On a day full of Manufacturing/PMI surveys from around the globe, the numbers everyone was looking at came out of China, where first the official, NBS PMI data disappointed after missing Mfg PMI expectations (3rd month in a row of contraction), with the Non-mfg PMI sliding to the lowest since 2008, however this was promptly "corrected" after the other Caixin manufacturing PMI soared to 48.3 in October from 47.2 in September - the biggest monthly rise of 2015 - and far better than the median estimate of 47.6, once again leading to the usual questions about China's Schrodinger economy, first defined here, which is continues to expand and contract at the same time.
Goldman Sachs said yesterday that financial markets are vulnerable because nobody can agree on what the Fed will do. While equity investors have been anticipating this moment with all the excitement and tension of a prizefight, as Bloomberg reports, bets on the outcome from the Federal Reserve’s rate decision are far more complicated than simply “win or lose” for stocks. Amid the tumultuous background, here are predictions of nine money managers and strategists on what to expect this afternoon...
Blink and you missed it. With stocks surging back to green and CNBC celebrating, one could be forgiven (were on a goldfish) for believing everything is truly awesome again. However, as Deutsche Bank details, there are ten good reasons why this is far from over...
More than merely a subjective, psychological state, the complacency of market participants can be effectively quantified, which is precisely what Deutsche Bank's David Bianco has done by looking at the ratio of the market's P/E to implied vol or VIX. As the chart below shows, on a daily basis the PE/VIX ratio just hit 1.49x - it has never been higher, and again based on DB's estimation, market sentiment has now crossed from the complacency zone into outright Mania. The last time this ratio was at the current level: late 2007/early 2008, just before the Fed had to launch a multi-trillion bailout to save capitalism as we know it.
With the Federal Reserve now indicating that they are "really serious" about raising interest rates, there have come numerous articles and analysis discussing the impact on asset prices. The general thesis, based on averages of historical tendencies, suggests there are still at least three years left to the current business cycle. However, at current levels, the window between a rate hike and recession has likely closed rather markedly.
It started off as the perfect storm for futures: after Sunday night's latest plunge in WTI, which saw it drop to the lowest price since Lehman, the double whammy that has now forced Deutsche Bank to become the first major institution to forecast no growth for S&P500 EPS in 2015, namely the strong dollar, reared its ugly head and the EURUSD seemed dangerouly close to breaching the all important 1.04-1.05 support level we first noted last week. However, overnight parties tasked with preserving "financial stability" appear to have once again stepped in, and not only has the EURUSD rebounded off 1.05, but crude is now just barely down from the Friday close as all firepower is put to the same use, that sent the Shanghai Composite soaring by 2.3% overnight, and which sent the Dax over 12,000 for the first time ever.
No matter how bad the overall profitability picture got, S&P500 earnings per share (assisted almost exclusively by a record amount of stock buybacks in 2015 putting downward pressure on the PS in EPS) would grow by the tiniest of amounts, just so the profit recession stigma could be avoided in a world in which the stock market is the last remaining bastion of faith in central planning and confidence in the economy. No more. Overnight, Deutsche Bank finally did the unthinkable, and "broke the seal" of optimistic groupthink, when its strategist David Bianco became the first sell-sider to forecast that not only will 2015 EPS not grow (at 118 on a non-GAAP basis, this will be unchanged Y/Y), but "down a bit ex bank litigation costs."
"...this hiking cycle is nothing like any experienced before and the key to PEs will be how LT yields react. But in the meantime, EPS risk remains to the downside on FX, whereas the debate on magnitude of Fed hikes and how bond yields and PEs react will last all year... We see risk of a near-term 9% dip."
While there will be much debate over the economic pros and cons to tumbling oil prices (there is no debate if the plunge is confirmed to be the result of a global collapse in demand: that would scream global recession) with a definitive answer unlikely to be forthcoming for at least several quarters, when it comes to corporate profitability the outcome is already known, because between plunging oil prices and the soaring dollar, what is most likely next in store for the US economy may or may not be a full-blown economic recession, but a profit recession seems virtually inevitable.
Today's markets exist in an Oz-like, fantasy world. For 5 years now, stock and bond prices have risen like Dorothy's balloon, with hardly a puff of downdraft to spoil the fun. Everybody likes higher prices, so let's have them always go up! Forever! But what if...
While not exactly a "bear", Deutsche Bank's David Bianco - until this weekend - had the lowest S&P 500 target for 2014 year-end at 1,850. That's all changed now...
Thanks to buybacks, multiple expansion has been the driver of equity market strength as non-economic actors know one thing - buying stocks at record highs pays better than 'investing' in Capex or growth. However, the Treasury market's yield curve is sending a message loud and clear that multiple-expansion is due to end. As Wells Fargo's Gina Martin Adams notes, "Index P/E is likely to fall," as the spread between 10Y and 2Y yields compresses. Historical data shows the P/E ratio contracted in seven out of eight periods when the curve flattened since 1975. As Bloomberg adds, Martin Adams expects the S&P to close 2014 -7.5% from here at 1850 (tied with Deutsche's David Bianco for lowest prediction among 20 strategists).
The algos and chart traders are making another run at 2000 on the S&P 500, attempting to convince the wary investor one more time that buying on the dips is a no brainer. And in that proposition they are, ironically, correct. To buy this utterly manipulated market at these nosebleed valuation levels is about as brainless of an undertaking as is imaginable.
Is there something particularly notable about a 17x trailing PE multiple on the S&P 500? According to Deustche's David Bianco, there is especially during mid to late cycle expansions, i.e., after three (or much more in this case with the S&P 500 now repoting 5+ years of EPS growth) years of rising earnings. In fact, as DB calculates, the only two periods of a PE over 17 after 3 years from the last EPS decline are 1965-66 and 1996-98 (Figure 2) below. And right now. It should be self-explanatory that both of those historic periods ended with a sharp equity correction.
Risk assets have started the week off on a slightly softer footing but overall volumes are fairly low given the quiet Friday session last week and with the lack of any major weekend headlines. Equity bourses are down between 25-50bp on the day paced by the Nikkei (-0.4%). In China, a number of railway construction stocks are up 3-4% after reports that China Railway Corp will buy around 300 sets of high speed trains and may potentially launch 14 news railway construction projects soon as part of national investment plans.