Friday, May 24, 2013

The Fed has put the market on notice that it is seriously thinking of reducing the level of accommodation it has been providing lately. The debate within in the Fed appears to be about ‘when’ instead of ‘if’ it should happen.

The most reasonable takeaway from all of this is that if the economy continues to improve and doesn’t show any notable signs of weakness in the coming weeks, then we can expect the taper decision to come as soon as the Fed’s June meeting. This is not the consensus view, as most investors expect the decision to come later this fall or early next year. But the possibility of the taper announcement coming soon can’t entirely be ruled out anymore.

Market participants use terms like ‘hawks’ and ‘doves’ for those on the Fed’s policy-making committee that are for or against the tapering decision. We know the identities of these ‘doves’ and ‘hawks’ and what their concerns are. The ‘doves’, which includes Chairman Bernanke, appreciates that the economy is improving, but they are concerned that recent fiscal changes like the payroll tax hike and budget sequester could be problematic for the economy. Knowing this provides investors a useful framework through which to look at all incoming economic data going forward.

What this means is that the data doesn’t need to show a lot of strength; it just needs to avoid the onset of weakness. If there is no evidence of fresh weakness in the data, then it improves the odds of the taper decision. Using this simplified framework, this morning’s April Durable Goods report favors the taper decision, with both the 'headline' and 'core' components coming in better than expected.

We are unlikely to see major moves in the stock market in today’s session. But the overall tone will likely be on the weak side ahead of the long weekend. Overnight markets out of Japan improved from the day before, but they still remained fairly volatile.

Sheraz Mian
Director of Research

Thursday, May 23, 2013

The overnight weak economic news out of China adds to the market uncertainty created by Fed related developments from Wednesday. Hard to tell at this stage whether the global market turmoil is a justified response to what we learnt on Wednesday or the typical over-reaction. But it nevertheless proves beyond any doubt the primary role that the Fed’s monetary policy has been playing in pushing the market into record territory.

Let’s put the China news out of the way first. A highly watched reading of activity levels in China’s manufacturing sector came in weaker than expected. The HSBC preliminary purchasing managers’ index (PMI) for May came in at 49.6 from 50.4 in April. A combination of factors, ranging from weak demand domestically to problems in international markets and increased competition from Japanese suppliers following the sharp drop in the exchange value of Yen appear to be at play here. But the PMI weakness follows weak economic readings in recent months, including the first quarter GDP growth that came in below expectations. Given China’s outsized influence in the basic materials and commodity sectors, this is a net negative for companies in those sectors.

China is no doubt important, but the bigger story for the markets today is the U.S. Federal Reserve. The signals coming out of the Fed’s two reports on Wednesday – Bernanke’s Congressional testimony and minutes of the last FOMC meeting – may be confusing, but they both indicate that the central bank is seriously thinking about tapering the monthly level of bond purchases. In fact, the announcement could come as soon as the Fed’s June meeting. This will be a major shift in monetary policy when it comes as it would be indicative of the central bank’s confidence in the U.S. economy’s ability to start moving on its own.

But this is no easy move for Bernanke & Co. The tricky part will be in convincing the markets that the tapering decision was not the start of a full-blown unwind of the last few year’s extraordinarily loose monetary policy. They certainly don’t want the tapering decision to spark a major rise in bond yields. But that may actually be inevitable. Rates have to rise to reflect the economy’s ground realities; they can’t forever stay at rock-bottom levels. And this represents the major threat to the stock market; it would no longer be the only game in the investment town.

Keep in mind, however, that markets almost always over-react in the short term. It is very likely that the turmoil in global markets today is just such an over-reaction. We may not know when the Fed will start tapering, but we know for a fact that they don’t want to rock the boat.

Sheraz Mian
Director of Research

Wednesday, May 22, 2013

The Fed remains in the spotlight today as Bernanke testifies before Congress. Investors will be trying to handicap the Fed Chairman’s thinking about whether the central bank is moving towards tapering the pace of bond purchases. The dominant view in the market appears to be that the Fed will do nothing to its QE program at the June meeting. But others, myself included, look at the question differently and see the Fed moving towards a change of policy in the near future.

