Weekly Update: All over the place in N.C.


This week I traveled throughout lovely North Carolina, with stops in Pinehurst, Raleigh, Greensboro, Winston Salem, Charlotte and Cornelius. And with new market highs seemingly at each stop, opinions were all over the place. Marveling at the run, advisors described still cautious clients: “I can’t tell you how many high-net-worth clients are scared to death of him (President Trump). They think he’s going to cause another 2008.” “In 35 years, I’ve never had a client take my call while in the shower! She said she didn’t mind talking there, since ‘you have all my money. But if you lose it I will kill you!’” Another advisor spoke of his client, the CEO of an international company, who “doesn’t trust this market and is heavily in cash.” But others reported their clients are getting greedy, fulfilling 1 of 3 key indicators Trend Macrolytics says may point to a correction soon, the other 2 being new post-crisis lows in the equity risk premium and a “more presidential’’ Trump who won raves for his speech even as it lacked any policy specifics. Now, here are the exact quotes I heard from seasoned investment professionals in the various cities about their own personal portfolios: “If I could I would put everything into cash now.” “I’m in more cash now than I’ve been since 2007.” “I’m all in cash in my 401(k).” Why? Why? Why? “Because I don’t know what’s going to happen.” When do we ever? Everywhere I went, advisors wanted to know what’s priced into the market. Many of the sources I use suggest it’s 2018 earnings of around $135 on the S&P 500 before any potential positives from Ryan/Trump tax reforms and stimulus, and a Fed that hikes this month but remains on a slow path, with inflation remaining in the box (more below). I was asked if the dry powder waiting for the elusive pullback finally capitulates to drive the market further, “when will you know we’ve run too far?”

During the week, I read several comparisons between now and 1987 as the Dow completed a series of 12 higher consecutive closes and record highs, matching the previous record set in early 1987. From an historical basis, a consistent stretch of record highs tends to be followed by even more gains; but this comes with risks. Equities went considerably higher in the first 8 months of 1987 before prices came crashing down on Black Monday, the worst one-day sell-off in market history on Oct. 19, 1987. How similar or different are these two markets? Ned Davis Research notes the 1987 market began with fundamentals that implied equities were much cheaper than today’s market, with the S&P’s 12-month trailing operating P/E at 14.7 at the end of 1986 vs. 20.9 in late 2016. In both 1987 and 2017, earnings were emerging from a slump, but the big difference was profitability. GDP profit margins were 5.7% in 1986 vs. 12.1% in 2016, meaning corporations are far more efficient today than they were back then. Bonds were stiff competition for stocks back then, with the earnings yield, dividend yield, 3-month Treasury bill and 10-year Treasury bond yields at 6%, 3.4%, 5.5% and 7.1%, respectively; the current levels of 4.5%, 2%, 0.5% and 2.5% suggest equities are the better investment today. With earnings improving, market breadth strong and volatility low, today’s environment argues that the secular bull case remains firmly intact, with pullbacks representing opportunities to add.

Right now, there is simply a strong demand for U.S. stocks. Historically, it’s been wise to sit back and trade with the trend rather than overthink, overcomplicate and overanalyze in such markets, FBN Securities says. It’s Econ 101. Seasonally, the market tends to surge into the summer before moving sideways into year-end. In the 26 other occurrences since 1950 when the S&P started the year with up months in both January and February, forward returns the remainder of the year have skewed to the upside 12% on average, with only 2 negative years out of the 26, according to Strategas Research. That doesn’t mean there wasn’t a pullback in those positive years—on average, the S&P saw drawdowns of nearly 10% at some point, often in the weaker seasonal period. If this holds for 2017, it implies S&P reaching 2,650(!), a figure being suggested by some market pundits and believed by one advisor we met in N.C. I maintain that N.C. is the perfect year-round state for weather. It boasts a AAA credit rating, and the people are genteel. During the week, one lady asked to give me a hug, another described my speech as inspirational and a gentleman said that it would be scary to pick my brain. And some of the best questions of the year came from a couple of N.C. gentlemen: “Why didn’t you show us your shoes (during my speech)?” and “Have you lost weight?” I really must visit more often.


