Consumer Confidence, Gold, & Dow 30K

Consumer Confidence for October came in below expectations at 96.1. This is down -4.8% from the prior month and down -23.4% year over year. Not surprising, given the current employment picture, rising COVID cases, and election uncertainty. It will be interesting to see Novembers numbers given the progress on treatments and the elimination of election uncertainty. I suspect, much like small business optimism, there will be a pickup in confidence in future reports.

Overall, consumer numbers have surprised me with their resilience. I, along with many others, was expecting more of a slowdown given the runoff of employment assistance and general employment backdrop under COVID.

We had a slew of retail earnings last week, and for the most part they were solid. Some comments that stood out:

“The consumer economy has, I think, outperformed everyone’s expectations…The economy, I think, is resilient. The economy was relatively strong going in. And I think we’re – hopefully, we get back to where we were soon.” – CSX (CSX) CEO James Foote

“Walmart U.S. had another strong quarter. Comp sales increased 6.4%…Consistent with the second quarter, we saw customers consolidate shopping trips with larger baskets and fewer transactions.” – Walmart (WMT) CEO Doug McMillon

“Third quarter comparable sales increased 20.7%, reflecting a 4.5% traffic growth, combined with an increase in average ticket of more than 15%. Since the pandemic began in March, we’ve experienced a meaningful acceleration in basket growth, both in stores and online as guests have consolidated their shopping into much larger trips. Across channels, our store comps grew nearly 10%, while our digital comp sales grew 155%, contributing nearly 11 percentage points to the Company comp.” – Target (TGT) CEO Brian Cornell

“our third-quarter digital sales grew more than $2 billion compared with last year. For perspective, $2 billion is more than our company’s total digital sales for the entire year in 2014. Somehow, I think I should pause for a second and let that sink in” – Target Corporation (TGT) CEO Brian Cornell

Remember the market is always forward looking. So this could change. But an encouraging sign nonetheless.

The market seemed to get an extra boost of optimism when it was announced Biden was selecting Janet Yellen for the Treasury. The thinking is that she’ll be dovish on the fiscal spending side. Perhaps this is correct in the near term as we fight COVID, but I wouldn’t count on her being super dovish throughout her term.

In January, here is what Yellen told an audience in regards to the deficit:

“[T]he primary federal deficit in the United States is currently quite large. It’s around 2.6% of GDP, which is well above the level consistent with stability at anything near the current debt to GDP ratio, and it’s projected to rise much further as the population ages and entitlement spending rises relative to GDP. Absent changes in taxes or spending commitments, the U.S. debt to GDP ratio will rise very substantially in the decades ahead. I believe that needs to change to place the trajectory of the federal debt on a sustainable path over the long run.”

Now this could be another in a long list of public officials that decry high deficits while out of office, only to implement high spending when they take office. Current massive fiscal stimulus is only pulling forward future growth and would likely be a drag on future growth. Once COVID is behind us, I would hope that she follows through on her pledge to reign in deficit spending and not fall prey to those that think you can just keep spending until inflation becomes a concern.

Which is actually a good segway to my next topic, Gold. The above chart shows the prior declines over the last 3 years. In 2018, there was a decline of 14.77% and in early 2020 there was a similar sized decline of 14.87%.

Now as uncertainty begins to fade, some of the speculative money is coming out of Gold and the Volatility Index (VIX). The $1850 level failed and is now pushing towards the $1778 level I was watching. This will about match the size of the prior two declines, hit the 200 day moving average, and there are numerous prior highs in that vicinity. The confluence of support may (or may not) induce buyers back in. But I will be one of them.

This is not a market call. Gold only represents a small position for me. I’ve never been a huge fan of Gold, but as long as we have negative real interest rates, Gold will remain a part of my portfolio.

