Stocks rallied last week to move near their best levels of the year.
The Dow and the Nasdaq rose 1.8% while the benchmark S&P 500 was up 1.6%. The Dow is now just a bit more than 400 points away from a new record high while the S&P 500 is about 50 points off a record.
On the economic data front, this past week saw a mixed bag of readings on the US economy that overall indicated things are where we thought they were: not too hot, not too cold.
This week we’ll get a new policy announcement out of the European Central Bank, though expectations are the ECB will announce no changes to its benchmark rates or its asset purchase programs. Next week, the Federal Reserve’s latest statement is expected to keep rates unchanged.
But this week will be all about corporate earnings, with Netflix, Google, Microsoft, American Express, and McDonald’s all among the companies set to report earnings.
Living Wills. This week, five Wall Street banks were revealed to have deficiencies with their so-called “living wills,” or Dodd-Frank-required plans to wind down operations in the case of bankruptcy. (This information, however, wasn’t supposed to get out yet and now the Federal Reserve and FDIC are both probing how The Wall Street Journal got this scoop, according to a report from The Wall Street Journal.) Joo-Yung Lee, Managing Director and head of North American Financial Institutions at Fitch Ratings, told Business Insider, “The regulators are saying ‘basically tell us how you’re going to die and what is going to happen after’ and that’s not easy to do.” The counter is that people do this. Then again, individuals are not systemically important. (Sorry, it’s true!) On the other hand, the living will disagreement is more foundational in nature. The banks simply don’t think these plans are going to do anything but give regulators leverage in the case of a future downturn, according to NYU professor Roy Smith.
Recall that in the 2008 crisis there was no plan for what to do with large banks facing both solvency and liquidity crises. The result were some bailouts (and the bankruptcy of one large investment bank, Lehman Brothers). Of course, in reaction to that lack of a plan it seems sensible that regulators would want, well, a plan. But no business, really, is going to want to commit to a known plan of action that would arise from some as-yet-unknown crisis. Additionally, the post-financial-crisis response to how you build a more robust bank is you put more capital in the bank. It’s unclear if this will work. Then again, we’re in a post-crisis haze (still!) where the only scenarios being discussed are the kind of “global capitalism will fall apart if we don’t fix this right now”-type disaster we had back in 2008. Which is the sort of thing you can say you’re ready for but will probably not, you know, be totally prepared to handle. Or as Bloomberg’s Matt Levine wrote this week, there are a number of simple steps you can take to structure a theoretical large bank for an orderly failure, but you still might need a bailout anyway.
- San Francisco. It was a tough week for San Francisco bulls. The property market finally showed signs of cooling, with home prices in the city falling for the first time in four years in March, according to data from real estate brokerage Redfin. Additionally, the data showed that the per cent of properties agents saw bidding wars for — or multiple bidders for one property — fell to 77% in March from 94% the prior year. Redfin chief economist Nela Richardson said, “This suggests that the price drop is not about inventory, it’s about buyers fed up with high Bay Area prices and crazy competition.” This week, The Wall Street Journal reported that in the first quarter venture funding for startups was down 25%, the biggest drop the dot-com bust. Investing mega-firm T. Rowe price also wrote down the value of a number of startups it has invested in, including Dropbox, Uber, Airbnb, Evernote, and Warby Parker. So, the tech bust 2.0 is here?
- NAHB Housing Market Index (Mon.): Economists expect the latest housing market index from the National Association for Homebuilders — also known as homebuilder sentiment — will rise slightly to 59 this month from last month’s reading of 58.
- Housing Starts and Building Permits (Tues.): The pace of housing starts should slip slightly to 1.17 million in March, down from February’s annualized pace of 1.178 million homes. This report will also include the latest data on building permits, which in February fell 3.1% to an annualized pace of 1.167 million. Building permits are expected to rebound to an annualized pace of 1.2 million.
- Existing Home Sales (Weds.): Existing home sales should increase in March to an annualized pace of 5.27 million, better than the rate of 5.08 million in February, which was a huge disappointment.
