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Watch for more downgrades, AO World sinks
Stock markets in Europe fell sharply in the first day of trading in the new quarter, taking the cue from a dismal finish on Wall Street. It’s a sea of red for European bourses, though hefty early losses were pared after the first hour of trade. The FTSE 100 briefly dipped back under 7,000 – remains fully range bound. Banks and cyclicals bore the brunt, whilst utilities is the only sector in the green as defensives find some bid. The S&P 500 dropped steeply into the close, shedding about 40pts in the last 20 minutes of the session and ensuring the broad market’s worst month since March 2020 – remember it? It’s now through the 100-day SMA and well south of its 50-day line, about 6% off the all-time high – another 4% takes you to the 200-day support and almost a 10% correction. Stocks in Asia were broadly weaker, with the Nikkei off by 2.3% and the ASX down by about 2%. China and Hong Kong were closed for holidays.
I’ve been warning for a long time about stagflation – now this is at the heart of the market’s selloff. We can pin it on worries about persistent inflation, supply chain trouble making things more expensive, labour shortages in key areas because no one wants to work, central banks tightening to avert inflation becoming unanchored and slowing growth. It’s recalibration for a macro outlook that seems to be less optimistic than it was in the first half of the year. Yields were actually down, with US 10s back below 1.5%, though these have just picked up in the early European session again. Tech stocks were outperformers so the Nasdaq fell less than peers. It’s all rather messy, volatile and indicative of a kind of negative rotation taking place. Gold rallied as yields pulled back and the dollar treaded water for a second day after Wednesday’s big rally. Oil steadied as markets look ahead to Monday’s OPEC+ decision on production increases. No reason for the cartel to open the taps any more than they have already indicated they will through to Dec.
S&P 500 – looking like a rerun of 2020 for Sep/Oct?
Bed Bath and Beyond joined the likes of Boohoo, Nike, FedEx and Kingfisher in warning on supply chains, rising costs etc – this is how it’s going to go in Q4 and we can expect more downgrades, decelerating earnings growth and lower margins – not a great setup for equity markets into a volatile month.
AO World is the latest as it warned of “challenging market dynamics in both the UK and Germany” which resulted in lower volumes than expected and affected operational leverage. Management said UK growth was hit by the nationwide shortage of delivery drivers and ongoing disruption in the global supply chain. The company also noted “industrywide issues relating to ongoing supply chain disruption”. Shares took right at the update, plunging 17% with the growth rates in Germany of 3% in particular well below market expectations for +30% for the full year. AO World needs high double-digit revenue growth to justify its valuation. Margins in a highly commoditized business were always a problem and now the supply chain woes coupled with a shortage of drivers creates some serious headwinds for the stock, which benefitted greatly from the surge in online demand last year. It now faces some new challenges which seem set to perform the double trick of hammering margins and lowering revenue growth.
JD Wetherspoon shares fell 4% at the open before recovering as it warned off the chilling effect of lockdowns and problems in finding staff. The pub group said like-for-like sales in the first nine weeks of the current financial year were 8.7% lower than the same weeks in August and September 2019, before the pandemic started.
Today we look ahead to US inflation and the PCE personal income and expenditure report which is expected to hold steady at 4.2%. Core month-on-month is forecast to slow to +0.2% from +0.3% registered in July. Year-on-year core inflation has been steady at 3.5/6% for three months, but the headline PCE number has been on the march higher from 2.5% in March to 4.2% in July. It’s unclear whether this can change the narrative, which seems to have evolved from inflation being transitory to it being far more persistent. Input cost pressures and the supply chain problems don’t suggest we will see consumer inflation ease.
Finally, it seems Tesla bulls are getting out. Cathie Wood of Ark has dumped about 20% of its holding. Chamath Palihapitiya said he’s sold his Tesla stake, despite once being one of its biggest cheerleaders. Now he likes offline highly cash generative businesses. So I assume by that he means miners and oilers…Meanwhile, ARK investors are also getting out – third-biggest daily outflow ever on Wednesday…
Earnings Season Preview
- Wall Street banks kick off earnings season on Friday
- EPS estimates seen down -10%
- BofA, Citi calling top on frothy market
The S&P 500 has risen over 1% this week to make a fresh record high, closing above 3,800 for the first time in its history. Ebullience is a factor of the hope in vaccines leading to a return to normal, corporate earnings improving sharply in 2021, and a broadly expansionary fiscal and monetary environment offering succour to equity valuations. So we come into earnings season with markets in overall good shape, arguably looking a bit toppy and expensive as multiples are stretched and vaccines are yet to deliver the bounce back hoped for. Payroll numbers on Friday (-140k) highlight the problem facing the US economy in terms of long-term damage but also the low bar being set. Looking beyond the Q4 figures, guidance on the upcoming Q1 2021 quarter will no doubt be more important than ever.
