Via ConvergEx's Nick Colas,
Today we engage in a simple thought experiment: what 3 pieces of information would you need to confidently call the 2016 end-of-year level on the S&P 500?
A brief survey of senior Convergex traders yielded this list: year-end worldwide central bank rates, Chinese GDP growth in 2016, actual 2016 US corporate earnings, the winner of the U.S. presidential race, and the pace of increases in the Fed Funds rate for the year.
When we posed the questions to analyst friends, they added: 2016 U.S. wage growth, 2017 consensus corporate earnings (in December 2016) and any information about a significant geopolitical event. Everyone agreed oil prices were on the list.
All this pushes two other questions to the fore. First, what’s on your list, and why? And second, what’s not on any of these lists? Because maybe that’s what will actually move markets…
The 1920s were a period of immense technological innovation, but that didn’t stop many prominent thinkers of the age from believing that the living could speak to the dead. Sir Arthur Conan Doyle, creator of the deeply rational Sherlock Holmes, wrote more than a dozen books on the topic. French Nobel Prize winning physiologist (awarded 1913) Charles Richet was the original “Ghostbuster”, coining the term “ectoplasm” decades before Bill Murray ever got slimed. Even Thomas Edison thought about building a telephone to reach into the next world.
As a result of this air of respectability, tens of thousands of mystics plied their trade in Europe and the U.S., including one Mary Carter of Cincinnati Ohio. She had an especially powerful shtick in her repertoire. During a séance an assistant would place a small clean chalkboard in a box on the table where participants sat. They would ask their questions of people in the afterlife, and when the box was opened the slate would reveal the answer. A neat bit of magic, if nothing else.
In the mid-1940s, her son Albert Carter borrowed the idea to create a toy that is still popular today: the “Magic 8 ball”. Essentially, it was two dice with words (‘Yes’, ‘don’t count on it’, ‘it is certain’, etc.) printed on them, suspended in can of oil with a clear top. Ask a question, shake the container, and wait for one of the die to float to the surface with your answer. After he passed on, his partners licensed the idea to Brunswick Billiards as a give-away item to promote the brand. The container became the now well-known black sphere resembling an 8-ball.
Predicting capital markets action can, at times, feel much like using a Magic 8 ball. You ask a question, wait, and the market returns with an answer. Sometimes you like the answer, and sometimes you don’t.
But what if that plastic black ball became a crystal one instead? Those are far older, by the way. They date back to the first century A.D. – although they came into widespread use during the Victorian age just as the precursor to the Magic 8 ball was a bit of 1920s occult stagecraft. Something about periods of rapid technological advancement seems to give mankind false notions of grandeur, it appears.
Here is a quick thought experiment I gave to a handful of colleagues and friends this afternoon:
- I possess a crystal ball that can accurately foresee any future event or financial market asset price except the price of the S&P 500.
- If your task were to predict where the S&P 500 will close this year, what three things would you want to know from the ball?
- Since everyone would want to know the price of oil, I offered that up as a freebie. In this game, the price of crude oil will run between $30 and $40/barrel through the end of 2016.
I first asked the senior traders on the Convergex equity desk. Their replies:
- The contours of central bank monetary policy between now and year end (timing and magnitude of rate moves).
- Chinese GDP growth rates.
- Actual year-end 2016 earnings per share for the S&P 500.
- If Donald Trump wins the general election.
Then I posed the same question to some analysts. Their answers obviously overlapped with the traders’, but they added:
- What will be the consensus 2017 earnings estimate for the S&P 500 at the end of this year?
- Where will junk corporate bond spreads be at the end of the year?
- What is the Q4 2016 GDP growth rate for the U.S.?
- What will U.S. wage growth be at the end of 2016?
- Will there be any major shocks in global geopolitics this year?
For what it’s worth, here are my three and a bit of the reasoning behind them.
#1: Is the VIX over 30 for more than 5 consecutive days in 2016?
Reasoning: The first quarter of 2016 has seen an unvirtuous circle of negativity on basically everything that matters to equity investors – worries over the global banking system, worldwide deflation, the efficacy of central bank policy, etc. And yet the CBOE VIX Index never closed above 30. If things stay quiet – or there’s just a small bout of volatility at some point – equities will likely end the year up or down small (5-10%) from here.
Now, if there is any event – geopolitical or otherwise – that pulls the VIX over 30 and holds it there for a week, all bets are off. The most important lesson of 2016 thus far is that markets now openly question the ability of central banks to create specific economic outcomes. Negative rates, QE, jawboning, every implement that fills the tool box in a central banker’s work vehicle is being questioned. And that’s not good for markets. We’re walking a tightrope here, and any large external shock will raise far more questions than answers in the minds of investors.
#2: What is the Labor Force Participation Rate in December 2016?
Reasoning: This ratio of people in the workforce to total adult population has been declining since 1999, although it stabilized from 2005 to 2008. The drop since, to its current 62.9% from a peak of 67.3%, is a combination of demographic and other factors. Received wisdom has it that this number will continue to decline for the foreseeable future.
The funny thing is that LFPR is at one year highs, right now. So what will the Federal Reserve make of this number if it continues to rise through the year? Likely, it will interpret that as an indication that wages are rising fast enough to pull marginally attached workers back into the labor market. And that will inform their commentary on the trajectory of Fed Funds in 2017 more than just the ‘Jobs Added’ data or the unemployment rate.
#3: Where are used car prices at year end?
Reasoning: Yes, seriously, this is a thing. Demand for cars and light trucks have been the single brightest star in the U.S. economy since the Financial Crisis. Buying a light vehicle is the second most expensive purchase most households ever make, so good demand here means the rest of the economy is likely OK. And the February 2016 selling rate was one of the best of the last decade. Used car prices are proxies for trade-in values (the higher the better) as well as an indicator of income/spending levels for the 50-70% of American consumers who don’t buy new cars and trucks.
We use the Manheim Used Vehicle Value Index as our guide (see here http://www.manheim.com/services/consulting). It has been rock solid since 2011, although it’s begun to look a little shakier (down 1.4% in the most recent reading). There is a huge amount of chatter about the subprime component of new car sales, and I’ve seen enough cycles to know that fear plus negative catalyst equals reality. Yes, the U.S. auto industry is no longer as important to the overall economy as it once was. But how many cars GM can sell is still a better indicator of the economy than, say, how many Uber rides take place.
As a closing thought (or two): First, what would your three questions be? And second, what question is no one asking that will prove to be decisive?
Time to ask the Magic 8 ball.
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