Stocks took a breather from the record rally today, but earnings and Fed policy are still top of mind for investors. » Read More
The biggest names in the ETF business gather to debate the future of investing in booming exchange-traded funds. » Read More
Despite all the hype, volumes and open interest have been fairly small in Cboe and CME bitcoin contracts. » Read More
Earnings for the S&P 500 are expected to grow 11.8 percent in the fourth quarter, according to Thomson Reuters. » Read More
There is much more at stake in this earnings season than usual.
The great marginal mover of stock prices last year— the hope of tax cuts — has now become a reality. Prices are at historic highs across the board, in most sectors, in all market caps, and not just in the U.S. It is highly likely investors will demand unusually strong earnings beats and guidance to sustain prices.
The investing community is very optimistic about earnings. Analysts typically lower earnings estimates as the quarter ends, but not last quarter. Estimates for the S&P dropped by only 0.3 percent for the entire quarter, the smallest decline since the fourth quarter of 2010.
In most quarters, the final S&P earnings are about 3 percentage points above analyst estimates, but with analysts so optimistic, we may not see that kind of beat. Investors are expecting the opposite: bigger beats. They will likely be more willing than usual to punish companies with in-line or disappointing numbers.
"This is going to be a big quarter for guidance," Christine Short from Estimize told me. "Tax cuts were not baked into guidance last year, so investors are expecting much more clarity on what could happen, including on repatriation of foreign earnings."
You can bet investors want to see more companies raising guidance to justify the high prices. In most quarters, of those that offer guidance, about 35 percent will guide up and 65 percent will guide down. For the fourth quarter of 2017, 75 S&P 500 companies have issued negative EPS guidance and 35 S&P 500 companies have issued positive guidance, according to FactSet.
Investors are expecting a higher percentage of companies to raise guidance.
Investors also are expecting more aggressive buyback announcements in the wake of the tax cuts. And expectations for capital investments are equally high, also thanks to tax cuts.
Can CEOs really deliver on these high expectations? To me, this sounds like a pretty tall order. But there's some reason for optimism.
"A lot of good news has been priced in already, but I really like what I'm hearing from companies so far," Nick Raich from The Earnings Scout told me. "Revenue growth has been strong, and I am hearing more noises about capital spending."
He's encouraged because the 19 companies in the S&P 500 that have reported earnings so far have put up strong results. The 19, which includes Oracle, Carnival, Darden, Walgreens, FedEx, CarMax, Constellation Brands, and others, have reported average earnings growth of 18 percent, and sales gains of 11 percent.
That is 50 percent above expectations for the S&P as a whole for the quarter: 11 percent for earnings, 7 percent for revenue.
The numbers have been so strong analysts are raising earnings estimates. "That's great...we haven't seen analysts raise estimates in an earnings season in six years."
For Raich, capital spending is the key to sustained stock price growth. "When one company starts to spend, that is helpful to other companies. Buybacks are only helpful to the company buying the stock. Capital spending is part of the animal spirits we keep hearing about."
"If they increase spending, the rally could be extended for another 12 to 18 months."
We all know why the stock market is at new highs: It's a combination of the expanding global economy, record earnings and low rates.
That's the conventional narrative, and it certainly makes sense. But as earnings season begins in earnest on Friday, and with stocks at historic highs and interest in the markets increasing, many investors are wondering if there is enough stock to go around.
Call it "the buyback effect." Companies have been aggressively buying back stock for years, and investors are starting to notice the shortage.
My colleague Jim Cramer is one of them: "We don't have enough shares to go around," he said a couple of weeks ago on CNBC's "Mad Money." "There's just not enough supply, not enough stock to meet the demand from buyers who had to radically switch their orientation to deal with a much more positive backdrop."
He repeated that assertion Monday: "We do not have enough machinery and cyclical companies. That's a big part of this [stock market run-up]," he said on CNBC.
He has a point. In 2006, the S&P 500 represented some 307 billion shares of stock. After the 2008-09 financial crisis, that number shot up by 10 percent, to 332 billion by 2010, as many companies issued new stock to deal with the effects of the financial crisis.
Foremost among these issuers were financial companies, which nearly doubled the amount of their shares outstanding from 2008 to 2010. Bank of America's shares outstanding more than doubled, from 4.5 billion in 2008 to 10 billion at the start of 2010. J.P. Morgan went from 3.4 billion to 4.1 billion at the start of 2010. Wells Fargo went from 3.3 billion to 5.2 billion by the end of 2010.
But soon after that, buybacks became all the rage, even if many of the biggest banks were restricted from buying back stock. Beginning in 2011, the S&P share count dropped back to 303 billion and has remained around that level since, with 306 billion at the end of 2017.
Of course, during all this time, companies were issuing new options to their executives, then turning around and buying back stock.
The effect of all this activity is a wash: The number of shares is the same today as in 2006, but the prices have doubled. The average S&P 500 stock in 2006 was priced at roughly $50; at the end of 2017, it was $107.
Prices doubling, with the same amount of shares, means demand is much higher.
Cramer isn't alone in attributing part of the rally to buybacks. Howard Silverblatt at S&P Global has also noticed that shares outstanding are the same as a decade ago: "Considering all the new household wealth, and all the money that is going into the market, they don't have more places to put it," he told me. "They don't have more shares to buy. We are getting more demand, but the supply isn't increasing."