It is reasonable to assume that the views of Bill Dudley, the New York Fed President, mirror those of Bernanke himself. Dudley’s comments Tuesday did not indicate that any changes to the QE program were imminent. He essentially reiterated what was in the last post-meeting statement, meaning that the pace of bond purchases could increase or decrease depending on the state of the economy. This makes Bernanke’s characterization of current economic conditions in today’s testimony very significant for the QE program.

Investors will likely interpret any Bernanke comments about the fragility and weakness of the economy as evidence of no changes to the QE program. We know from prior public comments that Bernanke has been concerned about the potential negative economic impact of the budget sequester. They would like to see GDP growth resume in the third quarter after the slowdown in the current period.
The issue of Bernanke’s retirement at the start of next year may or may not be relevant to the future of QE. But the potentially smaller supply of treasury bonds in the coming months as a result of lower budget deficit is a strong argument for tapering the pace of bond purchases. My sense is that the FOMC will move towards changing the QE program at the June meeting after having seen the May non-farm payroll report earlier that month.
We will be getting the minutes of the last FOMC meeting later this afternoon as well that will shed more light on the QE debate from within the committee. But the Bernanke testimony has the potential to steal the thunder from that report.

Bernanke aside, we have underwhelming earnings reports from Target (TGT) and Lowe’s (LOW) this morning while Hewlett-Packard (HPQ) reports after the close. We have the usual comments about weather from Target that featured in the weak report from Wal-Mart (WMT) a few days back. But the reality is that the payroll tax changes from earlier this year may be a bigger issue for the Wal-Mart and Target shoppers than analysts are factoring in at present. The Lowe’s miss shows that the rising tide of the housing market may not be enough to lift the fortunes of all home-improvement retailers. At least that’s what we see in the disparity between Home Depot (HD) and Lowe’s.

Sheraz Mian
Director of Research

Tuesday, May 21, 2013

With nothing major on the economic calendar, stocks will likely remain in a tentative mood ahead of the Wednesday release of the last Fed meeting minutes and the Bernanke testimony before Congress. The key question for investors is to figure out whether the Fed is getting closer to announcing changes to its bond purchase program, which has been a key driver of the stock market rally.

Earnings reports from Home Depot (HD), Best Buy (BBY), AutoZone (AZO) and other will also be in focus in today’s session. Beyond the common thread of all three coming ahead of earnings expectations, there is not much in common among them. Home Depot appears to be firing on all cylinders, with the retailer’s housing leverage showing up in strong same-store sales (comps) growth and raised guidance. Best Buy came short on revenues, with margins and comps under pressure as it struggles with the 'show-rooming' phenomenon. AutoZone barely met revenue expectations as comps appeared weaker.

With respect to the Fed, the market has been paying special attention to all Fed speakers to foretell the central bank’s evolving view on the QE question. Last month’s FOMC minutes seemed to indicate growing momentum on the committee for changes to the bond purchase program. And we will likely see something similar in tomorrow’s minutes as well. We will know more from tomorrow’s Bernanke testimony as well, but I am increasingly of the view that we will see the announcement of changes to the program in the June FOMC meeting. Unless the May non-farm payroll report coming out on June 7th turns out to be unusually weak, I expect the decision to pare back the size of bond purchases to come out of the June 19th FOMC meeting.

The decision will reflect the need to synchronize the size of bond purchases with the expected lower amount of bond issuance later this year. Relatively better economic growth, higher taxes and somewhat lower spending levels have started eating into the trillion dollar deficits that the U.S. Treasury needed to fund through a boatload of bond issuances. As a result, the Congressional Budget Office now expects this year’s deficit to be $200 billion lower than their estimate of three months back. It is reasonable to expect the Treasury to issue fewer bonds in the coming months compared to the last few years.

If the Fed were to continue buying bonds at the same monthly rate, they would effectively be expanding the QE program. Bottom line, they need to taper the size of their bond purchases just to be in-line with the level of monetary stimulus they have been providing under the existing QE program. And my sense is that the announcement for this change will come in the June 19th FOMC meeting.