All else equal, stretched multiples in 2021 ought to contract slightly as rates rise but EPS should improve faster with more expansionary and redistributive pro-cyclical policy in Washington. The Democrat wins in Georgia have taken us to Blue Wave territory, though it’s important to stress that with the Senate 50/50 and one Democrat (Joe Manchin) already saying he would not approve more radical policies, we are not in Blue Tsunami mode.
The average earnings per share (EPS) on the S&P 500 are seen falling by around -10% on last year’s fourth quarter, with revenues seen flat. This compares with the –7% drop in Q3 and –32.2% decline in Q2 at the height of the pandemic and it has been revised up from –12.8% in September. Q1 2021 EPS is currently forecast at +12.6% so a key theme of this season will be to what extent corporates think the growth trend will pick up at the start of this year, or do they fear of a stop-start recovery?
- Are banks optimistic about net interest margins as yield curve steepens?
- Are banks ready to recommence buybacks? Or, rather, just big are these buybacks going to be?
- Do they see further reflationary pressures?
- Do CFOs predict earnings growth to pick up further in Q1 on the vaccine rollout?
- What do CEOs think about the likely fiscal expansion and procyclical stimulus from a Democrat Congress?
- Are CEOs fearful of Blue Wave of regulation and higher corporate taxes?
- How confident are the energy companies about oil price stabilisation persisting?
- How have the Stay-at-home stocks performed after the pull-forward in demand in Q2 and Q3?
- Are Zoom, Amazon, Netflix et al able to manage expectations for future growth?
This week’s highlighted stock
JPMorgan Chase & Co (JPM): JPM has been buoyed by strong trading revenues at its investment bank, whilst bad loans are not as big a problem as investors thought they would be at the peak of the pandemic. The arrival of fresh stimulus has undoubtedly been a boost to bank shares as it limits the damage of bad loans and it helps steepen the yield curve, boosting net interest income. JPM has already committed to buying back $30bn in stock after the Fed announced in December that it will allow Wall Street’s largest banks to resume share buybacks in the first quarter of 2021, subject to certain rules.
In particular, we will be keen to hear from Jamie Dimon and co about their outlook for rates and how this could impact net interest margins and income. In Q3 net interest income was $13.1 billion, down 9% year-over-year, predominantly driven by the impact of lower nominal rates. However, since then the 10-year yield has risen to nine-month highs above 1.10% and spreads have widened with the with the 2s10s curve steepening further to 0.91%, the widest in well over 3 years. The 5s30s spread is at its widest since 2016. Revenues expected $28.337bn. EPS expected $2.50.
Citigroup Inc (C) and Wells Fargo & Co (WFC) are also reporting on Friday a day after BlackRock Inc (BLK) gets the show on the road.
Jefferies upgraded JPM and WFC this week, stating that EPS estimates are up on a “less bad” credit outlook. And whilst banks are struggling to drive revenue growth, the analysts believe that “higher long rates and an eventual turn in loan growth could join strong deposit growth, better cost control, and a restart of buybacks as positives”.
