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February 21, 2018

Starting back in 2012, we have taken a snapshot of the Standard & Poor's forecast for future earnings in the S&P 500 every three months, approximately at the midpoint of the current quarter. Today's snapshot of the trailing year earnings per share for the S&P 500 reveals something that we have not seen in all the time that we've visualized S&P's earnings forecasts: a dramatic increase in the amount of earnings per share that the companies of the S&P 500 are forecast to record before the end of the calendar year.

Forecasts for S&P 500 Trailing Twelve Month Earnings per Share, 2014-2019, Snapshot on 2 February 2018

From mid-November 2017 to early-February 2018, the forecast for the S&P 500's trailing twelve month earnings per share has risen from $133.68 to $145.67.

This change may be directly attributed to the passage of the Tax Cuts and Jobs Act of 2017, which was signed into law on 22 December 2017. The law provides for a permanent reduction in U.S. corporate income tax rates, the statutory rates for which had previously been ranked among the highest in the world.

Since the amount of corporate earnings is determined after a company's revenues have been subjected to taxes, a rather large portion of this change reflects the positive impact of the reduction in U.S. corporate income tax rates. At the same time, there also has been an organic improvement in corporate earnings in recent months, which has been driven by improving business conditions. This latter effect can be seen to some extent in the chart above as the smaller improvement in projected earnings per share recorded for the S&P 500 in the period from mid-August 2017 to mid-November 2018.

Those improvements buck the "usual" pattern that we've seen consistently over the past six years, where projected earnings per share start off strong, but then go on to progressively weaken over time as the actual future for earnings failed to live up to initially forecast expectations.

Data Source

Silverblatt, Howard. S&P Indices Market Attribute Series. S&P 500 Monthly Performance Data. S&P 500 Earnings and Estimate Report. [Excel Spreadsheet]. Last Updated 16 February 2017. Last updated: 2 February 2018. Accessed 17 February 2018.

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February 20, 2018

After the wild ride it went on in the first full week of February 2018, the S&P 500 (Index: INX rallied in a subdued fashion during the second week of February 2018.

Alternative Futures - S&P 500 - 2018Q1 - Standard Model - Snapshot on 16 February 2018

The subdued rebound for the S&P 500 was all the more remarkable because it occurred in an news environment where a resurgence in consumer inflation became more of a concern for markets, to the point where speculation began to rise that the Fed might hike short term interest rates in the U.S. four times in 2018.

Checking in with the CME Group's Fedwatch tool, we find that investors are still only betting on three rate hikes occurring during 2018, near the end of the current quarter of 2018-Q1, and the more distant future quarters of 2018-Q2 and 2018-Q4, where the probabilities reported by the tool indicate a greater-than-50% chance that the Federal Funds Rate will be increased by a quarter point (or more) at these specific points of time in the future.

Probabilities for Target Federal Funds Rate at Selected Upcoming Fed Meeting Dates (CME FedWatch on 16 February 2018)
FOMC Meeting Date Current
125-150 bps 150-175 bps 175-200 bps 200-225 bps 225-250 bps 250-275 bps 275-300 bps
12-Mar-2018 (2018-Q1) 16.9% 83.1% 0.0% 0.0% 0.0% 0.0% 0.0%
13-Jun-2018 (2018-Q2) 3.9% 31.3% 60.3% 4.5% 0.0% 0.0% 0.0%
26-Sep-2018 (2018-Q3) 1.7% 15.3% 41.9% 34.7% 6.0% 0.3% 0.0%
19-Dec-2018 (2018-Q4) 0.9% 9.1% 29.2% 36.6% 19.4% 4.4% 0.4%

The headline of the week was the drastic reduction in the kind of volatility that characterized the previous two weeks for the S&P 500. So much so that if we were to redraw our "connect-the-dots" manual forecasts of the potential trajectory of stock prices in our alternative trajectories chart above, we would choose a projected point for the alternative trajectories of 2018-Q1 and 2018-Q2 in the second week of March 2018, which would fall outside of the short term volatility echo in our model's projections, where they would extend slightly longer and instead of being flat-to-slowly rising, they would indicate slowing declining-to-flat.

Still, all the other assumptions behind our red-zone forecast appear to be holding at this time, so we're going to let the original forecast ride. We're also noticing something potentially interesting in the level of stock prices with respect to the alternate future trajectories our dividend futures-based model projects, where they would appear to be consistent with the levels that our model had projected earlier this year, before the year's volatility events really took off, adding considerable noise to its projections. We'll take a closer look at what that might mean for our red-zone forecasting approach in March, after all the data for the S&P 500 through the period of the short term volatility echo has come in.

