Earnings reports from almost all companies in the last two weeks have been wonderful! The tax cuts have kicked in, the economy is doing great. Corporate profit margins are at all-time highs. The question must be asked, "IS THIS AS GOOD AS IT GETS?"
From the forward guidance of the reporting companies, it would seem a high probability that that is the case. Company after company talked about higher input costs. Some blamed tariffs. Some talked about labor shortages, higher interest rates, etc. But, it can be summed up in good old-fashioned cost/push inflation. Most companies feel they can pass through the cost increases with higher prices. Some cannot. General Motors cut its earnings guidance for 2018 by 10%. The stock is down almost 20% in a month. Ford is worse. There is a very good chance that profit margins for US companies have peaked for this cycle.
That might not matter if the economy stays strong enough to keep final demand up. The GDP report of the June quarter showed a big 4.1% advance! Great!! However, a lot of things, especially soy beans, were bought ahead of the tariff implementation. Thus, some sales were borrowed from future quarters. There is a good chance that this quarter may prove to be the best for growth for the next twelve months.
The stock market is a forward-looking machine. Lower profit margins and lower economic growth over coming quarters are good reasons why the market has been stuck in a rut since January. And, if you throw in the midterm elections that begin in earnest next month, it is hard to make a case for a big jump in stock prices.
That is especially true as Sentiment remains too complacent. There is not enough worry about these issues out there. Investor Intelligence reports 55% Bulls and only 19% Bears. This is the danger zone depicting an "overbought" market. Add to that an additional rate increase by the Federal Reserve in September and global "quantitative tightening" by all global banks in the Fall. The "goldilocks" market factors that we have enjoyed for years are coming to an end.
There are also changes within the market. Netflix is down close to 20% from its very recent high on disappointing subscriber growth. Facebook is worse for similar reasons. Can other bullet proof stocks like Amazon, sales force, etc. be far behind?
In the last week, value sectors like financials, energy, and telecom have been leading the market. We may not be seeing a shift in relative performance where big value significantly outperforms big growth. But, there is a good chance that the outperformance by growth is over for a while.
Keep some powder dry. The trading range that we forecast for the S&P 500 remains in place at 2500-2900. The markets failed again to push through the top of that range. There will be an opportunity to get more aggressive at the lower end of that range in coming weeks.
A note from WSC and WAMI . . .
Robert C. Davis is a Chartered Financial Analyst and is affiliated with Woodlands Asset Management, Inc. as a consultant. Founding partner of Davis Hamilton Jackson and Associates, a Houston based investment advisory firm; Bob is now retired and living in Chappell Hill, Texas. He now lends his expertise and knowledge of the markets to our company and customers. We hope you find it interesting and insightful.