JPMorgan shifts to the dark-side...
It would be hard for a year to start any worse than 2016 has.
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The SPX is now off >8% YTD and has slumped ~10% from the late-’15 high of ~2080. Chinese uncertainty (although more institutional than economic at this point vs. the opposite back in Aug), evidence of slowing domestic growth (JPM took its Q4:15 GDP forecast to +0.1%), trimmed earnings estimates (~$125 was being penciled in for this year back in Q4:15 but that is now $120 and falling), full multiples, and the absence of credible monetary policy responses (all the Fed will do is nothing which isn’t particularly impressive) are all conspiring to hit stocks and smoother sentiment (also the extremely uncertain US presidential election outlook is a big underappreciated headwind).
Prices are oversold and sentiment hasn’t been this despondent in a long time (even Aug/Sept wasn’t this palpably negative) but any bounce will not be particularly impressive and in a lot of ways that is the main problem as the upside just isn’t compelling enough to make a major stand ($120 and 16x gets the SPX only to 1920 and at this point those are “best case” scenarios). Enormous P&L destruction coming so early in the year, following the poor performance numbers from last week, has only made sentiment more miserable. The fact we are in the middle of a news vacuum doesn’t help as it allows single data points (such as CSX’s “things haven’t been this bad outside of a recession” comment) to color the whole market (the CQ4 earnings season is always more spread out and so investors won’t hear from the all the S&P 50 CEOs until Feb). However, just because the SPX won’t hit new highs doesn’t mean it will collapse either and there is something to be said for the fact that the index hasn’t made any progress for 18 months. The extremely gloomy predictions of bear markets (down ~20% from the recent ~2100 high would imply a ~1680 SPX) or 2008-like catastrophes seem overdone.
Top headlines/trends/themes from the week (in order of importance)
The big overhang is growth, not China. Obviously the CNY/CNH volatility has harmed sentiment and contributed to financial market volatility and China’s years-long economic slowdown is having global effects. But while China gets most of the headline blame, the more important driver behind the YTD slump in US equities is signs of economic softness. Q4:15 GDP estimates have been bleeding lower for months and are now sub-1% for many people. The slight miss in Dec auto sales, coupled w/the caution from AutoNation, was prob. the single most important financial market development so far in 2016 outside of China – autos have been a mainstay of US economic growth for years, prob. the shining light of the post-crisis recovery, and if it were to weaken a major pillar of support would be removed. Meanwhile the industrial economy is suffering enormous headwinds, many of them related to the carnage in energy (two industrial-levered firms, CSX and FAST, used the “recession” word on their earnings calls this week). The consumer ostensibly has a number of tailwinds (jobs, housing, gas, etc) but isn’t acting as a particularly strong economic driver at the moment. The bank earnings in aggregate were solid (from a macro perspective) but investors will need to hear from more CEOs in additional industries to bolster confidence in a ~$120 EPS number for 2016 (for the SPX). In all likelihood the US economy will continue along at the same middling pace its witnessed since the financial crisis, varying somewhat quarter-to-quarter but w/an annual growth rate that doesn’t deviate much from 1.5-2.5% (US GDP: +2.5% ’10, +1.6% ’11, +2.2% ’12, +1.5% ’13, and +2.4% ’14; the St is modeling +2.4% for both ’15 and ’16). JPMorgan’s M Feroli cut his Q4:15 GDP estimate from +1% to +0.1% on Fri in the wake of the retail and inventory report and took Q1:16 from +2.25% to +2% but stayed at +2.25% for Q2-4
It’s not 2008. It’s not 2010 either. The key transmission mechanism through which macro problems become systemic events is the banking system but capital levels are extremely healthy now (in contrast to 2006-2008) and thus banks aren’t at risk of being compromised. However, that doesn’t mean the outlook for risk assets is spectacular as the country remains later in its economic and corporate recovery cycle and multiples are fuller than they’ve been.
Multiples and earnings math suggest any bounce will be a shallow one. The key for this tape remains the same – earnings and multiples. The ’16 SPX EPS estimate has been bleeding lower for months, falling from ~$125 late in ’15 to ~$120 earlier this week (and some are few dollars below that). The sanguine macro commentary from bank mgmt. teams this week was nice to hear but it will take similarly positive language from other Dow Jones-caliber CEOs to bolster confidence in $120. As earnings forecasts were trimmed, multiples also were brought lower and whereas last year people could use $125 and 17x to justify ~2100+ for the SPX, at this time 16x is considered a ceiling for the time being (which means on a $120 EPS number the SPX at 1920).
