Weekly Update: On the road again

04-13-2017

With family health issues keeping me close to home for the last several weeks, I got this 1980 Willie Nelson hit song stuck in my mind, anticipating this week’s travel to South Florida. Willie is a country legend, now 80-years-old. Just can’t wait to get on the road again. The life I love is … goin’ places that I’ve never been…. Well, we started our South Florida trip around the tip in glorious Naples, where I have been many times but can never get enough. An advisor said his clients are “so scared.” About what? Geopolitics. The well-to-do just don’t want to lose their money—outside of that, there are a lot of golfers and complaints about the inability to get a dinner reservation. The Mister and I are going to move here one day! It’s been a good week to be on the road, meeting clients, going to dinners, having fun (not too much!) because there’s not a lot going on. The week of April 10 is one of the slowest of the year, suffering from a dearth of news, liquidity and attendance. Despite Tuesday’s setback, the S&P 500 still hasn’t moved out of its narrow range of the last 1½ months, stuck in purgatory that requires pro-growth policies to sustainably break above 2,400 but backstopped by growth dynamics keeping it from falling under 2,300. Stocks are looking to Treasury yields to gauge growth sentiment and the message isn’t good: the 10-year Treasury yield dipped below 2.30% this week (more below). On the upside, JPMorgan notes political expectations have so faded that there no longer seems to be an enormous Trump/Ryan premium (rather than 15%, 20% or even 25%, investors are just hoping for a 27% corporate tax rate by the end of Q1 2018).

Like a band of gypsies, we go down the highway. We’re the best of friends (me and one of my favorite wholesalers!) … insisting that the world keep turning our way. We next headed to Miami on a crowded 3-hour early morning commute along Route 75, dubbed “Alligator Alley.” It was filled with smoke from fires that have consumed the area for days; you could smell that smoke back in Naples. Next stop, Coral Gables where at a lively advisor meeting, a gentleman suggested “the $1 trillion infrastructure plan should be no problem to effect.” I disagreed but let the statement go as another gentleman stated during our interest-rate debate that, “You’ll never see 4% on the 10-year in your lifetime.” Amen! In Ft. Lauderdale, we debated interest rates again. The advisor remarked, “I love how all the talking heads told us all year that interest rates were going up.” Amen! Indeed, bond sales surged in Q1, showing investor reluctance to abandon a reliable strategy without more convincing evidence for expanding growth. High-rated and emerging-market bonds had their best quarter on record, according to Dealogic, while sales of high-yield bonds doubled from a year earlier. While the yield curve is flattening, that’s typical mid-cycle and 2-year Treasury yields are still rising. It’s not until the 2-10 curve inverts that we should get worried. One key is whether the economy will heat up enough to force the Fed to accelerate its pace. Despite the recent spike in volatility and flight to safety in bonds, gold and yen, the S&P remains in a strong technical position, just 175 basis points from an all-time high, having held its 50-day moving average for over 5 months.

In Boca Raton, a seasoned advisor who had spent 35 years in the bond market agrees with me that the $1 trillion infrastructure spend won’t be so easy. He insists municipalities don’t ever repair infrastructure until it fails. “As long as you flush and it goes away, they won’t do anything about it …. You need a major crisis before infrastructure needs get addressed.” This same advisor noted many of his clients hold a lot of cash and are “scared.” Our final stop was in Palm Beach for a client event. The wealthiest city on our trip, it’s also the location of Trump’s Mar-A-Lago—fortunately he is not in town today. As we drove past the complex, police were preparing for the president’s arrival on Friday. A conservative group that closely monitors presidential expenses puts the tab for each Mar-a-Lago visit at around $1 million. With the reporting season just underway, the current bottom-up consensus projections point to Q1 earnings-per-share growth of 10.5%, although RBC Capital Markets expects they’ll likely finish up 13-14%, assuming a normal pace of beats. Either would represent the first year-over-year (y/y) double-digit increase since 2011. But a lot of eyes are on revenue—it actually started to recover during the year-ago quarter after four straight quarterly declines, and was up 4.2% per-share during Q4 2016. Yardeni Research is calling for 7.1% sales growth in Q1, which would make for the best quarter in 6 years. Now, after an unprecedented spell of togetherness in our 30+ years of marriage, my Mister might be dismayed that I’ve been humming On the Road Again for over a week. That’s ridiculous, dear. You were always on my mind. You were always on my mind.

