After a long, frustrating flat run, stocks are now partying like it’s 1999! And, somewhat predictably, investors are celebrating by … worrying? Now, far be it from us to tell anyone how they should feel, but we like it when stocks rise. Yet the worried reaction to stocks’ latest all-time highs reveals a common theme of this bull market. Pundits bemoan one perceived negative, but when they get what they want, they conjure reasons to fret that, too! In our humble estimation, this is a prime example of folks wanting it both ways, and things don’t really work that way.[i] Here are three stories investors have flip-flopped on recently—evidence people are still looking for clouds in a silver lining and illustrating sentiment still has lots of room to improve as this bull market progresses.
Fretting the Flats or Fearing Heights?
Before the latest stock market records, headlines mostly focused on the market’s inability to hit a new high since May 2015. However, after that flat point-to-point spell, driven in part by a long correction, the S&P 500 finally claimed a new record about a month[ii] ago, and it has continued to charge higher since. Though global stocks haven’t recovered completely yet, they aren’t far off, either.
Rather than bullishness or relief, trepidation and wariness greeted markets’ sharp rebound following the correction’s bottom in February. Despite fresh new highs, many folks doubt the rally, wondering how much further stocks can climb—and whether they’re due for a pullback. A friendly reminder: Stock returns come in fits and starts. They aren’t a smooth, gradual climb. Moreover, while all-time highs are great for headline writers, they are arbitrary index levels that tell you only where markets have been—not about where they are about to go. Bull markets tend to generate numerous highs throughout their lifetime. Given current economic and political drivers, we expect the bull to make more for the foreseeable future, despite potential bumps along the way.
Folks can’t decide how they feel about corporate profits, either. In this bull market’s earlier years, pundits grumbled Corporate America was profitable only because firms were cutting costs, implying earnings growth wasn’t “real”[iii] or “sustainable.” This year, that script has flipped a bit. With S&P 500 earnings contracting for five straight quarters, fears over Corporate America’s falling profits ran rampant, with some even suggesting cutting costs to boost profitability.
To all that we say, “Whoa, Nelly! Hold your horses!” The earlier fretting over cost cutting’s impact missed the fact that this is typically how “sustainable” and “real” cycles look early on. And, though recent earnings growth numbers weren’t great, the long-struggling Energy sector—slammed by plunging oil prices—was the primary culprit. Outside Energy, earnings have largely beaten low expectations. At the start of Q2, FactSet reported consensus expectations for earnings growth were -4.9% y/y (and -1.5% excluding Energy). In the week ending 8/12/2016, with 455 companies reporting, earnings have fallen just -3.5% (and are up 0.6% excluding Energy).[iv]
Moreover, it’s ok to cheer improving revenues, which have done better than earnings. Excluding that big Energy detractor, revenue growth is up 2.7% y/y in Q2, easily outpacing earnings growth.[v] It is normal for revenues (or sales, if you prefer) to drive earnings growth in a maturing economic expansion. At the beginning of an expansion, even small revenue growth provides a big earnings boost since costs are low due to all the cost-cutting performed during a recession. Over time, however, firms’ costs rise as higher demand and increased capacity utilization force firms to spend more to make more—and here, revenue growth becomes a bigger driver. The shifting fears don’t seem to acknowledge the seemingly typical nature of this cycle’s profit and sales trends.
Inverting Inflation Indigestion
Folks have flip-flopped on their feelings about inflation as well, particularly in the UK. Tuesday, the Office for National Statistics announced inflation rose 0.6% y/y—a 20-month high. The pound remains low by historical standards, and some pundits are concerned this means inflation will spike soon since currency movements hit prices at a lag.
However, we don’t know how long the pound’s relative weakness will persist. If its decline proves temporary, this could be much ado about nothing. Also, those “accelerating” inflation figures are a function of weak data from a year ago (and, by extension, volatile oil prices). They aren’t Brexit-related, nor are they a function of the weak pound. On a month-over-month basis, CPI fell -0.1% in July—you read that right!—after rising in both May and June. Inflation may pick up a bit later, but let’s be clear: Current levels aren’t anything near problematic.
More importantly, in keeping with this piece’s theme, recall that in the not-too-distant past, deflation—falling prices—was the fear du jour in the UK and other developed economies. Central bankers, including Mark Carney, frequently referenced low inflation as a potential problem for the economy, and expressed a desire to get inflation back toward their 2% y/y target. (Nevermind that plunging energy prices were the primary deflationary pressure, not contracting money supply or weak demand.[vi]) Folks have gone from projecting deflationary doom to hot inflation—both of which are allegedly horrible for consumers. Seems to us this raises a salient question: What exactly do people want?
In our view, this flip-floppery reflects overall dour investor sentiment. No matter what the news is, investors find a cloud—a reflection of their feelings, not reality. Now, we don’t blame folks for being down. The news has been confusing, shrill and downright depressing at times. However, for investors, separating how you feel from portfolio decisions is of critical importance in ensuring you reach your investment goals.
[i] Insert cliché about having and eating cake.
[ii] In price return. In total return, the S&P claimed a new high in June.
[iii] As in “actually a thing,” not “inflation-adjusted.”
[iv] Source: FactSet Earnings Insight for the week ending 8/12/2016.
[vi] While central bankers have lots of powers, raising commodity prices isn’t among them. Otherwise, Vladimir Putin would surely have kidnapped and employed them by now.