Wall Street Underestimates The Great American Earnings Machine by Frank Holmes
We’re only halfway through the month, but so far the old trading adage “Sell in May and go away” seems a little premature.
This Thursday, the S&P 500 Index closed at a new record high, topping the previous record set on April 24 and extending the 6-year bull run even further. The surge came on the heels of weak economic data this week, which likely assured investors that the Federal Reserve will withhold raising interest rates this summer, if not this year.
All 10 sectors ended Thursday’s session in the black, with technology leading the rally. Apple, held in both our All American Equity Fund (GBTFX) and Holmes Macro Trends Fund (MEGAX), and Facebook, held in MEGAX, made the widest gains.
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Friday’s close came within just a few points of another new high, suggesting that a top has not yet been reached but that instead the market is looking to break out.
Dividend Growth at 15 Percent
With a little over 90 percent of S&P 500 companies having reported, it looks as if the index has risen a modest 2 percent for the first quarter. That might not seem significant, but as LP Financial Services Chief Investment Officer Burt White points out in a recent Barron’s piece, “given the steep uphill climb that corporate America faced due to the twin drags of the oil downturn and strong U.S. dollar, this is actually a good result.”
Indeed, when the earnings season began, economists were expecting to see a 3-percent drop because of depressed oil and the strong dollar. Of course, we’re now seeing a price reversal in both the commodity and currency.
Dividends from S&P 500 companies also jumped about 15 percent in the first quarter, defying lackluster estimates. Delta Air Lines, also in MEGAX, announced this week that it would be raising its dividend 50 percent as well as buying back $5 billion in stock over the next couple of years.
What’s important for investors to recognize here is that the S&P 500 dividend yield is currently at 1.92 percent, ahead of the 1.50-percent yield on a 5-year government bond. And unlike the government bonds, equities give you growth. It’s these high dividend-paying companies that GBTFX and MEGAX seek to invest in.
Investors Shrug Off Weak Economic News
The week’s economic data suggests that the U.S. economy is growing at a slower rate now than in previous months.
Employment improved marginally in April, bringing the unemployment rate down to 5.4 percent from 5.5 percent. But the Bureau of Labor Statistics revised downward its March numbers, from 126,000 new jobs added to a chilly 85,000.
According to the U.S. Census Bureau, retail and food service sales in April were little changed from March. Inventories are steadily creeping up.
Today, economists trimmed their forecast for the rate of jobs growth this year from 3.2 percent to 2.4 percent. Meanwhile, the University of Michigan consumer confidence index fell pretty dramatically from 95.9 in April to 88.6 in May.
This soft economic news appears not to have dampened investors’ spirits too much, however, as it means the Fed will be more likely to keep rates low for at least the short-term.
You can see that the M1 money supply, the most liquid form of capital, began to ramp up with the first round of quantitative easing (QE) in late 2008, pulling the S&P 500 up with it. We called the bottom of the market in an Investor Alert from December 2008.
After three cycles, QE officially wrapped up last October, but money continues to flow into the market, lifting all boats.
At the same time, investors have been moving more of their money out of domestic equity funds and into internationally-focused funds, especially European, according to a Credit Suisse report. This is in line with the results of a Bloomberg survey I shared earlier in the month which shows that global investors are most bullish on the eurozone than any other region, a good sign for our Emerging Europe Fund (EUROX).
Significant Inverse Relationship Between the U.S. Dollar and Gold/Oil
In response to the slowing economy, the U.S. dollar lost more ground for the fifth straight week, falling to its lowest level since January. This has allowed crude oil to begin its recovery—it’s currently trading just below $60 per barrel—while gold marks time in the $1,200 range.
As you can see, the dollar has reverted back to its mean after rising to close to three standard deviations as recently as mid-March. There’s plenty of momentum for the dollar to drop even further, which should help oil’s recovery.
Gold remains in a 3-year bear market. In an interview with Jim Puplava on the Financial Sense Newshour, I explained that the domestic equity bull market has lately overshadowed the yellow metal as an asset class, but that when gold’s down, as it is now, it might be time to put money in gold and gold stocks.
Next week we expect to see preliminary purchasing manager’s index (PMI) numbers for not only the U.S. and Europe but also China. We’ll find out for sure if the U.S. economy has really softened or if it’s simply taking a breather after months of steady growth.
- The major market indices finished higher this week. The Dow Jones Industrial Average rose 0.45 percent. The S&P 500 Stock Index rose 0.31 percent, while the Nasdaq Composite rose 0.89 percent. The Russell 2000 small capitalization index rose 0.73 percent this week.
