The Biggest Risk for this Market Right Now

I guess the biggest issue for global stock markets is how to absorb ‘bullish’ news when so much good news is already in the price.

Yesterday, the RBA made another pointless interest rate cut.

In the US, the market has already priced in an 80% chance of a rate cut when the Fed meets at the end of this month.

And on the weekend, President Trump made soothing noises about the trade war with China. The market rallied on that news too, even though investors have priced in a benign outcome on that front for months.

Overnight, stocks rose again. The Dow and S&P 500 rose about 0.3%. The NASDAQ underperformed on the day, rising 0.2%. But it’s closing in on April’s all-time high.

In the commodities space, oil plunged and gold soared. As I wrote on Monday, the gold sell-off caused by the easing of trade war tensions and Korean peace talks was a buying opportunity.

I still think gold will consolidate around these levels for the next few weeks. If you’re keen on the precious metal or gold stocks, use this opportunity to add on any price weakness.

Gold is in a bull market. In a bull market, the correct strategy is to be…well…bullish. That means buying on weakness.

There’s another angle to this gold bull market that has received almost ZERO attention so far. That’s because it’s still early days. But I think at some point in the next few months, investors will start to wake up to what’s going on.

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Where do markets go from here?

Getting back to the markets now, and as I said at the start…where do markets go from here? Is the promise of low interest rates now in the price? Or is there more upside to go?

And what about the force moving in from the other side…company earnings? Interest rates have a positive impact on markets as long as company earnings are holding up.

But are we about to see the arm wrestle between earnings and interest rates swing back to the side of earnings? CNBC ran a headline early this week titled:

Companies are warning that earnings results are going to be brutal

Stocks may have brushed up against record highs Monday. However, a looming threat is just a couple weeks away once profit reports from the second quarter hit.

Analysts have been taking a dimmer view of what is ahead for earnings. They’ve already forecast a decline for the first three quarters of 2019. Now companies are echoing those concerns with a level of pessimism not often seen from corporate America.

Ahead of a season that starts in earnest the week of July 15, 77% of the 113 companies that have issued earnings per share guidance have warned that their numbers will be worse than what Wall Street analysts are estimating, according to FactSet.

The lowering of earnings guidance is not surprising. Falling US bond yields are a sign of a slowing economy, so of course companies are going to struggle in such an environment.

But what’s extraordinary is the fact that the equity market is completely ignoring these earnings warnings. As Reuters reports, Wall Street just had a storming June:

On the heels of the S&P 500’s best June performance in more than six decades, investors are anxious to see whether earnings can justify further gains as the largest U.S. companies open their books in the coming weeks.

Analysts expect almost no profit growth for the second quarter in comparison with a year ago, versus a forecast of 6.5% growth at the start of the year. In addition, they expect a gain of just 0.7% in the third quarter, according to IBES data from Refinitiv. 

With valuations rising, market watchers are paying close attention to the earnings forecast trend. The S&P 500 is now trading at about 17 times forward earnings, up from 16.3 at the start of the month, based on Refinitiv’s data.

Valuations are not absolute. They are a collective belief. Right now, the market believes that the S&P 500 should trade on a P/E of 17 times earnings, despite no earnings growth.

All it will take to shake this belief is a few profit warnings from some large blue-chips.

That’s what I see as the biggest risk to this market right now. That is, the risk that the narrative will shift from one of confident optimism, to pessimism.

To be fair, the market should give us warning signs if this shift is taking place. You’ll see it in the charts. Charts are just a reflection of investor psychology.

But with indexes at or around all-time highs, there are no warning signs right now. Investors are bullish.

However, with US corporate earnings season kicking off in two weeks, I’ll be keeping a close eye on how markets react, and let you know if those warning signs emerge…

Regards,

Greg Canavan,
Editor, The Rum Rebellion

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Greg Canavan approaches the investment world with an ‘ignorance is bliss’ philosophy. In a world where all the information is just a click away at all times, Greg believes we ingest too much of it. As a result, we forget how to think for ourselves, and let other people’s thoughts cloud our own.

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