Pricey markets with rising default rates
As of Friday’s close, the S&P 500 was 1.9% away from all-time highs with trailing P/E ratio around 19x and forward P/E ratio at 17x, rather pricey market by historical standards.
Early last week the Russell 2000 closed above its 200-day moving average for the first time since last August, making for a total of 167 consecutive days below the 200-day moving average, the fourth longest streak in the index’s history. The three prior times is had running streaks longer, the index gained an average of 37.7% over the next six months.
Tech stocks experienced their worst day since the February lows on Friday and momentum for the NASDAQ is now decidedly negative with the MACD and the 14-day RSI in downtrends.
But if we look just under the surface, much is still being driven by short-coverings, with S&P 500 shorts cut in half recently and at 2016 lows – still some 17,000 options out there though so there is more room to go.
More importantly, where are the fundamentals? Price and value often diverge, but when they diverge a lot in either direction, it is either a selling or a buying opportunity.
The 24% of the S&P 500 non-energy companies that have already reported for 2016’s first quarter show revenue that is basically flat, up just 0.6% with operating income coming in a dismal decline of -6.6%.
The top-line revenue beat rate is currently at 54.4% , which is well below the bottom line beat rate of 63% and is so far better than we’ve seen in the prior four earnings season, but is still below the long-term trend.
I’ve talked a lot in the past about the lack of wage growth being a headwind to the economy. With unemployment rates getting so low, we are seeing wage pressures now with the wages and salaries rising an estimated 4.6% in Q2. But that is at a time when revenue is flat! Not good. Tough for companies to increase costs when their revenues are flat or declining.
In fact we are seeing an absolutely unprecedented imbalance between the growth rates of top line sales and private-sector payrolls. Going back to 1994, we’ve never seen such a diversion during the mature phase of a business cycle which means there is a heightened risk of a sudden and material jump in layoffs that would likely stall consumer spending. With an economy in stall speed, (GDP growth for Q1 expected to be less than 1%) this is something to watch.
Meanwhile the number of companies defaulting on their debt is hitting levels not seen since the financial crisis with 46 so far this year amidst projected corporate earnings that are projected to have declined 18.5% from their peak in late 2014, as measured by GAAP accounting.
In fact, so far in 2016, downgrades have supplied 82% of all US high yield credit rating revisions. Even after excluding those downgrades having exposure to the oil and gas sector, downgrades still account for 72%. This is the highest ratio of downgrades since Q1 2009.
With P/E ratios at historically high levels combined with high default rates, non-existent sales growth and rising wage costs, S&P 500 stocks look to be platinum pricing for a tin ring.
Last week also painted a less than rosy picture for the housing sector.
Monday the National Association of Home Builders/Wells Fargo builder sentiment was released, showing the index was unchanged at 58 versus expectations for 59, staying at the same level for the past three months. Builders outlook for sales over the next six months edged higher but view of current conditions fell.
On Tuesday we learned that US housing starts fell -8.8% versus expectations for -1.1%, with declines in both single-family (down -9.2%) and multi-family units (down -7.9%). Permits also dropping to a one-year low, down -7.7% versus expectations for a gain of +2%, making for the second biggest month-over-month fall since January 2011 and the biggest miss versus expectations since 2002. Looking at the longer-range trends, housing starts remain in the middle of the range they’ve been in since early 2015, but permits have been making lower highs and now lower lows.
The decline in housing market activity mirrors the slowing we have seen in business spending, trade and retail sales
This week we’ll get two very important releases, the Fed’s rate hike decision and the first estimate for Q1 2016 GDP. Late Monday Boston Fed President Eric Rosengren told Reuters that the Federal Reserve is set to hike rates more rapidly than is currently priced into futures market, which see only one modest rate hike in each of the next few years. I still think it is highly unlikely that the Fed will decide to raise rates this week, but when a bunch of economist get into a room, you can never be 100% sure.
This week we’ll hear about
- New home sales
- Durable goods orders (important for forward look on economy)
- Markit services PMI (service sector has been stronger than manufacturing – will see if that continues)
- Consumer confidence (typically a lagging indictor, but still useful)
- Personal Income and Spending (people making a bit more, but where is that money going?)
- Dallas, Richmond, Kansas City Fed activity index reports
