Keep in mind, however, that markets almost always over-react in the short term. It is very likely that the turmoil in global markets today is just such an over-reaction. We may not know when the Fed will start tapering, but we know for a fact that they don’t want to rock the boat.

Sheraz Mian
Director of Research
    
 

The issue of Bernaneke’s retirement at the start of next year may or may not be relevant to the future of QE. But the potentially smaller supply of treasury bonds in the coming months as a result of lower budget deficit is a strong argument for tapering the pace of bond purchases. My sense is that the FOMC will move towards changing the QE program at the June meeting after having seen the May non-farm payroll report earlier that month.

We will be getting the minutes of the last FOMC meeting later this afternoon as well that will shed more light on the QE debate from within the committee. But the Bernanke testimony has the potential to steal the thunder from that report.

Bernanke aside, we have underwhelming earnings reports from Target (TGT) and Lowe’s (LOW) this morning while Hewlett-Packard (HPQ) reports after the close. We have the usual comments about weather from Target that featured in the weak report from Wal-Mart (WMT) a few days back. But the reality is that the payroll tax changes from earlier this year may be a bigger issue for the Wal-Mart and Target shoppers than analysts are factoring in at present. The Lowe’s miss shows that the rising tide of the housing market may not be enough to lift the fortunes of all home-improvement retailers. At least that’s what we see in the disparity between Home Depot (HD) and Lowe’s.

Sheraz Mian
Director of Research

Is this a trial balloon by the Fed to prepare the market for the eventual changes to the program or the wishes of FOMC hawks who have long been arguing along these lines?

Hard to tell at this stage. But the reality is that the Bernanke Fed justifiably takes pride in its transparency and unambiguous communications. And they would take their time in preparing investors for the long-anticipated changes. The reality is that as extraordinary as the QE program has been in its size, scope and market impact, the unwinding process will be even more significant. One could envision the Fed stopping the bond purchases at some future date, but letting its balance sheet shrink back at a slow and methodical process over an extended period of time through natural maturities.

This is an extremely useful debate given the centrality of the program to the market's gains. And the debate may be timely as well. After all, the economy seems to chugging along just fine, with momentum in housing appearing to offset some of the headwinds from the payroll tax increases and the budget sequester. At least that’s what some of the more recent data, like Monday’s Retail Sales numbers, seem to suggest. We have plenty of important economic data on tap later this week that will shed more light on the economy.

The Fed’s goal will be to change the program without materially disrupting the market. Market disruptions mean sudden changes to interest rates, foreign exchange rates, and the values of other asset classes. But it's hard to envision the stock market hanging on its recent gains in the absence of an active QE program. I have long been of the view that the stock market's record level is not reflective of fundamental realities. As such, most of the recent gains will not be sustainable in a world after QE.

Sheraz Mian
Director of Research
 

Media reports about the Fed’s plans to modify the bond-purchase program will also be in play. However, the odds of a cold-turkey shift on the QE front are low given the Bernanke Fed’s reputation for transparency and openness.

We start the week on a positive note from the economy, with April Retail Sales coming in better than expected. The expectation was for ‘headline’ Retail Sales growth to be in the negative territory given the decline in gasoline prices. But strength in autos, building materials, clothing and online purchases more than offset the gasoline sales drop – gasoline sales dropped by the largest amount since December 2008.

‘Core’ Retail Sales or the so-called ‘controlled group’, which excludes gasoline, autos, and building materials, were up nicely at +0.5%. Forecasters use the ‘core’ data in their GDP forecasts as a proxy for consumer spending.

Estimates for GDP growth in the current period were steadily coming down in recent days, but today’s report will likely help reverse that trend to some extent. It appears that consumers have not let the payroll tax changes and the budget sequester weigh on their spending behavior.

It isn’t clear at this stage what could be driving the steady trend in consumer spending. Perhaps they are dipping into their savings or may be wage growth has actually been better than what economic data has been showing. In any case, the Retail Sales strength is a net positive for the economy and is in-line with last month’s positive payroll reading.

Today’s soft pre-open sentiment notwithstanding, stocks remain at record levels and show no signs of changing trends. But signs of stability in the economy, as today’s Retail Sales numbers would show, would strengthen the hands of Fed hawks who want to curtail the pace of bond purchases.

Plenty of economic data this week about inflation, housing, and the manufacturing sector will shed further light on the state of the U.S. economy. But as long as there are no changes to the Fed outlook, the stock market can be expected to remain on its current course.