While Week 2 of February 2018 was relatively subdued compared to the previous two weeks, there was no absence of potential market moving news during it. Here's the roundup of headlines and stories that caught our attention during the week that was.

Monday, 12 February 2018
Tuesday, 13 February 2018
Wednesday, 14 February 2018
Thursday, 15 February 2018
Friday, 16 February 2018

Meanwhile, The Big Picture's Barry Ritholtz outlined the positives and negatives for the U.S. economy and markets for the second week of February 2018.

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February 16, 2018

Did you ever want to get into quantum physics, but didn't know where to start?

A good place to begin understanding a complex, complicated thing like quantum mechanics is at the beginning, where believe it or not, it all started with, dare we say, a light bulb moment! Check out the following video from MinutePhysics on the origin of quantum mechanics, which is really all about how physics works on the tiniest scales possible.

If you're ready to move on to the next level, you might enjoy Dominic Walliman's explanation of Quantum Physics for 7 Year Olds. After that, before you get cocky, remember that "nobody understands quantum mechanics!"


February 15, 2018

In 2017, U.S. soybean producers sent an estimated 1.32 billion bushels of their crop to China, the second-most on record. The record for U.S-to-China soybean exports came a year earlier, when U.S. soybean producers exported an estimated 1.53 billion bushels of their crop that year to China, which was a dramatic increase over the 1.15 billion bushels they sent to China in the year before.

Estimated Bushels of Soybeans Exported by U.S. to China, 2012-2017

2016 would appear to be have been the most successful year to date for U.S. soybean exporters, but there's a lot more to that story.

Although the year saw optimal growing conditions for soybeans in the U.S., which resulted in a bumper crop, one of the main contributors to the success of U.S. soybean producers that year came about as a result of a severe drought in Brazil, the world's top soybean exporting nation.

Brazil's drought created a unique opportunity for U.S. soybean producers seeking to claim a larger share of the world market in 2016. Since Brazil's annual harvest peaks in the second quarter of each year, thanks to its Southern hemisphere geography that puts its growing seasons six months ahead of the U.S., the news that Brazil's 2016 soybean crop and exports would be reduced because of drought conditions provided U.S. growers with the advance warning they would need to respond to what, for them, would be an opportunity.

So they took it. U.S. soybean producers planted seed varieties that would optimize the yield for their crops, which helped contribute to 2016's bumper crop in the United States. They then aggressively harvested the crop to satisfy China's domestic demand for soybeans, where China was buying up as many bushels of soybeans from the U.S. as they could that year.

But there was a dark side to that success, which is now becoming increasing apparent. In choosing seeds that would maximize crop yields, U.S. soybean producers sacrificed the protein content of their crop, effectively reducing the quality of their product. In 2017, that meant having to compete with higher quality soybeans grown in Brazil as that nation's crops have rebounded from 2016's drought conditions.

U.S. soybean growers are losing market share in the all-important China market because the race to grow higher-yielding crops has robbed their most prized nutrient: protein.

Declining protein levels make soybeans less valuable to the $400 billion industry that produces feed for cattle, pigs, chickens and fish. And the problem is a key factor driving soybean buyers from the U.S. to Brazil, where warmer weather helps offset the impact of higher crop yields on protein levels....

Soybeans are by far the most valuable U.S. agricultural export, with $22.8 billion in shipments in 2016. Declining protein levels and market share pose another vexing problem for soy farmers already reeling from a global grains glut and years of depressed prices.

The quality problems of U.S. soybean producers go beyond that however. In their race to export as many soybeans as they could to China in 2016, they also got sloppy in their harvesting and processing practices, where an excessive amount of foreign material was being included within the industry's soybean shipments.

China's response to that problem was to impose stricter import specifications on U.S. soybean exports at the end of 2017, which is expected to negatively impact up to 50% of the nation's soybean exports in 2018. That impact will come in the form of higher costs for U.S. soybean producers, who will have to take steps to reduce the amount of non-soybean material that will be shipped to China.

Half of U.S. soybeans exported to China this year would not meet Chinese rules for routine delivery in 2018, according to shipping data reviewed by Reuters, signaling new hurdles in the $14-billion-a-year business.

More stringent quality rules, which take effect on Jan. 1, could require additional processing of the U.S. oilseeds at Chinese ports to remove impurities. This could raise costs and reduce sales to the world’s largest soybean importer, according to U.S. farmers and traders.

Half of the 473 vessel shipments in 2017 and half the total 27.5 million tonnes of U.S. soybeans exported to China this year contained more than 1 percent of foreign material, exceeding a new standard for speedy delivery, according to U.S. Department of Agriculture (USDA) data compiled by grain broker McDonald Pelz Global Commodities LLC.

