In This Market, ‘Fear’ Has A Split Personality

In case you haven’t noticed, the whole “peak profits” narrative gained a lot of traction this month amid the slide in U.S. stocks.

In fact, there’s a strong argument to be made that the fear of declining bottom line growth is one of the key factors weighing on sentiment. Everyone knows the effects of the stimulus are set to wane going forward and it looks like corporate bottom lines are destined to take a hit from Trump’s tariffs, especially if the administration moves ahead with duties on the remainder of Chinese imports.

On Monday, reports indicated that if there’s no breakthrough on trade following a meeting between Trump and Xi at the G-20, the U.S. will publish a new list of products subject to tariffs in early December. That means the actual imposition of the duties (after a two-month public comment period) would coincide with China’s Lunar New Year holiday. At that point, Trump would be taxing everything China ships to America.

Estimates vary, but for their part, Goldman says an all-out trade war with no import substitution and no pass-through to consumers in the form of higher prices will mean EPS growth for S&P companies flatlines in 2019. That’s a worst-case scenario, but do note that the only way to mitigate it is for companies to rework their supply chains on short notice or else raise prices – the former isn’t realistic and the latter is inflationary. In other words: There are no “good” options.

In any event, the “peak profits” narrative has folks concerned, and that’s meant everybody is hyper-sensitive to quarterly reports. “After the [early October] selloff, most of the price action has been closely linked to earnings releases”, Barclays said on Monday, adding that “every piece of good news has been met with a sharp rally and every disappointment with a selloff.” Here’s a helpful visual:

(Barclays)

This, Goldman writes, in a note dated Tuesday, is leading to a “divergence in fear”, with the single stock put-call skew hitting levels last seen in February, while the index put-call skew suggests investors are poised for a bounce.

(Goldman)

“This suggests investors fear gap-moves lower in single stocks over the next three months”, Goldman says of the elevated single stock measure. Macro investors, on the other hand, “seem focused on picking a bottom in the SPX which is oversold relative to other asset classes”, the bank continues.

The amusing thing about this is that in a world where the broader market depends heavily on the fate of a handful of Growth/Tech mainstays, gap-moves lower in those names are likely to lead directly to volatility at the index level.

In any event, this is interesting to the extent it underscores schizophrenia among investors who fear the “peak profit” meme could manifest itself in outsized moves to the downside in individual stocks, but who, by virtue of a decade’s worth of conditioning, are still predisposed to believing that every dip at the index level should be bought.

I’ll leave you with three passages from “The Mirage” as published here back in September:

The tax cuts have manifested themselves in a buyback binge and have also helped corporates report record profits. The former (the buybacks) serves as a powerful technical for the market, while the latter (record profits) bolsters the fundamental argument for staying long U.S. stocks.

At the same time, the effects of Trump’s fiscal policies are likely to prove ephemeral. You don’t have to be an incorrigible pessimist to believe that. Inherent in the word “stimulus” is the notion that what you’re doing is designed to produce quick results. Obviously, you’re going to try and design policies that also create a sustainable positive impulse (nobody comes out and admits to being deliberately myopic), but that doesn’t usually work out. This time isn’t likely to break with precedent in that regard.

So that’s a rather odd juxtaposition, isn’t it? U.S. equity investors are staring at two of the most overtly bullish catalysts imaginable (record buybacks and record corporate profits), but paradoxically, those two normally unequivocal buy signals may in reality be the exact opposite of “unequivocal” – that is, they may be a complete mirage.