As covered for you last week, forward earnings are picking up and have been for weeks now. Let’s stay patient though – I suspect that is unlikely to make a huge difference in this upcoming reporting season. Instead, we have noted for sometime that we expect the real improvement to show itself more at Q3 reporting and thereafter. Until then, the Barbell Economy continues to roll forward and improve – steadily – no matter the bearish rant.

The focal point of the week will likely center around two things:

~ Anything which carries a whiff of Brexit risk (forthcoming aftershocks should be expected), and…

~ The jobs number on Friday.

While it could be surprising to the upside, my hunch is we are in better shape if we simply assume it will be a light report. Many excuses will be used, the bears will call out two weak reports in a row and the summer churn should continue. And get this: IF we do get a strong report, the “concerns” will shift (in a millisecond) from Brexit to rising rates.

The bottom line here: prices have quickly recovered from the Brexit nonsense. Let’s hope more fear waves will arrive for value hunters before summer is up. Look at corrective waves as positive.

Quick Follow-Up on the Outside Year

In your last note, I brought a pattern to your attention which could be forming in the technical structure of the market. The only reason I like to be aware of these things at times is there are certain circumstances where the pattern becomes self-fulfilling.

Citi pointed out that 2016 has the potential to be a “bullish outside year” for the S&P 500 – meaning the highs and lows for this year’s candle are both outside of 2015’s range, if we get a close above last year’s high. If this were to actually unfold by year-end for the candlestick pattern of 2016, it would be only the 3rd time in history the S&P 500 posted a positive outside year. These have tended to be the end of significant congestion periods in the market, so let’s stay tuned.

Improvements Aplenty

Investors expectations have been hampered for months by the impact of the energy cycle we have witnessed. These issues have been, we feel, incorrectly tagged as deeply-embedded within multiple sectors. The loss of momentum in manufacturing and industrial production has also been a concern. But, the soft numbers can be attributed, primarily, to reductions in those energy-specific areas.

The good news? As suggested for months – it is improving but being misunderstood – again. Some charts from Calafia help:

The first chart above provides us a sense of the underlying improvements seen in manufacturing – and what it foretells about likelihood of stronger GDP readings ahead. Recall the ISM manufacturing index was stronger than expected (53.2 vs. 51.3) last week. One can see in the trends that we could also expect to see a much stronger GDP readout for Q2 to follow.

The second chart provides a snapshot of improving export channels. Oddly enough, while everyone pays attention to Brexit, this data hints of underlying improvements in overseas markets. Many things will be said about Brexit in the coming weeks and months. I stand by the idea that overall, Brexit – or whatever becomes of it – will be a positive for the US.

Meanwhile…Fear Remains Deep-Seeded

The fear gauges continue to show us why rates are so low. Fear is deeply-seeded and is being registered through many channels. Oddly, this is a good thing for long-term investors. In the Brexit aftermath, yet another wave of refi’s – corporate and personal – can be expected, further improving cash flows and cash balances.

Deflation Fears Can Fade?

In your late January notes I suggested that the stabilization of crude oil and its likely bounce back to a new trade range should clue us in to some new inflationary readings versus the rampant concerns about deflation. This chart below is beginning to suggest same:

Now that oil prices have risen for 4+ months, confounding experts again, we should not be shocked that a majority of firms are reporting higher prices paid. The seeds are sown: say good-night to deflation concerns.

In fact, we should expect further signs of inflation. Why? Well, there are other reasons than just the stability of crude oil. Indeed, the masses have done so much preparation to fight against a repeat of 2008-09, that a much larger event has been massively overlooked. Supplies of almost everything are tight.

The issue? In multiple channels, we are about to witness early waves of demand the likes of which we have not seen for decades. Housing demand is set to begin a move upward which will last for many years. Given a complete misread and the current very low supply of homes, prices are likely to rise there as well….and that will trickle down into other channels.

Just wait–after years of being told deflation risks were a death knell, the chant of inflation should really stir up the bearish chatter.

Equity Risk Premiums Revisited

The bears like to point out that the P/E ratio of the S&P 500 is about 15% above its long-term average. Here is the thing: that can be “fixed” two ways, either a fall in values or an increase in demand, revenues, earnings and prices. The important data being overlooked points to the latter.

That said, the P/E ratio of 10-yr Treasuries today is closing in on 80. One can argue the P/E ratio of equities is a quarter of that level.

Here is the reality based on long-term standards: As much as fear has blocked this possibility from view, given the “terrible risks” cloaking the horizon, this is an unprecedented valuation gap – in favor of owning equities.

The chart above shows the earnings yield (after-tax profits per share divided by share price) on equities remains well above average – post Brexit.

More important: EPS is stabilizing. The biggest surprise after all the experts bashing results over the last 5 quarters?

The EPS reports overall show they have fallen just 2.7% over the past year.

A complete dismantling of a major sector and we only saw a 2.7% dip? That should be a clue for most. Now? Our data suggest EPS is on the mend and quite likely to increase with the problems in the oil patch mostly in the rear view mirror.

The bottom line for investors: If profits merely hold at present levels, one can see a scenario where the expected return on equities can be significantly higher than the return on Treasuries.

Making certain you are focused on the Barbell Economy is critical.

The data and snapshots above continue to prove same. Eventually, this will become obvious to the masses – likely at much higher prices.

A Closing Thought

In his book The Rational Optimist, Matt Ridley writes, “Today, of Americans officially designated as ‘poor,’ 99 per cent have electricity, running water, flush toilets, and a refrigerator; 95 per cent have a television, 89 per cent a telephone, 72 per cent a car and 71 percent air conditioning. Cornelius Vanderbilt had none of these.”

I’m not suggesting here that inefficiencies, injustices, and inequalities don’t exist today over the income spectrum. Of course, they do. But they always have and always will.

The bigger point is this: by comparison, we are living in one of the most prosperous times in the history of this world.

We have a lot to be thankful for…and even better days are ahead for the US.

Yet, we have over $8.3 trillion sitting idle in US bank accounts. Combine this with a concerted drive to buy even more sub-2% bonds and you get the point: fear is our problem.

More later –

Until we see you again, may your journey be grand and your legacy significant.