The bulk of the S&P 500’s fourth quarter results have been announced and the average stock has posted a 5.7% annual sales increase and a 14.3% annual earnings increase. This represents the fifth quarter in a row of double-digit earnings growth for the S&P 500.
In the meantime, CNBC keeps talking about an “earnings recession,” which is starting to spook many investors. The analyst community is now forecasting that the S&P 500’s first quarter earnings will decline at an annual pace of 2.9% due largely to more difficult year over year earnings comparisons. FactSet is expecting that only 4 of the 11 sectors in the S&P 500 will post positive earning growth in the first quarter, lead by Healthcare (up 5.4%), Utilities (up 3.9%), Industrials (up 3.1%) and Real Estate (up 1.9%).
Severe winter weather has week impacted much of the U.S. in recent weeks, so this is a good time to remind investors that first quarter GDP is frequently adversely impacted by the weather. The Atlanta Fed is now expecting just 0.5% annual GDP growth for the first quarter, which is not too bad, since first quarter GDP is often negative when there is severe winter weather.
Interestingly, the final fourth quarter GDP is expected to be revised a bit lower, since on Wednesday, the Commerce Department announced that the U.S. trade deficit soared 18.8% to the highest level in a decade to $59.8 billion in December, as U.S. exports declined 1.9% to $205.1 billion, while imports rose 2.1% to $264.9 billion. I should add that some economists believe that imports soared in December because businesses were trying to build inventories, just in case tariffs were increased.
Speaking of tariffs, there has been a lot talk about a favorable resolution to the U.S. and China trade spat. Specifically, the U.S. is prepared to remove tariffs on $200 billion of Chinese goods in exchange for China lowering tariffs on U.S. auto, chemical, farm and other products. Furthermore, China would buy $18 billion in natural gas from Cheniere Energy and would not retaliate by bringing recent U.S. tariffs in a formal complaint before the World Trade Organization. A signing ceremony between President Trump and President Xi is expected in the next several weeks. In the meantime, China’s exports plunged 20.7% in February compared to a year ago, which is a sign of weak global growth, so I suspect that China wants to get rid of U.S. tariffs as soon as possible to further boost its exports.
There was a lot of positive economic news last week. On Tuesday, the Institute of Supply Management (ISM) announced that its non-manufacturing, service index surged to 59.7 in February, up from 56.7 in January, which was substantially above economists’ consensus estimate of 57.4. The ISM components for new orders and business activity were especially robust at 65.2 and 64.7, respectively. Additionally, all 18 ISM components rose in February, so this was truly a spectacular report for the ISM service index!
The Commerce Department on Tuesday reported that new home sales rose 3.7% in December to an annual rate of 621,000. For all of 2018, new home sales declined by 2.4%. Interestingly, median sales prices for new homes in December were $318,600, which is 7% lower than a year ago. At the current annual sales pace, there is now a 6.6-month supply of new homes for sale, which is high, so median home prices may remain under pressure. Overall, this was a very positive report for both new home sales and moderating home prices. Now that home and rental prices are finally moderating, the Fed will be much less likely to raise key interest rates.
The Commerce Department announced on Friday that new housing starts surged 18.6% in January to an annual pace of 1.23 million. Residential building permits rose a much more modest 1.4% in January to a 1.345 million annual paces. Both new housing starts and building permits came in at a much higher pace than expected, since economists were expecting new housing starts to rise 9.5% and building permits to decline 2.7%. Overall, it appears that the supply of housing will increase, which should further help median home prices to stabilize.
On Wednesday, the Fed released their Beige Book survey, where 10 of the Fed’s 12 districts saw “slight to moderate” growth, while St. Louis and Philadelphia reported “flat economic conditions.” Interestingly, the Beige Book survey had a surprisingly somber tone and noted that six Fed districts note slower economic activity due to the partial federal government shutdown that adversely impacted auto sales, retail sales, tourism, real estate, restaurants, manufacturing and staffing services. As a result, the Beige Book survey reported that retail sales were “mixed.” Also interesting is that the Beige Book survey cited the higher cost of credit as a reason for weak auto sales. Only the labor market was cited as a bright spot in the Beige Book survey. There is no doubt that the Fed will remain “data dependent” and is not likely to raise key interest rates anytime soon.
