Now that the earnings season is over, we can see that the recent six-quarter earnings drought has ended. Our friends at Bespoke Investment Group issued a report last Tuesday ("Best Earnings Season for Stocks in Two Years") which said that the fourth quarter of 2016 was the "strongest and the best since Q4 2014."
One of the biggest surprises this earnings season is how some big multinational companies posted better-then-expected earnings due partially to their aggressive stock buy-back activity. I must admit that I was expecting many of these companies to complain about a strong U.S. dollar hindering their sales and earnings. However, many multinational companies were able to sell new corporate debt overseas at ultra-low interest rates, and there is no doubt that many companies use this new cash to buy back their shares.
Although the stock market is overbought near-term and some type of consolidation is overdue, I don't expect to see a major correction anytime soon. Last week we saw consolidation in leading technology names, but this kind of consolidation typically happens at the end of earnings announcement season. At the same time, stock buy-back activity also tends to surface quickly after recent consolidations. Although I expect to see more rotational corrections, I think every dip should be viewed as a new buying opportunity.
There is an Academy-Award nominated Best Film of 2016 called "Arrival," which stars Amy Adams as a linguist who bravely tries to translate the visual language of a newly-arrived army of aliens, so that we can coexist with them in peace instead of going to war. Of course, I thought immediately of the Fed and their convoluted "Fedspeak," which they use whenever speaking in public or testifying before Congress.
On Tuesday, San Francisco Fed President John Williams told Bloomberg that historically low interest rates are here to stay. Williams wrote in the San Francisco Fed's latest economic letter that a low-rate world is "likely to be very persistent" as an aging population and lagging productivity hold down growth.
In his best Fedspeak, Williams also pointed out that it might make sense for the Federal Open Market Committee (FOMC) to raise key interest rates soon. What Williams' confusing comments really mean is that the yield curve flattens as bond yields moderate and the Fed raises short-term interest rates. Longer-term, Williams does not see dramatically higher bond yields due to very strong demand.
On Wednesday, the Fed released the minutes from their most recent FOMC meeting, in which they discussed raising key interest rates "fairly soon" in light of an improving economy and the possibility of renewed inflationary pressures. As always, the Fed remains data dependent and since healthcare reform is being introduced first and meaningful tax reform may not be implemented until August, the economic data in the upcoming weeks will likely be crucial in influencing its upcoming mid-March FOMC meeting.
Ironically, while the Fed continues to talk about raising key short-term rates, long-term corporate bond yields are pushing the yield curve lower. Furthermore, the demand for intermediate-to-long Treasury bonds remains robust, so the yield curve has flattened out a bit. Ironically, if Congress and the Trump Administration can get corporate tax reform passed, there is a growing belief that the 10-year Treasury bond might approach 2% due to relentless buying pressure if we see mass repatriation of overseas cash.
The FOMC minutes also cited "heightened uncertainty" from Trump's tax reform and spending increase plans. Essentially, the FOMC implied that excessive stimulus might spark inflation, which would give the Fed "ample time to respond" if inflation materializes. Translated from Fedspeak, the FOMC appears to be in a waiting mood, but all that could change if the February jobs report is stronger than anticipated.
What to Look for in Friday's Jobs Report
One of the most important economic reports that will likely influence the Fed most will be the February payroll (released this Friday). Even though we are near "full employment," the labor force participation rate is near historic lows, so we need to see over 200,000 new jobs created monthly to generate meaningful GDP growth and wage growth. Janet Yellen trained as a labor economist, so the wage growth component in the February payroll report will be especially crucial. Wage growth decelerated in recent months as companies continued to curtail healthcare benefits, which tends to suppress wage growth.
Today, after we go to press, we will see the second iteration of fourth-quarter GDP, which will likely be around 2%. According to the Atlanta Fed's GDPNow, first-quarter GDP is running at about 2.4%.
The other key indicators this month will be released as the Fed meets in mid-March. Ironically, on March 15, the Consumer Price Index, Retail Sales, and the Empire State Manufacturing Survey will all be released at 8:30 a.m. on a day in which the FOMC will announce its next rate decision (at 2:00 pm).
Speaking of interest rates, despite a recent uptick in mortgage rates, the National Association of Realtors announced on Wednesday that existing home sales rose to a 5.69 million annual pace in January, a 10-year high. The inventory of existing homes for sale remains unusually tight at a 3.6-month supply, so home prices are expected to continue to rise. The inventory of existing homes for sale actually declined 7.1% in January, which deepened the supply shortage. I should also add that on Friday, the Commerce Department reported that new home sales in January rose 3.7% to an annual pace of 550,000.
Overall, the strong pace of new and existing home sales is a sign that consumer confidence remains high, even though the University of Michigan announced on Friday that its final consumer sentiment index slipped to 96.3 in February, down from 98.5 in January. This is the first month in which the Michigan consumer sentiment index has dipped since the Presidential election. The impending battle in Congress over healthcare and the delay in tax reforms may be adversely impacting consumer sentiment.
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