It May Be Time for Financials to Consolidate a Bit Now
* The large money center banks are as close to "forever" stocks for me * However, the recent rise in the sector - and near +10% opening print higher - have been almost vertical and some backing and filling would not be a surprise * Indeed, some consolidation would be healthy
My upbeat position on this space has been clear repeatedly - banks represent one of the best areas of value in the market.
Many - fundamentalists as well as technicians - were in strong opposition of this view.
That said, the trajectory of the recent rise has been even better than I expected. Moreover, the gap higher - on the opening (e.g Citigroup (C) and Wells Fargo (WFC) rose by about +10% on the opening prints) - might herald a short term top.
As posted, I have previously taken profits in (GS) , (MS) and (PNC) .
I still am holding large positions in (BAC) , C, WFC and (JPM) - and I plan to hold on to the them for years.
But some backing and filling should now be expected.
Those with a shorter term time frame (than I) may consider paying heed to my view and observation this afternoon.
Position: Long BAC (large), C (large), WFC (large), JPM (large)
My Book Is Down Considerably in Both Gross and Net Terms
I am now essentially down to four large long positions in banks and three packaged foods positions. Against this I have a large short (QQQ) and medium-sized (SPY) short. In terms of individual equity shorts I remain short Apple (AAPL) and Caterpillar (CAT) . I am liquid.
* I have covered my entire large bond short ( (TLT) is down by another -$2.80 today) - I plan to reestablish the short on any TLT strength. * Reduced speculative (GE) from large to medium-sized. * Eliminated my large (PNC) long (the shares have moved from the low $80s to $127.50 in 2-3 months). * Sold the balance of my (GOOGL) . * Took in some of my (SPY) short (for a large loss) - moving from medium-sized to large-sized (I am staying with my (QQQ) short). * Sold my SPY puts for a loss. * I covered my (ZM) short (the shares are down by over $23/share in 1 1/2 trading days) - I plan to reestablish this short as well on a rally.
I just got back from morning meetings. The market's response to the jobs number is surprising. I will be spending the weekend analyzing the data and the investment ramifications. I have executed a number of trades (coming up in a new column).
Dow looks on the verge of a potential breakout. Technically it is in breakout territory, looking to extend. That has been thanks to some individual performances such as Boeing, etc. Traders will therefore look more closely at S&P.
The breakout there is going to be certainly higher up, somewhere around the 3160 to 3200 area and they will look to see if any such buying is broad. This morning's data has traders puzzled so they will just play it as the cards are dealt.
The May payroll report is an obvious focus today but we know we have to look at what the economy looks like after the reopenings are mostly complete outside of large gatherings like sporting events with fans and concerts. Then we can ask, how many businesses have reopened? How many of those laid off have come back? Will their pay be what it was? Will consumers spend at the same rate they did prior to Covid? Will companies try to do more with less in terms of its labor force? Will improving the balance sheet take priority? Etc...
After 6 years of negative rates and a balance sheet that has gone from 2 Trillion euros to one approaching 6 Trillion, we saw the ECB add another tranche yesterday all in an attempt to somehow accomplish higher inflation. It failed in Japan, it has failed in Europe but the 'do something' mentality on the part of central bankers never dies, regardless of what it is and whether it has any history of working. And just imagine if we eventually get higher inflation, which I believe we will, what an absolute disaster that will be. Today a Governing Council member of the ECB said "Deflationary risks have increased and that's one of the reasons the ECB is taking the action it is taking, to ensure that risk doesn't materialize. I'm among those who think that this crisis is essentially disinflationary, in the sense that some of the problems we had with low inflation are accumulating." So with double digit unemployment, the answer is to raise the cost of living?
Well, notwithstanding the ECB news where only Italian bonds really benefited, the trend of higher market interest rates this week continues today. The German 10 yr bund yield started the week at -.45% and today it's -.30%. Maybe one day again there will be a plus sign in front. The US 10 yr yield has risen about 20 bps to .86% with about half of that due to higher inflation expectations.
Helping to lift rates is the continued persistent rise in equity prices and all the stimulus coming, both monetary and fiscal. Today the EU Commissioner for Economic Affairs said "I think it's possible that the agreement of the European Council will come in July" with regards to the 750b euro package being discussed where 500b will be in grants and 250b in loans. All EU governments need to ratify it.
Danielle DiMartino Booth on the permanent/temporary employment debate:
As states reopen, surges in pent-up demand have been a catalyst for increasing home and auto sales; reflecting months of homebound online shopping, furniture sales have risen by an average 35% in the three most reopened states, compared to a 21% increase nationwide
Bankruptcies have been postponed for many businesses as forbearance measures and bloated court dockets delay the inevitable for small businesses; expect bankruptcies to accelerate, exacerbated by a continued build in permanent layoffs as companies struggle to survive
Even as the economy reopens, layoffs are rising as companies cut costs to offset falling demand; after a one-week reprieve, continuing jobless claims rose anew, flagging millions of pent-up layoffs as service and factory firms downsize and consumer credit tightens
"All very well for the bulge group, you may say. It will continue to dominate society as it passes through the decades like a pig through a python."
~ Russell Baker, New York Times Magazine, April 21, 1974
In economics and demographics, the "pig in the python" has traditionally referred to the baby boomer generation -- as was the case back in 1974. The technical definition is "a sharp statistical increase represented as a bulge in an otherwise level pattern." The metaphor, of course, refers to the digestive system of a python after they've swallowed large animals -- the bulge of the victim can be seen slowly traveling from the front to the end of the python.