This will likely be the beginning of the end for the QE program, though it will take a very long time to fully unwind the enormous expansion that the Fed's balance sheet has endured over the last few years. The Fed will likely never sell any bonds on its balance sheet – they can simply decide against replacing maturing instruments. It is not a bad development for the economy, as it would signify the Fed's confidence in the economy's ability to operate on its own. It will, however, have negative consequences for the stock market, accustomed as it is to plentiful liquidity and rock-bottom interest rates.

Sheraz Mian
Director of Research

Monday, May 20, 2013

Stocks may not do much in today’s session given the almost empty economic calendar, but the bias will likely remain to the upside. The rest of this week has a number of manufacturing and housing related reports on deck, but the spotlight will remain on the Fed as speeches by Fed officials and other Fed related data will keep the future of the QE program center stage.

Last week’s economic data was for the most part negative even though consumer sentiment and retail sales numbers were on the positive side. The Philly Fed and Empire State regional manufacturing surveys, Industrial Production, Jobless Claims and even Housing Starts all came in weaker than expected. But stocks were still able to eke out a gain, with the S&P 500 up +2.1% on the week for another record close. The Fed has been and continues to be the key driver of this rally, with investors assigning low odds to the possibility of imminent changes to the QE program.

Wednesday will be particularly notable on the Fed watch as not only will Bernanke be on the Hill to testify before Congress that day, but the minutes of the last FOMC meeting will also come out that day. Many view the eventual scaling back of the QE program as a given, but timing remains uncertain. Last month’s FOMC minutes seemed to indicate growing momentum from within the committee to start making changes to the program this summer. But Fed doves, which includes Bernanke, may not be ready yet to do any tinkering at this stage, particularly given the still-fragile economic scene in a restrictive fiscal backdrop.

On the earnings front, the Q1 earnings season is now at its last leg with just 35 of the S&P 500 companies still to report results. We will get closer to the finish line by the end of this week as by then 25 of those remaining companies will have reported results. Besides Target (TGT) and Gap (GPS), this week line-up of earnings reports includes Home Depot (HD) and Lowe’s (LOW) which have had impressive runs lately given the housing momentum. These two retailers likely benefited from the Sandy related reconstruction activities as well.

Overall, Q1 earnings are on track to be up +2.2% on -1% lower revenues. In terms of dollar earnings levels, earnings are expected to total $251.6 billion, the all-time highest quarterly total. Earnings estimates for Q2 have come down, though expectations for the second half of the year have held up quite well. Total earnings in 2013 Q2 are now expected to be up +1.2% on -0.7% lower revenues. This is a drop from the +3.9% total earnings growth expected in Q2 on +0.5% higher revenues in early April.

Sheraz Mian
Director of Research

Monday, May 20, 2013

Stocks may not do much in today’s session given the almost empty economic calendar, but the bias will likely remain to the upside. The rest of this week has a number of manufacturing and housing related reports on deck, but the spotlight will remain on the Fed as speeches by Fed officials and other Fed related data will keep the future of the QE program center stage.

Last week’s economic data was for the most part negative even though consumer sentiment and retail sales numbers were on the positive side. The Philly Fed and Empire State regional manufacturing surveys, Industrial Production, Jobless Claims and even Housing Starts all came in weaker than expected. But stocks were still able to eke out a gain, with the S&P 500 up +2.1% on the week for another record close. The Fed has been and continues to be the key driver of this rally, with investors assigning low odds to the possibility of imminent changes to the QE program.

Wednesday will be particularly notable on the Fed watch as not only will Bernanke be on the Hill to testify before Congress that day, but the minutes of the last FOMC meeting will also come out that day. Many view the eventual scaling back of the QE program as a given, but timing remains uncertain. Last month’s FOMC minutes seemed to indicate growing momentum from within the committee to start making changes to the program this summer. But Fed doves, which includes Bernanke, may not be ready yet to do any tinkering at this stage, particularly given the still-fragile economic scene in a restrictive fiscal backdrop.

On the earnings front, the Q1 earnings season is now at its last leg with just 35 of the S&P 500 companies still to report results. We will get closer to the finish line by the end of this week as by then 25 of those remaining companies will have reported results. Besides Target (TGT) and Gap (GPS), this week line-up of earnings reports includes Home Depot (HD) and Lowe’s (LOW) which have had impressive runs lately given the housing momentum. These two retailers likely benefited from the Sandy related reconstruction activities as well.