Sheraz Mian

Director of Research

Pre-market sentiment is pointing towards a positive start to today’s market action, at least on the open. But stocks may struggle to sustain the momentum throughout today’s session given the lack of any economic or earnings news. That said, the market’s push into record territory has not exactly been driven by any specific data.  

We could actually say with a lot of confidence that the market’s gravity-defying performance has come through in spite of economic and earnings data and not because of it. The Fed is the key driver of the outsized market gains. But to be fair to the Fed, they are not alone doing this – we effectively have a global central bank cartel comprised of the Bank of Japan (BoJ), the European Central Bank, Bank of England and others.

The BoJ has come late to this central bank party, but they are the most aggressive of all the central banks. The resultant drop in the Japanese Yen and momentum in Japanese stocks are in a league of their own. The bottom line is that investors remain confident that as long as the Fed and other global central banks keep the money spigots open, they don’t need to worry too much about economic and earnings data.

Next week’s data docket includes the April Retail Sales report and a host of inflation and housing reports. We will also get the Philly Fed and Empire State regional manufacturing surveys. Hard to envision any of these reports getting the market off its positive trend-line, but Monday’s Retail Sales report could be the most significant.

Earlier fears of the payroll tax changes and the budget sequester have not shown up in consumption numbers as yet, but that doesn’t mean they wouldn’t have any effect at all. Manufacturing has lost some of its oomph lately as well and next week’s data will shed some more light on developments in that key area.

The earnings season is effectively over, with more than 90% of the market cap of the S&P 500 already out with Q1 results. Earnings growth has turned out to be better relative to pre-season expectations, but there is no revenue growth and the majority of companies came short of top-line expectations.

Expectations for Q2 have come down, largely reflecting the overall negative tone of management guidance, but estimates for the back half of 2013 and full year 2014 have held up quite good. Given what we have seen in Q1 and the last few quarters, it is hard to have any confidence in those expectations.

But investors don’t seem to losing any sleep over it. Investors seem to believe that as long as the Fed remains on its easy-money policy track, they don’t need to worry much about pesky issues like economic and earnings data.

Sheraz Mian
Director of Research

Total earnings for these 423 companies are up +3.7% from the same period last year, with 66.4% beating earnings expectations. Revenues are down -0.8%, with only 41.1% of the companies coming ahead of top-line expectations. The composite growth rate for Q1, where we combine the results of the 423 companies that have reported results with the 77 still to come, is for +2.4% growth in earnings on -0.7% lower revenues. This earnings growth rate compares to the modest decline expected at the start of the reporting season.

Consensus expectations for the coming quarters have started coming down, with total earnings in 2013 Q2 now expected to be up +1.6% on -0.5% lower revenues. This is a drop from the +3.9% total earnings growth expected in Q2 on +0.5% higher revenues less than four weeks ago. Expectations for the back half of the year still remain elevated, though they have started coming down modestly. For full-year 2013, total earnings are now expected to be up +6.1%, down from the +6.8% growth pace expected a few weeks back.

Sheraz Mian
Director of Research

The ‘headline’ April jobs number of 165K came in better than expectations of about 150K and March’s 138K level (revised higher from 88K). The consensus estimate did not fall much following the weaker than expected report from ADP on Wednesday, though many were ‘ready’ for another soft jobs report. Today’s positive jobs report follows weeks of soft economic data, including this week’s weaker than expected ISM and ADP (ADP) surveys. We get the service-sector ISM survey sector a little later today, but the manufacturing ISM survey earlier this week was barely in the positive territory.

The revisions trend was particularly positive, with net positive revisions to March and February adding 114K to the total. March’s originally reported 88K tally was revised higher to 138K and February was raised to 332K from 268K. Average weekly hours for the private sector ticked down by 0.2 hours to 34.4, while average hourly earnings went up by 4 cents $23.87. The labor force participation rate remained unchanged from the March level at 63.3%, but down from 63.6% in January.

Private sector jobs totaled 176K in April, up from 154K in March, but significantly below February’s 319K tally. The private sector gains were concentrated in professional and business services, food services, retail, and healthcare. Professional and business services added 73K jobs in the month, bringing the industry’s 12-month tally to 587K (Temporary jobs were up +31K in April). Contrary to fears, Retail added 29K jobs in April, which should help ease concerns that the payroll tax changes were a big drag for the sector. Construction and manufacturing didn’t add any jobs during the month.  

This is a good report and should help ease concerns about the economy a bit. And it’s a market-friendly report in the sense that it doesn’t affect expectations about the Fed. Monthly job gains in the April vicinity are not strong enough to prompt the Fed to scale back its bond purchase program. The market’s upbeat response to the recent spate of soft economic reports that has pushed stocks into record territory is based on the assurance that the Fed will continue its cheap money policy. Today’s jobs report wouldn’t change that view.