But there's a new pig on the block, a fresh surge that, as was the case with the economy shutting down, will wreak havoc with data for some time. It's called "reopening" and feels a lot better than the shutdown... at the moment. The pig has just eaten the python -- and it's delish.
Home and car sales, the top two telltale leading indicators of consumption that drive the U.S. economy into and out of recession, are surging. Expect that to continue as the rest of the U.S. economy reopens reflecting the follow-through on purchase intentions that had been frozen in time. Think families that had plans in motion to relocate by the start of the school year, drivers who had an eye on a new car just in time for their local dealership to temporarily shutter and remodeling plans put on ice. Now add to this, dynamic endless online hours to precisely plot your planned purchase right down to the color of the car's trim and a short list of homes you've virtually toured. Finally, dabble on an unprecedented fear factor for millions of sheltering-in-place city dwellers whose first move, once they could move, would be to move the hell out of said city. That's your pig -- pent-up demand the likes of which this economy has never seen.
To cite one case in point, Bank of America's latest reopening real-time tracking survey data show that furniture spending is up 21% over last year nationwide. That compares to an average of 35% in Arizona, Florida and Georgia -- the three states they identify as the "Most Opened." This compares to an average -0.33% in overall spending across these three vs. -9% overall nationwide.
As we contemplate what's to come after today's May payrolls, visualize the pig moving through the python. At some point, it will be time for the next meal -- the follow-through to reopening.
That's what gets us to the permanent/temporary debate, one we've tried to settle by using only permanent data that is incontrovertibly, well, not temporary -- not initial claims, not emergency stimulus measures, not furloughs. After verifying with Challenger, Gray and Christmas that they only report permanent layoffs (red line), we can say with near certainty that the 1,446,823 jobs announced through May will take out 2001's prior full year record of 1,956,876 cuts.
In fact, expect that to be taken out by July and keep going based on the blue bars (bankruptcies) and a second wave of higher-income jobs Bloomberg estimates to be six million, casualties of the demand destruction COVID-19 has left in its wake.
For the moment, business bankruptcies present a conundrum. They peaked at 10,586 in 2009 and "only" amount to 2,994 through May. But bankruptcy attorneys point to forbearance measures that have postponed Chapter 11 filings for smaller companies as well as (reopened) court systems struggling to keep up with bulging dockets. But the pent-up supply of insolvencies is without a doubt in the pipeline. At the highest level, a half trillion in distressed debt leaves little doubt we'll see bankruptcy filings continue to swell.
As for the layoffs to come, what the heck does six million layoffs to come mean, focused as they're expected to be in professional services, finance and real estate? At the highest level, after one whole week's reprieve, continuing jobless claims resumed their upward march from 20.8 million last week to 21.5 million. And what's the point of all of these numbers without putting faces on them? As a follow up to Wednesday's one-day parade of layoff headlines, we give you Thursday's.
Homebuilder Hovnanian (HOV) is "streamlining our organizational structure and reducing our workforce," and expects "these steps to result in approximately $20 million in annual overhead savings." By the way, the contract cancellation rate in its fiscal second quarter ended April 30 was 23% vs. 19% in the prior three months. Expect increasingly stringent mortgage lending standards to play a growing role after the initial pent-up housing demand is satisfied.
We also heard from former unicorn Stitch Fix, the San Francisco-based online personal styling services now valued at less than $2 billion -- it will make redundant 20% of its workforce, or 1,400 employees. Carpenter Technology, the Philadelphia-based materials company will also reduce by 20% its headcount that last numbered 5,100. Texas Steel Conversion of Houston will reduce by 491 its fracking workers. New York investment bank Perella Weinberg Partners will lay off 7% of its employees tied to slowdown in deal-making. Michigan's La-Z-Boy will lay off 10% of its workforce, or 850 employees, and close an upholstery factory in Mississippi. And finally, Southlake, Texas' Sabre, the software and technology company for global travel industry will lay off 800 in addition to the 400 in committed voluntary early retirements.
As anyone with a pulse recognizes, stock valuations are keying off a perfect reopening with full follow-through. The risk is that after the reopening pig is digested, the python will be hungry for a long time to come.
J.M. Smucker had a large EPS beat relative to expectations in the fourth quarter of 2020 -- at $2.57 vs consensus of $2.20-$2.25. Organic growth was slightly above 10%, well ahead of projections. Gross margins rose by over 60 basis points and the EBIT margin was +200% year over year. SG&A margin declined year over year (-150 basis points) reflecting reduced promotional support (in light of the high demand for its products -- citing "millions of new buyers in its coffee and consumer brands"). However, the projected 2021 guidance range of $7.90-$8.30 was under the consensus of $8.45. The shares faltered in the belief that the company's demand was pulled forward because of Covid-19 and that organic growth will slip modestly in the new fiscal year. Smucker cited declining sales in Away From Home Business and some pantry de-loading in Pet Food (leading to little in the way of year over year Pet division sales or profit). My view is that the guidance will prove too conservative -- in an attempt of new management to break the skein of profits disappointments of the past. My 12-month target price is about $130/share, implying a forward 12x Enterprise Value/EBITDA multiple against next year's EPS forecast. This is still a -12% discount to its packaged foods peers (and in line with history).
