Market Recap

Posted on October 25, 2019 by Gemmer Asset

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Faint Positive Hints in the Manufacturing Sector…


There wasn’t a lot of new economic data this week, but what there was hinted at stabilization, not deterioration. The Richmond manufacturing index hooked higher, as you can see below.



While this is a narrow regional number, it gets a lot of attention because it is tightly correlated with the national ISM manufacturing number (chart below).



It raises the possibility that manufacturing nationwide might stabilize in the next couple months. If true, the recession risks will clearly diminish. But so much hinges on trade policy, and on that front we didn’t learn much new this week.


…as Well as Corporate Earnings


We are right in the middle of third quarter earnings season, and through Thursday roughly a third of U.S. companies have reported numbers. So far we’ve seen a positive surprise of about 5%, but this comes after a significant reduction in estimates the last couple months. Such a cycle isn’t unusual. As Ed Yardeni notes:


“It’s not unusual to see such downward revisions since industry analysts tend to be too optimistic about the future and become more realistic as the actual results approach during earnings-reporting seasons. Oddly, they tend to overshoot on the pessimistic side in the weeks before earnings seasons. That, in turn, means that there is often an earnings ‘hook’ to the upside as actual results beat expectations.”


As you can see below, we saw the fall in Q1 and Q2 estimates before they hooked higher. The signs show we are experiencing something similar in Q3. Now whether this will be enough to push the numbers into positive territory is another matter.



So far 82% of companies have beaten earnings estimates and 66% have beaten sales estimates, as you can see below.



Year-over-year growth is coming in at +2%, five points better than expected. But this will change – only a third of firms have reported. But so far earnings season is shaping up reasonably well.


The Start of a Long Pause


The main event next week will be the Fed meeting on Tuesday and Wednesday. The consensus is they cut rates by another quarter point. The markets are placing odds of almost 94% on a cut. The Fed isn’t likely to surprise anyone.



The bigger question concerns the December meeting and the first couple next year. Opinions here are pretty much split between only one cut next week and two more by April, as you can see below.



It is a decent bet the Fed will tailor the statement to keep all their options open. They will say they are data dependent, flexible, etc. Basically, their policy will follow the economy and the markets, just as it has for the last few years. If we had to guess we would say that October’s cut could be the last move, either up or down, for a number of months. With political uncertainty building in 2020, the Fed could very well be on hold until after the November elections.


Things That Stuck Out This Week


First up is this exhibit from Bespoke Investment Group. They noted this week that just one Qualcomm (total market cap) now separates the market cap of the entire Russell 2000 and Apple + Microsoft.



So the market cap of 2000 companies could be surmounted by just two firms. That’s pretty amazing!!


Next up is PG&E.


As everyone probably knows, common stock holds the lowest rung in a company’s capital structure. When a firm goes bankrupt and liquidates the secured creditors get paid first, then the unsecured creditors, etc. All the way down at the bottom are the stock holders who get whatever crumbs are left.


It is looking more and more likely that there won’t be any crumbs left for PG&E shareholders. The stock fell 25% Friday as reports hinted that the new Kincade Fire may have been started by faulty power lines.



Only a couple weeks ago the stock was slammed after the judge presiding over PG&E’s bankruptcy ruled that a competing restructuring plan put forward by bondholders, led by Elliott Management should be considered. The decision means PG&E will not have the sole right to propose a plan for moving out of bankruptcy and settling billions of dollars of damages from wildfires tied to the utility’s equipment.


The bondholders’ proposed plan would raise fresh capital and use most of PG&E’s equity to repay debts, while PG&E’s plan raises both debt and equity to get out of bankruptcy, allowing shareholders to avoid larger losses.


Have a good weekend.




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