Wall of Worry

We've all heard this expression, to refer to stocks clawing gains to new highs amidst a market of doubters. It's contrarian logic. Buy when others are selling, when skies are at their most foreboding.

Recent reports have highlighted significant equity mutual fund and ETF outflows of both domestic and international equities, suggesting at least retail investors may be worried indeed. An article in Barron's indicates that fund outflows from U. S. equities in July deepened to a six-year low. International stocks followed suit. ISI Evercore Research reports that fund flows out of equity mutual fund and ETFs last week alone totalled $6 billion, bringing the year to date fund flows to negative $95 billion, a near record.

Now, to those of the contrarian view, the data argues for bullishness with the market soon to drive ever higher. Well, maybe. While markets have been known to climb a wall of worry, just as often investor uneasiness plays out as expected in future events. The herd isn't always wrong.

Take a look at the chart above. It shows the historical pattern of U.S. domestic equity fund flows paired with the S&P 500. While retail investors were seemingly caught off guard in the 2001 tech wreck, only to pull money from equity funds as the market fell to new lows, the stock market crash of 2008 paints a very different picture. While markets pushed ever higher throughout the fall of 2007, equities began to see negative fund flows as early as April, with money being pulled out of the market in increasing volume throughout the year, before the market began to topple in early 2008.

Today's negative fund flows from US domestic and international equities could be just the contrary signal that bulls are looking for, or this time, the herd could simply be right.

Warning Signs in Consumer Product Company Revenues

President Obama recently spoke about the economy, pushing back against nagging naysayers who point to disappointing growth, arguing that his detractors are attempting to make the US recovery look less robust than it really is. He pointed to job growth, a falling unemployment rate, rising wages and, did I mention job growth? Truth is, President Obama shouldn't take it so personally. An $18 trillion economy is more that the doing of one man.

On closer examination, though, there's no denying that something is downright fishy about the economy. Corporate profits for the S&P 500 have now declined for five straight quarters. More disturbing, and to our point about economic growth, top line revenues of S&P 500 companies have fallen for the past six.

It's not just struggling energy companies, or retailers shouldering these declines, both of whom it could be argued are not representative of the broader economy. In the former case, bulls would point to the nearly unprecedented fall in the price of oil, in the latter the shift to online shopping. But truth be told, the poor sales and earnings of major retailers like Macy's, Nordstrom, Walmart, Kohls, Ralph Lauren and Apple all take into account their online sales. So it's not just a shift to online shopping. There is something wrong with the consumer.

The issue is manifest in top line revenue of major banks like Citibank, JPMorgan and Bank of America. While their customer base is as corporate and institutional as consumer, top line revenues for each of these banks has fallen sequentially for the past five years. The banks are in effect shrinking themselves through expenditure reductions to keep cash flow positive.

But it's the consumer brands, like Colgate that are the most disturbing and highlight the structural weakness in the economy. Net sales for Colgate's products fell 7% last year - now bear in mind this is a company that makes consumer staples like toothpaste, mouthwash, soap, deodorant and household cleaners. Assuming for a moment that inflation is zero (if you buy that argument) the world's population is unquestionably growing. How can a company that markets consumer staples see shrinking sales in a growing world? And it's not that Colgate is somehow falling behind its competitors. After all, the stock trades at 47x trailing earnings and is at the top end of its 52-week trading range. Clearly, investors value the franchise.

As dreary as this picture might be, Colgate is not doing nearly as badly as America's largest consumer products company, Procter & Gamble. P&G has seen declining annual revenues, sequentially, for each of the past five years. Its revenues were fully 20% lower in 2015 than in 2012. P&G saw its sales decline last year alone by $10.9 billion. Pepsico's revenue fell by 5.4% last year, and came in $2.5 billion below its sales level of 2012. General Mills, another leading consumer products company, saw revenue decline last year by 6% vs. 2014. How is this all possible in a healthy economy?

Maybe this is what Bill Gross, Stan Druckenmiller, George Soros, Carl Icahn and other billionaire investors see that scares them so terribly about the economy and the stock market. After all, for revenues of major consumer brands to see continuing sales declines, something has definitely gone off track with the economy.

Earnings Beats Continue to Drive Markets Higher

When it comes to investing, I guess I'm old fashioned. There, I said it. I still dream of owning shares of companies that are growing, building businesses, expanding production, services, facilities and markets. But if you've been trading stocks for less than ten years, this perspective might appear archaic, outdated, downright foolish.

Gina Martin Adams, Equity Strategist for Wells Fargo was on Bloomberg TV yesterday touting renewed bullishness on US equities. Her enthusiasm was driven by the "75% of companies reporting earnings this quarter that exceeded analyst estimates". You can watch the full interview here. Tom Keene, the venerable host, for whom I have great respect, failed to ask the most compelling question: what percentage of companies reported earnings that actually exceeded prior year's results. After all, as old-fashioned as I may be, I still like the idea of owning shares of companies that are growing their businesses, not companies that are failing, but a little less badly than analysts had predicted.

We've discussed this topic elsewhere in this blog, in respect of US banks like Morgan Stanley and Goldman Sachs, then in a blog post just after Apple reported a stunning 27% decline in year over year quarterly earnings (the stock popped on the news, by the way). We saw yet more of this silliness yesterday as Polo Ralph Lauren reported a same store sales decline of 9%, with its stock up roughly the same percentage on the day. Today's pop is over at Macy's up 17% as of this writing on news of an earnings beat. Nevermind the fact that revenue declined by $230 million on a year over year basis, that the retail giant is shuttering 100 stores or that the company is forecasting a full year decline in comp sales of 3-4%.

But markets are markets and the market is never wrong, so what's going on here? My guess is that computer algorithms run by investment banks, hedge funds and other institutions are now programed to spot earnings beats, irrespective of overall company performance, and buy shares on the news. A beat is not always sufficient to drive a stock higher, but if it works in 90% of the cases, the odds are quite favorable for an institution trading hundreds of thousands of shares per day.

For the retail investor, however, this poses a great challenge. Do you seek out growing companies with rich stock prices, or beaten down companies hoping they'll fail a little less spectacularly? If you choose the latter, and I'm not arguing you shouldn't, bear in mind the risks of a miss on the stock performance of a downtrodden company as can be seen from market action following Macy's 2015 Q3 results.