After the most recent meeting of the Federal Reserve, traders started reviewing their assumptions about rate hikes. Within days, futures of Fed Funds, a critical short term interest rate market, were pricing in the likelihood that there would be no more rate hikes.

This marked a reversal in the outlook of just a few months ago. The reversal can be seen in other interest rate markets as well. The chart below shows the interest rate on ten year Treasury notes and the recent trend is down, reversing a longer up trend.

Lower rates would be likely if the pace of economic growth is slowing and mounting evidence indicates that is a possibility. If this trend continues, it could have important implications for the stock market and in particular for certain groups within the stock market.

Banks Could Be Turning

Interest rates always present a puzzle to investors in the financial sector. Some analysts argue that lower rates are bearish for banks while others argue the opposite. A recent article in Barron’s highlighted the view of one of the most well respected analysts in the sector.

“The market for banks stocks is fickle,” says Wells Fargo analyst Mike Mayo, a bull on the sector. “Investors always seem to be viewing the glass as half empty.”

Industry sources cited Mayo as “a prominent bank analyst when Wells Fargo & Co. hired him in 2017. The analyst was hired to “make calls on large-cap bank stocks in its securities business, according to a statement released on Monday.

“Mike’s stature in the industry is well-recognized,” Diane Schumaker-Krieg, global head of research, economics and strategy at Wells Fargo Securities, said in a statement. “We are thrilled to have such an influential voice in this critical sector join our growing platform.”

Now, his view on some banks is bullish.

According to barron’s, “Mayo’s view is that major banks represent a bargain, trading for an average of just 10 times projected 2019 earnings, and many yielding 3% or more. He sees bank profits rising 8% to 10% this year as the industry boosts revenues and keeps a tight lid on costs.

“The negative sentiment has created an opportunity with uniquely attractive valuations,” he says.

Banks have the most aggressive capital-return plan of any major industry group, at around 100% for the 12 months ending in June. That is providing a major lift to earnings per share.

Some banks like Citigroup (NYSE: C) and Wells Fargo (NYSE: WFC) are expected to return more than 100% of their earnings to holders in dividends and stock buybacks.

Yet bank stocks were among the worst performers in a strong stock market Thursday afternoon. The KBW index of 24 leading banks was down 1.7%, while the S&P 500 index rose 0.7% to 2,699. Banks also were down Wednesday in the face of a big gain in broad market indexes, with the S&P up 1.6%

Among top banks Thursday, Bank of America (BAC) was off 96 cents, or 3.3%, to $28.11: JPMorgan Chase (JPM) fell 1.5% to $102.89; and PNC Financial Services Group (PNC) declined 2% to $121. Morgan Stanley (MS) was off 1% to $42.05 and Goldman Sachs Group (GS) lost 2.4% to $197.65.

The downdraft in bank stocks comes after a strong start to 2019. Even with the losses Thursday, bank stocks are ahead of the overall market with a nearly 12% gain, versus less than 8% for the S&P 500. Banks, however, were whacked in 2018, losing about 20% on average, while the S&P 500 declined 6%.”

The chart of Invesco KBW Bank ETF (NYSE: KBWB) is shown below.

Interest Rates Could Change the Trend

Barron’s continued, “Banks are viewed as beneficiaries of higher rates because they generally can boost loan rates faster than deposit rates and a higher-rate environment normally occurs when the economy is robust. Economic strength is good for loan demand and credit quality.

The most “asset-sensitive” banks, meaning those that tend to get the biggest earnings boost from higher rates, were among the worst performers Thursday. Bank of America and Comerica are viewed as being particularly asset sensitive. Other asset-sensitive regional banks showed similar losses.

Bank-deposit “betas,” or the percentage increase in market interest rates that is passed on to depositors, is around 50%. That means that the higher rates do tend to fatten bank profit margins, although Mayo says that is often overstated as a factor behind earnings growth.

He argues that Bank of America is benefiting from a 25-year effort to build a national banking footprint and that its major investments in technology should continue to allow it to outpace the industry. Bank of America trades for around 10 times 2019 earnings and yields 2.1%.”