Overall, Q1 earnings are on track to be up +2.2% on -1% lower revenues. In terms of dollar earnings levels, earnings are expected to total $251.6 billion, the all-time highest quarterly total. Earnings estimates for Q2 have come down, though expectations for the second half of the year have held up quite well. Total earnings in 2013 Q2 are now expected to be up +1.2% on -0.7% lower revenues. This is a drop from the +3.9% total earnings growth expected in Q2 on +0.5% higher revenues in early April.

Sheraz Mian
Director of Research

Friday, May 17, 2013

Stocks will likely reverse the modest decline from the day before in today’s trading session if the positive pre-open sentiment carries through to the end of the day. But we do have the University of Michigan Consumer Sentiment and the Conference Board’s Leading Indicators coming out a little later, with consensus expectations of both surveys showing improvement from the prior levels. These surveys will have some bearing on how the market behaves today.

There is nothing on the earnings calendar this morning, though last evening’s reports from J.C. Penney (JCP), Applied Materials (AMAT) and others were on the weak side. We have now seen Q1 results from 465 S&P 500 companies, with total earnings for these companies up +2.8% from the same period last year, with 65.3% coming ahead of earnings expectations. This earnings growth and beat pace is respectable enough by the standards of the last few quarters, through the revenue performance stands out for its weakness. Total revenues are down 1% from the same period last year, with only 41.5% of the companies beating top-line expectations.

The overwhelmingly negative tone of company guidance has prompted analysts to materially cut their estimates for 2013 Q2, through estimates for the second half of the year and next year have held up fairly well. Total earnings are expected to be up +9.7% in the second half of 2013 after increasing by +1.7% in the first half of the year. This growth momentum is then expected to continue into 2014, with total earnings growing +11.4%.

Hard to see these growth expectations coming through in the current constrained economic growth backdrop. But investors appear more than willing to overlook this reality as long as the Fed doesn’t change the stance of its monetary policy. Next week will shed a bit more light on the course of Fed policy with the Bernanke testimony before Congress and the release of the minutes of the last FOMC meeting. But the fact remains that the Fed’s QE program is essentially the only game in town when it comes to handicapping the direction of the stock market.

Sheraz Mian
Director of Research

The stock market has plenty to chew on in today’s trading session and most of the data this morning in on the negative side. Jobless Claims jumped in the wrong direction, while Housing Starts came in weaker than expected and the CPI numbers seem be in the benign territory. The housing data is not all bad, as housing permits came in much better than expected.

Housing Starts for April came in weaker than expected and the numbers for March were modestly revised lower. The consensus expectation was for April starts to come in at the seasonally adjusted 969K annualized pace, below March’s one million rate where they had reached for the first time in 5 years. But Starts actually came in at 853K and the March tally was revised down to 1.02 million from the originally reported 1.03 million. The negative surprise notwithstanding, the current Starts level represents a significant improvement over the year-earlier level. We should keep in mind, however, that Housing Starts still remain below the roughly 1.3 million level considered ‘normal’ for the U.S. housing sector (Starts were above 2 million during the bubble).

On the positive side, Building Permits came in better than expected, crossing the one million mark for the first time in 5 years. The surge in Permits assure that building activity should maintain the positive momentum in the coming months. We saw this in the April homebuilder sentiment index as well. The index, which came out Wednesday, showed an improvement for the month after stalling out over the last few months.

The construction and broader housing industry remains the economy’s brightest spot, helping offset weakness from the factory floor and headwinds resulting from fiscal tightening like the payroll tax increase and the budget sequester. This morning’s earnings miss from Wal-Mart (WMT) is a timely reminder that these fiscal drags are having an impact on consumer behavior even though we haven’t seen much corroborating evidence in economic data at this stage.

The tone of this morning’s data is negative, but this need not be a big problem for the stock market. In the convoluted logic of looking at every piece of economic data from a Fed-inspired prism, soft economic data provides good-enough justification to double down on stocks. Will we see the same trend play out in today’s trading session as well? We will find out soon enough.