- Initial Jobless Claims (Thurs.): Initial filings for unemployment insurance are expected to total 265,000 this week, up from the prior reading’s 253,000 but still showing remarkable strength in the US labour market. Last week’s reading was the 58th straight week that initial claims were below 300,000, the longest such streak since the early 1970s.
- European Central Bank Announcement (Thurs.): The latest policy announcement from the European Central Bank is due out Thursday, with economists expecting the ECB to keep interest rates unchanged and make no changes to its asset-purchase program. Currently the ECB’s three key interest rates — the main re-financing rate, the marginal lending facility, and the deposit rate — are at 0%, 0.25%, and -0.4%, respectively. The ECB is also purchasing 80 billion euros worth of assets, including some private and local sovereign debt, each month. “The headline event this week will be the ECB policy meeting on Thursday, but we expect no action following the package of measures announced last month,” write economists at BNP Paribas. “We expect ECB President Mario Draghi to signal that the door to lower rates has not been fully closed.”
- Philly Fed Manufacturing (Thurs.): The April reading on manufacturing activity from the Philadelphia Federal Reserve should hit 8, down from the prior month’s 12.4 reading but still indicating overall expansion and optimism in the region.
- FHFA Home Price Index (Thurs.): Home prices should rise 0.4% in February against January’s 0.5% increase, according to the latest index from the Federal Housing Finance Agency.
- Markit Flash Manufacturing PMI (Fri.): The preliminary reading on US manufacturing activity in April from Markit Economics is expected to hit 52.0, better than the 51.5 reading seen at the end of March and indicating not just expansion in US manufacturing activity but continued improvement in the measure as the US manufacturing sector pulls itself out of what was a tough 2015.
It’s really just about earnings.
Over the coming weeks we’ll get an update on the performance of some of America’s corporate giants during the first quarter of the year. It’s not expected to be that great.
Stocks, meanwhile, have made back all of their early-year losses and are now roughly flat for the last 15 months.
On the heels of this rebound, Adam Parker, chief US equity strategist at Morgan Stanley, said that most of the questions he’s been getting from clients are about why stocks rebounded and what happens next. These queries, however, are outside the sphere of the fundamental reality that ultimately drives stock prices: earnings:
“The main questions investors ask us today seem to be about the exterior appearance of the market and not fundamentals,” Parker wrote in a note to clients on Sunday.
Parker adds (emphasis mine):
“What is this price action telling you?” “What are other investors asking you about?” “How are other people positioned?” Or, “what’s the current sentiment?” They start by saying “I’m a contrarian investor by nature” and then go on to say the same thing about their view that we have heard in several previous meetings. Romanticizing that you are a contrarian when you are indistinguishable from consensus can’t be good. Our favourite investor question lately has been “when Morgan Stanley’s Prime Brokerage data show net and gross exposures of the hedge fund industry are back to 2-3 year averages, where will the S&P 500 trade?” We are flattered that someone thinks we can compute that, as if isolating a nine-variable problem to one provides us with an accurate answer. We should have answered “2137” or something that seems exact even though it would have been pulled out of thin air. Using the patient analogy, it seems like the stock market doctors are asking the wrong questions. They are looking at the price, or external appearance, in making their forecasts and not the fundamentals.
You know what we haven’t been asked in the last month? What is the growth in earnings implied by today’s price? How has your view of that trajectory changed this year? Which areas of the market may show accelerating growth in cash flows? What is the future value of all cash flows discounted back to the present? How have your assumptions about growth or rates changed recently? In recent weeks, it has been rare to attend an investor meeting that hasn’t been filled with the words “positioning” or “sentiment”. We think investors should stop worrying for a bit about how fat or thin the market appears, and focus on “what it is eating.”
Our view is that the earnings outlook for the S&P 500 for the next two years is pretty similar to what it was when the market was at its lows in mid-February, as we continue to project about 4% per year earnings growth through 2017. Should the recent price action alone alter our view of corporate earnings growth? We think the US consumer is in pretty good shape, with confidence, delinquencies, jobs, housing, and obligations all in reasonable shape.
So not amazing but not terrible. As we note time and again, stocks usually go up. And while the minds of investors can change rapidly and send stock prices up and down accordingly, earnings are likely to improve. So too should stock prices.
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