Industry leader JPMorgan (NYSE: JPM) also trades for 10 times 2019 earnings and yields 3.1%. The S&P 500 index is valued at about 16 times forward operating earnings.

The long term chart of JPM is shown below.

The chart looks similar to the bank ETF. This is true for most banks. The recent lows, below the previous lows, could be a bear trap and a bullish reversal would push the stocks in the industry to new highs.

Other analysts agree with Mayo according to Barron’s. “Bernstein analyst John McDonald recently wrote that the earnings baton for banks is passing to loan growth from rates. He sees 3% growth in net interest income in 2019 and 2020. driven by a 65%/35% mix of loan volumes and rates, against a 35%/65% mix in 2018.

He noted that banks like SunTrust Banks (STI) that have shown accelerating loan growth have been outperformers. Loan growth in recent months has accelerated to a rate of 4% from 2% in the middle of 2018, McDonald wrote.”

Of course, this demonstrates why it is difficult for individual investors to make sense of analyst expectations. ETFs can be helpful to avoid the need to identify individual stocks that are likely to be winners.

In addition to KBWB, investors can consider Financial Select Sector SPDR ETF (NYSE: XLF) or SPDR S&P Bank ETF (NYSE: KBE) as diversified investments offering exposure to the banking industry.

 

 

Did you know that dividends have rewarded investors for at least 100 years, at least since John D. Rockefeller said, “Do you know the only thing that gives me pleasure? It’s to see my dividends coming in.”

We have prepared a special report about dividends that you can access right here.

 

It’s often said that stock market investors dislike uncertainty. When conditions are uncertain, that can lead to a bear market. Uncertainty could be caused, for example, by unclear announcements of central bank policy, debates about tax increases or new regulations, or slowing economic growth.

A means of quantifying the degree of uncertainty was highlighted in a recent quarterly earnings call. The CEO of Prologis noted:

“Let me just add one more comment that I found the most interesting, probably the most interesting statistic that I’ve seen about the economy is something called the global Economic Policy Uncertainty Index…it’s a scale of the degree of policy uncertainty around the world.

And let me give you a couple of points. During the 9/11 attack and the Iraq-Iran – excuse Iraq war breaking out that index was at 200. At the peak of the global financial crisis it was at 210 and Brexit it got to 300…

…and today given the China war and the government shutdown and all that it’s well north of 300. Now I have no idea whether there is any academic rigor or anything related to this index, but I just found it fascinating that the world thinks we’re in a much less certain environment.

Now certain is – uncertain is usually viewed as bad.”

That quote highlighted the index, which is in fact based on a high degree of rigor and was developed by economists associated with the International Monetary Fund (IMF).

Quantifying Uncertainty

The index is designed to measure policy related to economic uncertainty and is constructed as an index from three types of underlying components.

One component quantifies newspaper coverage of policy-related economic uncertainty. A second component reflects the number of federal tax code provisions set to expire in future years. The third component uses disagreement among economic forecasters as a proxy for uncertainty.

The first component is an index of search results from 10 large newspapers. The newspapers included in the index are USA Today, the Miami Herald, the Chicago Tribune, the Washington Post, the Los Angeles Times, the Boston Globe, the San Francisco Chronicle, the Dallas Morning News, the New York Times, and the Wall Street Journal.

From these papers, the developers construct a normalized index of the volume of news articles discussing economic policy uncertainty.

The second component of the index draws on reports by the Congressional Budget Office (CBO) that compile lists of temporary federal tax code provisions.

The developers create annual dollar-weighted numbers of tax code provisions scheduled to expire over the next 10 years, giving a measure of the level of uncertainty regarding the path that the federal tax code will take in the future.

The third component of the policy related to uncertainty index draws on the Federal Reserve Bank of Philadelphia’s Survey of Professional Forecasters.

Here, the developers utilize the dispersion between individual forecasters’ predictions about future levels of the Consumer Price Index, Federal Expenditures, and State and Local Expenditures to construct indices of uncertainty about policy-related macroeconomic variables.

The authors explain:

“We construct a new index of uncertainty—the World Uncertainty Index (WUI)—for 143 individual countries on a quarterly basis from 1996 onwards. This is defined using the frequency of the word “uncertainty” in the quarterly Economist Intelligence Unit country reports.

