The stock market has run into a rough patch.
Since its March 5 high, the Nasdaq is down 8.2%. The S&P 500 is down 3.1% during that same period.
Investors can’t help but wonder if we’re in for a Wile E. Coyote moment.
As you’ll read below, there are reasons to remain optimistic about the economy and the markets.
Here’s your Monday Scouting Report:
The Unexplained Sell-Off: In what’s been dubbed an “internal correction,” investors have been dumping high-priced, high-growth stocks for more cheaply-priced, value stocks.
Interestingly, many strategists are struggling to identify a catalyst for the sell-off. “What makes the moves particularly puzzling is the lack of an obvious cause,” said Citi’s Matt King. “The Fed Minutes were generally perceived as dovish. That may help explain the rally in Treasuries, but not the sell-off in risky assets. The latest headlines in Ukraine are potentially concerning, and oil and gas prices have risen slightly, but EM generally has outperformed. Similarly, while the latest negative trade and price data out of China have us and others scrambling to shave growth forecasts, we struggle to see them as the cause of market weakness more broadly.”
Deutsche Bank Keith Parker points to the positioning of the smart money as exacerbating the selling.
For now, Wall Street is saying this is a buying opportunity. Here’s UBS’s Jonathan Golub on his 2,075 year-end price target for the S&P 500: “We would be more apt to change this outlook if we saw signs of either fundamental deterioration in the economy or indications that Fed policy was negatively impacting markets. Neither of these conditions are present, in our view.
The CapEx Comeback Story May Be Happening: Economists have long been arguing that a surge in capital expenditures would carry the U.S. economy through the next phase of growth. And more and more analysts agree that the boom could happen this year.
The most compelling evidence of this has been the recent acceleration in bank loans, which has been pointed to recently by Charles Schwab’s Liz Ann Sonders and Goldman Sachs’ Kris Dawsey. “[W]e will likely receive further anecdotal information from company management on the recent pickup in bank lending and how sustainable it is expected to be,” said Dawsey about the current earnings season.
“In both the New York and Philadelphia Fed March manufacturing surveys, the net per cent of respondents reporting higher six-month ahead capex spending plans improved,” said UBS’s Maury Harris. “In the Business Roundtable Q1(14) survey of corporate CEOs, the net per cent planning higher capex in the next six months rose to a relatively high 41% versus 17% in the previous quarterly survey.”
Harris noted that a proprietary UBS survey also supports this thesis: “[I]n the latest Q1(14) UBS quarterly survey of our global analysts’ expectations for their industries (1), the net per cent of analysts expecting higher 2014 U.S. capex rose to 48% versus 32% in Q4(13) and 33% in Q3(13).”
- Retail Sales (Mon): Economists estimate sales climbed by 0.9% in March. Excluding autos and gas, sales are estimated to have climbed by 0.4%. “Retail sales probably rose solidly in March after severe winter weather weighed on recent sales performance,” said UBS’s Kevin Cummins. “Among components, auto sales likely increased solidly after only a modest rise in February and sharp declines of 2.2% in January and 2.1% in December; a significant rebound in unit motor vehicle sales in March has already been reported. In the other direction, we estimate the gasoline component slipped, following a gain of 0.1% in February; reflecting lower prices (after seasonal adjustment).”
- Empire Manufacturing (Tues): Economists estimate this regional manufacturing activity index increased to 8.0 in April from 5.6 in March. “The new orders index jumped back into positive territory in March, and while the employment index declined somewhat on the month, its six-month moving average stands at 5.5 and suggests modest future gains in manufacturing employment,” said Barclays’ economists.
- Consumer Price Index (Tues): Economists estimate consumer prices increased by 0.1% month-over-month in March. On a year-over-year basis, they’re expected to have climbed by 1.4% and 1.6% excluding food and energy. “We continue to expect inflation to be a non-issue even as overall economic activity begins to pick up,” said Wells Fargo’s John Silvia. “As headline GDP growth begins to strengthen over the course of the year, inflation will gradually edge higher but remain modest. For 2014, we expect overall consumer prices to rise 1.7 per cent before accelerating in 2015 to around 2.1 per cent on a year-over-year basis.”
