Financial Review

Lucky Sevens

…Stocks post strong week. Gas prices move higher. Auto summit in D.C. Trying to tackle drug prices. Beware inversion. 1Q earnings season shines.

Financial Review by Sinclair Noe for 05-11-2018

DOW + 91 = 24,831
SPX + 4 = 2727
NAS – 2 = 7402
RUT + 3 = 1606
10 Y un = 2.97%
OIL – .85 = 70.51
GOLD – 3.30 = 1318.90


The Dow Industrials posted a seventh straight winning session – the longest winning streak since last November. The S&P 500 inched forward. The Nasdaq pulled back a little. For the week, the Dow is up 2.3%, the S&P 500 is up 2.4% and the Nasdaq is up 2.7%.


The import price index rose 0.3% in April because of the higher cost of oil. Excluding fuel, import prices rose 0.2% last month. The initial University of Michigan consumer sentiment index was unchanged at 98.8 in May.


Gas prices are ticking up. When Trump withdrew the United States from the Iran nuclear deal this week, he set in motion a series of events that will develop unpredictably. But it’s likely Iran will end up selling less oil into the global market before long, since the return of US sanctions triggered by Trump’s decision will punish entities that purchase Iranian oil, beginning in November. That will probably push oil and gasoline prices up. Oil and gas prices have already risen notably during the last month. Crude prices are up nearly 20% this year, to about $71 a barrel for West Texas Intermediate. The average price of gas is around $2.85 per gallon, with summer driving season kicking into high gear in about 2 weeks. Gas could easily crest $3 by summer, since prices typically rise as people hit the road for vacation and demand surges.The cost of gasoline, advertised in foot-high signs at stations everywhere, is the most visible price tag many consumers ever see, which is why gas prices serve as a symbol of how the whole economy is doing. Now that oil has crossed the $70 a barrel level, we start wondering about $80 a barrel, maybe even $100. There’s a countervailing force. The higher oil prices go, the stronger the incentives for American frackers and other non-OPEC producers to drill, which tends to boost supply and bring prices down – or at least slow the rise.


Trump talked with the executives from leading auto makers — including the CEOs of GM, Ford, and Fiat Chrysler about loosening emission and freezing fuel-economy standards. California and other states supportive of stronger standards have already sued the EPA over its move to change course. The auto industry executives stressed their desire for a uniform national standard, saying a patchwork of state standards would create an untenable regulatory tangle. Also, as a deadline nears to renegotiate the North American Free Trade Agreement, Trump didn’t appear to signal a wish to reach a deal with Canada and Mexico. One of the biggest sticking points relates to the portion of a car that must be made in North America to qualify for Nafta’s zero tariffs. American automakers support high levels of North American production, but they do not want onerous requirements that prevent them from using products from Mexico or countries like China and Japan. The auto industry is among the sectors most vulnerable to trade disruptions because its business model is increasingly global, in terms of both production and sales. One in five cars made in the United States is now exported, and one in four vehicles sold in America were produced in factories run by foreign-owned companies.


The White House said the Department of Health and Human Services will take steps to end the gaming of regulatory and patent processes by drugmakers to unfairly protect monopolies, advance biosimilars and generics, consider whether to include prices in drugmaker ads, and accelerate the approval process for over-the-counter drugs. One thing not mentioned — a campaign promise to use Medicare to negotiate lower drug prices. Big pharma doesn’t seem scared. Drugmakers’ stocks jumped immediately after the speech, as did the stocks of pharmacy benefit managers, the “middlemen” who Trump said had gotten “very, very rich.” The NASDAQ Biotechnology Index climbed 2.68 percent on Friday, and companies that make expensive specialty drugs saw their stocks rise, including Vertex Pharmaceuticals and Biogen. Pharmacy benefit managers Express Scripts closed up by 2.59 percent, and CVS Health finished up at 3.17 percent.


