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The Wall of Worry

Written by Briton Ryle
Posted November 4, 2019

Let's see, we've got a seemingly severe slowdown for the U.S. manufacturing sector. Recent surveys show activity contracting sharply across the board. Corporate spending — CAPEX — has dried up. Every bit of the 1.9% GDP growth for October came from the U.S. consumer. 

The House is moving steadily forward with the impeachment process, with public hearings coming next. Trade negotiations haven't been torpedoed (yet), but any hope that a substantive deal gets done is pretty much gone. 

Global growth estimates continue to fall. The Fed is likely done cutting rates for now, though it has injected $400 billion into banks since September 15 to fix the liquidity issues affecting the overnight lending (or "repo") market. 

The balance of power in the Middle East is changing faster than ever. Russia and Turkey are making out like bandits (literally). 

Third quarter earnings are on pace to be about 3% lower than last year. So it goes without saying that bullish sentiment is very low.

And yet here we are: The S&P 500 is surging into record territory. 

Yep, stocks are climbing the proverbial wall of worry. It's kind of a dumb phrase. It always makes me picture investors wringing their hands and pacing. But I've learned to pay attention when stock prices move higher when the economic news is bleak. 

Because it takes many billions to push prices higher. And the people allocating those billions in money are not stupid. Well, unless it's SoftBank. Looking back at the way it handled the WeWork fiasco, SoftBank might actually be stupid. 

So what's going on?

Another Brick in the Wall...

First, let's go back to that GDP report. It might seem like companies completely shutting down their CAPEX spending would be a very bad thing. And in most situations, you'd be right. Layoffs tend to follow CAPEX cuts like — ahem — hangovers follow freaking awesome Sunday night Ravens beat-downs of the New England Patriots.

Speaking of which, sorry this article is getting to you a little late...

BUT layoffs are not picking up. In fact, the non-farm payroll report from Friday showed that companies are adding workers at a faster than expected pace. 

Huh. Whaddya know.

Could it be that companies are hiring to meet existing demand here in the U.S. (consumer spending), but they are not expanding production capacity globally due to the uncertain trade situation? 

Why yes, I think that's exactly what's happening. 

Supply chains are critical to the success of just about any business. And we know the tariff situation has meant that it's more expensive for companies to use/sell goods manufactured in China, right?

We also know companies are taking steps to get their supply chains out of China, right? 

Well, that process is basically a trade secret. It will absolutely create competitive advantage, so... 

Companies are not going to tell us what they are doing until it is done. 

As you know, I read quarterly earnings reports in my downtime. Oh, it's a glamorous life. And I've seen more than a few companies saying they will have completely nullified their supply chain exposure to China by the end of this calendar year...

Once that process is done — and not before — that's when we will find out how much savings these companies will achieve, and also what the current state of demand really is. 

And it's not really a mystery. The market is telegraphing the message right now...

What Hath God Wrought? 

Fact is, third quarter earnings haven't been as bad as expected. 

The awesome analysts at FactSet say:

To date, 71% of the companies in the S&P 500 have reported actual results for Q3 2019. In terms of earnings, the percentage of companies reporting actual EPS above estimates (76%) is above the 5-year average. In aggregate, companies are reporting earnings that are 3.8% above the estimates, which is below the 5-year average. In terms of sales, the percentage of companies (61%) reporting actual sales above estimates is above the 5-year average. In aggregate, companies are reporting sales that are 0.9% above estimates, which is also above the 5-year average.

Translation: Earnings are coming in a bit better than expected; revenues are coming in a good deal better than expected. 

To me it sounds like demand is there, hence the revenue gains. But there are some added expenses that are hurting earnings. Huh. Wonder if those expenses could be related to moving supply chains out of China?? 

We will get fourth quarter earnings in mid-January. And that's when we will hear companies say that demand is solid, supply chains have been moved, and here are the savings we expect, and here are our raised expectations for 2020. 

Of course, stock prices will be a good deal higher by then... forewarned is fore-stock-boughted. And yeah, that is absotively a word.

Until next time,

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Briton Ryle

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A 21-year veteran of the newsletter business, Briton Ryle is the editor of The Wealth Advisory income stock newsletter, with a focus on top-quality dividend growth stocks and REITs. Briton also manages the Real Income Trader advisory service, where his readers take regular cash payouts using a low-risk covered call option strategy. He also contributes a weekly column to the Wealth Daily e-letter. To learn more about Briton, click here.

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