“That’ll be the day … “when the Fed hikes the rate … It could be in December !

   Schwaben Blog

November 20, 2015 

Weekly Statistics:

  Today Week Ago Year Ago
  20-Nov-15 13-Nov-15 20-Nov-14
       
S&P TSX 13,433 13,075 15,111
S&P 500 2,089 2,023 2,052
DJIA 17,824 17,245 17,719
OIL $39.39 $40.73  $75.86
USD vs CAD 0.7493 0.7507 0.8903
Gold $1,077 $1,083  $1,194

 

As more members of the Federal Reserve are starting to point towards a rate hike in December, market participants become more optimistic about the health of the US economy. In the past, investors did not respond well to the possibility of a rate hike due to higher business borrowing costs. Investors recently shifted their perspectives due to strong economic indicators. Investors are more confident that the US economy is strong enough to sustain an interest rate hike. Minutes from the October meeting of Federal Reserve officials supported the idea that rate hikes will be very gradual. This improved the sentiment of equity markets.  The Dow Jones, S&P and the TSX recorded gains of 3.4%, 3.3% and 2.8% respectively. S&P 500 recorded its best week in six weeks and the DJIA climbed back into the positive year-to-date territory. One of the major reasons why the Fed has not yet raised interest rates likely is lower inflation. However, recently St Louis Fed President James Bullard said that the rate of inflation will soon rise towards the Fed’s 2% annual target. This reduces concerns that stagnant inflation could dissuade policymakers from raising rates. Many members of the Federal Open Market Committee (FOMC) are in the favor of a rate hike at the December meeting. The image below is of the CME FedWatch Tool, which shows the probability of an interest rate hike of 74% probability at the December meeting, up from 70% the previous week. Further, should interest rates increase; there is a 73.6% probability of a 50 basis points hike and 26.4% probability of a 25 basis points hike.

The Effect of US Dollar on Equities

   Schwaben Blog

November 13, 2015

Weekly Statistics:

Today Week Ago Year Ago
13-Nov-15 06-Nov-15 13-Nov-14
S&P TSX 13,075 13,553 14,843
S&P 500 2,023 2,033 2,039
DJIA 17,245 17,910 17,652
OIL $40.73 $44.52  $75.01
USD vs CAD 0.7507 0.7537 0.8827
Gold $1,083 $1,088  $1,165

In the S&P 500, 444 companies have reported their earnings for Q3 2015 until last week. 74% of those companies have reported earnings above the mean estimate and 46% have reported sales above the mean estimate. The blended earnings decline for Q3 2015 is -2.2%, compared with earnings expectations of -5.2% on September 30, 2015. This will mark the first back to back quarters of earnings decline since 2009 if the index reports a decline in earnings for Q3. It will be almost certain that the overall earnings will be negative unless the remaining 56 companies report stellar results. The blended sales growth is -3.7%. Two main factors responsible for decline in earnings and sales across the index are strong  US dollar and a struggling Energy sector. The Energy sector was the largest contributor to the year-over-year declines in both earnings and revenues for the index. The blended earnings growth rate for the S&P 500 (ex-Energy) for Q3 is 4.5%. Hence Energy has contributed -6.7% to earnings this far. The other factor for decline in earnings and sales is strong USD. A recent analysis by Factset to quantify the effect of strong USD on S&P 500 companies found that companies that generate more than 50% of sales inside the US had a blended earnings growth rate of 4.8% but for companies that generated less than 50% of the sales inside the US, the blended earnings growth is -10.6%. The results were similar for the blended sales growth rate. This is a sign of the worsening effect that a strong USD has on the US conglomerates. After last week’s astounding payroll report, analysts and economists have become overly confident of a rate hike in December. According to CME FedWatch tool, there is a 70 % probability of a rate hike during FOMC meeting in December. Should interest rates increase, then there is a 69.8% probability of a 50 basis points hike and 30% probability of a 25 basis points hike.  The high likelihood of a rate hike led to  sharp decline across all major indices this past week. A rate hike in the US would lead to a stronger US$, the greater the rate hike the more the US$ would strengthen. The graph below compares the change in price of the S&P 500 with the change in Forward 12 month Earnings per share for the index.

Are we in for a rate hike in December?

