Futures are ~50bps higher this morning on the back of better-than-expected economic data in
China and the In U.K. , the overnight PMI release beat expectations, coming in at 54.7 vs. the 53.8 consensus. China Asia, ex-Japan, was up ~2.5% overnight. In the , October Manufacturing PMI rose for the first time since March and beat expectations slightly. Elsewhere in U.K. Europe, however, Irish-German bond spreads blew out to the widest levels ever, as German chancellor Angle Merkel takes a tough stance against frivolously indebted Eurozone nations. European trading is mixed to slightly lower thus far this morning. In economic news, September Personal Income came in light, at -0.1% vs. the +0.2% expectation. This is also substantially lower than the prior month’s +0.4% reading. The year-over-year PCE (Personal Consumption Expenditure) price index was slightly lighter than expected, at +1.2% vs. +1.3%/e. ISM data due later today (10am). Oil +2.4%. Gold +20bps. USD flat. U.S.
Not much to say about the rest of the week that hasn’t been said already…elections tomorrow, FOMC Wednesday, ECB statement Thursday, October payrolls Friday. In trader talk terms, time to “strap it on.” In terms of commentary, here’s a sold summary – and the bullish case – from BTIG’s Mike O’Rourke:
How the S&P 500 Wins the Disappointment Trade.
Just like everyone else in the financial markets, we have obsessed over the FOMC’s re-introduction of Quantitative Easing (QE2), which is expected to be announced on Wednesday. As equity market bulls, we have been encouraged by the great deal of focus upon the easy “QE trades” of buying Treasuries, Commodities, Gold and shorting the Dollar versus just about any currency out there. Market watchers are quick to point out that the S&P 500 has risen 13% since the end of August as QE talk picked up momentum, and that equities are at risk for disappointment.
The S&P 500 has rallied and sold off mid to high single digit percentages every month since April. The WSJ started reporting about the FOMC’s reversal of the QE strategy at the start of August. Since then, the S&P 500 is up a more modest 7.5%. During that same three month period, equity market volumes have been the slowest of 2010, on average 17.6% slower than the first 7 months. On a year over year basis, August volume was down 20%, September was down 23% and October was down 18%. Despite the rally in prices, the activity is hardly a representation of investors flooding back into equities as a result of QE. Positioning of vanilla money confirms that, as it continues to favor the safety of bonds over equities. Since the end of July last year, the only months that domestic equity mutual funds have experienced inflows are January, March and April.
Despite our bullish view, last week we noted that we were hoping for some type of corrective move going into the announcement but one has yet to materialize. One reason we worry it may not materialize is the inherent under-exposure to equities that is prevalent in the marketplace. We have asserted that the Fed’s haphazard approach to introducing QE2 has distorted investment objectives and a disappointment will help reset them. Rather than look for the easy QE trades as “speculations,” focus will shift back to “investment” opportunities. Another positive side effect of a disappointment is that the uncomfortably optimistic sentiment prevailing in the market will likely suffer a very constructive shakeout.
Here is the reason why we believe equities will be the winner if investment objectives are reset as a result of a QE disappointment. Although the investment community is playing QE through various other markets, anecdotally, it seems as though equities are the assets investors want to sell first. In making such sales, investors will need to look at the underlying fundamentals behind the S&P 500. According to Standard & Poor’s, current estimates for 2010 are $83.63, and according to Bloomberg, they are $84.58. Peak earnings for the S&P 500 were $87
.72 in 2006, the second best year was 2007 at $82.54. With more than 3 quarters of the year already in the books, there is a notable likelihood that 2010 will be the second best earnings year on record. It will only take 4.5% earnings growth in 2011 to set a new record for S&P 500 earnings. As many investors know, current estimates, which are likely to keep coming down, are for 12.8% earnings growth or $94.30. In such a fragile economic environment, investors are being responsible and conservative and are not putting too much faith in that number. According to the S&P, another interesting stat is that cash on the balance sheets of the S&P 500 Industrial-Old (which is the S&P 500 minus Financials, Utilities and Transports) is equivalent to just over 10% of market capitalization.
If equities experience a pullback of 5%-7%, then based on 2010 estimates, the index will be trading 13-13.3x earnings. If we factor in any portion of that cash hoard, then they are looking at a market between 12.5-13x earnings. If we factor in a very conservative 4.5% (considering estimates are 12.8%) earnings growth for next year, then they are looking at a market trading 12.5-12.75x earnings. Again, when one thinks about the high levels of cash, then the market is closer to 12x forward earnings. A market trading at such multiples is hard to short. Every piece of positive economic data will send shorts lacking conviction scrambling to cover positions. If the market does wind up disappointed by the Fed, and there is a correction, it is likely to be short lived. As the result of such movement, as capital flows out of “speculative” QE trades, we suspect many investors will recognize what an excellent “investment” opportunity the S&P 500 is.
MACQ raises semi stocks to positive. Barron’s positive MSFT, WHR, QCOM. WSJ speculates of new EBAY website today. BofAMLCO ups PCAR. CITI ups CSE. FBRC ups CMO. OPCO ups HAL. BofAMLCO cuts ART, OLN, SPLS. OPCO cuts SLB. ABK declares bankruptcy. ACOR beats by 43c. ANH misses by 4c, downgraded at JMP. CTSH beats by 6c. Speculation that IBM will buy FTNT. GLW misses by 1c. IPGP beats by 5c. JKS beats by 79c. ORBK beats, and GE to acquire medical solutions biz. RYAAY lower on earnings but raises FY2011 guidance. SATC initiated Buy at JEFF. WL to be acquired by MTB for $3.84/share. YRCW restructuring plan ratified by union.
S&P 500 PreMarket 8:30am (last/% change prior close/volume):
Today’s Trivia: What country has the largest number of islands?
Yesterday’s Question: 746 watts is equivalent to what commonly-used measure of power?
Yesterday's Answer: ~746 watts = 1 horsepower.