Globally, the Index spikes near the 9/11 attack, SARS outbreak, Gulf War II, Euro debt crisis, El Niño, European border crisis, UK Brexit vote and the 2016 US election.

Uncertainty spikes tend to be more synchronized within advanced economies and between economies with tighter trade and financial linkages.

The level of uncertainty is significantly higher in developing countries and is positively associated with economic policy uncertainty and stock market volatility, and negatively with GDP growth. In a panel vector autoregressive setting, we find that innovations in the WUI foreshadow significant declines in output.”

Recent data is shown in the chart below.

Source: PolicyUncertainty.com

The current value is much higher than it has been at any time in the past. There are also indexes available to track the level of uncertainty in several countries and regions.

It is interesting to begin with a look at the index for the United Kingdom. Brexit is roiling the country and the deadline lies just weeks away with no consensus of what will happen. It would seem to be the very definition of uncertainty.

Source: PolicyUncertainty.com

The index is rising but is well below the highs seen around the time of the Brexit referendum. It would seem that despite the great deal of uncertainty associated with this event, the United Kingdom is not the primary cause of the spike in global uncertainty.

The US and China Account for the Uncertainty

The next chart shows the index for the United States.

Source: PolicyUncertainty.com

Here, we see that there have been several regimes of uncertainty with the general level of the index having risen to a high level in recent years. The index seems to have reached a higher plateau than it reached in the past and may have become almost permanently elevated.

The authors note, “as measured by our index, we find that current levels of economic policy uncertainty are at extremely elevated levels compared to recent history.

Since 2008, economic policy uncertainty has averaged about twice the level of the previous 23 years.”

While this transition predates the election of President Trump, there seems to be no doubt that Trump’s policies have resulted in the elevation. This is confirmed by the next chart which shows the index for China.

Source: PolicyUncertainty.com

The spike in the past few months has been relentless and appears to be related to threats of a trade war.

The elevated level of uncertainty could be a concern for investors. The developers have observed, “We find that an increase in economic policy uncertainty as measured by our index foreshadows a decline in economic growth and employment in the following months.”

And, this seems to affect the stock market, “We find that the number of large movements in the S&P 500 index, defined as a daily change of 2.5% or more, has increased dramatically in recent years relative to the average since 1980.

Moreover, since 2008, an increasingly large share of these large stock movements have been caused by policy-related events.”

This is yet another indicator investors could consider following and is yet another indicator that raises concerns for investors.

 

 

 

Did you know that dividends have rewarded investors for at least 100 years, at least since John D. Rockefeller said, “Do you know the only thing that gives me pleasure? It’s to see my dividends coming in.”

We have prepared a special report about dividends that you can access right here.

 

 

 

 

 

 

 

At least for now, the government shutdown is ending. It has been weeks since parts of the government shutdown and MarketWatch.com explained the importance of the shutdown:

“At 35 days in duration as of Friday, the partial government shutdown has become the longest one on record, based on figures that go back more than 40 years.

President Donald Trump on Friday announced a deal to end the shutdown, but that’s after it turned into a historic one while dragging on.

It easily exceeded the prior record, which had been held by a 21-day closure during the Clinton administration that began in December 1995.

The chart below, based on Congressional Research Service data, shows how the current shutdown tops all other closures or gaps in funding in the last four decades.”

Source: MarketWatch.com

While this is the longest, there is a long history of shutdowns. This may be surprising to many since the news coverage indicates the shutdowns are partisan affairs and partisanship appears to be rising in the past few Presidential terms.

Potential Economic Impact

It is likely the extended shutdown had an economic impact. According to White House estimates, the impact could be significant. As CNBC reported,

“The Trump administration now estimates that the cost of the government shutdown will be twice as steep as originally forecast.

The original estimate that the partial shutdown would subtract 0.1 percentage point from growth every two weeks has now been doubled to a 0.1 percentage point subtraction every week, according to an official who asked not to be named.

The administration had initially counted just the impact from the 800,000 federal workers not receiving their paychecks. But they now believe the impact doubles, due to greater losses from private contractors also out of work and other government spending and functions that won’t occur.”