   Schwaben Blog

November 06, 2015

Weekly Statistics:

Today Week Ago Year Ago
06-Nov-15 30-Oct-15 07-Nov-14
S&P TSX 13,553 13,525 14,690
S&P 500 2,033 2,079 2,031
DJIA 17,910 17,662 17,573
OIL $44.52 $46.59  $78.61
USD vs CAD 0.7537 0.7650 0.8827
Gold $1,088 $1,141  $1,146

With the release of October Payroll report the fear of an interest rate hike as soon as December is back on the table. After last week’s report that the US economy posted a disappointing growth of just 1.5 percent (annualized) in Q3 2015, investors discounted the probability of a rate hike anytime soon and started getting back into equities. But today’s jobs report left little doubt that the US economy is growing again. The gain of 271,000 in payrolls was the biggest this year and exceeded analysts’ expectations of a gain of 185,000. After almost eight years, the US economy now has more civilians working in full-time jobs than it had before the financial crisis of 2007/08. According to CME FedWatch tool, there is a 70 % probability of a rate hike during FOMC meeting in December. Also, if the interest rates are increased, then there is a 69.8% probability of a 50 basis points hike and 30% probability of a 25 basis points hike. Last week, the probability of just a rate hike was less than 30%. I still think that the likelihood of an increase in interest rates is around 30-40%.  Even though employment numbers have far exceeded the expectations, the average blended earnings growth for S&P 500 is -2.2%. If the index reports an earnings decline in Q3, it will be the first back-to-back quarters of earnings declines since 2009. According to Factset, 76% of companies are reporting EPS above estimates. This is above the 5 year average earning surprise for the index, while only 47% of the companies are reporting sales above estimates. With interest rates at record lows, companies are buying back their shares at a record pace and this raises EPS. The share buyback increases EPS however it may not be a sign of significantly increased earnings. Although employment gains last month were a lot stronger than expected it may not necessarily point to an excessively growing US economy.

Source- Bloomberg, Globe Investor Gold, Financial Post, Market Watch, Trading Economics

Reasons for the Recent Rally in Equity Markets.

   Schwaben Blog

October 23, 2015

Weekly Statistics:

Today Week Ago Year Ago
23-Oct-15 16-Oct-15 23-Oct-14
S&P TSX 13,953 13,838 14,227
S&P 500 2,075 2,033 1,950
DJIA 17,647 17,216 16,677
OIL $44.33 $47.17 $80.39
USD vs CAD 0.7657 0.7757 0.9012
Gold $1,164 $1,177 $1,233

The consecutive announcements by the European Central Bank (ECB) and the People’s Bank of China (PBOC) on Thursday and Friday respectively drove equity indices higher. The ECB signaled that it would expand its $1.28 Trillion quantitative easing program in December and cut its deposit rate if the slowdown in emerging economies threatens the eurozone’s economic recovery. Furthermore, the Chinese central bank dropped their benchmark interest rates by 25 bps. Many analysts are viewing this cut in interest rate as a measure by Chinese leaders to spur the country’s economic growth to their target of 7 percent. The reduction in interest rates is planned to stimulate the growth of the Chinese economy and stimulate global equity markets. Unexpected smaller declines in profits in US equities also drive the recovery in equity indices from a few months ago. 77 percent of the 173 companies that have reported their earnings for Q3 2015 have reported above expectations. On September 30, the estimated earnings decline for the S&P 500 for Q3 2015 was -5.1 percent. As of today, the earnings decline has been revised to -3.8 percent. Upside earnings surprises by companies in the Information Technology, Consumer Discretionary, and Telecom Services sectors accounted for most of the decrease in the earnings decline for the index. Microsoft, McDonald’s, Amazon, AT&T, GM as well as other Blue Chip equities had a positive impact in their respective sectors. Energy and Materials are the largest contributors to the earning declines across all sectors.

Source- Bloomberg, Globe Investor Gold, Financial Post, Market Watch, Trading Economics

Is S&P 500 Ready to Touch Previous Highs?

   Schwaben Blog

October 16, 2015

Weekly Statistics:

Today Week Ago Year Ago
16-Oct-15 09-Oct-15 16-Oct-14
S&P TSX 13,838 13,964 14,227
S&P 500 2,033 2,015 1,862
DJIA 17,216 17,084 16,117
OIL $47.17 $49.49 $79.84
USD vs CAD 0.7757 0.7725 0.9012
Gold $1,177 $1,156 $1,244

The earnings season for the S&P 500 kicked off last week with Alcoa reporting well below analysts’ estimates. On September 30, the estimated earnings decline for the S&P 500 for Q3 2015 was -5.1 percent. As of today, the earnings decline has been revised to -4.6 percent. This can be attributed to the positive earnings surprises released by many companies. Of the 58 companies that have already reported their Q3 earnings, around 81 percent have reported above the mean estimate. At the sector level, the Information Technology (100%), Health Care (100%), and Energy (100%) sectors have the highest percentages of the companies reporting earnings above estimates, while the Materials (33%) sector has the lowest percentage of companies reporting above estimates. These positive surprises combined with the release of the FOMC’s meeting minutes, which showed the strength of the US economy, have led to a rally of more than 4 percent across the major indices of the US. Equities are rebounding from their worst quarter in four years, while investor sentiment oscillates between ripple effects of a slowdown in Chinese economy, and optimism that the Federal Reserve won’t raise interest rates until policy makers are satisfied that overseas turbulence won’t derail the US growth. The S&P 500 has rallied around 8.5 percent from the low during August selloff and is only 5 percent away from it’s all time high of 2,135 but with tax-loss harvesting around the corner, investors should be careful and should not consider every dip in the markets as a smart buying opportunity.

