Geopolitical Worries Cause After-hours Selloff Tuesday

Stocks Fall Slightly (Geopolitical Risk Increases)

The stock market fell slightly on Tuesday, but that might be just the beginning of the decline. Stocks fell after hours because at least 12 ballistic missiles were fired at an Iraqi airbase that hosts American troops. Iran claimed responsibility for this action. In response to this S&P 500 futures fell 49 points, oil prices rose 4%, and the 10 year yield fell 10 basis points. 

Again, the stock market fell slightly as the S&P 500 was down 0.28%. It’s good to see modest declines because it will allow the market to become less overbought without a sharp correction. CNN fear and greed index fell 4 points to 89. While a small decline or a horizontal correction will get rid of frothiness, stocks will still be expensive unless they decline sharply. 

According to FactSet, on January 3^rd, the S&P 500’s forward PE multiple was 18.3. It’s tough to get around high valuations unless there is a decent sized correction or prolonged horizontal movement.

Details Of Tuesday’s Action

Nasdaq fell just 3 basis points because semiconductor stocks rallied sharply. SOXX semiconductor ETF was up 1.84%. Last time semiconductors were up this much while the S&P 500 was down was last June. The industry may have been helped by the CES event stoking excitement. 

We are seeing TVs that roll into a box, folding phones, and Bluetooth than works with multiple headsets so a few people can have audio directed to their headphones from one device. OnePlus revealed a concept phone with electromagnetic glass that makes its camera lenses disappear.

Russell 2000 was down 0.3%. It will be hurt by the geopolitical worries because the first thing investors do when these events occur is buy treasuries. Lower yields hurt bank stocks. Even with the decline on Tuesday, the VIX fell 6 basis points to 13.79. It will likely increase on Wednesday if the after hours session is any indicator of how stocks will do. Every sector fell even though the S&P 500 was only down modestly. Worst decliners were real estate and consumer staples which fell 1.19% and 0.73%.

Tesla was a big winner as its stock was up 3.88%. It’s up 12.13% year to date. A rise in oil prices doesn’t hurt the company. But its stock was up before the latest geopolitical news came out and pushed oil up (it had been down). Investors are betting on a very successful launch of the Model Y. It should sell much better than the Model 3 because Americans love crossovers. Lightweight trucks are 73% of the auto market.

Earnings Update

Let’s look at the latest data on earnings estimates as we are a couple weeks away from the main part of Q4 earnings season. 2020 earnings will be pivotal because stocks have gotten expensive. As of January 3^rd, the estimate for Q4 EPS growth was -1.5%. 

As you can see from the chart below, if estimates follow the average trend, EPS estimates will fall and then rise as firms beat them. Final growth should be near 0.5% using FactSet’s numbers.

Final 2019 EPS growth is currently expected to be 0.3%. Once Q4 estimates are beaten, growth will be closer to 1%. Full year 2020 EPS growth is expected to be 9.6% which is down from 10.9% on September 30^th. I’m projecting mid to high single digit earnings growth. There should be multiple compression in 2020 as the earnings recovery that was expected in 2019 gets underway. Multiples shouldn’t be high because there probably won’t be growth acceleration from 2020 to 2021.

According to FactSet, this has been a bad quarter for earnings estimates. Q4 estimates fell 4.7% which is the most since Q1 2019 when they fell 7.3%. Besides that decline, this was the largest decline since Q1 2016 when they fell 9.8%. This has been a worse than average quarter as estimates fell 3.3% on average in the past 5 years and 3.1% in the last 10 years. 

Finally, in the past 15 years, the average decline was 4.4% as it includes the financial crisis. In Q4, the biggest EPS declines were in consumer discretionary, energy, materials, and industrials. Their estimates fell 15%, 13.3%, 11.5%, and 10.4%. At least tech wasn’t one of the biggest decliners again.  

Trade Deficit Narrows

Trade in goods report last week as gave us only the goods portion of the report. It was a very important report because it signaled the overall deficit would shrink. That’s why the consensus for the overall deficit was for it to shrink sharply. In October, the deficit fell $300 million to $46.9 billion. 

As you can see from the chart below, the trade deficit fell to $43.1 billion in November which was the lowest since October 2016. It was lower than estimates for $43.9 billion even though we already knew it would decline because of the advance trade in goods report.

Real exports were up 0.4% and real imports fell 3.4%. Trade was impacted by the trade war with China, the strong dollar, and policy uncertainty. Trade deficit with China is on pace to decline for the full year for the first time since 2013. Year to date deficit is down $61.3 billion to $320 billion. 

China has started importing more American goods, but America isn’t doing the same. America exporting oil is also helping the deficit. U.S. petroleum surplus rose to $800 billion and imports of crude oil fell to the lowest level in almost 28 years. In September, America was a net exporter of crude oil and petroleum for the first time since at least 1973.  

Current trade deficit is great news for Q4 GDP growth. Due to this lower trade deficit, Oxford Economics is now expecting 2.4% Q4 GDP growth with 1.2% growth coming from trade. Inventories are expected to drag down GDP growth by 0.5%. A boost from trade is expected to be the most since the financial crisis. Tuesday’s Atlanta Fed Nowcast update shows growth will be 2.3%. Declines in the estimates for real PCE growth and real gross private domestic investment growth were offset by the trade data.