Weekly Update: 'I'm crazy bullish!'

12-02-2016

Heading to the airport for this week’s trip to Arizona, my chatty 5 a.m. driver said the stock market’s in a bubble and as the only one of his golf group (11 older men) who didn’t vote for Trump, he’s willing to give the man a chance. He brought up trickle-down economics, which he believes in, figuring if the market does well, I’ll travel more and his services will be needed. I like the way he’s thinking, although I find I’m more popular during bear markets. While not wanting to even say the word “Trump,” comments in a number of my Phoenix/Scottsdale meetings centered around international concerns—specifically China (debt and inflation worries) and India (which I have not been questioned about for some time). At an annual breakfast gathering, I talked with a Merrill Lynch advisor who spoke of the accuracy of his firm’s portfolio manager cash survey, which has a history of correctly calling market trends. The current level of cash holdings suggests good returns in 2017. Meanwhile, he reports his clients are all bearish, “the ones who are generally wrong but also the ones who are sometimes right.” His conclusion, “I’m crazy bullish!”—great for me to hear since I meet so few bulls. I liked his perspective very much. We only get 3 secular bulls in our lifetime, the first when we have no money, the third when we are about to die, and the middle one—this one! Let’s relish it. What spirit! I finished my trip as a panel member before a large group of professionals. Sitting between a D.C. political expert, who admitted to “eating crow” after predicting a Clinton landslide weeks before the election, and a strategist for a large bond fund family who posits that interest rates are going up but stopped short of calling for a secular bond bear market, my mantra was, “let’s take it easy.”

December can be a volatile month, with end-of-the-year cross-currents due to tax-loss selling, quarterly or annual hedge-fund redemptions, mutual fund window-dressing and pension fund rebalancing. It’s also usually a strong seasonal month, with early consolidation followed by a closing rally. Over the last 30 years, December’s been the “best’’ month, rising an average 1.74%, Evercore ISI says. And after robust Novembers such as we just had, year-end moves tend to be even more favorable. The market’s main handicap is a rich P/E multiple. At 21.2 on a trailing 4-quarter basis, it’s well above its long-term average. Another risk to valuation in the year ahead could be rising inflation, particularly if it hits 4% or more. That doesn’t appear to be the case at this stage—while headline and core PCE have been rising, both measures remain well below the Fed’s 2% target. The equity market needs better earnings growth in order to lower P/E multiples and support the current advance, growth it may get if the Trump team’s fiscal agenda is adopted. Back-of-the-envelope estimates suggest every $100 billion of stimulus (through tax cuts or deficit spending) could add roughly 50 basis points to GDP growth, Wolfe Research says. Many worry the dollar, already at a 14-year high, will keep strengthening, pressuring multinational earnings and U.S. competitiveness. But Dudack Research notes a stronger dollar’s rarely been harmful to earnings until year-over-year (y/y) gains exceed 10%. As of November, the dollar’s up only 2% y/y. On Nov. 21, the Dow, Nasdaq, Russell 2000 and S&P 500 made new highs together, a rarity that last happened in 1999. The historical record looks good a year later, not so much 3 months later, reports Ned Davis Research.

November’s price action completely engulfed October’s trading range—there’ve only been 28 other instances since 1950 in which the S&P’s monthly close topped the prior month’s close while its monthly low also was lower than the prior month’s low. Historically this signals above-average forward returns. Since the election, U.S. equity funds have seen $36 billion of net inflows, including the highest weekly inflow in 16 years ($31 billion Nov. 10-16). Bond funds witnessed outflows of $8 billion the same week. A similar rotation is occurring in other developed markets, with investors energized by heightened expectations of a regime shift from monetary to fiscal stimulus. Still, JPMorgan sees the broader dynamic as being characterized by 2 opposing trends: Trump fiscal anticipation, performance anxiety/chasing, favorable seasonality, oil tailwinds in light of OPEC’s production cut and vacuums (news/liquidity) vs. dollar headwinds, multiple-inhibiting effect of rising yields and very elevated political expectations. On this last point, Washington’s inertia makes candidates more similar than different. That’s why presidential terms often are defined by the first 100 days after inauguration, the honeymoon period in which goodwill prevails and things may actually get done. But when there’s a regime change (Dems to GOP or vice versa), the market’s susceptible to being swept off its feet, with the period between election and inauguration stronger than during the first 100 days. I’m bullish, but not crazy :) Let’s take it easy … honeymoons end.

