Monday was the start of spring, which usually brings in some milder weather and a breath of fresh air. The latter was certainly what the stock market received yesterday when it had its worst day in a number of weeks.

For us here at Tematica, we’ve been talking about the growing disconnect between the stock market, the real speed of the economy and the growing likelihood that President Trump’s stimulative policies will arrive far later than the mainstream expected. The fact that there are several other snafus helping to deter progress is Washington — like the FBI investigation into potential links with Russia, judicial pushback on the second attempted travel ban and an attempt to repeal the Affordable Care Act that doesn’t have full support of Republicans in the House and Senate — are pushing out the focus on infrastructure spending and tax reform.

The good news is that once again the herd is catching up to what we’ve been saying. The not so good news is it means we’re likely to see the stock market give back some of its 2017 gains as these GDP expectations and subsequent earnings expectations get reset. If we look at several companies that reported earnings this week, including Rise & Fall of the Middle-Class contender Nike (NKE), and Economic Acceleration/Deceleration players FedEx (FDX) and Actuant (ATU) each of them have given their own warning signs:

• Nike’s future orders fell 1 percent;
• FedEx missed quarterly expectations and cut its 2017 global GDP forecast to 1.6 percent from the prior 2.6 percent;
• Actuant guided its current quarter earnings and revenue below consensus and reduced the top end of its 2017 EPS guidance.

Overnight we’re also reading that Payless (PSS) may file for bankruptcy next week and Sears (SHLD) mentioned in its latest 10-K filing just a day or two ago that, “substantial doubt exists related to the company’s ability to continue as a going concern.” Candidly given the rise of Connected Society company Amazon (AMZN) in apparel, as well as its Zappos business, we’re a little surprised that Payless has hung on as long as it has.

The point is we’re starting to see 2017 expectations get adjusted, and the new question we need to focus on is the degree of those negative revisions. With hindsight being 20/20, last year we saw a steady move lower in earnings expectations for the S&P 500 and we wound up seeing 2016 earnings growth come in at a whopping 0.5 percent for those 500 companies.

As we entered 2017, the expectation was those 500 companies would grow their collective earnings more than 12 percent compared to 2016. Even before we get March quarter results, the view on 2017 earnings growth for the S&P 500 has fallen to just over 10 percent. With several highly anticipated policies getting pushed out, odds are companies will have to reset EPS expectations for 2Q 2017 and most likely 3Q 2017 as well, which means we are likely to see full year 2017 expectations come down further.

As this happens, the market will likely continue to wake up to current valuation levels, especially since if the price of the S&P 500 remains steady and earnings get cut, the market valuation will climb. Odds of that happening are rather low given the market’s stretched valuation and it would mean paying more for even slower earnings growth. What this means is we’re likely to see the market move lower over the coming weeks as all of these expectations get rejiggered lower.

We’ve been patient as well as selective, and we’ll continue to do so.

The most recent addition to the Tematica Select List, the Connected Society “missing link” that is United Parcel Service (UPS), was one month ago. While we use the expected retrenchment in the market to identify new players for the Tematica Select List, we’ll continue to look for confirming data points for the existing positions. A great example was the piece we published earlier this week on Applied Materials (AMAT) and Universal Display (OLED) as well as Disney (DIS) that saw Barron’s backing our thematic rationale for having these three companies on the Select List.

With 8 trading days left in the quarter, a number of companies will soon be entering their “quiet periods” and that means we’re going to have our “scope up” as it were for potential earnings pre-announcements. If we get more negative warnings than usual, or from some larger blue chip companies, we could see the market get a little bouncy. In times like that, we’ll look to scale into positions where it makes thematic sense, especially if we can reduce the cost basis on the Tematica Select List. It’s a strategy that’s paid off for Dycom (DY), AMN Healthcare (AMN), International Flavors & Fragrances (IFF) and several others positions.

Be sure to check the website for more comments and insights, and be sure to listen to our Cocktail Investing Podcast — it’s all the insight with some good humor and more than few laughs as well.

