This historic stock market melt-up of the past few weeks has given way to a new bout of fear and uncertainty. The Dow Jones Industrial Average is tumbling back toward its 20-day moving average for the first time in a month. And the lift we saw after the European Central Bank cut its deposit rate into negative territory has been reversed.
Sentiment had reached historic extremes, on many metrics hitting levels not seen since the 2007 and 2000 market tops. The bears went into hibernation.
But now, a cavalcade of concerns has the bulls in retreat. Let’s take a look at them.
Click to Enlarge The gap between hope and reality could be clearly seen in the way Wall Street analysts and investors had started to take as gospel the idea that the economic weakness seen in the first quarter was merely due to weather (Barclays Capital is looking for Q1 GDP growth to be revised down to a -2% contraction) and that an epic rebound in activity will soon be upon us.
Yet as recently as late May, analysts were looking for the economy to surge 3.5% in the second quarter.
Unfortunately, weak retail sales data out Thursday morning is calling that into question. Month-over-month growth was less than expected and so-called “core sales” less autos and gasoline were flat. The consensus was looking for a 0.5% rise. The trend, illustrated by clothing sales shown above, isn’t good and is calling into question the GDP optimism baked into the market at these prices.
Click to Enlarge Investors have similarly been very optimistic about the path of corporate earnings growth going forward as well as the valuation multiples assigned to those earnings.
The Street is looking for 5.4% in Q2, up from 2.1% in Q1, before accelerating to 9.7% in Q3 and 10.3% in Q4. That 10.3% figure is actually an improvement from the 9.9% expected at the start of the year. And according to Bank of America Merrill Lynch, analysts are now making more positive than negative revisions to earnings for the first time in two years.
On valuations, Bloomberg recently noted that the S&P 500 is now trading at 16.5 times forward earnings (with expectations quite optimistic) vs. 14.8 at the start of February. Moreover, Bespoke Investment Group highlighted that the S&P 500 was recently less than 20 points away from the average year-end target of 20 Wall Street strategists.
The problem is that corporate profitability will be challenged not only by the softness of the overall economy (which will hit revenues) but also from the rising labor costs associated with a tighter job market. Just look at the short-term unemployed as a share of the population (chart above), which is down to levels not seen since the 1950s. These are the folks businesses like to hire first.
No wonder more and more businesses are complaining of a labor shortage and are reporting higher labor costs.
Click to Enlarge In headlines seemingly ripped out of the Bush Administration era, Iraq is back in the news as an army of Islamic militants have captured two major cities in the north (one, Mosul, is Iraq’s second-largest city), captured hundreds of millions of dollars from a central bank branch, and have forced the displacement of more than 500,000 citizens. The extremists are from an organization known as the Islamic State of Iraq and the Levant (ISIL), also referred to as the Islamic State of Iraq and Syria (ISIS).
ISIL reportedly has taken the country’s largest oil refinery and have threatened to march on Baghdad.
An outright civil war is a rising threat as Iran reportedly sends elite commandos to bolster Baghdad while the Kurdish forces expand their control by taking oil-rich Kirkuk.
Crude oil has soared to nearly $107 a barrel in response — level not seen since last September — complicating the situation by pressuring already vulnerable consumers, pushing up inflation (which is already at the Federal Reserve’s 2% target), and potentially forcing short-term interest rates to rise sooner than expected.