A great many asset classes have been moving almost perfectly sideways for months now. That is unusual by any standard, but more so given the circumstances of late 2016. This might be indicative of doubts, some of which are being reinforced by weakness that might be characterized as “unexpected” but really no longer is.
Today’s data on Chinese exports is a good example. To hear economists tell it, the weak start to this year as leftover from last year was a close call but one that is now just history. This is the view that predominates of wishful thinking on the FOMC. And, at times, it did seem as if this was a realistic scenario; Chinese trade including imports did appear to be improving if only as less negative. But as optimism builds for that scenario it is regularly interrupted by its opposite; September exports fell very sharply, casting serious doubts as to what the real trajectory might be. Is it actual growth just delayed, or more of the same stagnation and worse?
Translating that into asset markets, especially stocks, it has resulted in what can only be described as indecision. In the past two weeks, however, the hesitancy has manifested in a highly unusual trading pattern. For the second week in a row, the S&P 500 just underwent another “inside week.” That is a technical term for where the index fails to match the prior week’s range at either the top or the bottom. The market trades the whole week “inside” the prior week’s range.
To do it once is rare; two in a row is especially so and thus perhaps deserving of attention in the context of this tentativeness over the past few months. As CNBC reported earlier this week:
“Inside weeks happening several weeks in a row is almost unheard of,” Miller Tabak equity strategist Matt Maley commented Monday on CNBC’s “Trading Nation,” calling it a sign that investors “don’t know what’s going to happen next — they don’t know what to do with their money.”
According to CNBC, the last three times two “inside weeks” in a row were spotted was February 2008, June 2007, and January 2000. I am not a big proponent of technical analysis, but where it may match fundamental possibilities and do so in such an outlier fashion needs to be at least considered. Those periods are immediately recognizable for their close (economic) comparisons to how the current environment may be described – and how markets weren’t sure then as now what to make of all that.
In terms of earnings, Q3 earnings season is underway and like Chinese exports it is already set to disappoint yet again. Some estimates for S&P 500 EPS are still stubbornly negative.
According to FactSet, analysts collectively expect S&P 500 companies’ third-quarter earnings to show a roughly 2 percent drop from the third quarter of 2015. This, according to FactSet, would represent the sixth straight quarter of year-over-year earnings declines, for the first such streak going back to the third quarter of 2008, which is when the company started collecting such data. [emphasis added]
And that is surely one of the factors playing upon market uncertainty; earnings by now “should” be growing again after so much prolonged negativity. It is this expectation for “transitory” weakness that has likely been holding stock prices largely where they are, a parallel to the economic narrative that late last year was nothing more than a close call. But as earnings contraction, like economic contraction, instead lingers still further now into the completed third quarter, the market has to really start to consider that “something” might be truly wrong with that expectation.
As I wrote several months ago, “The market appears to be waiting for earnings to ‘correct’ rather than prices.” As earnings increasingly refuse the license, markets are left contemplating that which was thought impossible; that the economy and fundamental environment as represented by earnings is at best stuck in a protracted and very real form of stagnation (I call it depression). At prices that are far too often valued comparable to only dot-com levels, this is a huge problem as investors are paying huge premiums for at best malaise. You don’t pay 20+ times earnings for a rut, those premium prices are reserved for actually rapid and inarguable growth.
It is, I believe, the possible last remnants of QE religion in stocks. Investors were willing to pay up for just the prospects for rapid growth that especially QE3 and QE4 would surely deliver. Like economists, stock holders viewed the arrival of the “rising dollar” with suspicion but still holding on to that QE-positive scenario as if only delayed by it.
The continuation of 2015 processes well into 2016 increasingly threatens those expectations. In other words, a “market” waiting for earnings to “correct” higher fulfilling if belatedly those expectations of QE effectiveness begins to understand that just isn’t very likely, then expectations start to turn toward paralysis as to what other piece of P/E might have to instead “correct” to restore much needed balance. The market seems dazed as if not wanting to believe this is possible, but accepting at least in part that though Janet Yellen still says it isn’t it really and truly is.