Markets look to be in pretty buoyant mood, cheered on by more than decent earnings numbers coming out of the US (again!) – the numbers are coming in thick and fast and so far 45% have reported. According to Deutsche of the 230 S&P 500 companies (55% of market cap) that have announced so far:
- 77% reported better-than-expected Q1 earnings, a sharp recovery from Q4 when the beat rate (68%) dipped to its lowest level in 7 years;
- Earnings beats are running at 6.4% (4.7% median), vs 3.4% historically;
- Earnings look to have grown 2.4% in the aggregate (4.6% median) and blended growth for Q1 is tracking 1.9%, which is a big positive surprise to our model-implied estimates of -0.4%. ( Will Q1 Mark The Bottom in Earnings Growth? )
At this point, the cynic would shrug their shoulders, remind us that earnings estimates are only being revised up over the course of reporting because they’ve been cut in the run-up. Even so, we are still looking at US earnings barely posting any growth at all in Q1. The hope is that US earnings growth will recover later in the year. In the meantime we have a potential meltup on our hands and volatility has crashed back down again. Not unsurprisingly according to Deutsche we are seeing US equity futures positioning increasing for the third consecutive week and is near the top of its historical range. Deutsche also reports that short interest in stocks and ETFs is at multi-year lows.
The fly in the ointment might be inflation, from one of two potential sources.
The first is wage pressure in the US. There are more and more reports coming out now that skilled workers especially are demanding – and getting – much better wage increases. That’s good for the US consumer but potentially bad for corporates if they can’t pass these pricing pressures on because of intense price competition.
The other source of potential pain is oil, which has rallied strongly of late (as has the dollar, a pairs trade that usually operates in the opposite direction). In oil long positioning in futures has continued to rise and according to Deutsche has “become more stretched. The large divergence in both performance and positioning from the historical relationship suggests the current dislocations are likely to revert.”
Or possibly not. I note with interest a note to investors last week from Jean Louis Le Mee, a specialist energy investor at Westbeck Capital. Now they run a fund that invests in this space (long and short) so of course, they’ll talk up their book but what struck me was the sheer conviction of their latest update. The big catalyst – for a more bullish position – is the sanctions on Iran which they reckon is as hawkish a surprise as possible. They now expect Iranian oil exports to drop to around 600kbd.
“surprised oil is not up a lot more on the news…[with] physical oil markets are on fire … we believe Brent should have been trading in the $80s even before the Iran announcement. We are not sure the markets really understand that while Saudis / UAE will keep the oil markets supplied they are expected to do so only AFTER the scale of disruption becomes apparent. In other words, the Saudis are now the price-setter and they will drive Brent to their $80-$85 desired range in short order, in our view. Now we expect conversations around global spare capacity (or lack thereof) to again start making the rounds in the coming weeks. We had 3Q19 in a 1.3mbd deficit before these new sanctions for 2mbd of available global spare capacity. Assuming Saudis and UAE match every new Iran barrel lost (after the fact), we now expect a 1.3mbd deficit for 1.2mbd of global spare capacity. These numbers should have every investor worried:
- There are currently significant risks to large additional supply losses in Venezuela, Libya, Nigeria and Algeria.
- Oil demand is starting to recover and could outpace our forecast.
- These sanctions will only exacerbate the crude quality issues we have written about extensively, increasing the odds of an IMO ‘demand shock’ this summer.
We believe the risks for an oil price spike to $100+ this summer are increasing.”
Needless to say, that if Westbeck is right, then if oil prices do rise sharply, we could see those much predicted but largely dormant inflationary pressures emerge. If these coincide with margins pressure from increasing wages, we could see a nasty shock in the equity markets. My guess though is that we are some way of this scenario…for now. And that equity markets might continue rising.