The sharing (many would call it over-sharing) by Federal Reserve officials of their plans for eventually reducing the flow of money being directed into financial markets has firmly fixed Wall Street’s twitchy gaze on every quantum of incoming economic data.
Now all Wall Street needs is some confidence that the coming summer news on the economy and corporate profits will be good enough to substantiate the sturdy performance of stocks in the first half of 2013.
The two broad areas that will soon come under high-stakes scrutiny are the employment “tell” for June, and second-quarter company results in a patchy-at-best world economy.
Fed Chairman Ben Bernanke’s clearly stated intention to sunset the central bank’s $85 billion-per-month bond-buying program in, perhaps, a year rattled markets that had grown complacent by "heads-I-win-tails-you-lose" thinking. Good economic news early this year meant better profits and a still generous Fed; bad news meant an even more resolutely solicitous Fed to finance risk taking.
Since Bernanke spoke and the stock market rushed to a nearly 6% retreat and Treasury yields shot up to 2.5%, a team of Fed messengers has commandeered microphones to tell investors they overreacted, that any change would be “data-dependent.”
This is what’s heightening the attention paid to every number that hits the wires. And given that the Fed has put out there that it expects a better economy and is looking for a chance to ease back, investors should now hope for better data. They need to assume the economy would now have to take an uncomfortably nasty turn for the worse to get the Fed back on the offensive – likely from weaker levels in the markets.
The very recent run of economic statistics has supported the idea of a firmer domestic economy, with pending-home sales, durable goods and personal-income growth arriving on the stronger end of forecasts. With Fed talkers fighting the perception that loose money will become less loose preemptively, the fact that stocks found their footing in the past week reinforces the idea that better economic news is taken as a positive.
And so this Friday’s monthly employment report, coming on an odd island trading day between the Independence Day holiday and a weekend, is easily the next most important test of the “just right” bullish argument. The current forecast is for a gain of 165,000 net jobs in June, a bit lower than the six-month average, and a downtick in the unemployment rate to 7.5%.
Barclays strategist Barry Knapp argues that the likely market response to Friday’s data is more likely to be negative than positive. He says, “The number would have to be extremely weak to change the outlook for Fed policy.” In other words, the market should recognize that the Fed’s default mode is to begin an exit process – unless the data get frighteningly ugly. Merely “OK” data won’t evoke much friendlier noises from policy makers.
In an odd way, though, investors might wish for employment data – and especially the unemployment rate – to improve more slowly than measures of capital spending and global industrial production. The latter areas are much more important for big-company profits, yet the former seem to provide the Fed’s threshold triggers for withdrawing stimulus.
A fast-falling unemployment rate at a time when business-investment bellwethers lag (note the weak Chicago Purchasing Managers Index Friday) isn’t a good blend for investors looking for a tidy handoff to a re-acceleration of earnings and stock prices.
The profit pinch
The best that can be said along the corporate-earnings front is that, once again this quarter, expectations have been hammered pretty low. Among the 108 S&P 500 companies that have issued updated guidance for the second quarter, a record 87 of the outlooks have been negative, according to FactSet Research. The percentage of negative guidance announcements versus positive is also running at an all-time record – topping the first quarter of 2013. Overall, revenue is expected now to have declined a smidge for the S&P 500 in the quarter just ended, says S&P Capital IQ.
Chris Baggini, portfolio manager at Turner Investments, says there remains a wide gap between the full-year aggregate profit forecasts of optimistic bottom-up company analysts and more cautious top-down investment strategists. These figures should converge as the quarterly results come in, perhaps buffeting the indexes a bit.
With both profit margins at record highs and foreign economies slowing or shrinking, companies have nearly run out of levers to pull to keep earnings growing absent an economic re-acceleration, after years of cheap-debt refinancing, cost-cutting and share buybacks bolstered results.
One ugly example came Friday as IT-services giant Accenture Ltd.’s (ACN) results fell way sort of forecasts, costing its stock 10% of market value and dragging down International Business Machines Corp. (IBM) shares with it.
Yet, broadly speaking, investors are not conditioned to expect dazzling results. The first quarter saw scant overall profit growth, which hardly blunted the market rally – though perhaps the widespread expectation of Fed help all the way to the horizon contributed.
This is why the current cycle places investors in a tricky spot. The last time the Fed was trying to condition the market for less-easy money in 2004, stocks suffered a few 5% setbacks – but that was only the second full year of a corporate-profit recovery. Now, as the Fed inches toward cinching-up policy, we’re in the fifth year, with margins near record highs and price-earnings multiples expanded substantially versus a year ago.
With stocks no longer outright cheap and a global economy with plenty to prove, the market might be surfing from headline to headline for a while this summer.