Sheraz Mian
Director of Research

The market sees all evidence of economic weakness as guaranteeing continued Fed support. As a result, stocks have moved into record territory as economic and earnings data have come on the weak side.

We have the manufacturing ISM reading coming out a little later, but the jobs data from Automatic Data Processing (ADP) this morning was clearly off the mark. The ADP miss today means that estimates for Friday’s non-farm payroll report from the government’s Bureau of Labor Statistics (BLS) will likely come down. But I would be surprised if the market would react differently in any material way to today’s soft economic data.

The April ADP jobs tally came in weaker than expected this morning: up +119K vs. consensus of +155K. The March tally was revised lower -27K to 131K. This report is expected to serve as a preview of the non-farm payroll report from the government’s BLS coming out on Friday.

The consensus expectation is for ‘headline’ BLS gains of +150K. A straight extrapolation of today’s ADP report would mean that Friday’s BLS number would be around 110K instead of the 150K consensus expectation pre-ADP.

Small businesses, with employers having less than 50 employees, added +50K jobs in April. Medium-sized businesses (less than 500 employees) added +26K jobs in April, while large businesses (1000+ employees) added +43K jobs during the month. Weakness in the small-business group is the most pronounced, with some anecdotal evidence that changes to healthcare mandates may be having an impact on hiring trends in that space.
 
The goods-producing sectors added +6K jobs in April, substantially lower than the last few months, while the services-providing sector’s tally of +113K jobs in the month was not substantially different from sector’s recent pace. Construction added +15K jobs, a slower pace than would be expected given the broad momentum in the sector. Manufacturing lost -10K jobs, reconfirming the negative trends from other data points about the factory sector.

We will see how the April manufacturing ISM reading shows a little later, though the Chicago PMI numbers from Tuesday don’t bode well on that front.

Sheraz Mian

Director of Research

Total earnings for these 295 companies are up +2.2% from the same period last year, with 66.8% beating earnings expectations. Revenues are down -0.4%, with only 38.6% of the companies coming ahead of top-line expectations. The median surprise is +3.2% on the earnings side and negative -0.4% on the revenue side thus far. The +2.2% earnings growth rate is comparable to what this same group of companies achieved in 2012 Q4 and preceding few quarters, though the revenue performance is decidedly on the weak side.
 
The composite growth rate for Q1, where we combine the results of the 295 companies that are out with the 205 still to come, is for +1.4% growth in earnings on +0.2% higher revenues. This earnings performance would normally be inconsistent with a stock market in record territory. But these are not ‘normal’ times; the Fed has rigged the system. And fighting the Fed is never the best course of action.

Sheraz Mian
Director of Research
 

We have a ton of earnings reports this morning as well. And barring a few standout negative surprises, most of the reports were along the lines of what we have been seeing repeatedly this earnings season – companies are beating bottom line expectations at a rate comparable to recent quarters, but positive revenue surprises are hard to come by.

Including this morning’s long line-up of earnings releases, we now have crossed the halfway mark in the Q1 earnings season; not in terms of the number of companies that have come out with results, but in terms of total market cap. Accounting for this morning’s results from Exxon (XOM), 3M (MMM), Dow Chemicals (DOW), UPS (UPS) and others, we now have Q1 results from 232 S&P 500 companies that combined account for 56.4% of the index’s total market capitalization.
 
Total earnings for these 232 companies are up +2.2% from the same period last year, with 66.8% beating earnings expectations. Revenues are down -0.7%, with only 33.6% of the companies coming ahead of top-line expectations. The median surprise is +3.3% on the earnings side and negative -0.5% on the revenue side thus far. The +2.2% earnings growth rate is up from +0.6% gain for the same group of companies in 2012 Q4, but is below the 4-quarter average earnings growth rate of +3.3% for the same cohort. The revenue decline of -0.7% compares to the +0.6% growth rate in Q4 and 4-quarter average revenue growth pace of +0.1%. A key standout is the weakness is on the revenue ‘beat ratio’, which at 33.6% is materially below the rate for the same group of companies in recent quarters.
 
The composite growth rate for Q1, where we combine the results of the 232 companies that are out with the 268 still to come, is for +1.1% growth in earnings on +0.3% higher revenues. The composite earnings and revenue growth for Q1 has been going up since the earning season got underway; it was in negative territory at the start of the reporting cycle.

