We’ve hit a macro news vacuum that should last for the next week and a half. The September jobs report hits tomorrow morning, but labor conditions aren’t holding the Fed back from a hike. The BoJ releases its decision next Wednesday, yet officials have already started lowering expectations. Minutes from the Fed’s September meeting will be released next Thursday, but Yellen spoiled the surprise with her hour long speech in Amherst. The combination of a nervous stock market and little news typically doesn’t result in rallies.The present angst can be distilled down to concern over two particular issues: 1) economic activity in China and 2) the Fed. China will be shut down for “National Day” all of next week, so we won’t see any data or price signals. Meanwhile, the Fed will be digesting the spate of manufacturing indicators that hit this week. Chicago PMI contracted to 48.7 in September, the fifth time it’s been below 50 in 2015. The ISM index, which looks at the whole country, was also a disappointment at 50.2. The Citi surprise index is inherently mean reverting, but if August marked this cycle’s peak it would be the lowest high since the index started in 2003. Meaning expectations are low and headed lower.
While the macro market goes dark, earnings season gets underway next Thursday with Alcoa (AA) batting leadoff. Third quarter results could be the most important in recent memory as the S&P 500 sits at precarious levels. Analysts are bracing for the third consecutive quarter of Y/Y declines in earnings. Looking at earnings momentum reveals a similarly bleak picture. 2016 forecasts for the highly cyclical semiconductor sector in the US have been written down -8.3% over the past three months. In other words, there’s not much momentum at all.
Much of this is already priced into the market, but fundamentals could get much uglier if share buybacks slow down. In the second quarter, S&P companies bought back a net $104bn in shares, up +7% Y/Y. But if you look over a longer period, buybacks have essentially flat-lined after three years of huge increases. The sector by sector breakdown reveals this trend. The energy sector bought more than $10bn per quarter last year, now it’s less than $2bn. The materials sector saw a similar drop, and media buybacks are down over 30%. It’s no coincidence that these three sectors have performed poorly this year, and there are concerns this trend will spread to the broader market.
Over the last six quarters, at least 20% of S&P 500 companies have reduced their share count by at least 4% - boosting EPS by 4% as a result. It stands to reason that if earnings (especially forecasted earnings) are declining, there will be less capital to fund buybacks. Keep an eye on the PowerShares Buyback ETF (PKW). If those shares roll-over, it’s safe to say we’re entering a bear market.
The Cup & Handle Fund is up around 6.0% YTD, and +19.0% Y/Y. This week we closed some positions that have been in the portfolio for many months. They all made money and probably have further to go, but realizing profits is never a bad thing. We’re now sitting on a little bit of cash, which I expect to be deployed shortly. The October investor letter went out this morning, and it’s a bet I feel good about. If you’d like to start receiving these letters click here.
With that I give you this week's letter:
As always, if you have any questions or comments or just want to vent, please send me an email at firstname.lastname@example.org.
Until next time, tread lightly out there,
Managing Editor – Cup & Handle Macro