Pre-Trade Tuesday – Markets Appear Untroubled But Weakening

No one seems worried.

The Volatility Index (VIX) is back around 13 after a brief spike to 17 when we bombed Iran and Iran bombed our bases in Iraq but that was so last week and now no one is worried about anything as we look forward to tomorrow's signing of the Phase 1 China Trade Pact, which accomplishes nothing in particular after two years of waiting.

The deal leaves out the fundamental changes to Chinese economic policy sought by many U.S. leaders and prioritized by President Trump, who has promised further negotiations. Chinese officials, though, feel they have little to gain from a second deal forcing Beijing to ease state control of the economy, and Trump has already said that a phase-two agreement probably wouldn’t conclude until after the November election.

U.S. Trade Representative Robert Lighthizer defended the deal Monday, saying on Fox Propaganda Network that it would include “a variety of real structural changes.” He then named only one, commitments to refrain from competitive currency devaluation, which Treasury Secretary Steven Mnuchin announced earlier in the day, already  dropping Treasury’s designation of China as a currency manipulator based soley on their thin promise to behave in the Future.

“By giving away leverage with a temporary deal…these structural issues will only become more challenging to address in future negotiations,” Senator Schumer wrote. “China pledging to make short-term purchases of American goods will not address the fundamental problems that undermine long-term U.S. economic opportunity, prosperity, and security.”

Tariffs remain in place that will still cover the same $360 billion in Chinese goods that the Administration taxed before the signing. Nearly two-thirds of everything Americans buy from China are still tariffed, compared with less than 1% before Trump began his anti-China campaign, according to calculations by economist Chad Bown of the Peterson Institute for International Economics.  The deal eases — but does not eliminate the trade-related uncertainty that Federal Chair Powell has blamed for weak business investment and a manufacturing slump.

The "Phase One" Trade Deal was announced back on December 12th and, since then the Dow has gained 1,000 points, or about 3.5%, putting a huge cherry on top of what had already been a 21% rally from 24,000 in January of last year.  Of course there were promises of a trade resolution all fall and the Dow rose from 26,000, where it had stagnated all Summer. 

That was up a realistic 8.3% from the start of the year but it's all distorted from last Winter's market collaspse that cost us 22.5%, albeit briefly.  The Dow was actually at 27,000 at the start of 2018, fell to 22,500 at the end of 2019 and now we're back at 29,000 but the key metric to me is we're up from 17,500 at the 2016 elections and that's 65% in 3 years – historically a bit extreme for market growth.

If we're going to pay 65% more for stocks, they should be earning 65% more money, right?  Forget the fact that most of the earnings boost has come from paying less taxes – silly as that is, it does still drop money to the bottom line so we'll count it like it's real earnings and can't be taken away. 

Still, it took a 70% reduction in Corporate Taxes to boost Corporate Earnings 20% so it's simply not possible for that to be repeated in the next few years but analysts tend to extrapolate earnings growth to continue at the pace it has for the last few years.  And, if corporate profits are up just 20% but we're paying 65% more for those profits – at what point can investors no longer afford those relatively meager profit returns?

We'll see how well profits are holding up as we begin tallying Q4 earnings.  JP Morgan (JPM), Citigroup (C) and First Republic (FRC) all beat this morning but, as we expected, Wells Fargo missed by 120%, putting up an 0.17 loss vs an 0.93 profit expected by clueless analysts.  WFC noted a $1.9Bn Operating Loss that included an impact from litigation accruals totaling $1.5Bn, or 0.33 per share.

That's right in-line with the expectations we had in yesterday morning's PSW Report (which you can subscribe to here) and the trade set-up in our Earnings Portfolio ended up looking like this:

So we're well on-track to getting $2,500 back from our net $455 investment in 67 days (March options expiration) and all we have to do is keep taking advantage of lazy analysts and we'll have a very nice earnings season indeed.  

More importantly though, let's keep our eye on the macro-picture and make sure companies are growing into these +65% valuations because, if they are not, we're going to be heading into a correction where nothing is likely to be spared – not even Tesla (TSLA) – which is reaching peak idiocy at $550!