Positives

Sentiment stays strong The University of Michigan’s early take on consumer attitudes in April bounced back to near January’s post-election peak as Americans’ optimism about their current financial situation and the economy was at its strongest since 2000. The NFIB small business gauge reflected similar strength, slipping slightly in March but remaining near its highest reading since 2004 as respondents continued to expect a resurgence in growth, tax cuts and other business-friendly policies from the Trump administration. Notably, capital expenditures (capex) hit a 12-year high and capex plans rose again, boding well for productivity improvements.

It’s too early to worry about inflation While various gauges have moved closer in line with the Fed’s 2% target, there are signs prices are stabilizing—and not accelerating. This morning’s report showed producer prices declining in March for the first time since last August, with core PPI personal consumption inflation (ex-food, energy and trade services) slipping to 1.6% y/y. Import prices also fell last month for the first time in 4 months on the decline in oil after its late-2016 rally. Y/y prices were still up 4.2%, but only 1% ex-fuel. This augurs a slow Fed path.

It’s too early to worry about jobs Despite March’s payroll miss, the household measure—which counts employed people whether they have 1 or more jobs rather than the part-time and full-time jobs captured in the payroll measure—jumped 472K on top of February’s 447K gain. Meanwhile, Yardeni’s proprietary proxy for private-sector pay rose to another record high, while Treasury tax receipts—a reliable and timely gauge of wages and employment—suggest accelerating incomes and GDP growth. Also, weekly jobless claims have been below 300K for 110 weeks, the longest stretch since 1970; the 12-month average job openings are a new high, according to JOLTS; and March’s Employment Trends Index rose the most in nearly 2 years.

Negatives

All eyes on the yield curve The recent Treasury surge can’t be ignored as yields and stocks continue to paint very different pictures of the macro world—this is by far the single most important issue facing domestic equities, JPMorgan contends. The long-term yield curve (30-year Treasury minus 10-year) has an impressive track record of predicting recessions by an average of 16 months and has flattened significantly since the election. (Nevertheless, we remain constructive on equities, see Steve Auth’s latest piece.)

No one is talking about entitlements Dudack Research estimates the number of Social Security beneficiaries has risen since December 2008 at nearly twice the pace of the labor force. In the same time frame, growth in Social Security beneficiaries has been substantially higher than the 4.4 million people entering the 65-69 age category. This suggests many Americans, and probably discouraged job-seekers, took early retirement in the last 8 years, adding to pressures on the Social Security system overall. 

Is 2% as good as it gets? The Congressional Budget Office calculates a quarterly series for potential real GDP growth dating back to 1952 and running through 2027, with the outlook for this year and beyond based on demographic projections that are used to estimate labor force growth and productivity. From 1952 through 2001, potential real GDP grew in a range mostly between 2.5% and 4%, averaging 3.5%. Since then, growth has consistently been below 3% and, since Q1 2007, below 2%.

What else

A ‘choose-your-own-adventure’ sell-off That’s what JPMorgan calls the recent weakness with investors citing a litany of “reasons:” Syria and North Korean tensions, French election uncertainties, Trump disappointment (timing/scope of taxes, infrastructure, etc.), ongoing Treasury strength (reinforcing growth anxieties), poor-bank price action, Apple insourcing worries, etc. The market’s twin vacuums (news and liquidity/attendance) are allowing this narrative of gloom to propagate without much opposition.

This is a lot different than the 1990s market In a little less than a decade, investors have poured $1.6 trillion into bond mutual funds and ETFs, and the pace has accelerated recently. Over the same period, investors have pulled $400 billion out of equity funds, and that’s with the S&P up 70%.

Lots of PIPs in South Florida During my trip, I learned a new term: PIP=previously important person. Bernie Madoff would fall in the category. He was mentioned during our client luncheon in Palm Beach, where he was well established. Apparently, if you wanted to join the Palm Beach Country Club, you had to invest with Bernie—it was an unwritten rule. When he was unmasked, a lot of people lost money here.