"Worry is a cycle of inefficient thoughts whirling around a center of fear." -- Corrie ten Boom
Some mainstream media types seem worried that this weekend's G20 meeting in Baden-Baden, Germany, did not come off so well. Germany's Minister of Finance Wolfgang Schauble (a tough guy in his own right) seemed frustrated. He indicated that Secretary of the Treasury Steve Mnuchin had "no mandate" to settle his nation's positions on trade. Schauble said "We have reached an impasse", and "We did go to great lengths, we tried everything, we went down many avenues together, and unilaterally." Poor Wolfgang.
Steve Mnuchin was able to persuade the G20 as a group to drop their prohibitive language regarding economic protectionism. More specifically, most of the rest of the G20 tried to persuade Mnuchin to allow such wording, or to allow global warming to gain a mention in that closely watched release. We're a long way from coming to any conclusions on trade. Heck, we don't even know exactly where the cards will fall from a domestic point of view, but it is said that most of the rest of the G20 left Germany confused. The less stringent language used in the official statement allows the U.S. to use sanctions where necessary, and to react to what the administration believes to be unfair trading practices.
Where I come from, when your will is imposed upon a larger group, and said group (your competitors) leave both frustrated and confused ... well, that's pretty darned successful.
Equity valuations, by traditional metrics, are a little high. That's not news. You've been watching that story develop for several years now, and since the election, this recent truth has only been exacerbated. Everyone is cozy with an S&P 500 broadly colored with a forward-looking PE ratio of a rough 16. The current consensus estimate for S&P 500 composite earnings for full year 2017 is running at around $131, which would place today's valuation at about 18.3x. "Animal spirits" is a term we've heard thrown around, and those spirits really cannot be discounted, nor measured, yet certainly must be taken seriously when one factors out the supply/demand equation.
Still, at some point, like an oversized shirt handed down from your very large cousin, earnings must grow into what price discovery has wrought. Or else that shirt will never fit. We do not get to those levels without tax reform, without the infrastructure/defense build, or without further deregulation. As we approach this week, expectations for first-quarter earnings are starting to be reeled in a bit. Health care reform will likely be voted on in Congress this week. A satisfactory resolution to that issue is central to moving on, economically, and toward filling out that shirt.
Parts of this market are ill. I'm not talking about the obvious, let's say the energy sector, which is held hostage by market prices for crude and natural gas. I'm referring to two areas that many traders traditionally look to for leadership, or market support. The S&P 500 is up more than 6% year to date. Really, although it feels like the market has gone sideways for what seems like forever, it's only been about three weeks or so. Starting the chart with the New Year does make both the transports and the small-caps look a lot more vulnerable than the marketplace in general.
As "Dow Theory" makes plain, as go the transports, so goes the market -- eventually. The Dow Jones Transportation Average is on the plus side for the year, only to the tune of about 1.1%. The transports as a group are fractured, however, and I think that the theorist crowd may have to take a pass on this one. The rails are stronger than the rest. That's the group that will primarily move goods made by the industrials. The manufacturing sector of the U.S. economy has clearly found a bottom, and is now working from a place of obvious strength.
The railroads in aggregate are up 8% this year. Trucking services are also up, about 2.2%, which is encouraging. The trouble with the transports is almost all confined to the airlines (-3% ytd), and delivery services (-1.3% ytd). The airlines are currently dealing with competition due to rising capacity and rising labor costs, thus compressing margins. They must be looked at separately from the rails. As for delivery services, FedEx (FDX) reports quarterly earnings tomorrow night, and could be as important as any other release this week.
Taking a look at the small-caps makes one wonder if they really are all that sick. The Russell 2000 is still up 2.5% ytd and has outperformed the broader market, albeit by a gap that is narrowing since election day. This drawing of the small-caps back to the pack could be seen as expected, given the delays that we have seen in administering to the trajectory of the president's economic platform. Corporate tax cuts, spending on infrastructure and a potentially strong dollar environment all lend themselves toward improved business conditions for smaller firms due to their higher effective tax rates and their generally domestic-based business models.
Worried? Always concerned. Concerned about the broad marketplace due to the recent underperformance of the airlines, and the small-caps? Only mildly. Concerned about earnings not filling out that "hand-me-down" t-shirt? Yes, valuations are on my mind. I am definitely putting on less risk of late, and taking action to preserve gains already made. Let's see how long health care drags on.
08:30 - Fed Speaker: Chicago Fed President Charles Evans will open a week very heavy in Fed speakers with an interview with Maria Bartiromo on the Fox Business Network. Evans, who is a voting member of the FOMC, is expected to answer questions on current economic conditions and forward looking monetary policy.
13:10 - Fed Speaker: On a day void of meaningful economic data, we'll be exposed to Chicago Fed President Charles Evans for a second time. Evans will speak from New York City, and then take questions from both the audience and the media. Though formerly considered to be a dove, Evans did vote with the majority at the policy meeting last week that resulted in a third quarter point increase in the Fed Funds Rate over a 15-month period.
Sarge's Trading Levels
These are my levels to watch today for where I think that the S&P 500, and the Russell 2000 might either pause or turn.
SPX: 2398, 2390, 2384, 2377, 2365, 2357
RUT: 1414, 1405, 1398, 1390, 1382, 1371
Monday's Earnings Highlight (Consensus EPS Expectations)
Before the Open: (MOV) ($0.23)