While BTFATH has caught on as the new normal meme, Cti's Tobias Levkovich has another that is just as critical to comprehending the current euphoria: LMNOP = "Liquidity, Momentum, Not Operating Performance." In essence, Levkovich notes that the recent sharp move has come about as liquidity concerns have shifted to the sidelines; upward momentum for stock prices following the shutdown ending is just pulling in more short covering while long-only investors also have been buyers given the need to meet alpha generation or benchmark requirements; but operating performance by companies is simply not there in the manner that is perceived. As he concludes, "we have not seen this kind of deviation before and it is troublesome to us... we must admit to being a bit worried that investors might be facing some near term volatility."
Via Citi's Tobias Levkovich,
Companies are beating lowered estimates, but it does not seem to be all that clean.
While roughly 70% of companies have again beaten 3Q13 estimates thus far (with approximately 45% having posted results), one needs to recognize that the numbers came down from near 6% year-over-year expected EPS growth back in late June to less than 1% by the time earnings began to get reported. Moreover, a good number have made or topped forecasts on lower than expected tax rates or one-time items, suggesting that results were not necessarily comprised of high quality beats. Accordingly, it is challenging to argue that the reporting season has been all that good when some detailed insight is applied.
The margin story continues to be far less about efficiencies than smart tax and balance sheet planning.
While there is much discussion about companies being able to manage their businesses wonderfully and thus even small revenue gains can generate more impressive bottom-line increases, this mindset is illfounded, in our view. The broad data shows that overall S&P 500 operating margins have been flat to down for more than six quarters and the true story behind net margins has been lower effective tax rates and interest expense. As a result, the somewhat less than inspiring quality seen in earnings recently only supports this idea and it may not be well understood by just headline-seeking investors.
Earnings guidance has been less than stellar with a weakening trend being noted. It is always worthwhile to track the trend of guidance from companies that provide such outlooks and unfortunately, here again, the forecasts have been coming down. While estimate cuts have been anticipated, the trading direction disparity relative to forward guidance is surprising.
Indeed, certain sectors’ profit growth forecasts for 2014 still look aggressive to us, such as Materials where investors are buying the shares that have been outperforming of late but could be surprised negatively in the weeks or months ahead.
The Citi Economic Surprise Index (CESI) is sliding almost uniformly around the world.
Many investors monitor the CESI and there is coincident correlation with stock prices. Hence, it is a bit disturbing that the European, U.S., Japanese and G-10 indices have all dipped from recent highs with the inherent mean reversion characteristic of the models suggesting further weakening in many of the regions potentially acting as a drag on equity markets. While many within the investment community are hoping for a strong rally into year-end, there is the distinct possibility that it has happened already and some modest correction is more likely.
Momentum trading and excessive liquidity appears to be keeping stock prices aloft even as some other nearer-term fundamentals are slipping. With QE tapering pretty much off the table until 1Q14 at the earliest and there being no imminent government shutdowns in the next couple of months, there has been a sense that there is an open avenue for liquidity and momentum to drive share prices higher. Indeed, seasonality is cited regularly in client meetings as support for this concept.
But, as noted with respect to the CESI, quarterly results and earnings guidance, the near term may not be as rewarding, just as September seasonal weakness did not occur either.
We have not seen this kind of deviation before and it is troublesome to us, but it potentially reflects the aforementioned liquidity and momentum drivers versus less than impressive fundamentals. With our Panic/Euphoria Model approaching complacency, we must admit to being a bit worried that investors might be facing some near term volatility.