Covenant Weekly Market Synopsis for May 4, 2018

May 5, 2018

Through Friday, 82% of S&P 500 companies had reported Q1 operating results, and the numbers have been strong. According to data from Goldman Sachs, year-over-year earnings per share (EPS) growth was 23%. The lower tax rate contributed to Q1 earnings strength, but companies experienced top line (i.e., revenue) growth as well. Revenue growth is a “purer” measure of organic growth as is not influenced by financial engineering (such as stock buybacks) or the reduction in the statutory tax rate. And thus far, with more than 80% of the companies reporting, revenue growth is up 11% from last year and more than 40% of S&P 500 firms posted revenue results that exceeded expectations.

It’s also worth noting that having reported earnings, the corporate “blackout” periods are now ending for a majority of S&P 500 companies. Blackout periods prevent companies and insiders from repurchasing shares in the month before the release of corporate earnings. Flush with cash from higher earnings and tax reform, some analysts estimate stock buybacks will reach nearly $1 Trillion in 2018. Indeed, last week Apple announced a new $100 Billion stock buyback program on top of the $23.5 Billion of stock it already purchased in the first quarter. Corporations have been one of, if not the, largest buyers of stocks since the Financial Crisis and this trend is set to continue.

Weekly, month-to-date and year-to-date asset class performance are available here.

Ageism – This past Monday, April 30th, marked a milestone as the current economic expansion, at 106 months in duration, is now tied for the second longest on record. For those keeping score at home, the longest expansion occurred in the 1990’s and lasted 120 months. The first half of a legendary Wall Street adage is “Expansions don’t die of old age…” And that’s true. But just like a living creature, the older an expansion gets, the more things can go wrong from supply constraints pushing up inflation to the Federal Reserve committing a monetary policy error.


Source: National Bureau of Economic Research and Covenant Investment Research

On that latter point, the complete maxim is “Expansions don’t die of old age, they are murdered by the Fed.” Indeed, since the Federal Reserve was created there have been thirteen rate hiking cycles, and ten have ended in recession (source: Gluskin Sheff + Associates). Currently, the economy appears on solid footing and a recession in the next year is a low probability event. It would seem that 106 months is the new 90 for the U.S. economy! However, to reach or exceed 120 months, the Federal Reserve will need to raise rates at precisely the correct pace to stave off excessive inflation without constricting financing to the point where consumers and businesses no longer want or can afford, to borrow. And this delicate Fed maneuvering will be taking place against a backdrop of global synchronized tightening through the removal of ultra-accommodative stimulus measures (i.e., the proceeds from Quantitative Easing). New Fed Chairman Jay Powell has an opportunity to make history overseeing the longest expansion on record, but he and his FOMC cohorts will need to play their cards flawlessly, lest this expansion becomes another Fed casualty.

Sucking Sound – The chart below shows the monthly asset purchases since the Financial Crisis of four key central banks: the Bank of England, the Federal Reserve, the Bank of Japan, and the European Central Bank. As the chart highlights the central banks globally, coordinated stimulus program peaked at close to $200 billion of asset purchases in March 2017.


While the central banks’ largesse is waning, there remains significant residual liquidity in the system. Still, as we often say around here, change happens on the margin. Could it be a coincidence that 2018’s suddenly volatile market (following years of utter tranquility as central banks were aggressively buying bonds and equities) comes on the heels of peak liquidity? Nope. At least not to our thinking.  Central bank asset purchases provided a significant buffer to financial markets as their inexorable asset purchases covered macro, economic and financial events that otherwise would have created market volatility. Now that the liquidity is being sucked out of the global financial markets, volatility should normalize along with it.

Be well,