- The Hang Seng Composite gained 0.89 percent this week; while Taiwan fell 1.16 percent and the KOSPI rose 1.01 percent.
- The 10-year Treasury bond yield fell slightly closing at 2.14 percent.
Domestic Equity Market
The S&P 500 ended the week higher, up 0.4 percent on solid jobs data for the month of April.
- Consumer staples and health care were the best performing sectors this week as investors turned slightly more risk averse due to weak economic data released this week. The S&P 500 Consumer Staples Index and the S&P 500 Health Care Index rose 1.17 and 1.06 percent, respectively.
- April’s employment gains brought the unemployment rate down to 5.4 percent, its lowest level since 2008. Employers added 223,000 jobs in April. Furthermore, worker confidence is on the rise as the amount of people quitting their jobs reached 2008 highs.
- NFIB small business optimism came in higher than expected this week, at 96.9 versus an expected 96. This data point coincides with the stronger employment data seen recently.
- Retail sales were particularly weak during the month of April according to the data released this week. Retail sales growth came in flat for the prior month compared to an expected growth of 0.2 percent. The underwhelming data release could negatively impact retail-oriented industries.
- Empire manufacturing came in weaker than expected for the second straight month. The continued weakness of this data point is concerning for industrials and other cyclical sectors.
- Industrial production declined for the month of April, contracting 0.3 percent. While this is an improvement from the prior month, which saw a contraction of 0.6 percent, it was still lower than expected and should have implications for more cyclically oriented industries.
- The spread between the U.S. government 10-year yield and the German 10-year yield remains extended. As this effectively puts a cap on how high U.S. rates could rise, utilities and other high-yield plays should benefit.
- The yield curve has steepened a significant amount over the last few months as the global economy experiences an elevated risk-on mentality. A steeper yield curve should benefit financials moving forward.
- Mortgage rates continue to remain attractively low. With plenty of room to grow, housing plays should continue to see benefits from low rates.
- Analysts are expecting May’s Markit U.S. Manufacturing Purchasing Manager’s Index reading released next week to come in at 54.5 versus 54.1 for the prior month. Should the data fail to meet these expectations, industrials and other cyclicals could suffer.
- While the dollar has depreciated significantly against major currencies over the past few weeks, its pullback could be overextended. Should the dollar reverse course and begin to appreciate, companies with significant foreign sales exposure would be at risk.
- Yields have shot up globally over the last couple of weeks, making bonds a more attractive asset class compared to equities than they have been in the recent past. If this trend continues, equities could be negatively impacted.
The Economy and Bond Market
U.S. stock indices rose to new records on Thursday. However, surprisingly weak retail sales, industrial production and consumer sentiment data indicate that the U.S. economy might be losing some momentum, and potentially delaying the U.S. Federal Reserve’s first rate hike. Easing monetary policy in China sparked equity rallies in Hong Kong and Shanghai. Eurozone GDP increased to a two-year high, with Spain and France posting the strongest growth. As the selloff in global bond markets gained steam, ground zero was German bunds, where a spike in volatility rattled investors in this usually-quiet corner of the markets. A sharp move in bonds had investors in U.S. Treasuries licking their wounds, raising the specter of the 2013 “taper tantrum.” By the end of the week however, yields tempered with the yield on the U.S. 10-year note at 2.14 percent and down from an intra-week high of 2.29 percent.
- Initial jobless claims of 264,000 this week beat expectations, resulting in the fewest claims for jobless benefits in 15 years.
- S&P 500 earnings continue to handily outpace analysts’ expectations for the first quarter of 2015.
- Eurozone GDP numbers reflect present relative stability as well as growth in the eurozone. France, in particular, surprised to the upside.
- The U.S. dollar languished to three-month lows this week after poor U.S. retail sales proved a huge disappointment to those expecting a swift rebound from a weather-weakened first quarter. The key measure of sales was flat in April.
- The vicious selloff in the global bond market has continued into another session, as several important global benchmark bonds hit lows on Tuesday before retracing some of their losses over the remainder of the week. Yields remain elevated from levels seen just two to three weeks ago, even after bonds strengthened into the end of the week. The startling rise in yields is making equities look more expensive in comparison to debt, keeping stock markets subdued.
- Consumer sentiment fell to a preliminary May reading of 88.6, a seven-month low compared with a final April level of 95.9.
