Weekly Update: Nothing going on here, so ...

02-03-2017

So, Trump is the main topic of discussion (and front page news daily) in gorgeous Vancouver, British Columbia, which I visited this week. Canadians were said to be “over-the-top interested” in Trump, “at least 10 times more so” than “the snowboarder leading our country,” Prime Minister Justin Trudeau. I inquired as to the PM's approval rating. “By whom? Men or women?” an advisor asked, noting Trudeau's considered “dreamy” with his handsome good looks. The many Canadian advisors I met were having much political fun with me, one wishing that “we had an Alec Baldwin to portray Trudeau.” Before my first meeting with end-clients, my host prepped me that they are very concerned about a Trump presidency. Indeed, questions from this reserved, genteel group were about trade wars (Nafta, unsurprisingly, came up in numerous meetings), last weekend’s events, drug pricing, etc. So, I asked, is anyone excited about President Trump? Quiet … no one? “We’re Canadians,” was the response. The individual investors seemed to be holding back, but none of the advisors I met were. One said the biggest challenge regarding U.S. politics is getting accurate media information, noting that every source seems to be biased. Indeed, the people of Vancouver, I was told, are really worried about our new regime. An advisor spoke of one of his clients who “is not sleeping at night” and believes our president is a “raving lunatic.” I heard from numerous advisors that their clients are wondering if they should sell their U.S. investments now, with some already giving the order.

Dust-ups over the new travel ban and inauguration crowd sizes, rifts with Mexico and Australia, and criticism of euro policies—European Union President Donald Tusk says Trump is “seeming to put into question the last 70 years of American foreign policy”—have the market placing a greater weight on the potentially more deleterious pieces of a Trump presidency. As the rancor grows louder and the complexities of implementing a growth package become better known, investors are coming to recognize it may take the GOP far longer to enact the “Big 3” (corporate tax reform, infrastructure spending and deregulation) than previously thought. In Congress, Ryan can pass pretty much anything he wants with a simple majority in the House, but the Senate is a much tougher institution to navigate and a lot of what Republicans desire will require at least some Democratic support. It’s possible that lowering the corporate tax rate to 20-25% without major code changes could sail through. But when combined with other pieces of the agenda as well as Affordable Care Act (ACA) repeal/replace and fiscal constraints—the Congressional Budget Office projects the deficit to climb 75% the next 5 years before any policy changes—the math gets increasingly difficult. The timing does, too, as Congress seems intent on a border-adjustment tax (BAT) as part of tax reform—Cowen & Co. estimates BAT implementation likely won’t come until Jan. 1, 2019, at the earliest. Moreover, health care is likely to be a larger political lightening rod than markets appreciate and could deplete a big chunk of Trump’s political capital. If ACA replace legislation hasn’t been passed by summer’s end, it could imperil passage of Trump’s other priorities in 2017.

With 3/4 of S&P 500 companies having reported, earnings are on pace to rise 9%, a return to trend growth after several lackluster years. Guidance has been particularly bullish, suggesting a very strong 2017 even without passage of pro-growth policies this year—a nod to an economy that appears to be getting off to a good start (more below) in 2017. That’s helpful as forward P/E’s are residing just below their cyclical peak, leaving little wiggle room. Seasonality isn’t favorable. February historically's the second lousiest month of the year, and regime change may add to that burden. The S&P has declined 4% on average in a new administration’s first February as staffers learn the ropes and make mistakes. With Trump’s staff having less government experience than previous ones, more missteps than usual are likely. Trump’s low approval ratings relative to most newcomers may help—a divided country has been relatively bullish for stocks in the past, possibly because it prevents optimism from becoming too extreme. That said, this week's Investors Intelligence tally of bullish advisors jumped to a 19-month high and has been above the danger zone of 55% 10 straight weeks. Personally, I don’t think Trump & Ryan will throw away this historic chance to get Republican-sweep policies in place. The path of least resistance is to do what Republicans did the last time they had one-party control: ram the 2003 Bush tax cuts through reconciliation without offsets, violate the Byrd Rule that can block legislation if it raises the deficit, invoke a 10-year sunset, create a fiscal cliff and deal with it later. A Trump administration promises to be a roller-coaster ride—get your popcorn, remain focused on the economy, earnings and multiples, and let’s take it easy. I thoroughly enjoyed my Vancouver visit. Love their sense of humor! I was sent off with a remark I’d been anticipating after last weekend’s airport protests: “Are you sure they’re going to let you back in (to the U.S.)?”  

