The Line Between Progress and Reality Is Blurred
The gap between the rising U.S. stock market and the visible deceleration in the rate of global economic growth has been widening in a more dramatic and conspicuous fashion over the past several weeks, and my cautious market view is growing more bearish.
The weakness in the most recent U.S. March ISM release, the fall in consumer and small business confidence, disappointing March retail sales, a sharp drop in the Citigroup U.S. Surprise Index, worsening EU economies and/or any of a number of other factors affirm that global growth is slowing to a rate that will likely imperil the ambitious consensus for corporate profits. Other recent endorsements of the slowing global growth thesis include (most notably) the intensification in the drop in commodity prices (copper and gold, in particular). Also:
- U.S. Treasury yields are falling;
- the yield curve is flattening;
- the high-yield credit market is no longer rallying;
- the economically sensitive transportation index is faltering;
- there has been a near-record percentage in the number of companies issuing earnings warnings;
- the U.S. stock market leadership is focused on defensive high-quality consumer staple stocks (paying relatively high dividends) as opposed to aggressive, high-beta stocks; and
- with the exception of the U.S. and Japan, many markets around the world are struggling.
Consensus Corporate Profits Expectations Are Overly OptimisticIf we distill my multiple concerns into one concern, it is the more difficult earnings backdrop that should become increasingly apparent to market participants in the near term. Given that the growth in nominal U.S. GDP is trending at under 4%, corporations have little in the way of pricing power. And with profit margins at all-time highs and nearly 70% above the mean levels achieved in the last seven decades, earnings forecasts are threatened based on slowing top-line growth and a likely mean reversion in margins. Though early in the reporting period, a chill in early first-quarter earnings is already visible (across many industries). Fastenal (FAST), FedEx (FDX), J.B. Hunt Transport Services (JBHT), Harris Corporation (HRS) and many leading technology companies have missed consensus forecasts and/or lowered forward guidance -- even during a first quarter in which the U.S. will likely exhibit +3% real GDP. I remain fearful of what will happen to earnings when the rate of real growth in the domestic economy halves to around +1.5% over the last three quarters of the year.
An Extreme Short-Term OverboughtUp to now there is little question that investors are feeling the pressure of underperformance, chasing price strength and ignoring the warning signs of slowing global economic growth, a worsening profit outlook and expanding technical divergences (and low NYSE volume). Hedge funds are now at their highest net long exposure in some time, sentiment studies are uniformly bullish, and retail investors are warming up to stocks. As a result of these factors (and others), stocks are overbought -- maybe even dramatically so. But I see it as only a matter of time until reality adversely impacts stocks. In fact, it is my view that this could happen momentarily.
The Bottom LineIt is for the reasons above (and others) that I am short of the market.
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