Something more frightening to investors than North Korea

By David Nelson, CFA

On the heels of an excellent earnings season strategists from Merrill Lynch to Goldman are discussing the disappointing price performance of stocks that beat expectations. A sell the news mentality has been the driving force as traders and algo driven machines exited positions stepping aside hoping for a better entry point.

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The weakness coincides with a geopolitical backdrop that has many making comparisons to the Cuban Missile Crisis of the 1960’s. Every President since Reagan bears some responsibility failing to understand North Korea’s end game. As I pointed out to CNBC anchors Brian Sullivan and Melissa Lee, any military option would have to be massive wiping out at least half of the Korean Peninsula. Even if successful, North Korea’s conventional weapons on the border sit just 30 miles north of Seoul.

kim_jong_un_president_trump_-_Google_SearchIf markets continue to slide, North Korea’s Kim Jong Un and President Trump will certainly be the scapegoats. However, maybe something is going on that’s even more frightening for investors than a potentially suicidal dictator or a President that many fear won’t listen to his military commanders urging a diplomatic solution.

Stocks are a discounting mechanism always looking forward but sometimes we fail to look far enough. Right now the look forward shows much of the same with consensus for the S&P 500 sitting at $131 for 2017 and $145 for 2018. This translates into 12% and 11% growth respectively.

S&P 500 Growth 2017 & 2018
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Some like Goldman’s David Kostin aren’t so sure and has cut his numbers implying that the better than expected earnings season isn’t being reflected in 2018 numbers. In fact according to Bloomberg, estimates have actually come in slightly for the last 4 weeks. It’s still too soon but multiple expansion will come to a halt if the second derivative of growth turns south.

S&P 500 estimate revisions not reflecting the good news
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Coming into the year post the election, investors believed the administration would be able to push through pro-business fiscal reforms. As healthcare faded tax reform became the rallying cry as it enjoys some measure of bipartisan support. Sweeping tax reform like we saw under President Reagan that could deal with a monstrous 77,000 page tax code is all but a dream. The best we can hope for is a corporate tax cut and if we’re really lucky repatriation of some portion of the $2 Trillion in corporate cash held captive overseas.

Given the congressional calendar and the need to pass a budget as well as extend the debt limit any progress on the above is likely to be pushed out well into 2018. Earnings and revenue growth are the life blood of stock performance. If you’re looking for a road map as to which way the market is headed start with the numbers. Reacting to the latest news cycle is hardly a strategy. Sure, it might take you out of the market before it all hits the fan but what will be the trigger to get back in? The all-clear signal never rings at the bottom, only the top.