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By HaleStewart July 3, 2016 8:14 am
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US Equity and Economic Review: The Market Makes a Round Trip; Now It's About Earnings (Again)

     On Tuesday, the BEA released the last revision of first quarter GDP.  While gross domestic income rose a fairly strong 2.9%, GDP increased a far smaller 1.1%.  A big reason for the drop was the 1.6% decline in durable goods purchases, which was largely caused by a 3.2% drop in vehicle sales, the first in 13 quarters.  Purchases for non-durable goods and services were in line with previous reports, with respective increases of 1% and 2.1%.  Business investment was soft: commercial real estate, which dropped 7.9%, declined for the third consecutive quarter while equipment purchases, which were off 8.7%, declined for the second consecutive quarter.  Intellectual property bucked the trend and rose 4.4%.  In contrast with the business sector, residential investment continues to be strong, this time increasing by 15.6%.  Exports shook off a strong dollar and increased .3%, largely thanks to an impressive 1.1% rise in goods exports.  In contrast, service exports were down 1%.  Finally, federal spending was down 1.6% while state and local increased 3.2%.  The report confirmed what we already knew: the first quarter was weak.  But on the bright side, the 3rd report showed a fair amount of improvement from the first.

     On Wednesday, the BEA released personal income figures, which increased .2% M/M, the same amount as reported for disposable personal income.  Monthly increases in spending for durable goods, non-durable goods and services were .3%, .6% and .4%, respectively.  These figures continue the now-familiar pattern of a consumer who reluctantly continues to spend.

     On Friday, the ISM announced the latest report on manufacturing. The headline PMI rose 1 to 53.2; new orders increased 1.3 to a very strong 57; new export orders rose 1 to 53.5 and production increased 2.1 to 54.7.  13 of 18 industries are expanding.  Most encouraging were the anecdotal comments:

  • "We are gaining new customers through better sales management." (Food, Beverage & Tobacco Products)
  • "Slower shipments because of weather related flooding." (Chemical Products)
  • "Conditions have remained steady from [the] past month and are in line with our forecast." (Computer & Electronic Products)
  • "Very good start of summer for business levels/orders." (Fabricated Metal Products)
  • "Business is steady with some signs of increase." (Machinery)
  • "Business is still strong, but slowing slightly." (Transportation Equipment)
  • "Business conditions are good, production and demand are stable." (Miscellaneous Manufacturing)
  • "Orders are slowing from China. American customers still steady." (Primary Metals)
  • "Demand continues to be robust." (Plastics & Rubber Products)
  • "Business is still slower than expected." (Nonmetallic Mineral Products)

There are a few comments that highlight slight decreases in orders.  But overall the statements are bullish.  The overall tenor of the report was very positive, especially in light of recent economic and market turbulence.

     ISM also asked a series of questions related to Brexit.  While some were worried about resulting currency movements and financial market instability, overall, respondents saw a negligible impact from the vote.       

     On Friday Ward’s Auto reported that U.S. light truck and vehicle sales were at a 16.2 million annual rate, which is down 4% M/M and 2% Y/Y.  As the following chart from Calculated Risk shows, it appears more and more likely that auto and truck sales have topped for this cycle:

     Economic Conclusion: this week’s news was positive.  While first quarter growth was a still weak 1.1%, the much higher national income figure indicates the 1Q weakness was more likely than not an anomaly.  The consumer continues to spend, although the slightly declining auto sales number could indicate his spending on durable goods has reached its peak.  And the ISM manufacturing number was very encouraging, especially the Brexit questions.  The only drawback is Brexit is such a new development that it’s not fully incorporated into any of the numbers. 

     Market Analysis:  the market is still expensive.  The current and forward PE of the SPYs and QQQs is 23.74/22.62 and 17.82/18.88, respectively.  And despite increased volatility over the last few weeks, the markets have taken a round trip and wound up where they started before Brexit:

The top chart is for the last 30 days and it shows the large price dip caused by Brexit along with the quick rebound to near previous highs.  The bottom chart is a weekly chart, and it illustrates that while prices did experience a strong rally, the market is technically running into its old nemesis: the 210-212 level, which has provided stiff resistance throughout the last few years. And while the advance decline line is moving higher, the number of issues above their respective 200 day EMA is now close to highs seen when the market peaks.

     That means we’re back to earnings.  And the 2Q earnings season looks like the last 4: weak.  From Zacks:

Total earnings for the S&P 500 index are currently expected to be down -6.1% from the same period last year on -0.6% lower revenues, with earnings growth expected to be in the negative for 9 of the 16 Zacks sectors. The Energy sector continues to be the big drag, but Q2 earnings growth for the index would still be in the negative even on an ex-Energy basis

Factset.com makes the same argument but with different figures:

As a result of downward revisions to sales estimates, the estimated sales decline for Q2 2016 is -0.8%, which is larger than the estimated sales decline of -0.5% at the start of the quarter. Six sectors are projected to report year over-year growth in revenues, led by the Telecom Services and Health Care sectors. Four sectors are predicted to report a year-over-year decline in revenues, led by the Energy and Materials sectors.

As a result of the downward revisions to earnings estimates, the estimated year-over-year earnings decline for Q2 2016 is -5.3% today, which is larger than the expected earnings decline of -2.8% at the start of the quarter (March 31). Four sectors are predicted to report year-over-year earnings growth, led by the Telecom Services and Consumer Discretionary sectors. Six sectors are projected to report a year-over-year decline in earnings, led by the Energy, Materials, and Information Technology sectors.

     So, despite an exciting market caused roller coaster ride, we’ve back where we started.  The market is expensive and needs increased earnings to move high.  But those aren’t coming.  

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