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FactSet StreetAccount Summary - US Weekly Recap: Dow +1.24%, S&P +1.34%, Nasdaq +1.86%, Russell +2.71%

Jun 6, 2014

Overview:

  • US equities finished higher this week. The S&P 500 was up more than 1% for a third straight week, its longest such winning streak since last September.
  • In line with the recent trend, this week’s push higher lacked a specific catalyst. However, while the macro narrative remained little changed, there were several positive dynamics at work. 
  • The still favorable global monetary policy backdrop remained in focus. Despite the weeks of hype, easing measures announced by the ECB seemed a bit more dovish than expected.
  • Several May data points this week, including vehicle sales and nonfarm payrolls, helped to underpin recovery sentiment. Takeaways from the airline sector and class 8 truck order data were also upbeat.
  • While there were no meaningful surprises out of this week's sell-side conferences, there seemed to be more focus on the pickup in earnings growth coming out of Q1. Strategists also continued to highlight improved earnings revision trends.
  • Despite some well received data points, there was no shift in expectations surrounding the Fed’s exit strategy. In addition, a report of a pickup in Fed concerns about financial instability risks failed to gain any traction.
  • Aside from the ECB, there were some other favorable external developments. There were more policy fine-tuning headlines out China, while renewed reform sentiment continued to provide a tailwind for Japan.
  • There were some relatively upbeat takeaways from the price action as several cyclical pockets of the market outperformed, including the banks. The recent bounce in small-caps gained momentum, while defensives largely lagged.

ECB delivers against high expectations:

  • The most widely anticipated even this week was the ECB policy meeting. Despite all the hype over the last few weeks, the moves outlined by the ECB seemed to be a bit more dovish than expected, particularly given that all decisions secured the unanimous support of the Governing Council. A 10 bp cut in both the main refinancing and deposit rates to 0.25% and (0.10%), respectively, was at the lower end of the consensus range. However, the credit easing measures intended to revive lending to the corporate sector were more aggressive than previewed by the Street. Most of the discussion revolved around the two targeted LTROs to be conducted in September and December this year that will allow banks to borrow up to 7% of their outstanding loans to the non-financial private sector, excluding mortgages. The ECB said that this amounts to €400B. Four additional targeted LTROs will be conducted between March 2015 and June 2016. The central bank also said that it is intensifying the preparatory work for outright ABS purchases. However, while Draghi continued to leave the door open, he did not given any indication that the ECB is ready to unleash a large-scale asset purchase program.

Key data points underpin recovery expectations:

  • There were several data points this week that helped underpin the pickup in recovery sentiment coming out of a weather-constrained Q1, while also having no impact on expectations surrounding the Fed’s exit strategy. The auto sector remained a standout as US light vehicle sales came in at a ~16.8M saar in May, an acceleration from the 16M pace in April and up from 15.5M in May 2013. This was well ahead of the 16.1M consensus and the strongest month since July 2006. JPMorgan also talked up the quality of the data as both incentives and inventories tracked healthy. While largely in line with expectations, Friday’s employment report seemed to be good enough for the market. Nonfarm payrolls increased 217K, while the unemployment rate held steady at 6.3%. Average hourly earnings were up an as-expected 0.2% m/m and 2.1% y/y. There were some other favorable recovery levered data points outside of the traditional economic calendar in focus this week. Class 8 truck orders were up a better-than-expected 4% m/m and 14% y/y in May. Both sell-side and corporate commentary surrounding the airline group was upbeat. DAL +5.8% reported May PRASM up 7%, at the high end of guidance.

Street still looking for meaningful earnings growth acceleration:

  • One positive dynamic for market sentiment that seems to be getting more attention is the stability of expectations for a nice acceleration in earnings growth coming out of Q1. According to FactSet, over the first two months of Q2, the Street has cut the bottom-up estimate for S&P 500 earnings by 1.2%, the lowest amount since Q2 2011. It is also well below the 3.1% average reduction over the last year. S&P 500 earnings are currently expected to grow 5.4% in Q2, up from 2.1% in Q1. Growth is expected to accelerate further to 9.7% in Q3 and 10.3% in Q4. In addition, the 10.3% S&P 500 EPS growth forecast for Q4 actually represents a slight improvement from the 9.9% expected at the start of 2014. Improved revision trends have also received some attention in recent strategist commentary. BofA Merrill Lynch noted that in May, the three-month earnings revision ratio increased for the second straight month. It said it rose to 1.07 from 0.85, implying that analysts are now making more positive than negative revisions to earnings estimates for the first time in two years. It added that its one-month earnings revision ratio also ticked up to its highest level since April 2012.

