as oil and energy decline.
SORRY BOND TRADERS, GREECE IS BACK
Here’s something that many bond investors probably never thought — or hoped — they’d see in their lifetimes: Greece tapping the debt markets for new financing. The country, which was the epicenter of the European sovereign crisis that began in 2009, is looking to sell five-year bonds, according to an Athens Stock Exchange filing. With the sale, the government of Prime Minister Alexis Tsipras is seeking to chalk out a path for an exit from the current bailout program, which ends in August 2018, while also capping the country’s financing needs in 2019 — expected to be about 19 billion euros ($22.1 billion), according to Bloomberg News’ Sotiris Nikas and Lyubov Pronina. The IMF agreed to a new $1.8 billion conditional loan for Greece on Thursday, with disbursement contingent on euro-zone countries providing debt relief. A day later, S&P Global Ratings raised the country’s sovereign credit-rating outlook to “positive” and affirmed the long-term foreign currency debt rating at B-, or six levels below investment grade.
CHEAP MEAT ON THE WAY
Cattle prices plunged the most in nine months after a government report showed that the outlook for U.S. red-meat supplies looks more abundant. The number of cattle moved into feedlots in June was the highest for the month since 2006, as rising profits and drought across the northern Great Plains pushed more animals off pastures. According to Bloomberg News’ Jeff Wilson. Placements rose 16 percent from a year earlier, topping the 6.8 percent increase expected by analysts surveyed by Bloomberg. June marked the fourth straight month that cattle placements rose by more than 11 percent. Feedlot operators typically buy year-old cattle called feeders that weigh about 500 pounds (227 kilograms) to 800 pounds. The animals are fattened on corn until they are about 1,300 pounds, then sold to meatpackers. “The market was clearly surprised by the sheer size of the increase,” said Steve Wagner, market analyst at CHS Hedging. On the Chicago Mercantile Exchange, cattle futures for delivery in October plunged by the 3-cent limit, or 2.6 percent, to $1.144 a pound. A close at that price would be the biggest loss for the contract since Sept. 30.
The IMF just cut its 2017 economic growth forecast for the U.S. to 2.1 percent from the 2.3 percent it estimated in April. But if you need more evidence that confidence in a strong second-half rebound in the economy is waning, keep a close eye on the Treasury Department’s auction Tuesday of $26 billion of notes due in two years. That’s because those securities are generally more sensitive to changes in Federal Reserve policy than longer maturity debt. What’s notable is that the amount of bids relative to the amount offered rose at the each of the government’s last three auctions of two-year notes, with the so-called bid-to-cover ratio reaching a 2-month high of 3.03 at the sale a month ago. So, one conclusion is that bond investors are not worried about a sustained pace of Fed rate hikes in response to stronger growth if they are scooping up short-term debt so readily. Former Fed Governor Daniel Tarullo said on Bloomberg Television that weak inflation could weigh on the central bank’s discussions about whether to raise rates, with only little risk that prices will surge out of control.
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