After 35 days, or 5 weeks, the White House estimate implies a 0.5% hit to GDP. But economists interviewed by CNBC expected that deep a hit only if the standoff lasted longer.

“Mark Zandi, chief economist at Moody’s Analytics, forecasts a half a percentage point hit to GDP if the shutdown lasts through March, roughly a third of the administration’s new estimate.

“We estimate (the shutdown) will reduce first quarter real GDP growth by approximately 0.5 percentage points,” Zandi wrote in a research report.

“Of this, about half will be due to the lost hours of government workers, and the other half to the hit to the rest of the economy.” Zandi said his estimate could worsen if the administration can’t continue to triage the effects of the shutdown or if the administration can’t issue tax refunds.

On the other hand, Ian Shepherdson, chief economist at Pantheon Macroeconomics, believes the combination of the shutdown and the tendency of the first quarter to be statistically weaker than the other three means growth could turn negative.

“If the shutdown were to last through the whole quarter, we would look for an outright decline in first quarter GDP,” Shepherdson wrote in a report.”

With GDP already expected to slow, the shutdown could reverse the recovery that appeared to be underway in the economy. It’s possible the brief spurt in growth seen in the data could be ending.

Source: Federal Reserve

Room for Optimism

“Analysts have noted that the impact of the current shutdown has been somewhat limited, as it’s affecting agencies that represent about 25% of total government spending. But the White House did double its estimate of the shutdown’s impact on gross domestic product.”

History also provides room for optimism. LPL Research recently studied previous shutdowns and provided a bullish summary of the past.

“U.S. stocks have also historically fared well after shutdowns, showing that any economic impact wasn’t enough to derail market rallies.

Source: LPL Research

The report noted:

“It’s important to recognize, however, that the current shutdown has lasted for an unprecedented amount of time with no end in sight. The U.S. economy is also especially sensitive to a shift in confidence right now.

Consumer and business confidence gauges have declined from cycle highs recently as negative headlines from the U.S.-China trade dispute and geopolitical squabbles have rattled financial markets and soured sentiment. Government employees missed their first payday of 2019 on January 11, increasing tensions and pressure for a deal before the U.S. economy takes a material hit.

“Trade tensions have softened corporate demand, and the shutdown could eventually weigh on consumer demand,” said LPL Research Chief Investment Strategist John Lynch.

“A prolonged shutdown could have an outsized impact on consumer health as government workers pare back spending and other consumers feel the secondary impacts of lower demand and policy uncertainty.”

Right now, we believe this shutdown will have limited intermediate or long-term ramifications for economic growth, but it’s important to recognize that we’re in uncharted territory.”

Uncharted Territory

It is important to note that we are in uncharted territory because the shutdown did last for an extended period of time and the effects were felt beyond Washington.

Airlines are one example of the impact with The New York Times reporting.

“It’s not just airport security lines and control tower workers that are affected by the federal government shutdown. Airlines, too, are being hit.

The industry as a whole lost about $105 million in revenue in the first month of the shutdown, according to data from the consulting firm ICF. That figure represents only the loss of revenue from some government employees not taking work trips.”

Estimates are that the revenue hit could total $15 million for Southwest and $25 million for Delta. These revenue shortfalls could drive earnings below expectations and result in market weakness.

Time added, “When government employees spend less, stores and restaurants that serve them suffer. So do landlords and lenders that do business with federal workers. Though spending and growth will rebound once the government reopens, most of the restaurant meals missed and hotel stays canceled will never be made up.

“Creditors and suppliers hit by the shutdown will become less patient if it drags on,” Ian Shepherdson, chief economist at Pantheon Macroeconomics, said in a research note. “People and businesses are being hurt by the shutdown, and the pain will intensify.”

 

 

No matter what happens in the future, we can be certain that investing will continue to be difficult. In fact, the future might be more difficult than the past but we do know that dividends will continue to be rewarding to many investors, just as they have in the past.

We know dividends have rewarded investors for at least 100 years, at least since John D. Rockefeller said, “Do you know the only thing that gives me pleasure? It’s to see my dividends coming in.”

We have prepared a special report about dividends that you can access right here.