China gets blamed for a lot more than it should. China continues to undergo a massive, complicated, and unprecedented (for them) transition away from an economy focused on manufacturing and exports and towards one dependent more on consumer consumption and services. Meanwhile, the anti-corruption campaign (which President Xi this week pledged to sustain), efforts to clamp down on pollution, and a slowing in general economic momentum all create added challenges for this transition. The lack of specific clarity from the government about its intentions (see the vague aphorisms and platitudes from the PBOC and other gov’t institutions on a daily basis) only makes it more difficult for investors to form a confident view on China’s outlook. The currency vicissitudes are just one small example of the undermining uncertainty emanating from China – Beijing pledges to give markets a greater say in FX markets but intervenes heavily in the offshore market to stem CNH declines; it pledges to hold the yuan “balanced and level” but aggressively fixes the CNY lower; it shifts to a new reference basket w/o providing details on the member weights; etc. The stock market machinations (introducing new circuit breakers before quickly canceling them; coercing funds to refrain from selling; etc) are a whole other problem. The actual growth figures have been decent of late (including this week’s trade numbers) but this has had little effect on sentiment as institutional doubts grow larger. Despite all the skepticism though investors need to appreciate that China’s policy apparatus is still relatively immature and not necessarily as precise and deliberate as is the case in more advanced economies.
Oil remains a big problem. The oil price decline is wreaking havoc everywhere, skewing data, and sowing uncertainty. Global oil markets remain in a structural oversupply condition, something that doesn’t show many signs of ending. OPEC is still uncoordinated and stepped up Iranian supply is about to come to market (the nuclear sanctions could wind up getting lifted any day). US shale producers are experiencing enormous financial pain and bankruptcies are rising but supply destruction isn’t taking place fast enough to bring global markets into balance. While demand conditions aren’t helping, the bigger problem for crude remains massive oversupply. Despite the unfavorable supply backdrop though, the enormous volatility with which prices are swinging daily clearly is a function much more of financial flows and not changes in underlying fundamental conditions. The historical playbook considers falling oil a clear economic positive but that doesn’t seem to be the case today. To start, the US is now a major global producer and as such the domestic industry accounts for a lot of employment and capital spending. Meanwhile, the behavior of the consumer has clearly changed and the massive oil dividends are being saved, not spent. In addition, energy-linked companies were enormous issuers of equity and esp. debt over the last several years and the value destruction incurred by a lot of this paper is having real economic effects. Finally, inflation expectations globally are underpinned to a large degree by oil and thus break-even measures (and lately survey-based measures of inflation too) have declined.
Earnings – the CQ4 reporting season is too young to draw any firm conclusions but results from the one group w/a relatively large sample-size (the banks) were (mostly) encouraging. Investors were nervous about the banks for a few reasons but in particular concerns about a crushing increase in energy-related credit provisions have hit the group hard in the last several weeks. While provisions did tick higher for many due to commodity-related exposure (and NPAs/non-accruals weakened too), credit quality overall was very strong (and for the large money centers and regional banks energy lending remains small as a percent of their total loan books). The other main macro indicator, loan growth, was healthy in Q4 as well. In tech, TSMC and INFY both were solid (esp. INFY) while INTC underwhelmed (Data Center revs fell a bit short of expectations and mgmt. was a bit more cautious on the outlook for the core INTC business). The industrial indications still point to a very tough operation environment (both CSX and FAST talked about conditions being recession-like).
The US presidential election isn’t helping stocks. Lurking in the background is the approaching US presidential election as the collapse in Clinton’s poll numbers of late raises the prospect of a Sanders vs. Trump or Cruz contest, something that isn’t helping sentiment.
And finally - perhaps most importantly - Western central banks attempt to mollify sentiment with dovish rhetoric but to no avail.
The BOE liftoff expectations get pushed back. The ECB expresses a desire to do more should conditions warrant (as per the minutes out this week). And a variety of Fed officials pour cold water on FOMC’s own current four hike guidance (although Dudley on Friday didn’t sound too worried about the macro environment). The evolution in CB rhetoric isn’t particularly surprising and investors weren’t all that impressed regardless – monetary policy isn’t being looked to as a savior for the tape’s current travails.
For the Fed specifically, the market never endorsed the “four hike” guidance and even before the YTD break-down in equities investors were anticipating no more than two additional moves in ’16 (and that two is quickly moving to one or zero). The ECB could very well “do more” but prob. not for a few months (they just acted and keep in mind that decision was somewhat controversial internally).
Central bank policy overall is extremely accommodative and will stay that way for a long time but increasingly central banks are moving into the background as a driver for the tape’s narrative.
Source: JPMorgan
