January 18, 2019
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The stock market continued to recover this week despite the ongoing uncertainty about the federal government shutdown and Brexit. It appears that other than the IRS recalling 46,000 furlough employees to process tax returns that the federal government shutdown will continue to escalate. I am betting that the federal government shutdown persists through the State of the Union speech on January 29th, since President Trump is digging in on his border security demands and will likely relish in lambasting Congress.
Interestingly, on Thursday, the stock market rallied on the news that President Trump abruptly cancelled House Speaker Nancy Pelosi’s military plane for an overseas trip to Afghanistan, Egypt and Belgium with other Congressional representatives, but allowed them to “fly commercial.” As President Trump cracks down on Congressional junkets, as well as mocks them for running off with lobbyists to warm weather resorts, he is effectively trying to force our elected representatives to stay in Washington D.C. to work on a solution to the federal government shutdown, so there may finally be some progress in the upcoming weeks.
The world seems to be in the midst of a perpetual political crisis, especially in Europe where Britain and France remain in chaos. On Tuesday, British Prime Minister Theresa May suffered a massive Brexit defeat in the House of Commons, by a resounding vote of 432 to 202, that has resulted in a “no confidence” debate that Prime Minister May barely survived. Ironically, no one really wants to be the British Prime Minister leading up to the implementation of Brexit on March 29th, so the British pound remains volatile and international capital flight is expected to persist.
Another Brexit referendum is possible, but it has to be done before March 29th when the European Union (EU) is scheduled to boot Britain. The reason that there could be another referendum is there are substantial majorities in House of Commons and Parliament that do not apparently want to exit the EU. In the meantime, the euro remains weak due to the ongoing Brexit chaos and the uncertainty about that exit fees that the EU wants to impose, but Britain is increasingly unwilling to pay the EU any significant exit fees.
If this was not enough chaos, China’s woes are still making some investors nervous, but the trade talks are no longer the country’s biggest problem. I should add that Ivan Martchev had a timely MarketWatch article this week about China: https://www.marketwatch.com/story/watch-these-3-areas-to-tell-when-chinas-hard-landing-is-near-2019-01-13
Despite all the international chaos, the fourth quarter announcement season is off to a strong start, led by Netflix, which continued to surge in the wake of raising its monthly fees by 13% to 18%. On Thursday, the company announced that it added 8.8 million new subscribers in fourth quarter, which was substantially higher than analyst estimates of 7.5 million new subscribers. In the fourth quarter, Netflix’s sales rose 27.4% to $4.19 billion compared to $3.29 billion in the same quarter a year ago. The company’s fourth quarter earnings were $133.9 million or 30 cents per share, which were 25% higher than analysts’ consensus estimate of 24 cents per share. Overall, Netflix trades more on its new subscriber growth, but its new price increases should insure steady earnings growth for the next few quarters.
Now that the fourth quarter announcement season is underway, a “retest” of the Christmas Eve lows is becoming increasingly less likely. So far, the companies in S&P 500 that have announced their fourth quarter results have posted 7.8% annual sales growth and 21.5% annual earnings growth. Typically, the good sales and earnings announcements come out early, so I expect the S&P 500’s fourth quarter sales growth which decelerated to 6% in the upcoming weeks and fourth quarter earnings growth will decelerate to about a 16% annual pace. In should also add that our friends at Bespoke issued an excellent report this week that implied that since the S&P 500 has resurged approximately 10% from its Christmas Eve lows, a retest is becoming less likely.
On Tuesday, the Labor Department announced that Producer Price Index (PPI) declined 0.2% in December, which the biggest monthly decline in more than two years and was a bit more than economists’ expectations of a 0.1% decline. Wholesale gasoline prices declined 13.1% in December, while food prices rose 2.6%. The core PPI, excluding food and energy, was unchanged in December. In the past 12 months, the PPI and core PPI has risen 2.5% and 2.8%, respectively. Interestingly, wholesale service costs declined by 0.1% in December, which represents the first decline in four months. Overall, the PPI provided more evidence that inflationary pressures are “decelerating,” which means that the Fed can be “patient” and not raise key interest rates for the foreseeable future.
The December retail sales data from the Commerce Department has been postponed due to the federal government shutdown. However, based on credit card sales, it appears that the holiday shopping season was stunning. Naturally, retail sales are expected to stall in the upcoming months due to approximately 800,000 furloughed government employees. The situation for government contractors is much more dire, since back pay will not be restored when the federal government reopens.
The Fed announced today that Industrial Production rose 0.3% in December, which was better than economists’ consensus estimate of a 0.2% rise. For 2018, Industrial Production rose an impressive 4% and was led by the domestic energy boom. In December alone, mining (includes energy production) rose a robust 1.5%, while utility output declined 6.3% due largely to abnormally warm weather. The best earnings for the next couple quarters are expected to be predominately energy related stocks, so the domestic energy boom is expected to continue and boost Industrial Production in the upcoming months.
Overall, we are essentially in the midst of an interesting Libertarian experiment to see how much the U.S. economy and the stock market might rally without the federal government fully functioning. The good earnings tend to come out in the next three weeks and then the fourth quarter announcements will become more mixed. Amidst the federal government shutdown, multiple Fed Presidents, both doves and hawks, have clarified that there is no reason for further interest rate increases in the foreseeable future. With all the interest rate uncertainty removed, deflation and government uncertainty persists. Frankly, I am happy that the stock market has reverted to following fundamentals versus being “spooked” by external events, so I expect to make a lot on money in the upcoming weeks as my stocks celebrate their outstanding fourth quarter results!
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