US Earnings Calendar Highlights
|Mon 11 Jan|
|Tue 12 Jan|
|Wed 13 Jan|
|Thu 14 Jan||Blackrock Inc (BLC)|
|Fri 15 Jan||JPMorgan Chase Co. (JPM)|
|Wells Fargo (WFC)|
|Mon 18 Jan|
|Tue 19 Jan||Bank of America Corp (BAC)|
|Goldman Sachs Group Inc (GS)|
|Netflix Inc (NFLX)|
|Wed 20 Jan||Morgan Stanley (MS)|
|Proctor & Gamble (PG)|
|Thur 21 Jan||IntelCorp (ITC)|
|International Business Macines (IBM)|
|Fri 22 Jan||Schlumberger Ltd (STB)|
|Mon 25 Jan|
|Tue 26 Jan||3m Co (MMM)|
|American Express (AXP)|
|General Electric (GE)|
|Johnson & Johnson (JNJ)|
|Verizon Communications Inc (VZ)|
|Advanced Micro Devices (AMD)|
|Starbucks Group (SBUX)|
|Wed 27 Jan||AT&T (T)|
|Automatic Data Processing (ADP)|
|Apple Inc (AAPL)|
|Thu Jan 27||McDonald’s Corp (MCD)|
|Fri Jan 28||AON (AON)|
|Caterpillar Inc (CAT)|
|Mon 1 Feb||Alphabet Inc C (GOOG)|
|Alphabet Inc A (GOOGL)|
|Tue 2 Feb||ExxonMobil (XOM)|
|Lumentum Holdings (LITE)|
|Gilead Sciences Inc (GILD)|
|Snap IncA (SNAP)|
|Wed 3 Feb||General Motors (GM)|
|Spotify Tehcnology SA (SPOT)|
|Microsoft Corp (MSFT)|
|PayPal Holdings (PYPL)|
|Qualcomm Inc (QCOM)|
|Tesla Inc (TSLA)|
|Thu 4 Feb||Coca-Cola Co (KO)|
|Merck & Co Inc (MRK)|
|Philip Morris International (PM)|
|Takeda Pharmaceutical (TAK)|
|Twitter Inc (TWTR)|
|Activision Blizzard (ATVI)|
|Amazon.com Inc (AMZN)|
|Uber Technologies (UBER)|
|Visa Inc Class A (V)|
Stocks head lower after Gilead, EU disappointments
US stocks faded and European equity markets are broadly weaker following on reports Gilead’s Remdesivir drug isn’t what it was cracked up to be. It had been indications of early positive results for treating Covid-19 patients with the drug that sent markets up at the tail end of last week. We should note these are all leaked reports and the data is sketchy at best. What it shows is how the market is prepared to read into positive vaccine or anti-viral news with extreme optimism, setting the bar high for disappointment.
Data on the economy isn’t offering any disappointment – the bar is already so low that nothing can really be really upsetting. US initial jobless claims rose by more than 4m again, taking total unemployment claims to 26m from Covid-19. UK retail sales fell by a record 5.1% in March, but a drop of this magnitude was widely anticipated. Consumer confidence didn’t decline, but held steady at an 11-year low at -34.
Stimulus is being worked out. The US House of Representatives on Thursday approved the $484bn package for small businesses and hospitals. More will be needed, you feel. Today’s data of note is the US durable goods orders, which are seen falling 12%, with the important core reading down 6%.
In Europe, Angela Merkel made sure Germany’s economic weight will stand behind a €1tn package for the Eurozone to prevent weaker economies from recovering a lot more slowly than richer ones. This will be defining moment for the EU – if it cannot pull together now, what is the point of it? Of course, there are still strong differences between nations on the actual size and nature of the fund. Critically, we don’t know whether cash will be dispensed as loans or grants. There was a definite sense from Thursday’s meeting of the EU kicking the can down the road. The problem for the EU and the euro is that we’re heading towards a world debt monetization and it cannot take part. German and Italian spreads widened. Support needs to be agred – Lufthansa today says it will run out cash in weeks.
The euro continues to come under pressure on the disappointment and yesterday’s PMI horror show. Support at the early Apr lows around 1.07750 was tested as I suggested in yesterday’s note, which could open up a move back to 1.0640 without much support in the way.
Heading into the final day of trading for the week, the UK was outperforming – the Dow down 3% this week, while the FTSE was about 0.7% higher. The FTSE 100 shed about 100 points though in early trade Friday to give up its 5800 handle and head for a weekly loss.
Overall, it’s been a pretty indecisive week for indices with no significant developments in terms of the virus or economic data. It’s interesting that in terms of earnings releases, we are not seeing much other than a huge amount of uncertainty as companies scrap guidance. American Express is the main large cap reporting today. It’s already warned that Covid-19 would hit payments as lockdown measures force people to stay home. The momentum of the rally from the trough has faded this week and could see stocks roll over next week if there no more good news. It’s either a bullish flag pause, or a roll over to be signalled by a MACD bearish crossover. The question is do you think stocks should be down 10% or 20% from the all-time highs?
DAX: momentum fading
S&P 500: 50-day SMA proves the resistance with 2800. Watch the MACD.
Oil is proving to be more stable. Oklahoma’s energy regulator has said producers can close wells without losing their licences. Donald Trump started to look desperate, stoking tensions with Iran. You would not be surprised if it were a dastardly plan to boost oil prices. Treasury Secretary Mnuchin suggested the White House was looking at a bailout for the oil industry.
Today’s Baker Hughes rig count will be closely watched to see how much production is being shut in. Last week’s figures showed the sharpest decline in active rigs for 5 years, falling 66 to 438, around half the number drilling for oil the same time a year ago.