Italian Money

Why is it that, just as one “financial market monster” is vanquished another bigger, uglier and scarier one always seems to arrive?

And who amongst you, while pondering the next potential economic Godzillas out there truly thought Italian politics would usurp that crown?

Anyone? Bueller? Anyone?

In what seemed like mere hours, we went from Trump being a complete fool, crude oil going to $110 a barrel, new Ebola cases in the Congo (which, by the way, happens every year - like Bird Flu) and NOKO/SOKO back to becoming a sure nuclear wasteland, to “Rome is burning”?

And that’s allegedly because debt contagion is eating Europe alive again because the Italians can't get their sh*t together.

The lesson here is this: Just when we think the media has sent the investor audience off in the nuttiest direction ever, they top themselves; often in a remarkably creative manner…just like now.

“They” managed to drop “contagion,” “debt crisis” “Brexit," and "QE coming back" all into the latest pandemonium pasta.

But think this one through for minute: If Italy suddenly broke off and sunk into the ocean, would that really stop anyone over here in the US from, say, shopping at Costco, going out to dinner, building that new business, cancelling a vacation or putting off buying that new car, washing machine or house?

Seriously folks, let’s get a grip.

Case in point, in our latest articles we warned about exactly this type of scenario here and here arising in the media; this is due to "the A players going on holiday, the B players manning the trading desks, and lacklustre volume cueing the media to use the summer haze to obscure reality and take investors for a spin on the red side of the market."

It happens every summer. And the most appropriate reaction is always this: Pray for more.

Why? Because the next 90 days of made-up media hocus-pocus and sleight-of-hand drives the exodus of weak hands, lowers prices and in doing so creates buying opportunities.

Here are the Stats

Thomson Reuters IBES data (by the numbers)

  • Fwd 4-qtr est: $163.80 vs last week's $164.11
  • P.E ratio: 16.6x
  • PEG ratio: 0.78x
  • S&P 500 earnings yield: 6.02%
  • Year-over-year-growth of forward estimate: +21.4% vs last week's 21.75%

So, we can all collectively laugh off the so-called expert comments about “peak earnings,” just as we did for “peak oil.” 

Think of it like when a car slows from 90 mph to 70 mph; it’s still moving rapidly forward despite its slowdown in momentum.

And with all the negative perspective it’s very easy to forget that a major US tax bill just passed in December 2017, for which we’ve not yet seen most of the impact of that trickle-down effect.

It focused on corporate tax reform more than on individual rates, and corporations are now showing us how these tax cuts boosted their performance:

In fact, just before the tax cut passed, industry analysts were projecting S&P Earnings growth of 11.2% this year - a nice gain for sure.

But now they’re projecting almost twice that growth at +21.3%. And, by the end of summer and into September, markets will already be looking forward to 2019 earnings. As such, if the S&P 500 indeed earns $175 in 2019, a modest 16 P/E implies an S&P 500 reading of 2,800 by year's end. 

Not unlike trade ranges we have seen before, it would be a modest increase from here.  But, a more productive market mood could command an 18 P/E, which would push the S&P 500 closer to 3,150.

Profit margins are also expanding.

Industry analysts raised S&P profit margin estimates from 11.1% this year (and 11.7% in 2019) last December to 11.9% and 12.5%, respectively, as of May 3, according to Dr Ed Yardeni's data trackers.

If these numbers steadily come to pass, it would be the first time in decades that profit margins topped 12%.

And all the while investors are talking Italian.

Killer Bond Rates?

Remember just last week how the yield on the 10-year bond in the US was going to "crush valuations" in the equity markets? 

Meanwhile in this week’s reality please find me a single headline that says bond yields have done their own cratering:

That’s 34 basis points in three trading sessions. 

Not only that but note the global spread:  Bunds are back down to 26 basis points, and Japan is just under 3 basis points.

And where does the entire world rush to when things "look dicey"?

They flock to US Bonds and the US Dollar.

Yep, that’s the same dollar that experts were telling us was tanking as the year dawned.

One Other Little Tidbit About Italy…

Italy’s demographics stink. Their government will pay you to move there and have children. 

That’s because no births = no future. Period. End of story. 

The US remains the only developed nation on Earth with excellent, supportive, growth-driving demographic flows headed our way.

And their GDP is just about the size of Texas. That’s right. Texas; just one of 50 US states.

So let’s stop talking up Italy as a world ender.

Hasta la pasta.

Mike Williams
Founder and Managing Partner of Genesis Asset Management, New York