Thus, buybacks have contributed to the higher prices: "It's a double whammy: Companies have been reducing supply and adding upward pressure on prices by themselves buying back their own stock."
He concludes, "If shares are the same, and you have increased demand, prices will go up."
And it may get worse. Companies are expected to announce more share buybacks this earnings season in the wake of the tax cuts and companies bringing profits made overseas back home.
With the markets making quick work of Dow 25,000, here's the crucial issue: With so much good news now built into the market, is there room for higher prices?
Can you smell it? It's a slight whiff of euphoria around the stock market rally, the first time I have smelled it in a long time.
Oh sure, the market has been richly valued for a long time, but that's different than euphoria. A lot of people suddenly seem to believe that things are going to get a lot better in 2018.
Maybe, but remember one of the best things the market has had going for it for the past seven or eight years is how hated the rally has been.
Now people are starting to like the rally. A lot. Makes me a little nervous.
Here's something else that makes me nervous. The bar is now very high on the two most important components for stock valuations: economic data and earnings.
The Dow has passed 25,000, quite an impressive move considering it hit 20,000 on less than a year ago — on Jan. 17.
Many are still amazed that the market keeps advancing, but it's not incomprehensible.
It's a global rally. Reuters reported that China would stick with GDP growth around 6.5 percent as a goal in 2018. The Japanese market, which was closed Wednesday, finished Thursday at a 26-year high. Europe was up nearly 2 percent as euro zone businesses reported their strongest activity since 2011.
And in the U.S., the ADP jobs report at 250,000 was well above expectations of 190,000. This has been a trend recently, with economic reports coming in above expectations.
This year was a record-breaking year on all fronts for the ETF business: inflows of $476 billion, and assets under management swelling to $3.4 trillion.
For 2018, investors will continue to pour money into low-cost index ETFs. It will be great news for investors, who will benefit from even lower fees, but it will be increasingly tough for even the biggest companies to make money.
Where did all this money come from? Dave Nadig, CEO of ETF.com, says the answer is pretty simple: traditional actively managed mutual funds.
"This was a year of running away from high-cost alpha seekers into low-cost vanilla beta exposure," Nadig told me.
Remember when Marc Andreessen said, "Software is eating the world?"
In the ETF universe, indexers are eating the world.
U.S. equity ETFs attracted the biggest chunk of money, but international equity was strong, as earnings in Europe and emerging markets picked up and, despite lower prices, investors continued to put money into fixed income:
Will 2018 be a more "normal" year? 2017 was a year of surprises, but for 2018, not surprisingly, things are expected to be more, well, normal.
Which is why you should be suspicious.
It's true — by almost all measures, 2017 was one of the most extraordinary years in the history of the stock market. Investors saw:
What does all this mean? The stock market is a numbers game with a long track record. When you get numbers that are way out of the ordinary, it's logical to believe in mean reversion, that it is highly unlikely that returns or volatility will come anywhere near 2017.
That is exactly veteran market watcher Sam Stovall's advice to his clients. Stovall is chief equity strategist at CFRA, and in a note to clients advised that investors "would be better off anticipating an increase in volatility, a reduction in new highs, as well as a below-average price gain for the '500' in the year ahead."
Getting these extraordinary numbers tends to pull forward stock market performance. In years with above-average new highs and below-average volatility (exactly what we had in 2017), the S&P rose the following year only 55 percent of the time, with an average gain of only 3.1 percent, Stovall noted.
In years where the "dispersion" between the best- and worst-performing sectors was high (also what we saw in 2017), the S&P 500 was also up only 57 percent of the time in the following year, with an average gain of only 1.9 percent.
Stovall's conclusion: "As a result, one could say that in 2018 investors should expect more for less — more volatility for less return."
Get it? "Less surprise" is a big theme for 2018. Jim Paulsen, chief investment strategist for Leuthold Group, has noted that a good part of the stock markets' gain has been related to the string of strong economic numbers that we have seen recently: He notes that the U.S. economic surprise index rose to a 6-year high last week.
"Even if the recovery remains healthy in 2018, it can't continue to surprise," Paulsen says.
But why can't it continue to surprise? Peter Tchir, macro strategist for Academy Securities, is not so impressed with the "reversion to the mean" story.
Tchir notes that the global economic expansion continues, that earnings remain at record highs, and the tax cuts are pushing those numbers up: "It doesn't feel like the tax cut is being fully priced in, and there's no reason corporate America can't keep issuing debt and buying back stock. I'm not sure we can't have more of the same."
And absent some outside shock, why can't volatility remain low, he asks. "With ETFs, people have less need to chase daily trading, and I think that's a good part of the reason why we have seen reduced volatility."
Bottom line: Reversion to the mean does eventually happen, but we are in very unusual times.
The Federal Reserve may sound a bit more hawkish, as Fed Chair Janet Yellen's tenure comes to an end.
In the 10 best Januarys for stocks, the full year ended with a gain, and there was a fairly significant sell-off.
Regulators have targeted high-speed trading as an area where manipulative trading occurs.