Positives

Job growth November nonfarm payrolls rose a solid 178K, in line with expectations, while the jobless rate unexpectedly dropped to 4.6%, in part on declining participation. Hourly earnings also slipped after October’s big gain, putting the y/y increase at 2.5%. ADP’s separate count of private payrolls increased 216K, the most in 5 months and well above consensus. Combined, the reports clear the way for a Fed hike later this month.

Manufacturing growth Factories’ new-found momentum continued in November, as both the ISM and Markit gauges moved deeper into expansion territory on production and new-orders strength. The Chicago PMI also rose to its highest level since January and the Texas manufacturing gauge posted its first positive reading in nearly 2 years, reaching its highest level since July 2014.

Economic growth Revised Q3 GDP grew at a better-than-expected 3.2% annual rate, a 2-year high, on upwardly revised consumer spending and residential investment. The latter reflected improvements in housing, which has been a consistent source of strength. This strength carried over into October, with residential investment up 1.6% on solid growth in single-family and multi-family construction. Also, pending home sales rose again in October while September Case-Shiller prices climbed the most in 3 years to their highest level since March 2007.

Negatives

Waiting on capex Unlike housing, private nonresidential fixed investment was revised down in Q3 to a measly 0.1% annual rate from 1.2% previously, indicating persistent weakness in capital expenditures (capex). At -4.8%, equipment spending declined a fourth straight quarter, industrial equipment fell at a 3% annual rate and transportation equipment plunged at a 17.6% pace, its biggest drop since Q1 2009.

Waiting on Santa The early start to the holidays was ho-hum, as October consumer spending disappointed, rising at a pace suggesting modestly softer consumption growth. However, with personal income and sentiment on the rise—a post-election bounce pushed consumer confidence to a 9-year high—overall holiday spending is still expected to be robust. Indeed, Black Friday weekend sales at brick-and-mortar stores only slipped 1% y/y, far less than forecast, while online sales jumped 18%, more than expected.

Waiting on trade policy Yardeni Research notes that studies have shown it would be much cheaper to provide income support and retrain workers who have been harmed by globalization than to impose prohibitive tariffs to force production to come home, thus reducing the standard of living of all consumers, who must pay higher prices for domestically produced goods. On Nov. 27, Business Insider published an article entitled “Here’s what 5 of your favorite products would cost if they were made in the U.S.” The price of iPhones could more than double. Jeans would cost more than $200. The price of sneakers might also double. TV prices might not go up much since transportation costs would be lower for domestically produced units, but solar panel prices would be much higher.

What else

GOP sweep implications Republicans persistently put together legislation to repeal the Affordable Care Act despite the fact that Obama would veto the measure. They did this, Strategas Research says, to work out the quirks in moving legislation through the complicated budget reconciliation process so that if Republicans took complete control, they could strike quickly in 2017. Now that those quirks have been worked out, House and Senate leaders have a piece of legislation that can go directly to the floor of both chambers and be passed almost immediately should no changes need to be made, bringing a rapid end to the 3.8% Obamacare surtax on investment income.

Let’s decorate! Evercore ISI’s annual survey of regional Christmas tree associations, farmers and retailers reported “sales are taking off’’—jumping 12% y/y the first week of sales. Speaking of Christmas trees, Telebrands expects to be sold out of its Tree Dazzlers well before Christmas. These are lights that people can simply hang vertically over their trees, cutting decorating time down to a matter of minutes and taking the drudgery out of hanging lights on the tree (not to mention taking them off, too).

I like my odds! The average holiday bonus will be $1,081 this year, 25% larger than last year, according to recruiting agency Accounting Principals. Also, 75% of polled HR executives said their companies would be handing out holiday bonuses this year, compared with 67% in 2015.