Weekly Update: Don't be a gambler, be an investor

03-31-2017

Are you a gambler or an investor? I haven’t traveled in the last several weeks, with health issues hitting home. Timing was fortunate, though, as not much has been going on out there. After briefly spiking during the recent and shallow sell-off, the VIX has fallen back again and is just off year-to-date lows. With the heart of the Q1 reporting season not arriving for another 3 weeks, volatility could fall further. Stocks tend not to go down during such a quiet trading backdrop—Wednesday was the third-lowest volume day for the S&P 500 this year. And Monday’s key intra-day reversal atop the 50-day moving average strongly suggests the 3% counter-trend pullback has run its course. Even though some market sentiment indicators suggest a broader sell-off is overdue, macro-fundamentals imply there’s nothing imminent. Based on the 14-day relative strength index, only 50 of 997 names in the Russell 1000 Index are overbought and only 11 are oversold. The overwhelming majority are in the middle. We are banging around in a range here. Even beleaguered crude oil is displaying signs of life after twice staring down critical takedowns of $47 and $50 per barrel on their respective West Texas Intermediate and Brent benchmarks. This signals deeply oversold conditions during a period of typically strong seasonality. Oil and fuel prices still remain well off their 2014 highs, which should help stimulate world economic growth now that the energy recession is over. That’s bullish for stocks and not bad for bonds—low oil prices help keep a lid on inflation, after all. With all these global forces going his way at the same time, President Trump simply may have lucked out.

While politics will continue to be an important theme—next week’s Gorsuch vote could be the next big test—global data surprises are approaching 6-year highs and may be more important near-term drivers than any D.C. drama. In the real world, consumers and businesses are increasingly confident, the labor market is booming, and the public isn’t concerned about the House Intelligence Committee or North Carolina bathrooms. So what if the swamp hasn't been drained. Most people don't care. All that noise on the talk shows is a lot of nothing for them. The bad taste from the failure of repeal-and-replace already is leaving the mouths of investors, maybe because they recognize that, freed from getting bogged down with party politics, the GOP can now plow headfirst into constructing robust fiscal stimulus. The rise in animal spirits has always been about that. There’s even chatter the Trump administration is looking to reach out to Democrats (more below) to work on big issues and is considering packaging infrastructure and tax reform into one big deal. President Trump wants to get things done. He may still be finger pointing, Rhino Trading Partners says, but his other nine fingers are busy working overtime. With multi-decade highs in consumer confidence (more below) and business sentiment, positive inertia should persist whether or not Washington makes meaningful progress. While the post-election rally has fed on anticipated upward momentum for the economy—it grew at an upwardly revised but still very sluggish 2.1% rate in Q4—improving sentiment bodes well for future earnings and multiples. The profit recovery is gaining steam, with year-over-year (y/y) corporate profits rising in Q4 by the most since 2012.

With the short-end well anchored by Fed, the yield curve could resume its normal pattern of flattening if the long end remains relatively subdued as expected. That’s been typical in each rate-hike cycle since 1955, with the tightening usually coming against resurgent manufacturing activity, as is the case now (more below). But the Fed is expected to take its time—while the “Taylor Rule’’ argues for a 2.5% funds rate now, it might take 2 to 3 years to get there. This is partly because global growth and inflation, as reflected in today’s GDP and PCE reports, may still be too weak to support a faster pace. This “nothing much here” view helped fuel the rotation into defensive stocks this year as the Financials and Energy trade reversed even as the market reached new highs. Indeed, dividend payers have outperformed non-payers since the election. Returns do tend to be weaker during tightening periods, but the volatility of returns also tends to be lower, with sector leadership tilting toward defensive sectors. Things are much better at home now, and I will be back on the road soon. I thought a lot over the past weeks about how people approach their health—there are gamblers and there are investors. The same is true when approaching the markets—are you focusing on the trees or the forest? Are you parsing every political move in D.C. or watching broad-based earnings improvement and skyrocketing optimism? Are you calling for and calling and calling for a spike in inflation/interest rates or noticing the 10-year Treasury bond stubbornly stuck around 2.5% for years now? Are you waiting for and waiting for and waiting for the next cyclical bear or do you believe we’re in the midst of a long-term secular bull?  Are you a gambler or an investor?

