Well, we hit new record highs on the S&P Tuesday. Is the rally for real?
Let’s take a trip to technical analysis land and ask the imaginary chart patterns.
Here’s BofAML technical analyst Stephen Suttmeier:
“There were 414 calendar days between the May 2015 high and the recent one. Since 1929 there have been 24 instances where the market went 300 calendar days or more without making a new 52-week high, and in those times the forward return was much stronger than average. The bottom line is when I look at these numbers and if we do follow this signal, 250 days out the average return is about 15.6 percent, the median return is about 14.8 percent and the market is up 91 percent of the time. If you look at the price pattern here, it does support the case to get up to about 2,300 or even 2,400, and that dovetails with those targets from that signal."
Ok, then. Let’s ask UBS technical analysts Michael Riesner and Marc Muller what they think. This is from a note out this week:
“S&P 500 is overbought in near term, Friday’s rally was exhaustive (95% up volume event), current breakout not sustainable. Expect S&P 500 to move into trading top this week, followed by pullback. Re-break below 2120 would be initially negative and increase risk of false breakout as the basis for a more significant down leg into later July/early August.”
It would appear that the magic chart lines are sending conflicting signals. Good thing we have fundamentals and common sense to turn to in the event the crystal ball is broken.
Now that the UK has managed to achieve some semblance of political stability (a “bloody difficult woman” is the new PM) and with China having managed to mute expectations for yuan depreciation by suppressing offshore forward points, US investors can focus squarely on earnings.
We’ve talked at length about the outlook for corporate profits lately. The first thing to note is that there’s nothing cheap about this market. At 17X, we’re more than one standard deviation rich versus the 10 year median forward P/E. By comparison Europe is around 14.5X and Japan is around 13X.
We also know that corporate buybacks have played a role in keeping the S&P elevated and it’s not clear how much longer that can last.
Finally, we know that if estimates prove correct, Q2 will mark the fifth consecutive quarter of declining corporate profits. In other words, we’re mired in a prolonged earnings recession. The question is whether we can pull out of that and if so, whether the highly uncertain macro backdrop will reassert itself when it comes to weighing on sentiment going forward. The UK isn’t going away - well, actually they are, but only from the EU, not from the macro worries list - and neither is the yuan devaluation or political uncertainty in the US.
It’s with all of this in mind that we get a fresh look at guidance trends from BofAML’s equity and quant strat supergirl Savita Subramanian. According to Subramanian, the answer to the first question (“will the earnings recession end?”) is “yes” and the answer to the second (“will global macro jitters return weigh on sentiment?”) is “yes” as well. Here’s the good news:
“Aside from the Brexit shock at the end of the quarter, macro conditions were generally supportive in 2Q. Oil prices continued to climb from $40 to $50/bbl (-21% on average YoY vs -31% on average YoY in 1Q). The trade-weighted US dollar was actually down slightly on average YoY in 2Q (vs +4% YoY on average in 1Q). The ISM remained in expansion territory (and climbed higher in June).”
“Accordingly, analysts’ cuts to EPS have slowed. In fact, the 2% downward revision to 2Q EPS over the last three months was one of the smallest pre-earnings-season cuts in postcrisis history. And despite the numerous sources of macro uncertainty, corporates have actually grown increasingly optimistic in recent months: the three-month ratio of above-consensus vs below-consensus guidance has risen from 0.5—where it hovered for the first three months of the year—to 0.9 in June, now well above its long-term average of 0.6, and the highest since late 2014 (Chart 3).”
(Chart: BofAML)
Ok, great. So what’s the bad news?
“Few corporates were seemingly worried about Brexit: we found just 29 mentions of the EU Referendum or “Brexit” in 1Q earnings transcripts. Now “Brexit” has occurred, some companies with European/UK exposure may reduce earnings guidance on expectations of weaker European growth, a stronger US dollar and overall negative sentiment/uncertainty. Indeed, the earnings estimate revision ratio—which had been improving for three months—rolled over slightly in June (Chart 5).”
“Additionally, instances of guidance have recently been lighter than usual: there were just 23 instances of guidance from S&P 500 companies last month, the lowest ever for June. And on a rolling three-month basis, guidance instances fell to their lowest since 2000, with corporates pulling back on both quarterly and annual guidance (Chart 6). This may suggest growing uncertainty over the macro backdrop.”
(Charts: BofAML)
So a mixed bag, it would appear.
We’ll close, for now, with a kind of 30,000 foot look at where we are in the US. Here’s Citi’s economic surprise index versus stocks:
Again, a similar picture emerges. Although the economic outlook is the brightest it’s been since January of last year, it certainly appears to be priced in.