The big surprise last week was that on Thursday, the European Central Bank (ECB) stunned central bank observers by unveiling plans to stimulate the Eurozone economic growth. This was a major policy reversal, since not only did the ECB say that they would hold interest rates steady for the remainder of 2019, plus announced low cost loans to banks to help shore up their capital base. The first batch of ECB loans will be offered in September with a two-year maturity. The ECB slashed its 2018 GDP forecast to 1.1%, down from 1.7% back in December. ECB President, Mario Draghi, said “The persistence of uncertainties related to geopolitical factors, the threat of protectionism and vulnerabilities in emerging markets appears to be leaving marks on economic sentiment.” Draghi also added that the probability of a Eurozone recession was “very low,” but clearly the uncertainty surrounding Brexit on March 29th is a wild card that must be taken into consideration.
On Friday, it was announced that German factory orders declined 2.6% in January, which was substantially below economists’ consensus estimate of a 0.5% increase and the biggest monthly decline since last June. Orders outside the Eurozone were especially weak, which is consistent with China’s plunging exports. Domestic orders also fell, so if Germany follows Italy into a recession, the ECB will have to get much more aggressive, especially since Brexit is causing so much uncertainty.
Here is the U.S., job growth maybe starting to slow down. On Wednesday, ADP reported that 183,000 private payroll jobs were created in February, which was slightly better than economists’ consensus estimate of 180,000, but this was the slowest monthly pace since last November. However, the January ADP private payroll report was revised up to an impressive 300,000, up from 213,000 previously estimated. ADP continues to be the most reliable payroll report.
The Labor Department reported on Friday that 20,000 payroll jobs were created in February, which was substantially below analysts’ consensus estimate of 180,000 and the weakest report in 17 months. Despite this disappointing payroll report, the unemployment rate plunged to 3.8% in February, down from 4% in January. There is no doubt that the partial federal government shutdown distorted unemployment rate as well as some big snowstorms in February. Additionally, the proportion of the workforce that was part time declined to 7.3% in February, down from 8.1% in January, as jobs in construction, mining and retail declined. Interestingly, the December and January payroll reports were revised up to 227,000 (up from 222,000) and 311,000 (up from 304,000), so I would not be surprised if February’s payroll report is revised higher in the upcoming months. The best news was the February payroll report average hourly earnings rose by 0.4% or 11 cents per hour to $27.66 per hour in February and have risen an impressive 3.4% in the past 12 months.
Interestingly, this wage growth has not been inflationary, since the U.S economy continues to boost its productivity. Specifically, U.S. productivity in the fourth quarter rose at an annual rate of 1.9% and in the past 12 months grew at a robust 2.2% pace. In the past decade, productivity has risen at a 1.3% annual pace, so the acceleration in productivity in the past 12 months, seems to be driven partially by increased automation due to ongoing labor shortages for skilled workers.
Overall, we remain in a “Goldilocks” environment with accommodative central banks and moderating interest rates due to slowly global growth and serious Brexit concerns. There is no doubt that there is a global economic slowdown underway due to plunging Chinese exports and German factory orders, so the ECB has decided to provide new stimulus to try to avoid a Eurozone recession.
The key for investors in the upcoming months will be to concentrate on dividend growth stocks as well as conservative growth stocks that are still forecasted to post strong earnings momentum in a decelerating earnings environment. Our A-rated (Strong Buy) & B-rated (Buy) stocks in both Dividend Grader and Stock Grader are expected to remain an oasis for investors and should continue to benefit from persistent institutional buying pressure in an increasingly narrow stock market environment. See link:
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