Recap 2015-06-18: Some Thoughts


The FOMC was dovish as expected, but the effects have mostly impacted the belly of the curve. Long dated yields remain higher.

I’ve previously noted that sentiment was unusually pessimistic, and so the removal of near term FOMC uncertainty seems to have allowed the S&P to begin rallying. I think the rally has a good chance of extending for a few weeks. In addition to the sentiment backdrop, earnings estimates may start picking up soon as well.

As most readers know, the weakness in earnings has mostly been due to the Energy sector. Below is a chart of the average 12m change in 1y ahead EPS estimates by various groups. As the chart shows, the non-commodities sectors have been fairly resilient.

Unsurprisingly, the Energy sector EPS is fairly highly correlated to trailing measures of oil prices. Below is the rolling 2qtr median (with extrapolations out a few weeks) vs EPS estimates:

The point is that given the likely small uptick in expected Energy sector earnings, along with dropping out of base effects, the YoY change in Energy earnings estimates are likely to pick up over the next couple months.

This suggests that rising earnings is likely to once again start helping SPX performance over that time frame. The effects, however, are likely to be fairly mild until late in the year.

In addition, with the backup in yields, the supply dynamics for US credit may be changing soon. Blackrock noted that the US IG issuance since March has been double the average rate of the prior 4 years.

The majority of this seems to be related to M&A.

With the backup in global yields since March, there should be a slowdown in those activities, and hence issuance. That may allow long dated spreads to stabilize and eventually compress. The compression of credit risk premia is likely to also support equity prices.

Separately, the moves in EUR yields continue to be a key driver of EUR asset prices. 30y EUR swap yields are now 30bps higher than where they closed on the day QE was announced. The 2003 BoJ analog suggests that the broader sell off may be over for a bit, volatility not withstanding. Nevertheless, the effects on EUR assets has been powerful. That is likely to continue until it becomes more clear that we’ve past a local high for yields.

The EUR charts are looking… bullish. Momentum had turned by April, but the rising wedge suggests a potential break through 1.15 resistance. Through there, the next level of serious resistance doesn’t come into play until ~1.20.

Like the EUR, almost all of the Eurostoxx outperformance vs the SPX following the ECB meeting announcing QE has been unwound. The burden for outperformance remains on rising earnings. IMO, at current levels it’s not obvious that EU equities are cheap vs SPX even after adjusting for the better EPS growth over the next couple quarters. One possibility is that the (eventual) outperformance may not come until late this year.

Finally, I though this article from the WSJ was VERY interesting:

Prime Minister Shinzo Abe is expected to unveil a plan to balance Japan’s budget in five years, a move that underscores Tokyo’s resolve to improve its deficit-ridden finances even as it continues to pursue costly economic-stimulus programs. In a draft plan to be released early next week, Mr. Abe is expected to reiterate his long-held goal of eliminating a deficit in the government’s primary balance—the difference between tax revenues and government spending minus debt-servicing costs—as a step toward reducing the country’s debt burden, according to government officials.

This is a big deal because now it appears that Japanese fiscal policy makers is backing away from easing. In conjunction with Kuroda’s statements on the Yen, it appears that both fiscal and monetary policy makers in Japan expects to gradually wind down stimulus going forward.