Weekly Update: Nothingburger

03-17-2017

Nothingburger, a term used a lot in today’s D.C., was popularized by a 1950s gossip columnist. The Urban Dictionary defines it as something with high expectations that turns out to be average or over-hyped. This week, we had several: interest rates, Dutch election, "skinny" budget, POTUS’ old tax return. With Minneapolis Fed President Kashkari’s dissent (he voted against the hike), virtually no movement in the dot plot and a press conference in which the biggest news from Yellen was that there’s been no decision on when to start shrinking the Fed’s balance sheet, the market got a dovish surprise that was good for both stocks and Treasuries. With nine members expecting three hikes in 2017, the policy-setting Federal Open Market Committee (FOMC) seemed in no more of a hurry to normalize rates in March than it was in December, the recent shift in communications notwithstanding. We are nowhere close to the point where Fed rate hikes derail this market. In Holland, Prime Minister Rutte’s surprisingly easy centrist victory suggested a pause in the rise of global populism, which will get its next big test with the upcoming French elections. President Trump’s skinny budget offered less than zero on details—literally nothing on tax reform, not even a mention. So we’re back to watching the health-care saga (more below) and, Cowen & Co. suggests, a potential April 28 government shutdown. Once those are resolved, the fiscal 2018 budget process can begin … and then we probably get some details on tax reform/relief.

The data doesn’t suggest this is a rally driven entirely by hope on taxes, anyway. At around $146, S&P 500 forward estimates for 2018 have been remarkably stable since Election Day and remain at a record high $134 for 2017, according to Thomson Reuters. Wall Street currently is forecasting 9.6% earnings-per-share (EPS) growth, 100 basis points above its 27-year average of 8.6%. And in years in which there has been above-average EPS growth, S&P returns (excluding the financial crisis) have been 413 basis points higher than the 27-year average, according to Jeffries. It is difficult to expect a major pullback when international equities are trading this well, although the lack of overbought readings during the recent run-up suggests a correction could come soon—the longer the period of non-confirmation of the uptrend, the deeper and longer the sell-off is apt to be, Dudack Research says. Even if the S&P pauses or pulls back temporarily, it remains within a strong uptrend. And with hedge funds underperforming in February and the defensive stocks acting well, sentiment clearly has shifted from extreme optimism to more neutral or even a minor bearish position (AAII Bears haven’t been this bearish since February 2016)—a nice contrarian positive. It’s also difficult seeing stocks falling materially amid the current quiet trading backdrop. Although stretched valuations may slow the pace of the ascent, the rally should extend its gains in the short term with monetary policy remaining both transparent and certain. Also contributing to the calm is seasonality and the between-period lull in corporate earnings announcements.

The yield curve looks to flatten over the coming months, consistent with a tightening cycle when bull markets typically shift from a liquidity-driven advance to an earnings-driven one. Short of a shift in Fed strategy, this is likely to be a dominant thesis for some time. Indeed, a paper on inflation presented at the recent U.S. Monetary Policy Forum indicates that a behind-the-curve assessment of the Fed is premature. Headline inflation tends to fluctuate around core, and core inflation fluctuates around a slow-moving underlying trend. This trend responds weakly to labor-market tightening (more below) and little if at all to increases in inflation expectations. The dollar, financial conditions, and money and credit aggregates tend to have more of an effect on inflation expectations with large lags, and none of these variables is pointing to an abrupt rise. Investors seem to be somewhat uncertain about which way to go, putting $31 billion into equities over the past 6 weeks but $49 billion into bonds over the same period. It’s true everywhere I go, people are looking for the big thing that is going to happen. Well, mostly big things don’t happen. Should we worry about squishy retail sales (more below)? Nope, that was a big fat nothingburger. The Fed? No. The skinny budget—no; it’s very common for incoming new administrations to send over their first budget with little detail. The “skinny” budget got me thinking about my diet to shape up for the summertime. I know what to eat … a nothingburger!