Thursday, May 16, 2013

The stock market has plenty to chew on in today’s trading session and most of the data this morning in on the negative side. Jobless Claims jumped in the wrong direction, while Housing Starts came in weaker than expected and the CPI numbers seem be in the benign territory. The housing data is not all bad, as housing permits came in much better than expected.

Housing Starts for April came in weaker than expected and the numbers for March were modestly revised lower. The consensus expectation was for April starts to come in at the seasonally adjusted 969K annualized pace, below March’s one million rate where they had reached for the first time in 5 years. But Starts actually came in at 853K and the March tally was revised down to 1.02 million from the originally reported 1.03 million. The negative surprise notwithstanding, the current Starts level represents a significant improvement over the year-earlier level. We should keep in mind, however, that Housing Starts still remain below the roughly 1.3 million level considered ‘normal’ for the U.S. housing sector (Starts were above 2 million during the bubble).

On the positive side, Building Permits came in better than expected, crossing the one million mark for the first time in 5 years. The surge in Permits assure that building activity should maintain the positive momentum in the coming months. We saw this in the April homebuilder sentiment index as well. The index, which came out Wednesday, showed an improvement for the month after stalling out over the last few months.

The construction and broader housing industry remains the economy’s brightest spot, helping offset weakness from the factory floor and headwinds resulting from fiscal tightening like the payroll tax increase and the budget sequester. This morning’s earnings miss from Wal-Mart (WMT) is a timely reminder that these fiscal drags are having an impact on consumer behavior even though we haven’t seen much corroborating evidence in economic data at this stage.

The tone of this morning’s data is negative, but this need not be a big problem for the stock market. In the convoluted logic of looking at every piece of economic data from a Fed-inspired prism, soft economic data provides good-enough justification to double down on stocks. Will we see the same trend play out in today’s trading session as well? We will find out soon enough.

Sheraz Mian
Director of Research

Wednesday, May 15, 2013

Stocks have plenty of domestic economic data to chew on in today’s trading session, with this morning’s wholesale inflation reading essentially in-line with expectations and the Empire State manufacturing survey coming out a bit on the soft side. We will get the Industrial Production and homebuilder sentiment surveys a bit later, but the market’s focus will likely remain on the weak GDP data out of Europe.

First quarter GDP data for the Euro-zone shows the region is in recession for the sixth straight quarter, with even Germany barely in the positive column. The region’s combined GDP fell a bigger than expected -0.9% in annualized terms in the first quarter after the -2.3% drop in the 2012 Q4.

The rot that started in Greece three years back is now firmly entrenched in the region’s core, with conditions in France, Italy and Spain showing no signs of improvement. Recent data for Germany, which alone accounts for almost a third of the Euro-zone GDP, doesn’t inspire much confidence about the current period either.

The sickly state of the region’s economy contrasts with the +2.5% GDP growth in the U.S. in Q1. Even the Japanese economy is expected to show a positive growth number. Europe hasn’t been a growth engine for the global economy in recent memory, but it has never been a drag either. However, a host of companies — ranging from consumer-centric names like McDonald’s (MCD) to large-scale manufacturers like Ford (F) — been citing the region as the weakest link in their markets.

Financial conditions in the region have definitely improved, with the ECB’s easy monetary policy helping sovereign debt yields steadily come down, particularly in Spain and Italy. But these have yet to show up in improved business conditions.

On earnings front, we got a solid earnings report from Macy’s (M) this morning, while Cisco (CSCO) will report after the close. Cisco typically doesn’t have much trouble coming out positive earnings surprises, but management’s comments about business conditions will determine how investors react to the report. John Chambers, the company’s CEO, had cautioned against growing reliance on government contracts in a constrained fiscal backdrop at the time of the last quarterly release.

It will be interesting to see if they see any effects from the budget sequester in today’s release; the sequester issue did come up a few times in rival Juniper Networks’ (JNPR) quarterly release and their quarter ended in March (CSCO’s ended in April). The soft GDP data out of Europe this morning further underscores this unfavorable operating environment.

Sheraz Mian
Director of Research