What Could Go Wrong?
Yesterday’s missive took a glass-is-half-full stance by exploring the various tailwinds the bulls are counting on to keep stock prices movin’ on up. The list included earnings, economic growth, low inflation, ongoing QE, favorable seasonality, the flows into passive funds/ETFs, performance anxiety, performance chasing, the preponderance of dip-buying, and, of course, the tax trade. Good stuff.
However, since one of the key attributes of a good analyst is objectivity, I thought it might be a good idea to wander across the field this morning and talk to the players on the opposing sideline. The goal here is to try and understand each team’s key points so that we can make an informed decision on which argument is stronger.
So here goes… A rundown of the major issues that our furry friends in the bear camp are focused on from a near-term perspective.
What Everybody Knows… As the saying goes, something that everybody on Wall Street already knows isn’t worth knowing. The key here is that by the time everybody can (a) understand and then (b) quickly/easily espouse the reasons that something is supposed to happen in the market, the event is likely priced in. As such, the bears argue that the laundry list of positives are well known by now and thus, are likely priced into the market at this stage.
Earnings: I know what you’re thinking; how can both teams count an issue as theirs? In short, it depends on your point of view. While the bulls argue that earnings are growing at a strong clip, the bears suggest that the current trend of great quarters isn’t going to last much longer. Exhibit A here is although EPS for the S&P 500 enjoyed double-digit growth in the first two quarters of the year, the pace of growth is about to slow dramatically. According to FactSet’s approach (which combines actual results from companies that have reported with estimates for those yet to report results) EPS growth is expected to come in at 2.4% compared to the year-ago quarter. Now factor in (a) tougher comps going forward (especially at the beginning of next year) (b) some high profile misses from the likes of General Electric (NYSE: GE) and Wells Fargo & Co. (NYSE: WFC), and (c) the hit that insurers and reinsurers are likely to take in response to this year’s hurricane season. From the bears’ perspective, what you are left with is less than stellar fundamental support for stock prices.
Inflation: I know, I know… The bulls counted this one as a positive as well. While everybody knows that inflation has been MIA this year, the key here is the bears contend that there are signs of underlying inflationary pressures building – especially in wages. Whether or not these pressures materialize remains to be seen. However, this is an area to watch in the coming months because nothing can kill a bull market faster than a bout of inflation.
The Next Fed Chair: The betting markets suggest that the decision on the next Fed Chairman is down to Powell and Taylor. The key here is to understand that Powell is more of a status quo pick while analysts believe a Taylor nomination could lead to a higher “neutral” zone for Fed Funds and an extended tightening cycle. By the way, the bears don’t want to talk about the possibility of Janet Yellen getting the nod as this would likely be a bullish outcome for stock prices.
Valuations: We’ve covered this topic six ways to Sunday recently. And yes, everyone in the game knows that valuations are elevated. The point is there can be no denying that high valuation levels mean risk factors are also quite elevated.
Sentiment: Current sentiment readings are also quite high here. For example, one of the questions asked in the University of Michigan’s survey of consumers is the outlook for stock prices over the coming year. This week’s reading came in at an all-time high.
Yields: One of the main bear arguments is an oldie but a goodie – the end of the 30+ year secular bull market in bonds. Unfortunately, anyone singing this song has been dead wrong for years now. However, the current move on the 10-year from 2.06% on September 7 to yesterday’s 2.45% is causing the bond bears to start yapping about this issue again. The current thinking is that if/when 10-year yields hit 3%, bonds could actually become competition for stocks. Remember, post-crisis, stocks have been the only game in town as the Fed created a “cash is trash” environment.
Tax Reform Delay/Derail: It is easy to argue that much of the most recent run in stock prices is attributable to the prospects for tax reform to get done in the near-term. However, our furry friends remind us that pushing this deal across the goal line is by no means a sure thing. The bears contend that negotiations are likely to be intense and as such, there is headline risk relating to the deal ending up like the repeal/replace effort on the ACA. The bottom line is if tax reform is either delayed or worse, derailed, the 1800 point move on the Dow since mid-August could be given back in short order.
As I mentioned yesterday, this is by no means an exhaustive list of the potential negatives in the market. However, I believe we’ve hit the highlights this morning. And since I think it is important to take a walk in the other guy’s shoes every once in a while – in order to keep one’s objectivity in place – this morning’s exercise helps remind us that trees don’t grow to the sky.
Thought For The Day:
The trouble with talking too fast is you may say something you haven’t thought of yet. -Ann Landers
Current Market Drivers
We strive to identify the driving forces behind the market action on a daily basis. The thinking is that if we can understand why stocks are doing what they are doing on a short-term basis; we are not likely to be surprised/blind-sided by a big move. Listed below are what we believe to be the driving forces of the current market (Listed in order of importance).
1. The State of Tax Reform
2. The State of the Earnings Season
3. The State of Fed Policy/Leadership
4. The State of the Economy
Wishing you green screens and all the best for a great day,
David D. Moenning
Chief Investment Officer
Sowell Management Services
Disclosure: At the time of publication, Mr. Moenning and/or Sowell Management Services held long positions in the following securities mentioned: none. Note that positions may change at any time.
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