Market Recap

Posted on April 26, 2019 by Gemmer Asset

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Earnings – Is This the Trough?


You can probably tell by the headlines that we are in the middle of earnings season. Intel whiffed big time and the stock was hit with a 2X4 on Friday. Tesla was entertaining this week as usual. But in general, these high-profile shortfalls have been the exception – results are coming in better than expected.


In the U.S. about a third of companies have reported so far and 77% of those beat EPS estimates. Earnings growth is running at +5% y/y, surprising positively by 5%. All sectors except for energy and materials are up y/y. As for sales growth, more than half of the companies are beating estimates.



In terms of guidance for future quarters, the number of companies guiding both higher and lower are down from late 2017 and early 2018 (chart below). However, compared to last quarter more companies are guiding higher and fewer firms are guiding lower. This could be important in that it points to a trough in negative earnings revisions.



This idea is reinforced by the chart below from Bank Credit Analyst. It shows that earnings estimates for the next 12-months have hooked higher both in the U.S. and overseas. Again, this hints that the first quarter may mark the low in earnings growth for this year.



Decent Growth, Less Inflation


The other main news for the week was Friday’s GDP report. This is the first estimate of three for the first quarter, and this initial report came in at +3.2%, up from +2.2% in the fourth quarter last year and well above consensus estimates of +2.0%.



While the headline number was solid, the details were a bit soft. Both investment and consumer spending were weak. The consumer component increased just +1.2% in Q1, down from +3.2% in Q4.


Growth was bolstered by two items – a narrowing in the trade deficit and a big build in inventories. Together they boosted the headline number by +1.7%. Inventories in particular are a temporary boost and could be reversed in the second quarter. Core growth is probably running in the high +1% range. Not bad, but not great.


Probably a bigger number in the report was the inflation component. The Fed’s preferred gauge of inflation, the core personal consumption expenditures (PCE) index, fell to 1.3% in the first-quarter from 1.8% last quarter. This is a big decline, and no where near the Fed’s 2% target.



There has been a lot of talk lately that the Fed might act to try and get inflation back up to the target. Take comments by Alpine on Friday:


“Recent discussions by Fed Vice Chair Richard Clarida and Chicago Fed President Charles Evans about possible rate cuts on lower inflation suggest that the Fed’s dovish pivot may accelerate. Both men have talked about taking out ‘an insurance policy’ if core PCE inflation falls too low, say to 1.5%.”


Now whether the two gentlemen reflect the views of Chairman Powell remains to be seen, but this should make for an interesting Fed meeting next week. How much will Powell talk about inflation falling short of their goal? Does he hint of any plans to reverse the trend?


Long-Term Changes in Perception


Bigger picture, central banks are starting to think about different ways to run policy. The Fed is about to start a major review of how they conduct operations (read more here) that could have important implications. To quote Goldman Sachs:


“The Federal Reserve will conduct a review of its strategy, tools, and communication practices over the next year. The review will include a conference in Chicago on June 4-5 and town hall events around the country, culminating in a report in the first half of 2020.”


A number of items are under review, but top of the list will be the topics of how does the Fed respond to the next economic downturn and what should they do about falling short of their inflation goal. It might seem a bit strange the Fed actually wants to get inflation up, but there is a line of thought that higher inflation today could mean less deflation during the next recession. One thing under consideration is to change the Fed’s inflation goal. Rather than targeting 2% core inflation at all times, they should target an average. Goldman again:


“While price level targeting was the most popular option among Fed officials a year ago, average inflation targeting now appears to be the front-runner. Under an average inflation target (AIT), the Fed would aim…for inflation above 2% in good times to offset inflation below 2% during recessions, an approach proposed by senior Fed economists Michael Kiley and John Roberts that Chairman Powell alluded to in his recent Congressional testimony.


The (chart below) provides a stylized illustration of an AIT. If the inflation target for expansions were adjusted after each recession based on the most recent inflation shortfall rather than held fixed, the AIT would begin to approximate a PLT with memory.”



This may not seem like much of a change, but it would mean the Fed would choose to keep rates unusually low during good times until inflation overshoots. And how big would the overshoot need to be? Some economists (see here) think inflation might need to hit 3% in good times to offset the shortfalls during recessions.


This will be worth paying attention to.  Combine this possible shift with both Modern Monetary Theory (we will try and write more on this at a later date) and the apparent extinction of the rare bird known as the ‘fiscal conservative’, and the next decade could look very different in terms of inflation and debt trends.





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