Positives

Bullish on manufacturing March’s Philly Fed index topped 60 with new orders at their highest level since the early 1990s. New York’s Empire also saw several key components reach multiyear highs. This suggests a strong close to a good quarter—the manufacturing component of today's industrial production report for February rose the most in month since July 2015, lifting the 3-month growth rate to 5.2%, a 3-year high. This emerging factory strength drove February’s above-consensus increase in this morning’s Conference Board leading indicators, which have now risen a robust 0.6% for 2 straight months.

Bullish on single-family homes With single-family activity its highest in almost 10 years, February housing starts easily topped expectations even as multifamily starts slipped. The story was similar for permits as single-family permits rose while multifamily fell. Combined with this week’s jump in builder sentiment to a pre-crisis high, these favorable single-family fundamentals and their multiplier effects could mitigate any drag from higher mortgage rates, adding to economic acceleration.

Bullish on small business The NFIB’s optimism index held close to a 12-year high in February and, on a year-over-year (y/y) basis, was up the most since September 1983, indicating strong momentum in anticipation of pro-growth and business friendly policies under Trump. Job openings hit a 16-year high, a positive sign for the job market as small businesses account for the bulk of hiring. The Wells Fargo/Gallup Small Business Index also jumped in Q1 to near a 10-year high. Big businesses are upbeat, too, as the Business Roundtable said quarterly CEO optimism rose the most since 2009 on brighter outlooks for sales, jobs and capital expenditures.

Negatives

Consumers take a break February retail sales softened after a strong holiday season, as restaurants, auto dealers, electronics, clothing and sporting goods stores all reported lower monthly sales. Discounters were down as well and have been weak for months, suggesting the middle class may not be spending because tax refunds have been lagging. However, y/y trends remain relatively robust and consumer confidence is surging—this morning’s read on Michigan sentiment rose above forecasts on a jump in the current conditions component to a 17-year high, potentially a sign that the pace of consumption may be rising again.

Inflation Watch CPI inflation firmed modestly in February, with the headline up 2.7% y/y and the core rate up 2.2% y/y. PPI inflation also rose a sixth straight month, erasing much of the remaining gap between it and the CPI measure. The increases are broadly consistent with the view that inflation pressures are continuing to build, although inflation expectations have stabilized on oil’s modest pullback and few hints of wage pressure—the NFIB, for example, said compensation plans among survey respondents have eased. In the forward-looking paragraph of its statement, the FOMC signaled it will remain mostly focused on trends in core inflation when deciding on subsequent rate hikes.

Labor pains The Conference Board cautioned that stronger labor demand is likely to run into labor supply constraints this year, a warning that appeared in the Philly Fed survey, with more than 60% of respondents reporting labor shortages and 68% reporting job/skill mismatches. In the NFIB survey, 32% of firms said they couldn’t fill an opening (the highest since December 2000) and 17% cited the “quality of labor” as their single most important problem (the highest since November 2001). January’s monthly JOLTS report also reflected tightening labor market conditions, with 12-month average openings near a record high, hires near their pre-recession level and the ratio of unemployed persons per job near April 2001 lows.

What else

Political Watch Yardeni Research among others theorizes that Trump doesn’t really care if Obamacare repeal-and-reform (R&R) doesn’t pass. A timeout on the initiative would allow him and Republicans to go to their sweet spot—tax reform. Tax reform already is being worked on behind the scenes for the 2018 budget resolution as R&R flounders on center stage. Trump, who politically can still say he made R&R his first priority, must know that his big win would be tax reform. Market commentators have been baffled as to why his administration didn’t put it first. The answer is to get it out of the way whether it passes or not.

Why are retail sales so sluggish with confidence so high? Cornerstone Macro cites 3 reasons: Banks are tightening lending standards; interest rates are rising; and inflation is hurting real income as nominal income growth slows. Moreover, within the Conference Board confidence survey, the biggest gains have been among middle-income and older households. However, these cohorts are not the main drivers of consumer spending—that is, those who have the greatest ability to spend have not seen as large of an improvement in confidence.

Do you know who Mark Papa is? Thanks to shale, the U.S. producing more oil than it has in nearly 50 years, with crude production on pace to soon top the record set in 1970. The Institutional Strategist credits Mark Papa, the oilman who helped create the U.S. shale industry and only came along 10 years ago. With a favorable president at the helm, one gets the sense we have a long way to go.