Hamlet or Helmet?
In his famous play "Hamlet", William Shakespeare used the following phrase as the opening to the so-called "nunnery scene":
To be, or not to be, that is the question
In his (at least as) famous play/service, "Wheel of FORTUNE", The Fortune Teller used the following phrase as the opening line to his play "(make sure you wear a) Helmet":
Will there be, or won't there be a recession, that is not the only question
Today (September 9, 2019), we are exactly 10.5 years/126 months since the S&P 500 touched the 666 level back on March 9, 2009.
It has been nothing but great fun ever since, with the main indices delivering phenomenal returns.
Technology and growth have led the way, but even if you picked value and small-caps - there's nothing to be sorry for. Your total return might underperform the broad market, but it is certainly not disappointing.
- Invesco QQQ Trust (QQQ): +724%
- iShares Russell 2000 Growth ETF (IWO): +461%
- SPDR® S&P 500 ETF (SPY): +442%
- SPDR® Dow Jones Industrial Average ETF (DIA): +428%
- iShares Russell 2000 ETF (IWM): +412%
- iShares Russell 2000 Value ETF (IWN): +361%
It's nice (real nice, actually) to look back and see how well your portfolio has performed. Nevertheless, investing is all about the future. Past returns are not only no guarantee for future returns but they are also (almost) meaningless to decide what you should do from now on.
Should investors maintain the exact same course going forward, or is it time to change the decor, write a new script, and perhaps hire a new director?
Do we keep playing the good-old "Hamlet", or is it time to start wearing a new, modern, "Helmet"?
Earnings Growth is Declining
With 98% of companies already reporting their Q2/2019 earnings, the S&P 500 EPS is up only 3% Y/Y - the slowest earnings growth in exactly three years (since Q2/2016).
Now, if you think that a 3% earnings growth is still a decent number, you may wish to pay close attention to the estimates for Q3/2019.
While revisions for the second quarter earnings largely followed historical patterns, earnings estimates for the third quarter have taken a notably bigger hit, mostly attributed to trade wars/worries.
Q3 Looks Set to Buck the Trend
So much so that 60% of Q3/2019 revisions to companies' guidance are negative. Again, 6 out 10 revisions to prior earnings guidance have been to the downside.
According to FactSet, S&P 500 companies with revenues coming mostly outside of the US are going to see their Q3/2019 earnings growth declining in double digits.
Companies where the US account for less than 50% of their revenues are expected to see their earnings declining by 10.7%, on average.
Globalisation - Out, Nationalism - In
It's not only earnings that are being affected by the shift from globalisation to nationalism. The new approach is "don't ask what the world can do for your company, but what your company can do within your country."
Similar to earnings, companies with most of their revenues coming outside of the US are going to suffer compared to their domestically-focused peers.
While the average S&P 500 company is expected to see revenues growing by circa 3%, companies that rely on non-US revenues are expected to see a 1.7% decline in their top line.
Since when diversification and globalisation have become disadvantages!? For years, we hear how beneficial it is for the global economy that "the world is a small village".
(Not so) Suddenly, i.e. since the terms "trade wars", "tariffs", "currency manipulation", and "protectionism" popped in our daily economic news, global growth is near three-year lows.
A Recession: Yes or No?
We are not forecasting or expecting a recession… The consumer is in good shape, and really, our main expectation is not at all that there will be a recession. - Jay Powell, 9/6/19
As we already wrote:
It's also worthwhile noting that while consumption indeed accounts for 70% of US GDP, 90% of the decline in GDP growth during a recession comes from the change in gross investments.
Putting it differently, looking at the behaviour of US consumers isn't the right place to be looking at, or fearing of.
Powell can keep using reverse psychology while trying to avoid a Pygmalion effect. Who knows?... Perhaps talking about growth and remaining (disconnectedly) optimistic would be a self-fulfilling prophecy after all...
However, even if people are unable to see beyond the obvious, they surely have the tools to search for the truth. When it comes to identifying the start of a recession, economists (and central bankers) are the last to know (admit).
The Liquidity Risk/Factor
We wrote about this many time before, and it remains intact: It's always about the liquidity! Look no further at how much money comes in, or goes out, of the markets/system - and you'll have a pretty good idea where the wind blows.
Stocks fell in August mainly because global money supply fell by $1.4T. Contrary to that, September began with a notable, very strong, surge in global liquidity. About $400B were injected to the markets during the first few days of the month.
Nonetheless, this is where the good news regarding liquidity come to an end.
The US Treasury is about to flood the market with newly issued debt (thanks to the rise of the debt ceiling) to fund the $1 trillion deficit.
That is not only a real concern, that's a fear factor!
For the rest of this month - it's going to be a brutal loss of liquidity.
Recall that on July 29th, the Treasury announced:
During the July – September 2019 quarter, Treasury expects to borrow $433 billion in privately-held net marketable debt, assuming an end-of-September cash balance of $350 billion. The borrowing estimate is $274 billion higher than announced in April 2019. The increase in borrowing is primarily driven by changes in cash balance assumptions.
As of Friday, September 6th, the cash balance of the US Treasury stood at $181.5B:
Even if the UST is still looking to end September with $350B - we are looking for circa $170B to leave the market over the next 3 weeks.
Choose Your Play
Recession or no recession - the signs of a global slowdown are on the wall. Even the Fed's model says so (by the way, when the 37.9271% probability is seasonally-adjusted, the probability is about 49% now!)
The US can't, and won't, avoid the consequences of a longstanding trade war with China (MCHI, FXI). If the two largest economies in the world won't reach a trade agreement inside 2019, the likelihood of the US entering a recession would jump to over 50%.
In spite of Powell's hawkish tone, the Fed is now operating on a dovish mode. More rate cuts, and a new QE plan, aimed at reducing the liquidity stress among banks (XLF, KRE, KBE), are expected soon. The market wants it, the market expects it - and the market will get it.
Nonetheless, more stimulus is a very doubtful treatment for the illness the US (and global) economy is suffering from. If you take too much antibiotics, at some point, the effect of these drugs is minimal, possibly even damaging.
Monetary easing is highly effective in amplifying speculation only at times when investors are inclined to speculate and take risk. But what if investors aren't so keen on taking the excess risk anymore? What if they are too confused?
The below chart suggests that investors haven't been as confused as they are now in 20 years. This puts a big question mark next to investors' willingness to maintain the same level/magnitude of speculation (as we've seen over the past 10.5 years), going forward.
Here's how the average September looks like for the S&P 500. As you can see, things tend to get ugly later in the month...
This isn't a projection, but it's a warning.
You may decide to "Hamlet" - keep watching/performing the exact same-old play. I, on the other hand, am looking for "tickets" to the new play called "Helmet". I've heard it's a blast...
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.