- Economists are expecting the release of housing starts data next week to come in at 1.02 million, up from the previous 926,000. With the one-month trend above the three-month trend, the odds are for positive momentum to continue.
- The Conference Board month-over-month U.S. Leading Index is expected to come in at 0.3 percent next week and with the one-month trend above the three-month trend, a positive result could foreshadow future strengthening of the economy.
- Retail sales fell flat in April, but the relative outperformance of a number of discretionary categories suggests it is premature to write off a second-quarter rebound. Continued labor gains and fuel savings could yet provide a significant lift.
- Volatility has picked up as the markets prepare for the Federal Reserve’s rate liftoff this year. Volatility has moved closer toward highs reached during the pre-crisis period and the taper tantrum more recently in 2013.
Moreover, liquidity has been curtailed as primary dealers’ trading in Treasuries has receded recently. The share of Treasuries held by brokers and dealers as a proportion of total marketable government securities has plunged as well.
The rise in volatility has sparked concerns that reduced liquidity in fixed-income markets may amplify adverse reactions to the shift in Fed policy when it does occur.
- With year-over-year consumer price index (CPI) data being released next week, any signs of disinflation could cause concern given the weakness in recent data. The one-month trend in year-over-year CPI remains below the three-month trend.
- The preliminary Markit U.S. Manufacturing purchasing managers’ index (PMI) data for May is expected to come in at 54.5 next week. With April’s result coming in below March’s, a disappointing reading could solidify a softening trend in manufacturing.
For the week, spot gold closed at $1,224.06 up $35.68 per ounce, or 3.00 percent. Gold stocks, as measured by the NYSE Arca Gold Miners Index, gained 3.88 percent. The U.S. Trade-Weighted Dollar Index continued its weakly fall for the fifth consecutive week, shedding 1.61 percent; prices are down eight of the last nine weeks.
|May-13||China Retail Sales YoY||10.40%||10.00%||10.20%|
|May-13||Germany CPI YoY||0.40%||0.50%||0.40%|
|May-14||U.S. PPI Final Demand YoY||-0.80%||-1.30%||-0.80%|
|May-14||U.S. Initial Jobless Claims||273K||264K||265K|
|May-19||Germany ZEW Survey Current Situation||68||—||70.2|
|May-19||Germany ZEW Survey Expectations||49||—||53.3|
|May-19||Europe CPI Core YoY||0.60%||—||0.60%|
|May-19||U.S. Housing Starts||1018K||—||926K|
|May-20||HSBC China Manufacturing PMI||49.4||—||48.9|
|May-21||U.S. Initial Jobless Claims||270K||—||264k|
|May-22||U.S. CPI YoY||-0.20%||—||-0.10%|
- Gold traders remained bullish for a third week on speculation that a weaker dollar will increase demand. Supportive of this survey, Shanghai Gold Exchange withdrawals were 857.7 metric tons as of May 8. Gold imports by India exceeded 100 metric tons for a second month in April as easing of state curbs on bullion imports boosted demand. German investors increased their buying of gold coins and bars by 20 percent during the first quarter, the highest rate in a year, as a hedge against European Central Bank (ECB) policy and the threat of a Greek default. Lastly, by weight, April saw the strongest net demand for gold according to BullionVault since August 2013.
- Shares in gold mining companies are rallying this year while bullion prices have remained muted. Stock prices often anticipate moves in of the underlying drivers, so this could point to a turn in the gold market.
- Silver is no longer the poor man’s gold as solar demand surges. Demand for solar power is set to increase by 30 percent in 2015. After years of growth, silver production is expected to flatten as new investment in commodities has been put on hold.
- Gold ETF holdings declined as investors sold the most from bullion-backed funds in seven months, according to Bloomberg.
- Trading volumes in the global spot gold market have fallen to the lowest in a year, with shrinking liquidity and a slowdown in interbank trade, making customers reluctant to transact on a large scale. Tighter regulatory oversight post the accusations of price manipulation have curtailed interbank activity.
- Rallying Chinese stocks and a six-year U.S. bull market cut the appetite for gold in the first quarter according to the World Gold Council. Global demand for jewelry, coins and bars fell 5 percent in the first quarter from a year earlier as shoppers in the Middle East, China and the U.S. reigned in purchases.
- Peng Xingyun, researcher at the Chinese Academy of Social Sciences, published an article in the China Securities Journal saying that with U.S. interest rates expected to increase, China should increase gold reserves and reduce holdings of U.S. treasuries to further boost confidence in the yuan. On a related note, China also has ambitions to include gold market development in the “One Belt One Road” economic project, according to the Managing Director of the World Gold Council.