Positives

Soft’ confidence impressive The Conference Board’s Consumer Confidence Index jumped in March by the most in almost 2 years to its highest level since December 2000. Such a high level historically been associated with above-trend economic growth, although we’ve yet to see this exuberance translate into notably faster spending growth. But soft data tends to lead hard data, as it takes time for feelings to turn into plans and then into reality. One big factor driving confidence: the job market outlook, which was its most positive since January 1984. Final Michigan sentiment for March slipped a tad from the preliminary read but still was above February, led by the highest reading in the current conditions component in nearly a dozen years.

Signs point to a strong spring for housing The pending sales index jumped by the most in 7 years to its second-highest level since May 2006, indicating future existing sales should be good. The National Association of Realtors says expectations for higher mortgage rates later in the year has brought more buyers into the market. But even though mortgage rates have risen nearly a percentage point, they remain historically low and don’t seem to be an issue for builders, whose sentiment survey jumped to a 12-year high this month. The NAHB index is strongly correlated with housing starts 3 months out.

More signs of manufacturing resurgence The Chicago PMI jumped to a 2-year high in March on surging new orders, and the NEMA Electroindustry Business Conditions Index hit a 12-year high. Regional Dallas and Richmond Fed indexes also were very robust. This suggests next week’s ISM should be strong and that capital expenditures are accelerating heading into Q2.

Negatives

Are autos running out of gas? Y/y light vehicle sales growth has reversed, from +10% in October 2015 to nearly -1% last month, and has now been negative 9 of the last 12 months. This is causing new-car inventories to bulge (a decade+ high), sales incentives to soar (up 23 straight months) and used-car prices to fall (traditionally an ominous sign for the economy). Moody’s Investors Service warns auto sales have peaked this cycle and credit risks are rising.

Millennials are majoring in debt A new Consumer Federation of America study found that millions are in arrears on $137 billion in federal student loans, up 14% from 2015. All told, the federal government’s portfolio of student loans now stands at a whopping $1.3 trillion. The average federal student loan debt stood at $30,650 last year, a 17% increase since 2013. At the same time, the unemployment rate for college grads has risen 8 straight years while it fell for everyone else, according to the New York Fed. 

I hear a lot of talk about robots taking future jobs A new study from PwC estimates nearly 4 in every 10 U.S. jobs could be lost to automation in the next 15 years. Another new paper published by the National Bureau of Economic Research estimates that each additional robot in the American economy reduces employment by 6.2 workers.

What else

Another political divide A Gallup breakdown by political party to the question, “Is the economy getting better or worse,’’ found that the main reason consumer confidence is so high is that opinions among Republicans and Democrats have reversed since the election. The percentage of Republicans who believe the economy is getting better jumped from 15% in October 2016 to 80% in February 2017. The Democrats in contrast went from 62% who felt that way in October to 41% in January to 27% in February. So, Republicans have gone from the economy is terrible to it is getting very strong, while Democrats have gone from it is gradually getting better to now thinking it is getting slightly worse.

Political Watch In a CBS interview, House Speaker Paul Ryan said, “If this Republican Congress allows the perfect to become the enemy of the good, I worry we'll push the president to working with Democrats. He's been suggesting that much.”  In a tweeted response, Senate Foreign Relations Chairman Bob Corker, a Republican from Tennessee, said, "We have come a long way in our country when the speaker of one party urges a president NOT to work with the other party to solve a problem."

High debts or not, a student still has to party A recent survey by student loan news site LendEDU showed 4 out of 10 college students plan to use student loan funds to pay for their spring-break getaway; a third said they’ve used their loan funds for clothing and bar bills. About 44% of millennials hold student debt—or about 33 million Americans, with the average debt per millennial estimated at $25,000.