Earnings estimates numbers have been terrible so why are stocks soaring? While some analysts deny that a short squeeze has taken place, we’re seeing increasing proof that one did indeed take place. A study of some of the best and worst performing stocks indicate that a great deal of short covering has taken place recently, meaning that the rally in late February is looking more and more like the mother of all short squeezes.
Meanwhile earnings growth appears to be slowing with consensus earnings estimates declining rapidly.
The mother of all short squeezes
JPMorgan analysts released the latest edition of their “Eye on the Market” report on March 16, providing an update of how their views are shaping up in the current volatility that has spanned asset classes since the beginning of the year. They also included some charts they’re watching closely, one of which indicates a high level of short covering since the end of January.
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They examined the best and worst performing stocks and learned that short covering appeared to be playing a big role, although they add that what’s happening is less clear “for the rest of the distribution.
Earnings estimates on the decline
The JPMorgan team also noted that earnings estimates for the U.S. are falling as growth slows down. They said consensus earnings estimates for this year’s growth have declined 12% since last summer to only 2% now. This quarter is expected to bring another quarter of negative year over year growth after declines in the third and fourth quarters of 2015. JPMorgan analysts expect the earnings weakness to move beyond just the Energy sector in the second quarter.
They note that often in the past, one sign that the current cycle was ending was when earnings rolled over. On the flip side though, in five previous cycles looking back to the 1930s, profits rebounded after they rolled over. They add that in these cases, “usually, a heavy dose of monetary or fiscal stimulus was involved.”
Although they don’t expressly state this, they seem to be suggesting that the current macroeconomic climate in the U.S., which is heavily laden with stimulus, may be a good setup for a repeat of what we saw in the five examples they give. In other words, they appear to be suggesting that profits will rebound instead of the market slipping into a recession, which is one of the big debates that’s right now.
No recession expected
The JPMorgan team doesn’t think the U.S. will slip into a recession, and one big reason is “the resilience of the non-oil economy.” The two examples they give are capital spending and payrolls because while neither of them are showing signs of a “huge growth rebound,” they are at least stable.
They also note that high yield defaults are stable, which is another reason to think the U.S. is not about to be plunged into a recession. The JPMorgan team does note that energy defaults have climbed significantly to 12% of outstanding issues, not non-energy default rates are holding steady at a relatively small 2%, which is about where they’ve been at since 2011.