Source- Bloomberg, Globe Investor Gold, Financial Post, Market Watch, Trading Economics

Will the S&P 500 Miss the Earnings Estimate Again?

   Schwaben Blog

October 09, 2015

Weekly Statistics:

Today Week Ago Year Ago
09-Oct-15 02-Oct-15 09-Oct-14
S&P TSX 13,964 13,340 15,086
S&P 500 2,015 1,951 1,906
DJIA 17,084 16,472 16,544
OIL $49.49 $45.63  $83.58
USD vs CAD 0.7725 0.7507 0.9062
Gold $1,156 $1,137  $1,225

The minutes from FOMC’s September meeting were recently released and they clearly indicated that the members of Federal Reserve were more inclined towards raising the interest rates but did not do so because of fears of global slowdown. According to the minutes of the meeting, “ Participants anticipated that recent global developments would likely put further downward pressure on inflation in the near term; compared with their previous forecasts, more now saw the risks to inflation as tilted to the downside”. Although this led to sharp correction in the equity indices but the overall sentiment since the last meeting has greatly improved. Investors seem to have discounted the probability of a rate hike in October or probably even in December and a rally of around 4 percent (week-over-week) followed across the major indices of the US and Canada, but it does not mean that the outlook is certainly positive for equities. Earnings drive stock prices and with valuations at historical highs, it will take decent to strong earnings for this bull market to continue. According to FactSet, for Q3 2015, the average estimate for earnings decline is -5.5 percent for S&P 500. If the index reports a decline in earnings for Q3, it will mark the first back-to-back quarters of earnings decline since 2009. Only 5 percent of the S&P 500 companies have reported their earnings till now and many heavyweights like Intel, Johnson and Johnson, Kinder Morgan, JP Morgan etc. are reporting next week. Of the companies that have already reported their earnings, consumer driven companies like Nike, Costco have delivered strong results but industrials like Alcoa have disappointed the investors.  Slowing Chinese economy and a strong dollar could again be made the scapegoats and many companies have already cited a stronger dollar to have a negative impact on their Q3 earnings.

The US Economy Slowing Down?

   Schwaben Blog

October 02, 2015

Weekly Statistics:

Today Week Ago Year Ago
02-Oct-15 25-Sep-15 02-Oct-14
S&P TSX 13,340 13,380 15,026
S&P 500 1,951 1,931 1,965
DJIA 16,472 16,315 16,945
OIL $45.63 $45.58  $89.37
USD vs CAD 0.7507 0.7507 0.9051
Gold $1,137 $1,146  $1,226

With only two weeks left for the October FOMC meeting, it certainly doesn’t look like a rate hike is on the Fed’s agenda. The disappointing unemployment report for the US economy justifies the Fed’s decision to not to raise the interest rates during their last meeting. In September, the US economy added a seasonally adjusted 142,00 jobs compared with analysts’ expectation for a gain of 200,000 jobs. This is the second month of disappointing unemployment numbers, after the US economy added only 136,000 jobs in august compared with analysts’ expectation of 173,000. A significant correction in oil prices during last one year has led to mounting losses/ bankruptcies for many energy companies and they have cut 120,000 positions since December 2014. The longer the oil prices stay low, the deeper the losses for energy companies, and therefore more layoffs. These layoffs could be one of the reason for disappointing unemployment numbers since last two months. After deciding to keep interest rates steady during the last meeting in September, the Federal reserve chairperson, Janet Yellen, commented that most members on Federal Open Market Committee (FOMC) still expect a rate increase in 2015, but I believe that a rate hike in the first quarter of 2016 would be more prosperous for the US economy. The poor unemployment numbers in the last two months could also mean the economy did not grow at a decent pace in the third quarter. At a time when global economies were slowing down, the US economy grew at 3.9 percent in the second quarter and a dismal performance in the third quarter   would cast serious doubts over the strength of the economy.

Source- Bloomberg, Globe Investor Gold, Financial Post, Market Watch, Trading EconomicsUS Jobless Sep 2015