Meltup I: Raising Meltup Odds. I’m getting a lot of emails and phone calls asking if the meltup I started predicting in early 2013 has begun. The short answer is “yes.” So I might as well raise my odds of this scenario from 55% to 70%. I’m leaving my meltdown odds at 25%. So the iron laws of arithmetic leave me with just a 5% probability of a slow-and-steady ascent in stock prices.
I’m not a big fan of meltups. They tend to be followed by meltdowns, which tend to be hard to predict. Meltdowns are usually triggered by a financial crisis, which is also hard to predict. Let’s update the meltup scenario, now that it seems to be under way, and try to assess the likelihood of a meltdown:
(1) Bullish sentiment is absolutely giddy. As Debbie reported last week, the Investor Intelligence Bull/Bear ratio soared to 4.77 during the first full week of January (Fig. 1). That’s the highest reading since March 1987. The latest reading showed that 64.4% of investment advisers were bullish while only 13.5% were bearish. The remaining 22.1% were in the sheepish correction camp. The American Association of Individual Investors also polls investment sentiment; in its measures, recent bullishness readings match previous highs (Fig. 2).
(2) Broad-based rally. The S&P 500 is currently trading at 11.2% above its 200-day moving average, which is among the highest readings of the current bull market (Fig. 3). Furthermore, 77.7% of the S&P 500 companies are trading above their 200-dmas (Fig. 4). That’s also a relatively high reading.
(3) Up, up, and away! The S&P 500/400/600 are up 22.5%, 16.5%, and 15.4% y/y through the week of January 12. These three indexes are up 30.2%, 29.9%, and 33.5% since Election Day (November 8, 2016).
Meltup II: Earnings Melting Up Too. The meltdown scenario is somewhat less worrisome for now, since the meltup in stock prices in recent weeks has been driven to a large extent by a meltup in analysts’ consensus expectations for earnings. Consider the following:
(1) 2018 and 2019. The Tax Cut and Jobs Act (TCJA) passed at the end of last year is already boosting earnings estimates. Joe reports that analysts’ consensus estimates for S&P 500 operating earnings in 2018 rose a whopping $2.13 w/w to $150.15 per share during the first week of January. The estimate for 2019 rose $2.23 to $165.35 (Fig. 5).
Remarkably, revenue estimates also seem to have been boosted, but we think that’s attributable more to animal spirits than the TCJA. Industry analysts are now expecting revenues to rise by 5.7% this year and 4.6% next year, following the 6.3% gain last year.
Through January 4, profit margins are projected to rise from 10.5% for 2017 to 11.2% this year and 11.8% next year.
(2) Forward earnings. On a y/y basis through the second week of January, the 52-week forward consensus expected earnings of the S&P 500/400/600 are up 13.1%, 18.8%, and 15.0% (Fig. 6). So they account for much of the increase in their respective stock price indexes over this period.
As a result, forward P/Es are elevated, but aren’t much higher than a year ago (Fig. 7). The S&P 500 has a forward P/E of 18.5 currently, up from 17.1 a year ago. On the other hand, the S&P 400 and 600 forward P/Es are basically unchanged at 18.4 and 20.0 now vs 18.8 and 19.9 a year ago.
(3) Sectors showing widespread forward earnings improvement. Here are the y/y changes in forward earning per share for the 11 S&P 500 sectors as of January 4, from highest to lowest: Energy (22.9%), Tech (20.7), Financials (16.3), Materials (12.7), S&P 500 (11.6), Industrials (9.2), Consumer Staples (8.1), Utilities (6.4), Consumer Discretionary (4.8), Health Care (4.2), Real Estate (2.9), and Telecom (-0.4) (Fig. 8).
Joe observes that even before the Trump tax cuts, earnings estimates were being revised higher, especially in the S&P 500 Energy, Financials, Industrials, and Materials sectors (Fig. 9). The upward revisions in these cyclical sectors were largely attributable to the rebound in global economic activity, which drove up oil and other commodity prices. The tax cuts have added to the excitement on expectations that they will boost after-tax results.
Meltup III: Companies Are Paying it Forward. The most extraordinary development since the Trump tax cuts were passed is that several corporations have announced that some of their windfalls resulting from the cuts in the corporate tax rate as well as the tax on repatriated earnings will be paid out to employees in bonuses and wage increases. Many of their employees will also see more after-tax pay, resulting from the increase in the standard deduction and the lowering of individual tax rates.
This increases the likelihood of stronger economic growth in coming months, which will also be good for earnings. In other words, we may be experiencing an extremely unusual earnings-led meltup. If so, it is more likely to be sustainable than the run-of-the-mill P/E-led meltup, as long as it doesn’t morph into one. We’ll let you know if it does. For now, sit back and enjoy the show.
Meltup IV: Running Hot. There is clearly a coincidence between Trump’s election and the run-up in stock prices over the past year. However, coinciding with Trump’s victory was mounting evidence of a global synchronized boom. In our opinion, the run-up in stock prices over the past year has been a continuation of the bull market within a bull market that started on February 12, 2016. Since the bottom the day before, the S&P 500/400/600 are up 52.3%, 58.7% and 64.8%.
In our view, 2015 was the “growth recession” year for the global economy attributable to the bursting of the commodity supercycle. Then 2016 was the recovery year for the global economy. Last year was the expansion year, and this year is shaping up to be the boom year. Consider the following:
(1) Commodity prices. The CRB raw industrials spot price index fell sharply during 2015 (Fig. 10). It rebounded during 2016, stalled during 2017, and has rebounded in the past couple of weeks.
(2) Eurozone. During November, industrial production in the Eurozone rose 1.0% m/m and 3.2% y/y to a new cyclical high (Fig. 11). The volume of retail sales (excluding autos and motorcycles) in the region jumped to a record high that same month (Fig. 12).
(3) US GDP. At the end of last week, following the December retail sales and CPI releases, the Atlanta Fed’s GDPNow estimate for Q4 real GDP rose from 2.8% to 3.3%. Retail sales continue to grow along with the solid gains in wages and salaries, which just got a big boost from the TCJA, as noted above (Fig. 13).
Meltup V: 666 Again! The stock market is going a lot higher based on my 666 indicator. I turned bullish on the S&P 500 index after it fell to an intra-day low of 666 on March 6, 2009. I reiterated my bullish stance during January 2016, when I checked in to the Zurich Radisson Hotel and was assigned Room #666. Last Wednesday, I returned from a business meeting in Florida, and I noticed the bookstore at the airport was promoting a novel titled Lucky 666: The Impossible Mission. I’m still predicting 3100 on the S&P 500. But in a meltup scenario, I wouldn’t be surprised to see 3330, as that is 666 times 5.
Movie. “The Post” (+) (link) is a movie about fake news. However, it is about fake news concocted by the US government about its goals and actions during the Vietnam War, rather than by the press. The New York Times and The Washington Post exposed the government’s systemic lying about the scope of its involvement in Vietnam by releasing the Pentagon Papers, which was a history of the Vietnam War conducted by the Defense Department. The movie features Meryl Streep as Katherine Graham, the owner of the Post, and Tom Hanks as Ben Bradley, the editor of the newspaper. It was produced by Steven Spielberg. It’s a cri de cœur for freedom of the press, which has plenty of freedom today as well as a very loud critic in the Oval Office.
Dr. Ed Yardeni is the President of Yardeni Research, Inc., a provider of independent global investment strategy research.
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