Weekly Update: Trump, Trump, Trump ad nauseam

02-24-2017

I stayed around Pittsburgh this week, taking some of my leftover vacation days (use or lose), getting my hair cut, walking my pup around the neighborhood (the weather was spring-like). My hairdresser said all anyone wants to talk about is President Trump. Even the guy walking his dog stopped to talk about Trump. He relayed that during the campaign, one house on our street had a Hillary sign while across the street a yard had 6 Trump signs that, mysteriously, were torn down one night. He put the signs back up and said he had a video of the suspect, who didn’t return. Frankly, I’m getting bored with all this Trump talk. The markets and businesses have been really excited, but I’d like to see him stop talking about Hillary and the media, and start talking about how he’s going to work with Congress. Next week’s address before Congress could be a good place to start. Many are hoping Trump will move past campaign rhetoric with policy specifics and minimal histrionics. But others are concerned he may not feel comfortable giving a policy-oriented speech and could revert to a campaign-style address as he did for his inauguration, last week’s event in Florida and today’s CPAC keynote. Fundstrat says it’s important for the market to see Trump start the process of filling in details on issues, such as whether to pay for proposed tax cuts with a border-adjustment tax, how much he wants for an infrastructure program and how to pay for it, and the timing for an Obamacare repeal-and-replace strategy.

One concern is that without more fiscal stimulus and with inflation and interest rates on the rise, profit growth may be overstated, making a market that has gotten ahead of itself vulnerable to a sell-off. But most projections have been built off growth forecasts unrelated to what Trump can or can’t do on corporate taxes, et al. Jeffries looked at sector-neutral baskets of high and low tax-rate companies and found there may not be all that much priced into shares anyway. In fact, the quintile with the lowest tax rates has performed best since Trump’s election. Moreover, Credit Suisse says the $1.5 trillion of cash on large-cap company balance sheets is obscuring profitability and distorting valuations by making companies seem more expensive than they really are. It estimates that, ex-cash, stocks are trading near their historical averages. For example, at a current 18.6 forward P/E multiple, the S&P 500 is trading 13% above its 10-year average because of historic cash levels, according to Aswath Damodaran, a finance professor at New York University. “A high P/E ratio can point to overpriced stocks, but it can be caused by high cash balances and low debt ratios,” he wrote in a June blog. So what will trigger our much-needed sell-off? Faster-than-expected Fed tightening would be a good catalyst. Minneapolis Fed Chair Kashkari this week became the fourth Fed governor to confirm the central bank is ready to start shrinking its $4 trillion balance sheet. On top of Fed rate hikes—some in the bond market think 4 may come this year; this week’s minutes left much open to interpretation—it’s difficult not to see stocks being impacted by a shrinking Fed balance sheet. When the Fed suspended quantitative easing in late 2014, the dollar rose more than 20% in nearly 2 years and the market experienced periodic pullbacks that prevented it from sustaining new highs until the current post-election rally.

From a contrarian perspective, the major indexes are trading at levels associated with the start of a new bull market or a blow-off rally, both signs of near-term risk. Heightened investor optimism clearly represents a tactical trading concern. However, Oppenheimer notes in terms of a major market top, high optimism isn’t a concern until internal breadth weakens. With 71% of NYSE stocks above their 200-day moving averages, that’s not the case now. Still, this unrelenting rally that has sent the S&P above 2,300 has been filled with frustration and pain, with few red closes in February and no decline of more than 5 points since Jan. 30, all while the VIX has held near historical lows. Nobody knows how this Trump administration will play out! But we can probably say that the Republican sweep has pushed off a recession until 2019, at the earliest. Trump arrived with an economy near full employment and public debt-to-GDP the highest since Truman. Trump will have to deal with Congress and this rally could slow down. As part of my ongoing political research (as it relates to the market only, OBV), I happened upon one of the more conservative TV channels where one of the guests—an ex-comedian and ex-Pittsburgher—suggested a Congress focused on the 2018 midterms and a Trump on 2020 gets you 8 years of Trump (and a Republican-led Congress), likely followed by 8 years of Pence, then Ivanka (why not?), and then Barron will be of age. You may be laughing by now, but if you think about it … this is how we get the Game-Changer.