Lastly, as I write this the Dow is set to open near the 30K level. More than 7 years ago I wrote a blog post showing a projected upside target of Dow 150K over the very long term. I was incredibly fortunate to have Josh Brown of CNBC actually reach out and feature the post on his own site. Clearly, we are a long way from that milestone, but the Dow has more than doubled since I wrote it. The post was never meant to be a prediction, but rather to make people think about what could be. In the post 2008 world, everyone dwells on the negative and expects the worst all the time. I wanted to do something to shake that up a bit. Not sure I accomplished this, but I gave it my best shot.

Tis the season, and I just want to thank all my readers for their support. I appreciate all of you and I hope this site has provided some value. 2020 has been the most challenging year of my investing career, but we have navigated it quite well considering the circumstances. Regardless, I look forward to moving onto 2021. There is a lot to look forward to even though the near term could get quite bumpy.

S&P 500 Earnings & Market Update

The forward looking earnings per share for all S&P 500 companies combined ticked down from $159.92 to $159.89 last week.

The trailing twelve month (TTM), or earnings already reported over the last 12 months rose from $141.74 to $142.20.

The S&P 500 index declined 0.80% last week, so the earnings yield moves up to 4.49%, and the price to earnings ratio declines to 22.2.

For Q3, 95% of companies have now reported earnings. 84% have beat earnings expectations, and beating expectations by 19.5%. 78% of companies have beat revenue expectations. (FACTSET)

The indexes are all flirting with recent all time highs. The Dow finally broke above its pre-COVID intraday highs at 29,568.57.

The S&P 500 broke above its prior intraday highs at 3588.11 on the vaccine news two weeks back.

The short term trading setup here is to use the prior highs as a bull/bear line in the sand. Bullish above / bearish below. If price can’t establish itself above a prior swing high, a correction may be in order to find buyers for the next leg higher.

The Nasdaq is the laggard as the rotation to value and small caps continues. It’s still got a ways to go to retake prior all time highs and continues to show some weakness.

The bright spot is the russell 2000 small cap index. For two years this index failed to make a new high but has seemed to establish itself above.

Couple this with the strong market internals, as the advance decline line continues higher, and its hard to get overly bearish. This is typically not what you see before an important market top. But then again, nothing about 2020 has been typical.

Last week, weekly unemployment claims ticked up to 742k and continuing claims (although trending lower) are still above the peak of the 2008 recession. There are some undertones in recent economic reports that highlight the uncertainty and potential disruptions this could cause by end of 2020 and into Q1 2021.

As of right now, Q4 GDP is coming in around 5.6% but there is still a ways to go. Market technicals are solid and the economic recovery is intact, but the employment picture is still in recession and keeps downside risks elevated.

This holiday shortened week is light on earnings but some key economic data points like consumer confidence and new home sales will be released.

US Dollar and Gold update: Is the Fed’s monetary policy devaluing the currency?

The US dollar resistance at $94.60, that I pointed out awhile back, has held well. I thought we might get a push up to $95.70 on the election aftermath, but the outcome turned out to be better than expected (from strictly a markets and uncertainty elimination standpoint).

Dollar weakness in the short term looks like we may get a push back down to $91, and if that fails, back down in the range of $88.70 – $89.56. This would actually be a short term boost to earnings for multi-national corporations, as they covert their overseas earnings back to USD.

I also want to quickly address a point regarding the Fed and the US dollar. To say the Fed is intentionally devaluing the US dollar seems misguided. The above chart of the Dollar shows when the first Quantitative Easing (QE) program was announced on November 25, 2008, the Dollar exchange value was at $85.

Over the proceeding 12 years the Fed would go on to do QE 2, 3 and then 4 in response to COVID. The size of the Fed’s balance sheet increased from about $1 trillion to almost $7 trillion during this time. Yet, today the value of the dollar is about 9% higher than it was when QE began.

Even the trade weighted US dollar is higher than it was when this massive monetary experiment began.