- NAHB Housing Market Index (Tues): Economists estimate this index of homebuilder sentiment rose to 50 in April from 47 in March. “Weather conditions have improved, allowing for greater construction and buyer traffic,” said Bank of America Merrill Lynch economists. “However, builders still face challenges from limited lots and difficulty finding labour.”
- Housing Starts (Wed): Economists estimate that housing starts climbed 7.5% in an annualized rate of 975,000 units in March. “Single family should also tick higher, but we think the weather-related bounce may be dragged out for a few months,” said Bank of America Merrill Lynch economists. “The housing construction and sales data over the next few months have heightened importance as they represent the spring selling season after an abnormally cold winter.”
- Industrial Production (Wed): Economists estimate industrial production climbed by 0.5% month-over-month in March while capacity utilization slipped to 78.7% from 78.8%. “We expect to see continued improvement in mining and manufacturing production in March as the BLS reported that aggregate weekly hours worked in mining and manufacturing rose at a solid pace,” said Nomura economists. “In contrast, we expect utilities production to remain flat and forecast a decline in vehicle production as the inventories- to-sales ratio for autos has been elevated.”
- Beige Book (Wed): The Federal Reserve will publish its collection of economic anecdotes at 2:00 p.m. ET. From Credit Suisse: “After reverting to marginally more negative “modest-to-moderate” growth language in early March, the April 16 Beige Book may paint a slightly more upbeat picture of US economic activity. It is possible the word “modest” will be left behind, along with most of last month’s 25 references to weather in the report’s summary pages alone. Among the topics of interest to the market will be the extent to which financial companies continue to cite increased competition in their lending operations.”
- Initial Jobless Claims (Thurs): Economists estimate claims climbed to 310,000 from 300,000 last week. “At 316k, the latest four-week average in new jobless claims was the lowest since late September and, before that, 2007,” said UBS’s Cummins. “Despite the weather-related volatility, claims have trended down since the start of the year, and the latest data are consistent with both weather-related rebound in labour market activity in April and some improvement in underlying trends.”
- Philadelphia Fed Business Outlook (Thurs): Economists estimate this regional activity index climbed to 10.0 in April from 9.0 in March. “Along with the headline current activity index, the capital spending plans index in the report merits attention,” noted UBS’s Kevin Cummins. “In both the New York and Philadelphia Fed March manufacturing March surveys, the net per cent of respondents reporting higher six-month ahead capex spending plans improved.”
- Markets will be closed on Friday, April 18.
Wall Street remains bullish on stocks in the near-term, and many see the recent selling as a buying opportunity. But the longer-term story is a bit more cloudy.
Citi’s Matt King warns us of a “Wile E. Coyote” moment “where investors look down and conclude markets are treading on air.” It’s the scenario in investors come to believe that extraordinary monetary stimulus and loose credit standards aren’t strengthening the fundamentals in a way that would justify today’s high asset prices.
From King: “Try a bit harder, and you could paint a bleaker picture still, in which investors may be coming perilously close to realising that market levels owe everything to central bank stimulus and nothing to an improvement in underlying fundamentals. What if the much heralded “improvement in earnings to match the rerating in the market” fails to be delivered in coming weeks? How long till investors realise that extra stimulus in Japan might stem the Nikkei’s decline, but is unlikely to generate the economic recovery everyone is hoping for, no matter how large its size? And that the problem afflicting China — that the growth rates to which investors have become accustomed are utterly reliant on an unsustainable expansion of credit — is in fact a problem worldwide?”
The good news is that King isn’t so gloomy just yet.
“And yet for all that we share those longer-term concerns, we still see nothing to suggest that such a “Wile E Coyote” moment is even close to being reached,” he said.
For more insight about the middle market, visit mid-marketpulse.com.
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