- Bridgewater’s Ray Dalio announced that everyone should allocate some of their portfolio to gold, saying that those who don’t “either don’t know history or don’t know the economics of it.” Also, in a recent roundup on the outlook for gold, ScotiaMocatta said a strong upside surprise may be in store for the price of gold. According to the group, the most bullish aspect of the gold market is that other assets are already expensive and thus, when things correct, people will look for a cheap safe haven.
- Reuters reported that Mexico’s government is drawing up a land reform package to present to Congress in September that would strengthen the rights of private companies dealing with rural landholders in a bid to lure investment. In recent years, rural landowners have increasingly pressed to re-negotiate past agreements.
- South Africa’s biggest gold-mining labor union demanded a pay package of more than 80 percent for entry-level underground workers. The union’s wage request far outstrips the country’s annual rate of inflation. Negotiations are set to start in June. Along these issues, AngloGold Ashanti’s CEO said that South Africa’s competitive position is deteriorating rapidly. He said that there cannot be a debate on wage increases without economic consequences and pointed out that South Africa used to be the number-one gold producer in the world and is now ranked eighth.
- The South African Department of Mineral Resources has announced that only 20 percent of mineral right holders are compliant to the Mining Charter’s ownership requirements. In contrast, the Chamber of Mines has responded with a statement that its members representing 85 percent of the industry have met and exceeded these targets. HSBC believes these disagreements signal deterioration in the trust relationship between government and industry which bodes negatively for broader investor sentiment.
- According to GFMS analysts at Thomson Reuters, platinum prices could test $1,000 per ounce this year as supply from South African mines and global auto catalyst recyclers climbs by 22 percent and 10 percent, respectively.
Energy and Natural Resources Market
- Gold stocks outperformed this week on higher inflation expectations along with the release of underwhelming economic data. The U.S. dollar weakened following sluggish retail sales and industrial production data. Accordingly, the NYSE Arca Gold Miners Index rose 3.88 percent this week.
- Dry ships stocks outperformed this week as the industry was overdue for a bounce after three straight weeks of losses. The Bloomberg Dry Ships Index rose 2.43 percent this week.
- Following positive earnings releases, containers and packaging stocks rallied this week. The S&P 500 Containers & Packaging Industry Index rose 2.38 percent this week.
- Railroad stocks underperformed this week on the back of disappointing earnings releases and continued deceleration in the industry’s pricing power. The S&P Supercomposite Railroads Sub Industry Index fell 3.55 percent this week.
- Oil and gas producers fell this week as the group is experiencing a slowdown in its rally momentum along with a slowdown in the price rally. The S&P Supercomposite Oil & Gas Exploration & Production Index fell 3.21 percent this week.
- Oil and gas services and equipment stocks fell after the industry experienced downgrades this week. The S&P Supercomposite Oil & Gas Equipment & Services Index fell 1.56 percent this week.
- Natural gas futures are trading near a four-month high on speculation of warmer temperatures in key gas-consuming regions later this month. Seasonality for natural gas should be supportive as we enter the warmer summer months.
- Crude oil inventories in the U.S. are expected to decline further next week as refineries continue to ramp up production for summer gasoline.
- The price of lumber may rebound over the coming weeks in advance of a pick-up in building activity. This comes after a seasonally slow period marked by colder-than-normal temperatures that slowed construction projects.
- The 34-percent rally in crude oil from its $44 low in March could be in jeopardy if operators are able to hedge at WTI prices north of $65 a barrel; this would lock in returns following a period of cost declines.
- The U.S. dollar’s recent pullback has offered a tailwind for commodity prices. However, the dollar’s decline may be entering an oversold condition, setting the stage for a short-term rally, particularly as it reaches the key 150-day moving average support level.
- Copper’s advance from its January low may be slowed if next week’s HSBC flash purchasing managers’ index (PMI) data for China is worse than forecast. China consumes approximately 40 percent of the world’s copper supply.
- Turkish equities and the Turkish lira were incredibly strong this week, highlighting a potential trend reversal for the country. In fact, the Turkish lira closed up every day this week. This resurgence in Turkish markets is likely due to investors seeing an opportunity following the recent selloff. The Borsa Istanbul 100 Index and the Turkish lira closed up 4.22 and 4.62 percent, respectively.