Part of the reason for this is that QE, at its operational level, is not really “money printing”. The Fed swaps bank demand deposits for bonds with banks. Technically, no new financial assets are being “printed”. The composition of those assets are being changed. And since demand deposits aren’t lent out, its not creating the inflation that many predicted. This is being done to satisfy the markets demand for safe dollar denominated assets. Yes, the Fed is increasing the supply of dollars (M2), but its in direct proportion to the increase in demand for those dollars. If the demand declines (velocity of money increases), while the Fed is still increasing the money supply, then that’s when real inflation begins. So far this hasn’t happened, but that is why I’ve stated before that the Fed’s biggest concern is ironically a strong return to confidence (so demand for safe dollar assets declines significantly), because then they will have to tighten policy or risk inflation and serious currency devaluation. And tightening policy could end up causing the financial disruptions that it has tried so hard to avoid.

The Fed is trying to create stability by using very unstable assets. And other central banks around the world have gotten even more aggressive in their approach. For example, the Japanese central bank buys stock funds directly, and both Japan and Europe have gone to Negative Interest Rate policies. But this just takes money out of the private sector, and has proven to be more deflationary. It’s disturbing to me that they continue to double down on this approach even though its failed.

So I’m not absolving the Fed of guilt here. Hopefully, the strong return of confidence coincides with a stronger stable economy that can handle tighter monetary policy. But this whole monetary experiment brings us into uncharted waters. The Fed has certainly pushed investors into taking on more risk than they would prefer. There are trade offs to everything in life, so I often wonder if the Fed is trading off near term stability by putting the long term stability at risk.

I’ve studied enough financial history to know this can’t be ruled out as a possibility. The USD will not always be the worlds reserve currency and that is why I always maintain strict diversification standards. There is no way to take all the risk out of investing, but diversification (globally) helps reduce the risk of permanent loss. Which is most important for long term investors.

Following the theme for this post, lets now take a look at Gold prices. Gold has been holding the $1850 level, and if the USD exhibits further weakness, that support level may hold.

I’ve allocated a portion of my accounts to Gold and long term US treasury bonds as a hedge for my much larger allocation to stocks. I’d be looking to add to my Gold position (using the iShares Gold Trust ETF: Ticker IAU) if price gets down to the $1789 area.

You have to be an optimist to be an investor. After all, why would anyone invest their hard earned money today if they thought things would be worse in the future. I label myself as an optimist that expects bad things to happen from time to time. To me, that’s being a pragmatic realist. So global diversification that includes some hedging assets like bonds and gold makes sense to me. When people start to take extreme stances (both optimistic and pessimistic) is when they run into problems. Everything in moderation.

Retail Sales & Nvidia (NVDA) earnings

Retail sales for October came in at a gain of 0.3% over the prior month. The street was expecting a gain of 0.5%.

Still, a solid report on the consumer. This represents a gain of +5.7% over October 2019’s results (year over year).

Total retail sales is clearly in a V shaped recovery. With this months numbers, total retail sales is now +4.9% above the pre-COVID highs. The gains were not as broad based, as only 5 of the 13 major categories showed increases. Non-store retail continues to lead the way, as the rapid shift to ecommerce continues.

Nvidia reported its quarterly earnings Wednesday night. The company crushed earnings expectations (+46% growth year over year) and beat on revenues (+57% growth year over year). They also raised forward guidance for Q4 to +55% year over year growth in sales. Although their guidance on data center revenue came in below street expectations.

Gross margins ticked down from 63.6% to 62.6% and Operating margins also ticked down from 30.7% to 29.6%.

On a trailing 12 month basis, Nvidia revenues now come in just shy of $18 billion, another record.

While operating income made a new all time high at $4.9 billion.

Gross margins were unchanged at 62.8%.

Another impressive quarter for Nvidia overall but the share price trades down about 2% today. The stock is up +128% year to date and trades about 50x forward earnings (more than double the 22x for the S&P 500 index), and about 19x TTM sales.

The stock has been stuck inside a trading range for months, with the 9/2 closing high and 9/2 open price capping the upside, while the 9/8 open price gap and breakout point at ($493.92) supporting on the downside.

