Markets remain extremely volatile, leaving traders and investors everywhere asking that perennial question: have markets got it right?
Markets are discounting mechanisms, which means they price in the future expectations of the traders and investors who participate in them.
The ongoing declines in stocks, commodities, and interest rates appear to be signalling an increasing probability that we will or have already entered an economic recession.
Of course, markets aren’t always right.
“Did you know that the stock market has predicted 27 of the past 11 recessions?” Gluskin Sheff’s David Rosenberg quipped on Friday.
Market volatility will certainly be discussed when the Federal Reserve’s Federal Open Market Committee (FOMC) meets this week to discuss the economy and monetary policy.
So as traders, investors, and policymakers try to make sense of everything, here’s your Monday Scouting Report:
- It’s as if the Fed has already hiked rates 4 times. It’s one of the Fed’s mandates to promote price stability. And that means tightening monetary policy with interest rate hikes to prevent rampant inflation. Higher rates tighten financial conditions making it more difficult for businesses and consumers from obtaining financing. However, heightened volatility in the financial markets are already reflecting ever tighter financial markets. “Wrapping all of this together, there has been a substantial tightening of financial conditions since December — by our estimation the economic equivalent of 4 rate hikes,” Morgan Stanley’s Ellen Zentner argued. “The Fed raises rates to tighten financial conditions, it loathes to move when the market has already done its tightening for it.”
Oil isn’t what it used to be. There was a time in America when cheap oil was supposed to be a good thing, especially considering how much of our energy like gasoline, diesel, and heating oil was refined from imported crude oil. Lately, however, when oil prices go down, it seems that prices for all sorts of risk assets fall. But Morgan Stanley’s Andrew Sheets warns again confusing correlation with causation: “Brent was down 25% for the year through Wednesday, and the high correlation between oil and equity prices in this sell-off has implied a level of causation. We are more sceptical. Falling oil isn’t the economic positive that many (including ourselves) assumed a year ago, but its decline looks more like a symptom of other issues (growth concerns, a lack of risk appetite, a stronger dollar) than the cause.”
Allianz’s Mohamed El-Erian further notes that the threat of deflation and the damaging effects of the disorderly decline in prices are also sources of concern. But he’s optimistic that low oil prices will eventually be seen as a bullish force: “Most advanced economies (and some emerging countries too) will come out significant net beneficiaries. Their consumers and a notable part of their industrial base will have the possibility — if not probability — of translating their windfall gains into higher economic activity. And this could well be significant … that is provided the short-term transition challenges are managed well.”
- Dallas Fed Manufacturing (Mon.): Economists estimate this regional manufacturing index improved to -14.0 in January from -20.1 in December.
- S&P/Case-Shiller Home Price Index (Tues.): Economists estimate home price climbed 0.8% month-over-month in November, reflecting a 5.6% year-0ver-year gain. Here’s Bank of America Merrill Lynch: “The earlier released CoreLogic measure surged 1.3% mum this month. However, CoreLogic has a tendency to overestimate home price appreciation and be revised lower in subsequent months, so we anticipate a more conservative print for Case-Shiller. A strong labour market and lean housing supply will continue to support the uptrend in home prices, but we expect price growth to moderate as the housing market continues to rebalance.”
- Markit US Services (Tues): Economists estimate this services index fell to 53.9 in January from 54.3 in December.
- Consumer Confidence (Tues): Economists estimate the Conference Board’s index of sentiment was unchanged at 53.9 in January. Here’s Barclays: “Despite the sharp declines in retail gas prices, jobless claims have moved higher and stock prices have fallen more than 5 per cent year-to-date.”
- Richmond Fed Manufacturing Index (Tues): Economists estimate this regional manufacturing index fell to 2 in January from 6 in December.
- New Home Sales (Wed): Economists estimate the pace of sales climbed 2.0% in December to an annualized rate of 500,000 units. Here’s Bank of America Merrill Lynch: “Housing data generally benefit from favourable weather conditions, and this past December was the warmest on record. Indeed, the NAHB housing index for December showed a pick-up in the present sales component. Also, the employment report showed a strong improvement in the labour market that should underpin housing demand.”
- FOMC Rate Decision (Wed): At 2:00 pm ET, the Fed will publish its Federal Open Market Committee (FOMC) statement. Here’s Goldman Sachs’ David Mericle: “The economic picture has changed only moderately on balance since the FOMC met in December, with weaker activity data offset by strong payroll gains, and mixedtosofter news on inflation. But our financial conditions index (GSFCI) has tightened a further 70bp and now implies a negative growth impulse in 2016H1 comparable in magnitude to that sustained in 2015H2. We expect the FOMC to cautiously acknowledge the risks to the outlook posed by recent global economic and financial developments in its January statement, but without shutting the door to a second hike in March. Recent comments from Fed officials have indicated continued confidence in the growth outlook and only moderate concern about financial market volatility, though we think financial conditions would have to ease somewhat for the FOMC to hike again in March.”
