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By HaleStewart November 8, 2015 8:26 am
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US Equity and Economic Review: Bullish Moves On Weakening Revenue, Edition


     The ISM released their monthly manufacturing report this week.  Although the headline number was a barely positive 50.1, new orders increased 2.8 and production advanced 1.1 (both increased to 52.9).  These increases will hopefully keep next month’s number positive.  However, only 7/18 industries reported growth, meaning a majority were either stagnant or in a contraction.  The anecdotal comments were generally positive.  But there were a few important negative points:

  • "Demand remains steady with three percent top line unit growth. [Dollar] ($) sales are flat due to currency and cost changes." (Paper Products)
  • "Currency exchange is having a large impact on business results." (Chemical Products)
  • "Energy market continues to struggle. Effects are beginning to bleed into other areas." (Computer & Electronic Products)
  • "Business is improving. We still need young machinists to replace those retiring." (Fabricated Metal Products)
  • "Business is picking-up in general." (Transportation Equipment)
  • "Some level of slowing, but activity is acceptable." (Machinery)
  • "Customer backlogs are increasing now that the perception[s] of raw material[s] pricing have bottomed out." (Plastics & Rubber Products)
  • "Sales demand becoming more consistent. Beginning to see slightly more capital spending by key customers. Outlook more positive than negative." (Electrical Equipment, Appliances & Components)
  • "Wood products market is sluggish with prices varying up/down depending on size and grade." (Wood Products)
  • "So far bird flu has not been reintroduced as bird migration begins." (Food, Beverage & Tobacco Products) 

Although their general tenor was positive, the strong dollar continues to hurt business and the impact of the energy market slowdown is starting to widen.  These two developments would also explain this weeks 1% drop in factory orders:

   New orders for manufactured goods in September, down two consecutive months, decreased $4.7 billion or 1.0 percent to $466.3 billion, the U.S. Census Bureau  reported today. This followed a 2.1 percent August decrease.  

     In contrast to the manufacturing number, the service sector increased 2.2% to a composite reading 59.1.  New orders and production also advanced, the former by 5.3% with the latter up 2.8%.  Unlike the manufacturing sector, the service sector comments were generally positive:

  • "Less volatile pricing in last month. Concern remains about entering fall migration and Avian Influenza risk." (Accommodation & Food Services)
  • "Overall good weather keeps business results strong." (Arts, Entertainment & Recreation)
  • "Economy remains steady—new construction (residential and commercial) apparent in most areas serviced. Agriculture weakening significantly—especially cattle." (Finance & Insurance)
  • "Changes in Medicare/Medicaid requirements under the ACA are impacting healthcare businesses. Some insurance companies are discontinuing services in some states." (Health Care & Social Assistance)
  • "Economic outlook appears consistent, but clients suddenly very conservative with discretionary spending." (Professional, Scientific & Technical Services)
  • "Overall business and volume have been very consistent and strong the past month." (Retail Trade)
  • "Currently building inventories and work force for Q4, holiday, and peak seasons." (Transportation & Warehousing)
  • "Overall our business continues to grow at an unprecedented rate. We believe it to be in direct correlation to the price of gas giving the consumer more expendable income." (Wholesale Trade)

Auto sales increased 10% Y/Y.  As Scott Grannis notes, this sector is on fire:

     The Atlanta Fed’s GDPNow model currently projects 4th quarter GDP at 2.3%, while Moody’s model shows a 2.2% rate.  The Cleveland Fed’s interest rate model is a slightly lower prediction of 2%.  Conversely, the recession probability is very low.

     Economic Conclusion: the problems caused by the industrial recession continue.  The strong dollar, weak oil market and declining emerging market demand are hurting industrial machinery.  But the service sector is strong.  And consumers have confidence in the future, as evidenced by their continued purchasing of durable goods.

     Market’s Overview

     The markets are expensive.  The Current and forward PEs for the SPYs and QQQs are 23.41/23.05 and 17.65/19.98, respectively.  Other indicators also show the market is expensive (Based on the latest S&P 500 monthly data, the market is overvalued somewhere in the range of 51% to 88%, depending on the indicator, up from the previous month's 40% to 81%.).  In this environment, the market needs earnings growth.  Unfortunately, that is not coming.  From Bloomberg:

This U.S. earnings season is on track to be the worst since 2009 as profits from oil & gas and commodity-related companies plummet.

So far, about three-quarters of the S&P 500 have reported results, with profits down 3.1 percent on a share-weighted basis, data compiled by Bloomberg shows. This would be the biggest quarterly drop in earnings since the third quarter 2009, and the second straight quarter of profit declines. Earnings growth turned negative for the first time in six years in the second quarter this year.

Zacks’ analysis adds additional detail and color:

With results from more than two-thirds of the S&P 500 members already on the books, we have a good sense of how the Q3 earnings season has unfolded. The overall growth picture remains challenged, with companies struggling to beat lowered top-line expectations and estimates for the current period are coming down at an accelerated pace.


Including this morning’s reports, we now have Q3 results from 403 S&P 500 members that combined account for 83.4% of the index’s total market capitalization. Total earnings for these 403 companies are down -1.7% on -4.8% lower revenues, with 69.3% beating EPS estimates and only 40.3% coming ahead of top-line expectations.

Excluding Energy, total earnings for the rest of the index members that have reported would be up +5.2% on +1.1% higher revenues.

There are “pockets” of specific growth.  But, broad based revenue increases are not happening.  And that lack of meaningful, across the board growth raises questions about and advances long-term viability.

     This brings us to this week’s charts.  Let’s start by looking at the treasury market:

The IEFs (7-10 years treasuries) and TLTs (20+ year treasuries) fell through technical support and their respective 200 day EMAs.  Both of these are bearish developments, indicating traders believe the Fed will likely raise rates at their December meeting.  This should free up funds to move into equities, which, as shown in the SPYs chart, is clearly happening:

The SPY’s recently formed a double bottom, with the first occurring in late August and the second in late September.  Since then, prices rallied and are now sitting just below resistance at the 211-212 area.  But IWMS had the week’s best technical move:

Prices moved through the 200 day EMA on increasing momentum.

Last week also saw a massive inflow into stock ETFs – the largest of the year.

     However, last week’s bullish technical developments run headlong into a weak earnings environment, which deprives the rally of much-needed oxygen.  Rising interest rates takes away the arbitrage of companies borrowing to fund share re-purchases.  And a weakening international environment take meaningful additional growth off the table. 

     Overall, it still remains difficult to see a meaningful market advance beyond 5%.




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