Support for the Bull from Q1 Earnings
The stock market remains in a bull market despite rising FED funds rates and balance sheet tightening (sometime later). Earnings have something to do with this.
Q1 earnings are starting to come in with 23 S&P 500 companies (5%) already having reported. Of these, 74% have beat EPS estimates, and 57% beat estimate of sales. According to FactSet, the estimated earnings growth rate for Q1 2017 stands at 8.9% which, if this becomes the actual growth rate, will be the highest (year-over-year) earnings growth since Q4 2013. The probability of this happening is high, considering that over the past five years on average, actual earnings reported by S&P 500 companies have exceeded estimated earnings by 4.1%. This means that earnings growth for Q1 2017 could come in at double digit levels.
The reality is that the stock market is comfortable with current valuations (despite the constant worry coming from the bull-horn media and “analysts of the obvious”), which reflects the end of the earnings recession that started in Q1 2015. This, along with a 4.5% unemployment rate, makes the FED’s pronouncements of rate hikes and tightening, reasonable and acceptable — just like in past bull markets.
There is still an elephant in the trading room, however, and that is the central bank’s (CB) balance sheet. All Western CBs have been the buyers of last resort ever since the crisis of ’07, buying up assets of all kinds in order to prop-up global markets; i.e. Quantitative Easing. This asset buying comprised half of the CBs tool-box, with the funds rate making up the other half (only two tools in the box). Now that unemployment is at what many economists see as more than full employment, the FED finally feels it can start normalizing rates without killing the market, and in addition, the FED is preparing the market for the unwinding of their $4.5 trillion basket of assets. This latter action is not likely to start until 2018, and even then, only if the economy doesn’t suffer a tantrum due to the higher rates.
The prospect of the FED reducing its balance sheet, even though it is likely still a year away, has kept bond rates down despite the increase in the funds rate; traders don’t believe that rates will continue to rise while the FED sells assets. However, we think they can if fiscal policy is enacted that increases the velocity of money, and a new business cycle gets underway, as seems to be the case. The bull market will be in effect until it becomes evident that Trump is unable to enact fiscal policy (October of this year?).
Equities
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The similarity to the 1998–2000 period continues (charts below).
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The long-term moving averages continue to support a bull market, with a dip (chart below).
The Rydex bear/bull asset allocation ratio has come down from last week’s level, which could lead to the average also turning back down and negating the topping signal that was developing. This puts a neutral read on this pattern for the moment (chart below).
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Gold
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Since the start of 2017, we have been pointing out the pattern in the USD/JPY FOREX pair as being similar to that of October 2014 (chart below).
At this point, we find that the pattern is more similar to the action in the summer of 2013, and December 2014 (vertical dashed-lines on chart below). We still see the USD/JPY ratio recovering and gold retreating.
Inflation will continue to be kept in check by the FED’s rate normalization, and gold will continue to be under pressure. (chart below).
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Regards,
ANG Traders
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