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Market Commentary for April 19, 2016

market commentary

When is down really up?

Written by: Benjamin Bimson CIMA® / BCJ Financial Group

Earnings season for the 1st quarter kicked off last week and markets were happy with the results. It is a very odd game though. How do companies always outperform expectations? It is all in the art of communication. Analysts on Wall Street have a pattern of adjusting earnings expectations in order to create an environment where earnings “beats” are more likely.

Perhaps they are just trying to be honest about their expectations. However, markets love companies that beat earnings expectations. Does that mean that everything is going well? Perhaps. Perhaps not. It actually means that to understand, you have to see more of what is going on behind the scenes. Are businesses really growing? Are they getting stronger or weaker?

Let’s just take one big name as an example. JPMorgan Chase reported earnings last week on Wednesday. Net income and earnings per share both beat out analyst expectations and Q1 was deemed to be a bang up quarter for JPMorgan Chase. Their stock jumped in price as noted by the break in the line on the following chart.

 

Copyright © BCJ Financial Group

 

Pretty exciting stuff! So I wanted to know, are banks (JPMorgan can be my proxy) really doing swell? The net income, it is almost 7% less than last quarter (see chart below).

 

Chart created by BCJ Financial Group

Copyright © BCJ Financial Group

 

It is not their worst quarter decline by any means, but is that really what a bang up quarter means? I went further and thought it may be in their revenue. Here is what that looks like.

 

Chart created by BCJ Financial Group

Copyright © BCJ Financial Group

 

Revenue has been declining since low interest rates were adopted in full force by the Fed. So why does the market love it when earnings reports always beat expectations? Perhaps they just like good news. However, I believe there is a psychological benefit to the market as a whole when companies are viewed positively. I’m beginning to think we have to be careful not to get overly elated when earnings beat revised expectations. There has to be deeper analysis than just a rosy press conference.

Perhaps this will help the equity markets continue to grow and even make new highs, but we must investigate further in order see how healthy we are. Friday brought some economic data that was really interesting to look at because it is one of the economic indicators that has some broad implications. Industrial production and manufacturing continued to march lower, and I really like the following presentation of how various sectors behaved.

 

Chart Source: Economics – U.S. Daily Perspective. Ned Davis Research Group. April 15, 2016 [4/15/16]

Chart Source: Economics – U.S. Daily Perspective. Ned Davis Research Group. April 15, 2016 [4/15/16]

Why does this all matter? Well, Industrial Production is what consumers consume, export etc. Production can fall when there are surplus business inventories to sell, and as the next chart shows, there does appear to be some build up right now.

 

Chart created by BCJ Financial Group

Copyright © BCJ Financial Group

 

 

The only issue is that historically, when inventory to sales ratios are high, the economy isn’t quite as strong. The following shows how much they have been growing.

 

chart6

 

Lastly, I wanted to see how often we saw the phenomenon where we are well into an economic recovery cycle (non-recession), and where Industrial Production was dropping while Inventory-to-Sales were climbing. To do that I looked at Industrial Production going back to February of 1919. Here is what it looks like.

 

Chart created by BCJ Financial Group

Copyright © BCJ Financial Group

 

Nearly every time there is a big pullback in Industrial Production, we get recessions. I didn’t calculate the exact percentage so I can’t give that to you, but it is interesting to note that, although there were times in which production declined without an immediate recession, there was a recession to follow within 2 years of the first major decline.

The Takeaway

There is more than just press release information out there that explains where we are and where we are headed. While I believe there is very little risk of imminent recession today, given quite a few of the factors I have cited in previous weeks, I do believe we are late in the business cycle. With this said, I am hoping the Fed has a marvelous plan to help us out!

I know they are being cautious in this environment and they probably missed their best opportunity in 2013 when all of the economic indicators were stronger and markets were going gangbuster, but the market could keep going for another couple years, or we could be getting close to the next economic reset (sounds nicer than recession).

Those with a need or desire to retire or use invested assets in the next 5 years should be aware and have a plan. Having a sound strategy is going to save you a bundle if and when we do need to pay the piper. For now, it is important to understand that it is too early to cry wolf. Just be aware and informed. Try to be mindful of your needs and your ability to be patient.

 

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