- Initial Jobless Claims (Thurs.): Economists estimate that initial claims slipped to 281,000 from 293,000 a week ago. Here’s RBC’s Tom Porcelli: “Jobless claims look poised for a substantial drop in the wake of a print last week that was boosted by what looks to be a one-off in California and seasonal adjustment difficulties.”
- Durable Goods Orders (Thurs.): Economists estimate orders fell 0.5% in December. Nondefense capital goods excluding aircraft — or core capex — is estimated to have declined by 0.2%. Here’s Wells Fargo’s Sam Bullard: “With crude oil prices under relentless pressure, the U.S. dollar remaining firm and global growth under intense scrutiny, the December durable goods orders report looks set to signal more softness in the factory sector. On a three-month moving average basis, non defence capital goods orders ex-aircraft were down nearly 3 per cent over the year in November, a poor sign for demand for core goods. While we expect headline orders to rise 0.6% on gains from a surge in aircraft orders, we expect orders ex-transportation to be up a modest 0.1 per cent on the month.”
- Pending Home Sales (Thurs.): Economists estimate sales climbed 0.9% in December. Here’s Bank of America Merrill Lynch: “Signed contracts for existing homes have been on the downtrend in recent months, but a strong labour market and favourable weather during the month warrant some payback. Expectations of a Fed rate hike may also have some impact, leading to homebuyers pulling the trigger on locking in a mortgage rate.”
- Employment Cost Index (Fri.): Economists estimate employment costs climbed 0.6% in Q4. Here’s Credit Suisse: “We estimate headline Employment Cost Index (total compensation) rose by 0.6% in Q4, after a similar 0.6% increase in Q3. A quarterly gain in line with our forecast would keep the ECI’s year-over-year growth rate at 2.0% (and would indicate that the long-awaited acceleration in compensation growth has not yet arrived). The professional & business services industry and the information industry, which drove much of the volatility in compensation in the prior quarters, probably grew at more trend-like paces in Q4. The two main components of the ECI are Wages & Salaries and Benefits. Data on average hourly earnings from the monthly Employment Report suggest that ECI Wages & Salaries grew by about 0.6% in the final quarter of 2015. We estimate that Benefits costs (which account for just over 30% of total compensation) rose by 0.5% last quarter.”
- GDP (Fri): Economists estimate GDP grew 0.8% in Q4. Personal consumption is estimated to have increased by 1.8%. Here’s BNP Paribas: “We expect flat GDP growth, saar, for Q4 2015 — a noticeable slowdown from Q3’s 2.0%, due to substantial drags from inventories (−0.9pp) and trade (−0.4pp). With multiple headwinds hitting the economy, including low commodities prices, weak external demand, and a strong dollar, final domestic demand is projected to have slowed considerably as well (1.3% q/q saar vs 3.0% previously). Consumption will likely be the largest contributor to growth.”
- Chicago Purchasing Manager Index (Fri.): Economists estimate this regional activity index climbed to 45.9 in January from 42.9 in December. Here’s Nomura: “The Chicago PMI spent most of 2015 in contraction territory. In December, the new orders and order backlog subindexes fell off sharply, suggesting that we are unlikely to see a rebound in industrial activity any time soon. The start of the new year has been quite turbulent in financial markets, oil prices have continued declining and other regional manufacturing surveys for January suggest that the tepid industrial activity continued into this year. As such, we forecast that the headline Chicago PMI remained in contraction territory, at 47.2 in January.”
- Univ. of Michigan Sentiment (Fri.): Economists estimate the measure of sentiment slipped to 93.0 in January from 93.3 in December. Here’s Barclays: “We look for the University of Michigan consumer sentiment index to be revised lower to 92.5 in the final January estimate, down from 93.3 in the preliminary print. The mid-month advance was led by a sharp improvement in the near-term economic outlook, which contrasts with the recent soft patch in economic data releases. Strong December employment growth reported on January 8 was likely responsible for this gain; however, we expect the improvement was over- stated and look for a downward revision at month-end.”
While most Wall Street strategists acknowledge that risks are elevated and the near-term prospects for earnings are depressed, many would nevertheless argue that the sell-off in stocks has presented an opportunity for long-term investors to buy. Take Deutsche Bank’s David Bianco, RBC’s Jonathan Golub, and BMO’s Brian Belski.
We’re in the midst of Q4 earnings announcement season, and the bulls seem to think that investors may find confident in what they expect to be better-than-expected earnings.
Having said that, here’s FactSet’s John Butters with the markets broad expectations for earnings: “The blended (combines actual results for companies that have reported and estimated results for companies yet to report) earnings decline for Q4 2015 is now -6.0%. At the sector level, the Energy and Materials sectors are reporting the largest year over-year decreases in earnings of all ten sectors, while the Telecom Services sector is reporting the highest earnings growth for the quarter … The blended revenue decline for Q4 2015 is now -3.5%. At the sector level, the Energy and Materials sectors are reporting the largest year-over-year decreases in sales of all ten sectors. On the other hand, the Telecom Services and Health Care sectors are reporting the highest growth in sales for the quarter … During the Q4 earnings season, the market will likely be watching for comments from companies regarding the impact on earnings and revenues of lower oil and gas prices, the stronger U.S. dollar, and slower global economic growth.”
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