Sheraz Mian
Director of Research
 

These China concerns have been at the core of the sell off the commodity complex that has kept investors on edge in recent days. The Caterpillar (CAT) bounce on Monday after the mining and construction equipment maker’s weak quarterly results largely reflected the market’s appreciation of the company’s ‘throwing in the towel’ on the global mining market and not a reflection of better growth prospects. Caterpillar had been holding hopes in recent quarters on that front and its current guidance is believed to be excessively conservative. The growth outlook issue was also spotlighted by the weak flash PMI reading for Germany by Markit, which dropped to 48.8 in April from March’s 50.6 reading.

Including this morning’s reports from DuPont, Coach and others, we now have Q1 results from 124 S&P 500 companies or 36.1% of the index’s total market capitalization. For the Finance and Technology sectors, the two largest in the index, we now have Q1 results from 55.7% and 48.7% of the sectors’ market capitalization, respectively.

Total earnings for these 124 companies are up +4.4% from the same period last year, with 69.4% beating earnings expectations. Revenues are up +3.9%, but only 38.7% of the companies coming ahead of top-line expectations. The growth rates and earnings ‘beat ratio’ is comparable to what these same 124 companies reported in 2012 Q4, though the revenue ‘beat ratio’ is materially weaker (38.7% vs. 62.1%). The composite growth rate for Q1, where we combine the results of the 124 companies that are out with the 376 still to come, is for ‘flat’ or ‘no growth’ in earnings on +0.4% higher revenues.

Q1 earnings aren’t that bad, particularly relative to pre-season expectations. But the issue is with respect to the earnings picture for the coming quarters, particularly the back half of 2013 and next year. The consensus expectation is for a strong rebound in the second half of the year after ‘flattish’ growth in the first half. But given the global growth questions as spotlighted by the recent commodity price sell-off, those earnings expectations may be due for a revision.

The question is what the market’s reaction will be to this expected downward adjustment to earnings expectations. In my view, the recent uncertainty  in the market is essentially a reflection of the market's struggles with this very same question.

Sheraz Mian
Director of Research
 

The Q1 earnings season itself hasn’t been that bad, particularly when compared to the last few quarters. Yes, results from the Technology sector have been underwhelming and revenue overall have been on the weak side, but the aggregate picture emerging from the results thus far in terms of growth rates, 'beat ratios', and guidance aren’t materially weaker from what we saw in the 2012 Q4 earnings season. The market’s earnings worries are not about what it has seen thus far from the 107 S&P 500 companies that have reported Q1 results as of this morning, but rather what these results tell us about the coming quarters.

Consensus expectations for the first half of 2013 appear quite reasonable, with total earnings expected to increase by only +1.2% from the same period in 2012. But estimates for the back half of the year represent a significant ramp up of a +10.8% increase over the 2012 period. Consensus estimates then extrapolate the expected second-half 2013 growth recovery into 2014, resulting in further gains of +11.7%. It is hard to envision these growth expectations panning out in the current backdrop of slowing economic growth at home and abroad.
   
We have a deluge of Q1 earnings reports this week, with more than 650 companies coming out with quarterly results, including 162 S&P 500 members. Including this morning’s Caterpillar and Halliburton (HAL) results, we have seen Q1 results from 107 S&P 500 companies that show total earnings growth of +4.6%, with 69.2% of the companies beating earnings expectations with a median surprise of +3.2%. Revenues are up +4.2%, with only 39.3% of the companies coming ahead of top-line expectations, with a median surprise of (negative) -0.4%.
 
Please note that these 107 companies account for 33.7% of the total market capitalization of the S&P 500 as a whole. As such, the results we have seen thus far provide a fairly representative sample of the Q1 reporting season. The earnings growth rate and earnings ‘beat ratio’ (% of companies coming out with positive surprises) for these 107 is better than what these same companies reported in 2012 Q4. But the revenue growth rate and ‘beat ratio’ is lower, with the beat ratio particularly weak in the current period.

Technology results have been particularly weak thus far, though we will find out more as Apple (AAPL) and Amazon (AMZN) report results this week. Only 64.3% of the Tech companies have beaten Q1 earnings expectations thus far, weaker than the earnings ‘beat ratio’ for the S&P 500 as a whole of 69.2% and the 78.6% ‘beat ratio’ for the same group of companies in Q4. The revenue side is even weaker, with only 35.7% of Tech companies coming ahead of top-line expectations, weaker than the 39.3% revenue ‘beat ratio’ for the S&P 500 as whole and materially weaker than what the group’s revenue ‘beat ratio’ in Q4.

Sheraz Mian
Director of Research