- Chinese equities bounced back this week, and was widely expected as last week’s underperformance was primarily centered on profit taking. Even more significant, the Chinese government cut benchmark interest rates for the third time in six months on Monday, further highlighting the government’s commitment to stimulate growth. The Shanghai Stock Exchange Composite Index rose 2.44 percent this week.
- The Russian ruble had a strong week despite the government’s intent and actions to stem its appreciation. The ruble appreciated 3.41 percent against the U.S. dollar this week.
- Polish equities underperformed this week as investors were surprised with the first round of elections. The results showed the opponent of the incumbent seizing the majority of votes. The WIG20 Index closed down 1.25 percent.
- Hungarian equities fell this week as GDP growth for the first quarter came in lower than expected. Economic production grew at a rate of 0.6 percent quarter-over-quarter compared to an expected 1.0 percent. The Budapest Stock Exchange Index fell 1.54 percent, its first weekly drop since February.
- Greek stocks pulled back this week as uncertainty surrounding the country’s financial position continues to worry investors. The Athens Stock Exchange fell 3.21 percent this week.
- China’s latest interest rate cut is reinforcing the pattern of “bad news is good news” over the last six months for its stock market. April’s economic data came out predictably weak and stabilizing growth remains a top policy priority in the short run. With few inflationary signs, further monetary easing is almost imperative to lower the country’s real interest rate which stays elevated, even after the cut, at 100 basis points above the decade average. Should next week’s release of the flash HSBC purchasing managers’ index (PMI) data produce another humbling warning, then more supportive policies (whether monetary, fiscal or administrative), could be fast-tracked to anchor investor expectations.
- Next week, the central bank of Turkey will release its decision on the country’s benchmark policy rates. While the central bank remains under pressure to cut rates further, most analysts expect all three rates to remain unchanged. Should rates rise, the Turkish lira could appreciate further.
- The Czech Republic grew at a much faster rate than expected during the first quarter of 2015, according to the official data released Friday. As this upside surprise failed to move markets in a positive direction, further validation of the results could boost equities in the near term.
- Currently the yield on Turkish 2-year government notes are higher than those on the 10-year government notes, a situation commonly referred to as an “inversion of the yield curve.” An inverted yield curve is a common warning sign of future economic hardship and highlights investors’ relative fear of the short term versus the long term.
- The Russian central bank stated on Thursday that it has started buying dollars, a policy move primarily aimed at weakening the domestic currency. The rapid appreciation of the ruble this year has led to a decline in export revenue for the country, causing the central bank to step in and put a cap on the currency. It appears that the great ruble run is over, at least for the short term.
- Slowing economic growth and rising political noise in Indonesia may challenge the investment theme of infrastructure upgrades in the country. This also points to the lingering risk of rupiah depreciation, with potentially rising U.S. interest rates later this year, and could make Indonesian stocks increasingly vulnerable as a source of funds for foreign investors.
Leaders and Laggards
|S&P Basic Materials||322.44||-0.99||-0.31%|
|Hang Seng Composite Index||3,923.50||+34.46||+0.89%|
|Korean KOSPI Index||2,106.50||+20.98||+1.01%|
|S&P/TSX Canadian Gold Index||170.51||+5.13||+3.10%|
|Natural Gas Futures||3.02||+0.14||+4.72%|
|10-Yr Treasury Bond||2.14||-0.01||-0.28%|
|S&P Basic Materials||322.44||+7.35||+2.33%|
|Hang Seng Composite Index||3,923.50||-332.01||-14.83%|
|Korean KOSPI Index||2,106.50||-13.46||-0.63%|
|S&P/TSX Canadian Gold Index||170.51||+3.12||+1.86%|
|Natural Gas Futures||3.02||+0.41||+15.56%|
|10-Yr Treasury Bond||2.14||+0.25||+13.45%|
|S&P Basic Materials||322.44||-0.19||-0.06%|
|Hang Seng Composite Index||3,923.50||+559.39||+16.63%|
|Korean KOSPI Index||2,106.50||+149.00||+7.61%|
|S&P/TSX Canadian Gold Index||170.51||-9.81||-5.44%|
|Natural Gas Futures||3.02||+0.21||+7.56%|
|10-Yr Treasury Bond||2.14||+0.09||+4.49%|
Please consider carefully a fund’s investment objectives, risks, charges and expenses. For this and other important information, obtain a fund prospectus by visiting www.usfunds.com or by calling 1-800-US-FUNDS (1-800-873-8637). Read it carefully before investing. Distributed by U.S. Global Brokerage, Inc.