Thursday, July 11, 2013
What did we see in Wednesday's Fed minutes and in the Bernanke
speech afterwards that seem to have calmed the markets down? The
dollar and treasury yields have eased a bit as a result and
stocks are heading back towards new all-time highs.
There was nothing that was substantively new, but both the
minutes as well as Bernanke went to great lengths to dial back
expectations for the course of monetary policy - as a way to stem
the rising tide of long-term interest rates. And as we have been
seeing repeatedly over the last couple of weeks, the stock market
seems to be liking what it is hearing from the Fed. The bond
market still remains skeptical, though it appears to have a
paused a bit as well.
The Fed minutes tried to emphasize that the decisions to start
'tapering' and hike Fed Funds rates were distinct and unrelated.
In putting this gem of an insight into the minutes, the Fed was
trying to make the point that 'tapering' didn't mean tightening.
From the Fed's perspective, if they buy $65 billion bonds a month
post 'tapering' instead of the current $85 billion, they are
The bond market and most of the other 'normal' people think
otherwise. From the bond-market's perspective, 'tapering'
amounted to the first shot in a gradual monetary policy
normalization in which the Fed would first end the QE program and
then start eying the Fed Funds rate. As a result, the bond market
started rates higher, pushing it almost 100 basis points higher
in less than two months.
The Fed appears to have been unnerved by the bond market's
reaction and is trying its best to control it. Bernanke even went
to the extent in his speech yesterday that the Fed could hold off
on touching the Fed Funds rate for a very long time even after
the unemployment rate fell to 6.5%, which was the Fed's prior
target. We will see how all of this unfolds in the coming days
and weeks. But at least for now, the stock market doesn't seem to
be overly concerned by the jump in treasury yields and has no
problem reclaiming its May peak despite substantially higher
The stock market's response could be justified on grounds of
improved economic growth and corporate earnings outlook. While
consensus GDP growth estimates for 2013 Q2 are barely close +1%,
the same for the second half of the year and next year show a lot
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The same picture emerges from consensus earnings estimates for
the second half of the year. While total earnings growth is
expected to be barely in the positive territory in Q2, they are
expected jump by more than +5% in Q3 and more than +11% in Q4.
For full year 2014, total earnings are expected to be up an
additional +11.5%. We haven't heard much positive guidance for
the coming quarters from the companies that have already reported
Q2 results like
) and others. Financial firms typically don't provide forward
guidance, but it will be interesting to see how
) dealt with the sudden spike in interest rates in Q2. Both these
banking leaders report before the open tomorrow.
But if recent history is any guide, then we should brace
ourselves for another round of predominantly negative guidance
this earnings season as well, causing estimates for Q3 and Q4 to
start coming down. This trend has played out repeatedly over the
last few quarters, with investors essentially shrugging negative
estimate revisions each time. Market bulls believe that we will
get a repeat performance this time around as well, with the stock
market not losing even beat as estimates for the second half of
the year and next year come down. May be the bulls are right and
nothing will happen.
But forgive me for being a bit skeptical of these soothing
voices. My sense is that the stock market is disregarding the
jump in treasury yields because it is looking for strong earnings
growth in the coming quarters. But earnings growth can't
miraculously appear in the back half of the year or next year.
With margins already at historical highs and revenue growth hard
to come by in a growth-constrained world, double-digit earnings
growth may firmly be in the rearview mirror. Investors bidding up
stocks in hopes of strong earnings growth in the coming quarters
are heading towards a disappointment.
Director of Research