Rising Earnings And Stock Buybacks Keep A Floor Under This Market

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by: Louis Navellier

There are two theories about why the stock market finished the week in a poor mood last Friday. One theory is that an eerie full “blood moon” appeared, signaling that “the end of the world” is near. A more down-to-earth theory is that it was a Friday in the hot summer months, so traders wanted to clean out their inventories, leave early, and get an early start to the weekend. Obviously, I subscribe to the second theory.

So far, second-quarter earnings announcements are coming in much better than expected. With 53% of S&P 500 companies reporting results, 83% have delivered a positive earnings surprise and 77% a positive sales surprise. Earnings are 21.3% above last year’s level. Despite these blockbusters results, many leading growth stocks oscillated with the overall stock market last week. Last Tuesday, for instance, the Nasdaq Composite surged 0.86% in the morning and then pulled back 0.92%, closing down for the day.

Fortunately, this kind of reversal means nothing in the long run. Last Tuesday, our friends at Bespoke Investment Group looked at all such daily reversals – defined as a “gap up” of 50 or more basis points or a 1% or greater early rise, followed by a reversal to a decline by day’s end – in the Nasdaq since 1996 and found that the index was 1.55% higher a month later and a whopping 4.69% higher three months later. Those numbers are far above the market averages (1.05% and 3.25%, respectively) during those 22 years.

In other words, these “air pockets” are great buying opportunities. Since professional investors love to take vacations in August, more air pockets may be coming in the upcoming weeks. The bears continue to talk about “peak earnings momentum,” but third- and fourth-quarter S&P 500 earnings are forecasted to rise at a 22.4% and 18.7% annual pace, respectively; so if earnings are “slowing down,” it is like your car decelerating from 155 mph in the first quarter to 145 mph in the second quarter, reaccelerating to 150 mph in the third quarter and then “slowing” to 135 mph in the fourth quarter. The bottom line is that we are still going very fast. I expect many short sellers to get buried in the wake of these rising earnings.

Price-to-earnings (P/E) ratios are being compressed since the S&P 500 has not risen anywhere near as fast as earnings. Furthermore, I expect another wave of corporate stock buy-backs as the second-quarter announcement season winds down, which is exactly why May was so strong for so many fundamentally superior growth stocks. So far, 2018 is on track to be the biggest year for corporate stock buy-backs, which reduces the number of outstanding shares and thereby boosts their underlying earnings per share.

Trade War Fears with Europe Start to Fizzle

Tariff fears hit the news again last week. Commerce Secretary Wilbur Ross on Thursday commented that many of the tariffs that Europe imposed after World War II to help Germany and other countries recover are totally irrelevant today. Additionally, Europe has many farm subsidies that are outdated. During the Tour de France last Tuesday, some farmers protested reduced subsidies by placing hay bales on the course. As police tried to disperse protesters with pepper spray, unfortunately some pepper spray got in the eyes of some bikers, as well as some sheep. As a result, the Tour de France was temporary halted.

Despite some strong nationalistic support for tariffs within the European Union, EU President Jean-Claude Junker visited the White House on Wednesday and quickly reached an agreement with President Trump to “work together toward zero tariffs, zero non-tariff barriers, and zero subsidies on non-auto industrial goods.” A group of senior advisors will be meeting to facilitate trade and lower barriers.

Since the EU and the U.S. combined account for more than half of the GDP and trade around the world, this new spirit of cooperation to ultimately eliminate tariffs is a big deal. As the U.S. makes progress with the EU to eliminate tariffs, this will ultimately put pressure on China to eliminate its tariffs as well. The reason that the U.S. should ultimately win these trade wars is simply because the U.S. has greater leverage, since the U.S. is the largest trading partner of China, the EU, as well as neighboring Mexico and Canada.

Interestingly, the Chinese yuan recently hit its lowest level in a year. Typically, before China has compromised in the past, it has purposely weakened its currency to try to gain a competitive export advantage. The fact that the People’s Bank of China is allowing the yuan to depreciate is a good sign that China may cooperate with the U.S. regarding the tariffs that were recently imposed to force China to open its markets to U.S. exporters. Currently, for every $1 the U.S. exports to China, the U.S. imports $3.87.

GDP Growth is Fine but Coastal Real Estate is Suffering

On Thursday, the Commerce Department said that durable goods orders rose 1% in June. Excluding the volatile transportation sector, which reported a 4.4% surge in vehicle orders (the largest monthly gain in three years), durable goods still rose a healthy 0.4% in June. Interestingly, demand for metals, including aluminum and steel, declined 0.4% in June, the second straight monthly decline since tariffs were imposed. However, outside of aluminum and steel, tariffs are not having any significant impact on trade.

On Friday, the Commerce Department announced that its preliminary estimate for second-quarter GDP growth was an annual pace of 4.1%, which was below economists’ consensus estimate of 4.4%. Also, first-quarter GDP growth was revised up to 2.2% from the 2% previously reported. Consumer spending accelerated to a 4% annual pace. Business investment also grew at a healthy 5.4% pace. Inventories were being rapidly depleted, deducting 1% from the preliminary GDP estimate. However, this last point is very bullish for third-quarter GDP estimates, since those depleted inventories will need to be replenished.

The biggest negative in the economy continues to be the housing market. The latest example is that the National Association of Realtors announced last week that existing home sales declined in June for the third consecutive month to an annual pace of 5.38 million. In the past 12 months, existing home sales are running at a 2.2% lower annual pace, even though median home prices have risen 5.2% to $276,900.

On Wednesday, CoreLogic (NYSE:CLGX) reported that in Southern California, homes sales have declined by 11.8% in June vs. the same month a year ago. New home sales were especially alarming, declining by 47% in Southern California vs. a year ago. Affordability may be the problem as median home prices in Southern California hit a record of $536,250 in June, up 7.3% in the past year, but the new tax law is also a factor.

Another depressed housing market is New York City, where international buyers have been largely absent in the past 18 months. Furthermore, even the rental market in New York City is now experiencing a glut. Since both California and New York are high-tax states that are penalized under the 2018 tax reform that severely restricts both state income tax and property tax deductions, there is a concern that the glut of high-end homes for sale in both California and New York will continue to grow. As a result, I will be carefully monitoring consumer confidence for any potential concerns about the slowdown in home sales.

Disclosure: *Navellier may hold securities in one or more investment strategies offered to its clients.

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