Weekly Update: Santa does exist!

12-16-2016

 

He emits an orange hue and has a side-and-back comb-over under that hat! My last travel for the year took me to Connecticut, a charming place to visit, particularly around the holidays. We made stops in Stamford, Westport, Southport, New Haven, Old Saybrook and Essex. Our first meeting, a client event where the quite well-to-do audience was dismayed/concerned about a Trump presidency, every question concerned the upcoming administration. Two of my favorites: “With rising interest rates and government debt, how can he afford all that promised stimulus?” Bingo! And, “What happens when he nukes Iran and North Korea?” I wondered how to best answer this impossible question while thinking, “Let’s take it easy.” At an advisor meeting the next day, I was challenged on my “let’s take it easy” theme. An ex-derivatives trader watches options and insists the S&P 500 will reach 2,350 before this year is out and thinks “this will be a longer cycle than expected because malaise has held for so long.” His clients instructed him to invest spare cash “at the next pullback” after the election. The cash is still there, and “we are nowhere near the euphoria that historically ends a bull market.” Another advisor thinks tax reform is more bullish than I suggest. At my next meeting, another advisor disagreed with the “let’s take it easy” theme. “This is a rocket ship,” he said, referring to the market and an economy about to be treated to massive tax cuts and deregulation. At yet another advisor meeting, I found bulls agreeing that “people aren’t euphoric yet.” (The second time I heard this comment in 2 days.) I remarked that the advisors in Connecticut are bullish but their investor clients are not. “Well, that’s understandable, Connecticut is blue (referring to their election disappointment).” “Sure,” another advisor said, “but money is green.”

Elevated political expectations may be the single biggest risk facing the tape, where the percentage of S&P stocks trading to a new 65-day high exceeded 30% last week, an important threshold historically consistent with above-average forward returns. Many investors believe a large tax cut is coming soon, but the proposals being bandied about center on tax reform, which can take a lot longer to enact. And reform as envisioned by Congress may not be all that stimulative. Republicans want it to be as close to deficit neutral as possible, with reductions in personal and corporate income tax rates offset by the removal of tax deductions and credits. While Brexit and the presidential election received all the attention this year, Cornerstone Macro says it was a pickup in the data beginning in the summer that salvaged a market that was off to its worst start in history. This inflection point caused a 180-degree turn in leadership across the board, with the uptrend accelerating post-election. However, while subjective surveys on consumer confidence and manufacturing (more below) have recently soared, objective data such as nonfarm payrolls and retail sales (more below) exhibit only modest gains, with a declining trend in hires potentially signaling a late-stage business cycle. Moreover, inflation still resides below Fed targets (more below), while a stronger dollar—it hit a 14-year high this week—could be a headwind for momentum and earnings.

As the Fed raised rates for the first time in a year (more below), the macro backdrop looked much different than it did a year ago, when it was preparing its first hike since 2006. While 10-year yields were roughly the same level (a pre-statement 2.45% this week vs. 2.30% then), the Fed hiked into a deteriorating credit environment last year—high-yield spreads were at multiyear highs 12 months ago and liquidity conditions were weakening. Today, credit is supportive (spreads are at or below historical medians) and commodities are stable (in fact, oil and iron ore appear to have broken out). Equity correlations are also down sharply, hitting fresh lows this week, consistent with the improvement in credit. In Connecticut, where it seems everyone skis, my athletic wholesaler colleague argued several times that the market is getting over its skis. Indeed, the latest Investors Intelligence survey shows the percentage of letter writers identifying as bulls rose a 6th straight week to just fractionally below the 60% level where it suggests investors “take defensive measures.” Renaissance Macro says it’s hearing from people concerned about the market being up too much and too fast. But given seasonality, the positioning of the futures market and the empirical evidence of momentum, it believes the natural inclination to wait for anything other than a brief pause may prove costly. It’s hard not to be excited by this new Santa’s pro-business chops … He sprung to his sleigh, to his team gave a whistle, and away they all flew, like the down of a thistle. But I heard him exclaim, ere he drove out of sight, “We’re going to make investing great again!”

