Global profits near record highs

Donald Trump’s erratic behaviour and the Federal Reserve’s recent warning about expensive stock market valuations have occupied investors’ minds lately, but bulls can point to one big plus – global earnings are on the verge of hitting record highs.

Global earnings have hit $30 per share for the fourth time in the last decade, notes Schwab's Jeffrey Kleintop. In 2008, they subsequently collapsed as the global financial crisis took hold. In 2011, they retreated following recessions in Europe and Japan. In 2014, the advance was scuppered by collapsing oil earnings.

Now, the $30 level is once again in play, and Kleintop reckons new highs are coming. Different regions drove the past advances, but growth is more synchronised today. Each of the world’s 20 biggest economies is growing, marking the “strongest and broadest global economic growth in years”. The two regions yet to recover their past profit peaks – Europe and emerging markets – look especially strong, while the IMF expects global growth to accelerate in 2018.

The one hurdle is that valuations are “much higher” and near 15-year highs. If earnings don’t push through $30, the global equity advance will pause. However, the profit outlook is good, and a sustained earnings breakout “now appears more likely than it has in a decade”.

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Is a big earnings season priced into stocks?

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Stocktake: Will stocks ever dip again?

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Dalio underestimated Trump’s ‘craziness factor’

Memo to Trump: investors think you’re useless at best, and dangerous at worst.

Ray Dalio of Bridgewater, the world's biggest hedge fund, used to believe in the Trump trade, saying the "craziness factor" would likely be smaller than feared.

Dalio underestimated the “craziness factor”, however. Last week, he advised investors to buy gold and cut back on risk, saying he was “not encouraged” by the US administration’s handling of conflict.

Like Dalio, markets have lost faith. The dollar, having surged following Trump’s election win, has sunk in 2017. The small-cap Russell 2000 index, consisting of domestic companies poised to benefit from Trump’s proposed tax cuts, is now down for the year and has fallen below its 200-day moving average for the first time since June 2016. Hedge fund positioning indicates small-cap bearishness is at its highest levels since late 2009.

Trump’s tweets suggest he sees himself as God’s gift to the stock market, but it is strong earnings and a growing global economy that are driving market gains. Investors expect little from Trump.

Ironically, expectations are now so low that stocks should jump should Trump deliver on tax cuts, as analysts at Rhino Trading and Raymond James argued in recent notes.

Higher stock prices are good for investors, but there would also be a downside – more excruciating tweets and Trump’s ego becoming ever more bloated.

Pullback time for nervy markets?

The S&P 500 hasn’t experienced a 3 per cent pullback in 2017 and has been within 5 per cent of all-time highs since June 2016. With volatility finally increasing and stocks beginning to look shaky, is it time for a proper pullback?

Markets have appeared more nervy lately. Bespoke Investment Group last week noted the S&P 500 had experienced four 1 per cent daily moves in a nine-day period – as many as seen in the first seven months of the year.

Though the retreat has been minor, many stocks are coming under pressure. Almost 8 per cent of S&P 500 stocks are trading at 52-week lows – the most since February 2016, notes Merrill Lynch, which views weakening breadth as a warning sign. Fewer than two-thirds of stocks are up over the last 12 months, compared to 90 per cent in early February. Defensive stocks are outperforming cyclicals. Only 41 per cent of stocks are above their 50-day moving averages.

It’s been more than 200 trading days since fewer than 40 per cent of stocks traded above their 50-day average, notes Bespoke. What happens when such streaks end? Does it signal “a more prolonged market pullback has begun, or is it actually a good time to buy”?

Since 1993, there have been 13 similarly long streaks. Three months after they ended, stocks were higher on 11 occasions, averaging big gains of 4.65 per cent. Above-average one-month returns were also normal.

In other words, a big pullback looks unlikely. Buying the dip remains the obvious tactical play.

‘Extended selloff’ or market noise?

A question: what constitutes an “extended selloff”?

The question was prompted by a recent Wall Street Journal headline, “Stocks Bounce After Extended Selloff”. The piece noted the Dow Jones index had lost 418 points over the previous two weeks, before then recovering almost half that amount.

In other words, stocks fell less than 2 per cent over two weeks, and then bounced by almost 1 per cent.

An “extended selloff” sounds scary, but investors shouldn’t fret over hyperbolic headlines. This is mere market noise, the resumption of normal volatility levels after an oddly long period of market calm.