Feeling stronger every day Conference Board consumer confidence rebounded in February to its highest level since July 2001, as the post-election surge in optimism continues to hold. The index’s current level is historically consistent with above-trend economic growth. Among components, the present situation was its highest since July 2007, the assessment of current business conditions its best since June 2001 and confidence among the high end of the income distribution its highest since December 2000, likely reflecting the run-up in stock prices and expectations for income and business tax cuts from the Trump administration.

Manufacturing on a roll The ISM Manufacturing Index rose a sixth straight month in February to 57.7, its highest level since August 2014. The share of expanding industries, new orders and production all reached multi-year highs. Markit’s survey wasn’t as robust but still signaled solid growth, while all 6 regional factory indexes were entrenched in expansion territory. The broad-based improvement lessened disappointment over January’s durable goods report that showed core business orders slipping 0.4% on the month, although on a year-over-year (y/y) trend basis, they were positive for the first time in since November 2014.

Services also solid The ISM non-manufacturing index also rose more-than-expected to 57.6, consistent with solid growth in service-providing industries. Component details were similarly encouraging, as the new orders topped 61, new export orders rebounded to near 60 and business activity was its highest since February 2011. Again, Markit’s companion survey wasn’t as encouraging—it slipped to a 5-month low in February—but was still expansionary with increases in new contracts and product launches.


Inflation Watch The PCE Index, the Fed’s preferred inflation gauge, shot up in January by the most since April 2014, pushing the y/y headline and core rates to 1.9% and 1.7%, respectively. While still below the Fed’s 2% target, PCE inflation has gained momentum, which should allow the Fed to continue with policy normalization this year, with—as noted above—March firmly in play. Of course, a big part of inflation’s rise reflects the increase and stabilization of oil prices. That y/y effect should lessen unless oil prices take off from here—an outcome that the energy markets aren’t anticipating at this time.

Q1 GDP off to sluggish start The U.S. trade deficit in goods widened in January for the fourth time in 5 months, a negative for GDP in the year’s first 3 months. January real consumer spending also got off to a slow start, rising at a pace that equates with GDP growth of under 2%, and auto sales continued on a softer note as February came in a bit below forecasts. Finally, January construction spending unexpectedly fell 1% on a broad-based plunge in public outlays, down the most since March 2000. Real GDP growth rose at a 1.9% annual rate in Q4, unchanged from the flash estimate, and has averaged 2.1% in this expansion, below the historical mean of 3.1%.

Just a blip in pending home sales? Taking the shine off January’s jump in existing home sales, pending sales hit a 1-year low in January, suggesting weakness in winter’s waning months. The National Association of Realtors attributed the decline to insufficient inventories but still forecasts a 2.2% increase in existing home sales this year to 5.57 million units, with the median home price projected to increase 4%. The drop in the pending sales index was concentrated in the West, where massive storms could have caused delays in signing sales contracts.

What else

We’re going to be hearing a lot more about health care Trump and Congress have said Obamacare must be dealt with first before they can move on to their tax-reform and fiscal agendas. This comes as a Monmouth University poll found 1 of every 4 Americans surveyed reported that the cost of health care is their primary concern right now—up from 15% 2 years ago. Last year, health-care costs in America rose at their fastest rate since 1984. Drug prices, health insurance premiums and deductibles have hit alarming levels—far outpacing wages.

Keep an eye on stock-bond correlation From the late 1960s to the late 1990s, the correlation between stock prices and bond yields was negative, meaning higher bond yields were negative for stock prices because they led to higher inflation and Fed rate hikes. Since the late 1990s, the opposite has been true, with powerful deflationary forces causing higher interest rates to be viewed as bullish for growth by equity investors. If/when the correlation turns negative again, they will indicate that long-term rates are once again competitive with stocks.

Confidence’s end game Since 1972, high-confidence periods have tended to be associated with “animal spirits’’ in the markets and to occur closer to the end of an economic expansion. Since 1974, NFIB and Conference Board confidence measures have only been in the top decile only twice—August 1987 and March 2002, periods that subsequently saw equities decline 25%.