Friday, June 30, 2013
The markets appear to have taken a collective sigh of relief, helping stabilize bond yields and pushing stocks higher. The prevailing view appears to be that there is no imminent threat of the Fed getting out of the QE business. This view has been propagated by Fed officials in recent days, who seem to be climbing down from Bernanke’s fairly explicit guidance and timeline on the issue.
Fed officials are giving the impression that they are merely trying to ‘clarify’ the Fed’s true intentions – that the explanations are part of their communication job. But forgive me for being a bit skeptical of these clarifications. The way I see it, the Fed has been stared down by the bond market.
The Fed has long been of the belief that bond yields should be a function of the size of its balance sheet and not the pace of its monthly purchases - Bernanke has stated this view himself on multiple occasions. From their perspective, yields should remain stable as long as they don’t start cutting the size of their balance sheet, which they have all along been saying was a long time off. But the bond market called the Fed’s bluff, by pushing benchmark yields by almost 100 basis points in a few short weeks, at the mere mention of tapering. It's amazing that the Fed was surprised at this reaction - talk about living in a bubble.
This puts the Fed in a tight spot. They appreciate the diminishing returns and likely risks of continuing with the QE program. But they can’t afford to let the bond market unwind the gains in lower yields that they spent so much money to achieve. The emerging equilibrium of the last few days is not only unstable but also unsustainable. The Fed may not have the stomach for this confrontation at this stage, but it may not be able to avoid it forever. And this is the key vulnerability for this market.
The bond market may have won the first round in its match-up with the Fed, but the issue is far from over and will likely remain with us for a while. But the 2013 Q2 earnings season is upon us and gives us some distraction from the more exciting Fed debate. And on that front, this morning’s disappointing reports from BlackBerry (BBRY) and Accenture (ACN) likely showcase another source of vulnerability for this market.
Granted BlackBerry has been fighting to stay relevant ever since the arrival of Apple’s (AAPL) iPhone and is by no measure a bellwether for Tech sector earnings. The fact that Apple itself has been struggling lately tells us something about the extremely short shelf lives in the Tech space, particularly in the handset market. But Accenture may not be that irrelevant as this consulting firm sells its advisory services to all the major companies. The Accenture weakness confirms what we have heard from others like Oracle (ORCL) and FedEx (FDX) in this reporting cycle.
The coming Q2 earnings season is not so much about what happened in Q2, but rather what Q2 results tell us about the second half of the year. Keep in mind that while expectations for Q2 earnings growth remain extremely easy to beat, the same may not be the case for Q3 and beyond. Just to put the variance in context, while earnings are expected to be down -0.3% in Q2 after the +2.4% growth Q1, consensus expectations are for a material growth pick up in the second half of the year.
Total earnings are expected to surpass Q1’s all-time record quarterly haul and be up by more than 5% in Q3. The expectation is for another record in Q4 and a double-digit growth rate. In the big-picture sense, total earnings are expected to be up +9.7% in the second half after eking out only +1.1% in the first half.
You can get to those growth numbers only if you get the commensurate momentum in the economy. My sense is that the economy is in decent shape and will most likely produce an improved growth performance in the second half than what we got in the first half. But it may not be robust enough to generate the type of earnings growth rates implied by consensus expectations. What this means is that the Q2 earnings season will likely be accompanied by an acceleration in negative earnings revisions.
Investors didn’t show much anxiety to negative estimate revisions in recent quarters, helped to a large extent by the Fed’s QE program. Will it be different in a post-QE world? We will have to wait to find out.
Director of Research