In the short run, the choice to sacrifice quality to pursue additional revenue and higher profits made a lot of sense to U.S. soybean producers. In the long run, that choice could very well leave them worse off than if they hadn't taken that path. What choice would you have made in 2016 if you were playing the soybean export game?

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February 14, 2018

If you went by the media's reports on the U.S. trade deficit, you might think that the U.S. economy was in a bad position because it imported a record amount more than it exported in December 2017.

The U.S. trade deficit widened more than expected in December to its highest level since 2008, as robust domestic demand pushed imports to a record high, adding to the stiff headwinds faced by the Trump administration’s “America First” trade policies.

The import-driven surge in the trade gap reported by the Commerce Department on Tuesday also suggests 3 percent annual economic growth may be hard to achieve. Imports, which subtract from gross domestic product, could get a further boost from a $1.5 trillion tax cut package that became effective in January.

But surprisingly, China didn't appears to be a major culprit in the last month of 2017, even though the U.S.-China trade deficit "jumped to a record $375.2 billion" overall in 2017.

Imports from China fell 7.6 percent in December....

Exports to China surged 7.5 percent to a record high in December. As a result, the U.S.-China trade deficit declined 13 percent in December.

What does that look like in terms of the year over year growth rate of the value of trade between the U.S. and China? The following chart shows the answer (along with 383 additional months of historic U.S.-China trade data!):

We find that the year over year growth rate of U.S. exports to China jumped upward in December 2017 after having dipped in the previous two months to near-zero growth levels. That dip is somewhat misleading, because it is largely attributable to a year-over-year decline in America's soybean exports to China that typically peak in the months of October through December each year, where these months in 2016 had seen all-time record levels of U.S. soybeans go to China.

Estimated Bushels of Soybeans Exported from the U.S. to China Each Month from January 2012 - December 2017

Looking back at the year over year growth rates, we see that the magnitude of the rebound in the growth rate of U.S. exports to China in December 2017 nearly matches the year-over-year increase in the U.S.' imports of goods from China, which confirms a strong close to 2017 for both China and the U.S. At the same time, we see that 2017 was good for both nations.

But don't take our word for the U.S. side of the trade ledger. AEI's Mark Perry read the same trade data, and even more dismal media reports, before arriving at a similar conclusion:

But all we hear about is how rising imports and trade deficits are a drag on economic growth, and how the goal should be to stimulate exports to increase output and jobs. And yet rising imports can be a sign of economic strength for US firms, with a positive effect on US jobs. As a hypothetical example, suppose that US imports of foreign-made auto parts (or steel) are increasing. Why would that be? It’s only because US automakers or the foreign transplants that now manufacture 21 different vehicles in the US are expanding production in the US. And to expand domestic production requires more US autoworkers. Therefore, the fact that imports rose to an all-time high in December is consistent with a US economy that is expanding, both for output and employment. And that’s exactly what we see from the data – jobless claims adjusted for the population are at an all-time historical low, the 4.1% jobless rate is the lowest since 2000 (and likely headed lower), retail sales are up 9.0% annualized over the past six months through December, and January’s ISM Manufacturing and Non-Manufacturing indexes just hit the highest readings for a January in seven and 14 years respectively. In January, hourly earnings were up 2.9% from a year ago, the best reading since 2009. Private payrolls were up 196,000 in January for the past twelve months, and full-time employment has grown by 2.39 million jobs while part-time employment is down 92,000! The are now 5.8 million unfilled jobs and quit rates are at the highest levels of the recovery. Lots of evidence of both strong economic growth and job growth!

Perry suggests a solution for better seeing the importance of both imports and exports in indicating the relative health of a nation's economy:

The continual focus by politicians and the media month-after-month on the “trade deficit” is misplaced, and the ubiquitous media reports that describe “trade deficits” disparagingly miss the bigger picture of international trade. Rising exports and rising imports are both signs of an expanding, healthy economy, and tracking the total monthly volume of international transactions (exports + imports) is, therefore, a better measure of the importance of international trade to our economy than tracking net exports (exports – imports).

We have the monthly data going back to January 1985 - let's try it with the U.S-China trade figures through December 2017:

Combined Value of U.S. Exports to China and Imports from China, January 1985 - December 2017

In the chart above, we see that for both nations, the total volume of imports and exports between the U.S. and China rebounded strongly in 2017, as both nations' trade volumes showed robust growth as they recovered from a depressing 2016. This is definitely not the dismal economic picture being portrayed in the media.

We'll close by noting that Perry features a chart showing the combined total of the value of all of the U.S.' imports and exports in his post on the topic, so if you're looking for a chart with that data, here's where you'll find it with data from 2004 through 2017.


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