Positives

Existing home sales surge They jumped in January to their highest annual rate since February 2007, and December also was revised noticeably up as homebuyers shrugged off the pickup in mortgage rates and housing demand strengthened significantly. Single-family sales reached their highest level in nearly a decade. The available supply was unchanged at a downwardly revised 3.6 months, matching a record low and indicating tight inventories. As a consequence, home prices picked up more than 7% year-over-year (y/y). New home sales also rose in January, though short of expectations in this volatile series. Y/y sales were up more than 5%.

Sentiment stays strong Michigan’s final read for February came in above consensus and held near a 13-year high reached in the post-election surge. Like their small business counterparts, America’s midsized businesses also are ecstatic, with 80% (!) of 1,400 middle-market companies surveyed by JPMorgan Chase saying they were optimistic, by far the highest since it began the annual polling seven years ago and a sea change from the 39% who felt that way last year. The big reason: enthusiasm about the prospects for tax reform and regulatory relief.

Where are we in the economic cycle? It usually takes 2 years for Conference Board leading indicators index to set a new high after a recession has ended and 6 years for the next recession to begin after it peaks. It’s now been 91 months since the Great Recession ended and the index, at 125.5 in January, is still short of its prior record of 125.9.

Negatives

A hint of moderation Markit’s flash services PMI fell in February by the most in a year, while the manufacturing PMI slipped less than a point. While both remained firmly in expansion territory, the reports suggested private-sector growth may have moderated this month, with optimism about the 12-month outlook the weakest in 5 months among service firms.

Where are we in the economic cycle? Real income growth, the driver of consumer spending, slowed to a 2.1% y/y rate in Q4 2016 and likely will slip to just 1% in Q1 2017, Cornerstone Macro estimates. One reason: credit card lending standards have tightened as borrowing costs have trended higher, and banks are clamping down on auto loans. The New York Fed’s fourth-quarter consumer debt report showed debt growth remains far below its pace of the prior 55 years.

So, what can we worry about? Outstanding student loans have doubled since 2009, pushing the total to a record $1.31 trillion in 2016, the New York Fed says. Nearly 25% of borrowers are in default or at least 90 days in arrears. This is one of the biggest concerns that I hear as I travel. I also hear a lot about subprime auto loans, where delinquency rates are rising. But Deutsche Bank notes the $300 billion in outstanding subprime auto loans is very small relative to current household net worth of $90 trillion; the 2006 subprime mortgage market was much bigger and the financial system was much more highly leveraged. Similarly, student loan balances stand at $4,920 per capita, vs. $34,000 for current mortgage debt. The bottom line: for household debt to be a macro problem, we will need another big nationwide decline in home prices.

What else

Gold loves inflation While gold has underperformed stocks and bonds over the past 10 years, its absolute and relative performance should start to improve if the current reflationary environment evolves into one that is increasingly inflationary, Ned Davis Research says. That’s what happened when the reflation of the 1950s gave way to the inflation of the 1960s, when inflation and interest rates trended higher and equities entered a secular bear market. Gold has risen at a 19% annual rate when the spread between U.S. nominal GDP growth and long-term bond yields has exceeded 1%, as has been the recent case with bond yields lagging to the upside.

No one’s talking about this … yet The current funding resolution that keeps the government from shutting down runs out in roughly 60 days. April 28 is the first action-forcing event that will be a truly "must pass" bill that requires Democratic votes. If Congress cannot find compromise on funding levels (it needs 60 votes in the Senate so a minimum of 8 Democrats), the government will shut down.

Cool water The Mayo Clinic provides a litany of reasons why we all should be drinking more water. Among them: drinking 1 glass before going to bed helps avoid strokes or heart attacks; 2 glasses after waking up helps activate internal organs; 1 glass 30 minutes before a meal helps digestion; and 1 glass before taking a bath helps lower blood pressure.