Positives

January jobs robust Nonfarm payrolls easily beat consensus estimates (227K vs. 180K), with broad improvement across industries, and ADP payrolls jumped to 246K, a 7-month high. Despite the job growth, the unemployment rate ticked higher to 4.8% as the participation rate and labor force grew, easing concerns about a tightening labor market. The improvement in some ways offset December’s weakness, keeping the labor market supportive of the ongoing expansion. Notably, wage growth imploded, falling to its slowest pace since last April and lessening the likelihood of an early Fed move on the best of both worlds: faster job growth and subdued wage pressures. 

Manufacturing, services robust Led by production and a 2½-year high in employment, January’s ISM rose a fifth straight month to a 26-month high while Markit’s manufacturing PMI nearly hit a 2-year high as output grew at its fastest pace in 22 months and new-order growth hit a 28-month high. Rising December factory orders also signaled stabilization. Importantly, global manufacturing PMI held at its highest level in 3 years, i.e., no global recession in sight. The broader services economy also reflected strength as ISM and Markit surveys were near 1-year-highs. Combined, the reports were consistent with above-trend growth.

Solid housing forecast Despite rising mortgage rates and end-of-year sluggishness, home sales may be turning up. Pending sales, an indicator of future existing sales, rebounded an above-consensus 1.6% in December. The National Association of Realtors projects existing sales to increase nearly 2% this year, median home prices to rise about 4% and housing starts to jump nearly 8%, particularly if regulations are eased. Residential spending was solid in December, nearly offsetting a drop in public outlays as overall construction spending slipped 0.2%.

Negatives

Inflation Watch ISM and Markit price pressures intensified on broad-based commodity price increase—the ISM component hit a 6-year high—and Q4 unit labor costs rose at a 1.7% annual rate, nearly 9 times Q3’s rate. Home prices also reached a new high, in part on tightening inventories. But wage increases moderated to a 2.5% pace vs. 4% in past cycle peaks, causing the Employment Cost Index to slip to 2.3% year-over-year (y/y). This suggests core PCE inflation could stay below Fed targets a little longer, a view the hold-pat central bank and January jobs report reinforced this week.

A headwind for consumers Real disposable personal income growth moderated to a 2.3% y/y pace in December, and real hourly compensation slipped to 1.5% average annual rate in 2016, nearly half its year-ago level. This morning’s first look at wages in an otherwise robust jobs report also disappointed, with y/y average hourly earnings growth unexpectedly declining to just 2.5%. Despite rising consumer optimism (Conference Board confidence was just off a 10-year high), weakening income growth could restrain near-term spending. As if on cue, automakers this week reported that January sales fell nearly 5%.

Millennials Watch Reports that Saks owner Hudson’s Bay may try to acquire Macy’s is the latest example of landmark shifts occurring in traditional retailing as millennials eschew brick-and-mortar stores and sales increasingly are made online. Challenger job-cut announcements for January jumped nearly 37% to a 9-month high partly on continued cutbacks in a retail industry that "continues to reel from the shift toward online shopping.” Redbook, which measures sales at mass merchandisers, said same-store sales in January were their weakest since last August. We ignore this massive young generation at our peril.

What else

Political Watch Political capital is the all-important X factor in D.C., and Trump lost some last weekend, IESB says. Suddenly he faces grumbling within his own party and even among his new Cabinet nominees, who worry about needlessly provoking allies. But the most cutting gripe—from both parties—was the immigration plan was confusing, amateurish and poorly explained. Luckily for Trump, Democrats are still adrift, seemingly unable to capitalize on growing protests. It's not Democrats Trump has to worry about—it’s Republicans. If he starts to lose their support, his political capital will continue to fade before he has a chance to shift the focus to his strong suit: pro-growth policies.

Trump supporters were nowhere to be found in Vancouver Rather, I was told about the fear that “Trump will destroy the world!” Millennials there, “if you even whisper support for him, will totally ostracize you.” There is currently a poll in which Canadians can bet on when he will be impeached. “73% lack optimism in Trump’s presidency and think he will be replaced; 41% predict he will be impeached this year.” On Election Day, “the No. 1 Google search was how to emigrate to Canada—the immigration site actually shut down (due to search volume).”

This amazing city has been discovered! Vancouver has grown dramatically and now suffers the worst traffic in North America, I was informed, with a road system built in the 1960s. It is blessed with great fresh seafood choices—the Fraser River is the largest salmon-producing river in the world, according to my hosts. 90% of Canada’s population lives within 100 miles of the border and 80% live in urban areas. Not surprisingly, numerous advisors asked about the strong U.S. dollar vs. Canada’s. They joke when somebody turns 60 in Canada, they are told, “yes, but you are only 45 U.S.”