Concerns about financial instability fail to gain traction:

  • For some time now, the financial press has been cranking out articles highlighting the reach for yield and move further and further out the risk curve. This has played into concerns about pockets of financial instability and the potential spillover effects. The WSJ’s widely followed Fed-watcher, Jon Hilsenrath, reported this week that Fed officials are growing more concerned about market complacency. The article focused on the usual suspects, including the depressed VIX, which has gone 74 weeks below its long-run average. It also highlighted how corporate bonds are yielding only ~100 bp over Treasuries, the lowest level since July 2007, along with the surge in junk bond issuance. However, despite all the talk about the extent of the anxiety in the market, the article did not have any impact. The concerns expressed by the hawkish Fed members mentioned in the article have been widely discussed and did not represent any shift in Fed thinking. In addition, a WSJ article out just a few days earlier noted how three top Fed officials recently downplayed concerns about financial instability. It pointed out that some central bankers reiterated that regulatory, not monetary policy, is the better way to address risks surrounding financial instability.

Favorable external developments:

  • While not highlighted as a specific tailwind for US equities, there were some favorable external developments this week outside of the fresh easing measures from the ECB. Japan was one of the bigger bright spots with the Nikkei up just over 3%. Renewed reform sentiment seemed to be the big tailwind. This dynamic also helped to weaken the yen, a positive signal for global risk appetite. Much of the focus was on the $1.26T Government Pension Investment Fund (GPIF), the world’s largest. Yasuhiro Yonezawa, the recently appointed head of the GPIF investment committee, said that the fund could boost its investment in domestic stocks to 20% of its portfolio from the current level of 12%. The rule of thumb is that every 1% increase in domestic stock allocation by GPIF is expected to plow $10B into Japanese markets. Later in the week, Prime Minister Abe reportedly ramped up pressure on the GPIF to accelerate its asset allocation review. This week also brought news that Abe and his ruling LDP had agreed on a corporate tax cut starting in fiscal 2015. Recall that one of the big disappointments of the structural reform package unveiled last year was the lack of a corporate tax cut.

Good week for the cyclicals:

  • The cyclicals were a standout this week with the CYC +2.4%. The banking group outperformed for a third straight week with the BKX +%. There were a number of notable gainers in the industrials sector, which was the second best performer behind the financials. JOY +12.2% led the rally in machinery following its results. Rental equipment names HEES +8.7% and URI +4.9% also posted strong gains. HVAC and short-cycle stocks such as LII +6.6% and ROK +4.3% were the standouts among the multis. Most of the building materials stocks beat the tape, as did the homebuilders, with the XHB +2.9%. The Transports +1.3% were largely in line, though the airline group remained on a tear with the XAL +4%. Industrial metals stocks largely outperformed despite some of the renewed rehypothecation scrutiny in China. Aluminum names fared particularly well with NOR +13.1%, CENX +9.3% and AA +5.4%. The latter two caught upgrades at BofA Merrill Lynch. Retail rallied with the S&P Retail Index +2% despite continued concerns about the aggressive promotional environment. However, comps did beat expectations for a third straight month in May. Other consumer growth stocks put in a strong performance, particularly the autos with GM +5.7% and F +3.9%.

Sector Performance (vs S&P 500):

  • Outperformers: Financials +2.32%, Industrials +2.16%, Industrials +2.16%, Consumer Disc. +1.80%, Energy +1.39%
  • Underperformers: Telecom (1.19%), Consumer Spls. +0.31%, Healthcare +0.65%, Utilities +0.73%, Tech +1.22%, Materials +1.27%

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