Positives

More signs of rising business optimism The NFIB gauge rose by the most in 7 years to its second-highest level since 2007. Small businesses reported feeling decidedly better about the economy’s outlook and demand for their products on expectations for pro-growth, business-friendly policies under Trump. The Trump bump was in line with surges in other gauges of business confidence, i.e., Duke/CFO Magazine, Business Roundtable, Equipment Leasing and Finance. Not all the news was better: plans for stagnant capital expenditures (capex) fell further and firms unable to find qualified workers rose to a 16-year high.

Manufacturing ramps up November industrial production slipped on lower utility output because of warmer weather, but the real news was 3 key December indicators. The Philly Fed manufacturing index rose to a 2-year high and year-over-year (y/y) was up the most since May 2010, a sign of strong upward momentum. New York’s Empire gauge hit an 8-month high, and the Markit flash PMI reached its highest level since March 2015 on improving year-end conditions. Conditions also are improving outside the U.S.: 73% of country PMIs are up y/y, putting global manufacturing breadth at a 2½-year high.

Homebuilders excited The NAHB sentiment gauge jumped 7 points to 70 in December, its biggest gain since June 2013 and its best level since June 2005. All components advanced on post-election optimism, particularly with respect to potential regulatory relief. Prospective buyer traffic also moved above the break-even level for the first time since October 2005, possibly as fence-sitters seek to get ahead of rising mortgage rates. This morning’s report on November housing starts & permits wasn’t as encouraging, as both fell more than expected after a strong and upwardly revised October. But the weakness was centered in multifamily units, as single-family units have surged at a 25% annual rate the last 3 months.

Negatives

Where’s the real Santa? Retail sales growth disappointed in November after 2 strong months, as auto dealers and department stores saw activity slip. Still, overall sales were up 5.9% on a 3-month annualized basis, suggesting momentum heading into the holidays. The National Retail Federation projects November-December sales ex-autos, gas and restaurants to rise 3.6% y/y, up from last year’s 3.2% and a 2.5% 10-year average. Consumers told Pricewaterhouse Coopers they plan to spend 10% more this season, with 42% of the average $1,121 going to travel and entertainment.

Fed tightening shouldn’t hurt—yet While policymakers signaled 3 more moves in 2017 after this week’s increase, history shows tightening cycles rarely become a problem for equities until 3 or 4 hikes in succession. What happens next year may be out of the Fed’s control as it would depend on the amount and speed of any fiscal stimulus by Republicans, which would favor a speedier rate path, and a rising dollar, which would suggest a stickier path.

Inflation Watch Outside of a tight rental housing market (and rising health-care expenses), inflation pressures have not really surfaced so far in this recovery, with core inflation ex-housing stuck at a 1.3% y/y rate. November reports did reflect some y/y headline strengthening, with the CPI and PPI rising to 1.7% and 1.3%, respectively. Core producer prices also jumped four-tenths of a point to 1.6%. The question is will this hold if the dollar keeps strengthening—import prices fell last month by the most in 9 months, largely on lower petroleum prices but also on the dollar’s recent surge.

What else

And the Republicans thought they had it bad Relative to the 2016 Senate map for Republicans, the 2018 map for Democrats is far worse—arguably the worst map for any party since WWII. Democrats are defending 25 seats to the GOP's 8, with 5 in ruby-red states and another half dozen in competitive states. This leaves Senate Democrats with 2 roads: take the 2009 GOP path of obstruction, or cut deals with Trump to put some re-election points on the board with Trump voters. Cohen & Co. thinks the party will swing toward the Sanders/Warren wing, where all the passion resides. A tell-tale sign will be if Democrats start to cannibalize each other in the primaries a la the GOP in 2010.

Ho-ho-hello? Scammers have made 113% more holiday-related phone calls so far this year than they did last year, the robocall protection tool Hiya has found. The typical fraud scenario? Pitches for charitable giving, gift cards or holiday cruises.

There’s more than just shoes on my wish list The last meeting of my last travel for the year was at a theatre/museum in Old Saybrook, honoring Katharine Hepburn. A lifelong resident, she referred to her Fenwick home on the water as her paradise. Before my speech on stage (!) in front of a red-velvet curtain, a gentleman approached and asked where my red shoes were. No red shoes this time, but I  was complimented on my red coat and red handbag everywhere I went. People of Connecticut, you are both charming and too kind. Merry Christmas to you and to all of my readers.