Earnings Throw a Life Preserver to Wall Street

Strong corporate earnings today rescued a stock market that’s beset by a sea of traps. The main indices soared higher, following a multi-day slump.

But how long before those traps snap shut?

The stock market may not crash this week, nor next month, nor the month after that. But as an investor with a long-time horizon, you should be worried. Your future has been mortgaged.

First, the good news. Third-quarter earnings continue to excel.

Financial services bellwether Goldman Sachs (NYSE: GS) today posted earnings per share (EPS) of $6.28, exceeding the $5.38 estimate from analysts. Revenue of $8.6 billion exceeded the $8.4 billion estimate. GS shares today rose 3.01%.

Health services bellwether Johnson & Johnson (NYSE: JNJ) reported EPS of $2.05, versus $2.03 expected. Revenue came in at $20.3 billion vs. $20.05 billion expected. JNJ shares rose 1.96%.

But the market’s recent sell-offs could be harbingers of more pain to come.

U.S. Treasury Department data released Monday show that President Trump’s first full fiscal year in office has generated the nation’s largest budget shortfall since 2012. The U.S. deficit widened in fiscal 2018 to $779 billion, which is $113 billion more than the previous year, according to the Treasury’s yearly report.

So much for fiscal responsibility. This monster deficit was created by the $1.5 trillion tax cut bill, combined with increased federal spending. The temporary stimulus has pushed corporate profits and the stock market higher. But eventually, the monster will bite investors.

Several ominous trends are converging at the same time, setting the stage for a crisis.

The party’s over…

The Federal Reserve is doing its best to wind-down a decade-long party, by removing the proverbial punch bowl. After the 2008 great financial meltdown, sweeping programs of money-printing and low-to-zero-interest rate lending were launched to provide enough liquidity to keep markets moving.

Quantitative Easing (QE) in the U.S., and similar programs in Europe and Japan, saw central banks pumping an extra $12 trillion or more into the economy over the past 10 years.

Encouraged by QE and Zero Interest Rate Policy (ZIRP), big corporations borrowed prodigiously and gorged on stock buybacks. Bond prices fell and stocks soared.

A hangover will ensue, as the era of easy money comes to a screeching halt. Small wonder that Trump has been cursing the Fed, as well as his own bad luck that Fed tightening is occurring under his watch.

The tax cut package Trump signed in December 2017 depends on outsized economic growth to help balance the federal books, but such growth won’t happen if rates are rising. What’s more, the federal government will have to pay higher interest on the huge sums that it will inevitably be forced to borrow to pay for the tax cuts.

America plans to sell an increasing number of Treasury notes to pay for its gigantic deficit. In fact, starting today, October 16, the government unveiled a brand-new two-month Treasury bill, through which it hopes to raise $30 billion-$35 billion immediately.

China holds the cards…

Snap quiz: To help finance the federal deficit, on whom will Uncle Sam rely on the most to buy Treasury notes?

Answer: You guessed it. China.

China holds about $1.18 trillion in Treasury notes, making it our largest foreign creditor (see chart):

China is the same country against which we’ve launched a bitter trade war. China might decide it no longer wants to (nor can no longer afford) to continue subsidizing America’s exploding debt, which would in turn place even greater upward pressure on U.S. debt interest rates.

Citing the damage from tariffs and deficits, the International Monetary Fund recently reported that growth will slow this year in not only the U.S. but every large advanced economy.

Emerging markets, meanwhile, are grappling with economic and currency crises. These markets account for 59% of the world’s output, as measured by purchasing power. From Turkey to Argentina to Brazil, developing nations are teetering on a precipice. Europe has its own woes, with deeply indebted countries such as Italy threatening to topple the Continent’s banking system.

I’m not an alarmist by nature. If you had listened to the perma-bears, you would have missed the longest bull market in history. But if these interrelated trends don’t make you nervous, you’re not paying attention.

Savor your stock gains. But it makes sense to take partial profits from your biggest gainers, especially momentum stocks, and raise cash levels.

The question isn’t whether a recession (and concomitant stock market decline) await investors. The real question is, how bad will it be? We’ll soon find out.

Tuesday Market Wrap

  • DJIA: 25,798.42 +547.87 (2.17%)
  • S&P 500: 2,809.92 +59.13 (2.15%)
  • Nasdaq: 7,645.49 +214.75 (2.89%)

Tuesday’s Big Gainers

  • SendGrid (NYSE: SEND) +18.04%

Digital communications platform targeted for acquisition.

  • Hanwha Q CELLS (NSDQ: HQCL) +17.01%

Photovoltaic cell maker goes private.

  • CEVA (NSDQ: CEVA) +9.62%

Analysts turn bullish on maker of artificial intelligence processors.

Tuesday’s Big Decliners

  • JELD-WEN Holdings (NYSE: JELD) -18.91%

Door and window maker offers weak guidance; CFO departs.

  • Innophos Holdings (NSDQ: IPHS) -16.58%

Phosphate maker lowers 2018 guidance.

  • W.W. Grainger (NYSE: GWW) -11.95%

Maker of industrial supplies misses on earnings.

Letters to the Editor

 “When a recovery starts to age, which sectors look good?” — Peter K.

Towards the end of a boom cycle, when the Fed is raising rates—which is an acknowledgement of strong corporate profits—certain sectors often continue to do well, such as consumer staples, health services, and energy.

You have questions, I have answers. Reach me at: mailbag@investingdaily.com

John Persinos is the managing editor of Investing Daily.