Waiting for the Fed’s Economic Forecast Update

What a week it’s been! We’ve received a solid February jobs report, endured a March snow storm and late last night even saw another round of would-be news on President Trump’s 2005 tax return. Those two later stories were far less newsworthy than was widely anticipated as Trump paid a 25 percent tax rate and winter storm Stella’s impact wasn’t as extreme as expected, although it did leave trading volumes rather light yesterday. They would have been so regardless, as the market is still in wait-and-see mode as it eyes today’s afternoon announcement from the Federal Reserve on interest rates.

What was once thought of as a long shot, has reversed course and picked up steam with the market now widely anticipating the Fed to modestly boost interest rates. The rate increase is expected even though, as we pointed out in this week’s Monday Morning Kickoff, the Atlanta Fed has done nothing but trim its GDP expectations for 1Q 2017 over the last few weeks. Odds are, today’s latest iteration of that GDPNow report will see a boost up from the dismal 1.2 percent reading owing to the February Employment Report, but it will be hard pressed to break past the 1.9 percent GDP print for 4Q 2016.

Keeping in mind the Fed has a knack for boosting interest rates at the wrong time, and it looks increasingly like Trump’s fiscal policies will take longer than many have expected to take hold and boost the economy, we here at Tematica will continue to tread prudently and cautiously in the near-term.

Hope and enthusiasm can only carry the market so high for so long.

Yes, each week we continue to see confirming data points for our 17 investment themes, which you can see in our Friday missive that is Thematic Signals, but we remain concerned over the market’s stretched valuation and the simple fact that expectations have to catch up with the current economic reality.

Now when many hear talk like that, the first reaction is to get nervous. It’s understandable, but we’re not suggesting a market correction is coming. Even though there are signs the economy has slowed, it is still growing as evidenced by the recent reports from Markit Economics and ISM. Our thinking is that a market pullback — something we define to be in the 3-6 percent range — may not be popular to all the recently returned investors, but it would take, to quote former Fed Chief Alan Greenspan, some of the “irrational exuberance” out of the market. Not a bad thing as it would allow us to revisit some thematic contenders that have moved higher and faster than they probably should over the last four and a half months.

Like Warren Buffett is often quoted saying, “Price is what you pay, value is what you get.”

We couldn’t agree more.

Aside from the now largely expected interest rate increase itself, let’s remember the Fed tends to be very vague in its language and the market has a habit of not really listening to what the Fed is trying to communicate. As the Fed boosts interest rates, we’re likely to get an update on its economic and inflation forecasts in its policy statements and its that language that will either soothe the market or give it some indigestion.

You’ve probably come to the conclusion that it’s best to stand pat for now, and we certainly agree. 

We’ve got a number of positions on the Tematica Select List that are benefitting from pronounced multi-year tailwinds, like Connected Society company Dycom Industries (DY) and the 5G deployment; Disruptive Technology plays Universal Display (OLED) and Applied Materials (AMAT); Aging of the Population and AMN Healthcare (AMN) and the PureFunds ISE Cyber Security ETF (HACK) that is part of our Safety & Security investing theme to name just a few.

Two stocks we will be watching closely are Food with Integrity United Natural Foods (UNFI), which reported good quarterly earnings last week and recently stopped out Costco Wholesale (COST) shares. Both stocks drifted lower last week, with UNFI a tad below the average cost basis of $42.95 on the Tematica Select List and Costco shares breaking through their 50-day moving average at $167.34. When we’ve seen such moves in COST shares previously, it tends to take more than a few weeks for the shares to settle out. Given our Cash-strapped Consumer investing theme and the Costco’s continued expansion, as well as announced membership price hike, that should drive membership-related profits higher.

• We’ll continue to keep our eyes on COST for an opportunity to jump back in.

Ways to Get Prepared for Future Moves

Be sure to listen to the latest edition of Cocktail Investing, in which Tematica Chief Macro Strategist Lenore Hawkins and I talk with Steve Fredette of Toast, a restaurant technology company at the intersection of the Connected Societyand Asset-lite investment themes. We’ll have another episode out tomorrow that will wrap up all the key market and economic data with a special guest Jack Mohr, who up until recently worked with Jim Cramer — yes that Jim Cramer — managing his Action Alerts Portfolio.

Also be sure to come back to Tematica Investing during the week to see our latest thoughts and comments on the economy, the market and stocks, both in and out of the Tematica Select List.