Which way the stock will break is anyone’s guess. There is a measured move target around the $462.56 open price gap from 8/14 that could come into play (green dashed line). I’ve owned the stock for years with no plans to sell. I would only start getting interested in adding to the position unless it trades down to the $430 range. Otherwise it’s a hold for me.

If the company can complete its acquisition of ARM holdings, that would certainty cement its position as being an industry leader for many years to come.

S&P 500 Earnings Update

The combined earnings per share for all S&P 500 companies ticked up again last week, from $159.47 to $159.92. The combined EPS reported in 2019 was $162.93, which is now only 1.85% above the current forward estimates.

92% of S&P 500 companies have now reported Q3 results, with 84% reporting earnings above expectations and 73% reporting revenues above expectations. In total, S&P 500 companies have reported earnings that are 19.4% above expectations. (FACTSET)

Q3 earnings are down -7.5% from last year and aren’t projected to return to growth until Q1 2021. It’s still a stark improvement in expectations from 6 months ago. Of the 63 companies that issued Q4 guidance, 70% of those companies issued positive guidance.

While the forward EPS has risen, the S&P 500 price has risen about 10% in the last two weeks. Friday’s close was a new all time closing high for the Dow, S&P 500, and Russell 2000. Therefore the price to earnings ratio (PE) has risen to 22.4, which is 25% higher than the 5 year average and 38.5% above the 10 year average.

The earnings yield on the S&P 500 has ticked down to 4.46% (again, based upon the 10% increase in the index) while the 10 year treasury bond rate still hovers below 1.00%.

It’s a consistent theme of contrasting data points that give credence to the bull or bear thesis. Bears look at soaring COVID cases and a high PE ratio, while Bulls look at treatment options that increase the likelihood we can return to normal within the next 12 months, and reasonable valuations when adjusted for low interest rates. It’s the glass half full or half empty philosophy. Regular readers know I’ve leaned towards the half full side, and so far the markets have agreed with me.

I want to highlight the broad based nature of this advance. The above chart is the S&P 500 advance – decline line breakout out to new highs.

This chart is the emerging markets index fund also breaking out to new 52 week highs.

This chart is the international stock index fund also breaking out to new 52 week highs. This is all taking place as the Nasdaq 100 is about 5% below its all time highs. We were told the markets could never maintain the advancement without the leadership of big tech. The rotation into value, small caps, and international stocks is taking place and the market is still making new highs. Go figure.

Diversification has been a consistent theme on this blog. I believe in it whole heartedly. I don’t like crowded trades and I don’t allocate money based upon what has been performing the best. One of the things I look at is valuation on a sector basis. The above chart shows each of the S&P 500 sectors current forward PE against its 5 & 10 year averages. One of the reasons I mentioned my allocation to health care was its valuation against the averages. While the S&P 500 trades 25% and 38.5% above its 5 and 10 year average PE, Health Care currently trades only 5% and 10.7% above its 5 and 10 year PE. Which is the “cheapest” sector relative to each’s 5 & 10 year averages.

The other very important aspect that I incorporate is the growth rate. A sector may be cheap because its growth rate is low or negative. Based upon 2021 earnings growth and current forward PE estimates, the most attractive sectors are Industrials, Consumer Discretionary, Basic Materials, Financials, Health Care. I’m using the PEG ratio in my analysis.

I still remain overweight on tech but have been taking profits in the sector for the last few months and using the proceeds to move into these other areas of the market in preparation for the potential of a rotation. We’ve seen numerous times were value starts outperforming growth only to revert back to the prior norms. Based upon the financial results of these big tech companies, its hard to see them being taken over by new leadership. But we are in uncharted waters, and the reopening trade presents a plethora of opportunities.

This week we get earnings reports from Home Depot, Walmart, Nvidia, Target, & Intuit. Along with some key economic data points like retail sales and the CB leading economic indicators index.