St. Louis Fed President James Bullard said that after being dislocated over the past decade, workers are now on the same footing as employers. He also said the U.S. wasn’t in any danger of a breakout of inflation, but that he was worried the yield curve could invert as soon as September. Inverted yield curves, or the gap between the 2-year and 10-year Treasury notes, often precede recessions. The Federal Reserve has started raising short-term interest rates to reflect the economy’s recovery, but longer-term rates — over which the Fed traditionally has far less influence — have not moved nearly as much. By most measures, the economy is in fairly good shape as the current expansion — the second-longest on record — stretches into its ninth year. At 3.9 percent, unemployment hasn’t been this low since 2000. Corporate profits are strong. Manufacturing activity has picked up. But with rates in Fed-sensitive short-term government bond markets rising while longer-term rates are relatively flat. Over the last year, the gap between interest rates on 10-year and two-year Treasuries flattened from more than 1 percentage point to less than half a percentage point, its lowest point in more than a decade. But as the yield curve flattens, long-term interest rates run the risk of falling below short-term rates, a phenomenon known as an inverted yield curve. And when the yield curve inverts, as it did most recently in 2006-7, it amounts to an economic warning from the financial markets to watch out: recession is on the way.


That’s because a flattening yield curve makes banking — basically the business of borrowing money at low short-term rates and lending it at higher long-term rates — less profitable. If the yield curve inverts, it effectively slams the doors on lending. And because debt is the fuel that drives the economy’s engine, a recession often follows. That doesn’t mean an inversion is right around the corner – but it is getting closer.


Based on the earnings numbers so far, profits among the biggest American corporations are growing so fast that you may expect the stock market to be soaring like a rocket. Instead, we are still in correction territory, trying to recover from that big drop in February. There are valid reasons for the market’s lack of response to spectacular earnings, the main one being that by February the market had gotten way ahead of itself, reaching valuations that few people could justify. Stocks rose so rapidly in 2017 and early 2018 — on top of their increases since 2009 — that prices had begun to seem impossibly high. Add the negative impact of rising interest rates and heightened expectations for inflation — both of which tend to hurt share prices. Tax windfalls are certainly inflating the numbers, but the core earnings of American corporations look solid, nonetheless. And a year from now, the tax effect is expected to subtract from earnings growth when this year’s windfalls are baked into financial statements. But this first quarter earnings season is actually turning out to have been the best for corporate America in decades.


The tax cuts that went into effect this year have transformed excellent earnings into exceptional ones. Nearly 80 percent of the companies in the Standard & Poor’s 500-stock index that have reported so far have topped Wall Street expectations — 16 percentage points higher than the average number of companies that beat expectations. Earnings per share have grown 26 percent since the same quarter a year earlier. Net operating income — essentially, profit after taxes — has risen nearly 25 percent in the same period. Almost half of that gain, 11.6 percentage points, comes from the big cut in corporate taxes that took effect this year. The tax windfall alone accounts for a larger earnings increase than the stock market typically receives from conventional sources. Expectations of a tax cut may help explain the run-up in stocks in 2017 and earlier this year. But even if you take the tax cuts out of the equation, earnings grew 13.2 percent for the quarter. That’s really, really good. But what does it mean as we move forward? Look for earnings growth to decline to the roughly 7 percent annual rate that has been the historic norm. We’re already seeing it – estimates for the second quarter have remained stubbornly static. In other words, the growth picture coming out of this earnings season is very impressive, but there is no improvement in expectations for the current and coming quarters. The outlook should improve; it is typical for EPS estimates to fall in the first month of a quarter, and as we get a better grasp on business conditions, the estimates are revised higher. Just don’t expect a repeat of the first quarter earnings season.


The Trade Desk jumped 40% after the platform for managing digital-ad campaigns blew out earnings forecasts. It reported that streaming TV advertising surged nearly 2,000% over the year in the first quarter.


Shares of Nvidia fell 1.4% after the chip maker’s shares fell in late trade, even after the company reported results and an outlook that topped Wall Street’s view. The stock was one of the bigger drags on the overall technology space, and it also weighed on other chip makers. Advanced Micro Devices fell 1.8%. Nvidia’s quarterly results showed how strong demand is around the world for semiconductors. Revenue rose 66% from a year earlier, almost twice as fast as the pace in the previous three months. And that has propelled its stock price, which is up nearly 1,200% in three years.

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