Weekly Update: My periwinkle heels were killer this week

04-21-2017

 

The S&P 500’s narrow range over the past 1½ months has frustrated many, but equities actually are performing extremely well considering what’s happening in the bond market and broader economy. The yield on the 10-year Treasury is flirting with 2.2%, continuing its recent retracement to where it stood just a few days after November’s election. The yield curve has flattened even more; it’s back to where it pretty much was on Election Day. The risk-off move has come amid slippage across a range of hard economic data. The Citigroup Economic Surprise Index hit 6.6 this week, down from 57.9 in just 30 days, and the Atlanta Fed is projecting next week’s first take on Q1 GDP growth to come in at a miserly 0.5%. All of this is feeding talk that the “Trump trade’’ has played out, with many indicators suggesting post-election optimism has largely unwound. AAII investor sentiment, for example, has plunged to the bottom 20% of its readings over the past decade. Some believe these developments might pressure the Fed to remain on hold. But is that really such a bad thing? Every recession since 1950 was precipitated by a Fed that tightened too much, not too little. During a Chicago visit this week, an advisor responding to my suggestion that the longer-term outlook is one of slow growth with mild recessions/recoveries based purely on high debt and aging demographics, asked: “What’s so bad about slow growth without booms and busts?” Amen! There’s a big difference between slower and recession, and there’s nothing to suggest the latter will arrive anytime soon. This week’s Beige Book showed all 12 Fed districts reporting the economy growing at a moderate to modest pace.

For all its struggles—which isn’t so surprising for a White House of business executives learning political gamesmanship on the fly—the Trump administration has serious business chops. No matter your politics, President Trump has assembled a team of “doers,” guys like Commerce Secretary Wilbur Ross, Treasury Secretary Steve Mnuchin and Chief Economic Advisor Gary Cohn. While the president may have literally written the book about the art of the deal, they were too busy getting deals done to write books, Rhino Trading Partners observes. It dismisses the spin that suggests when Mnuchin recently dialed back tax-reform expectations for August, he actually meant “not this year’’ or “never.’’ Indeed, Mnuchin just yesterday said we’re “pretty close’’ to unveiling a major tax reform package. Moreover, there’s not a lot of fiscal stimulus baked into current S&P 500 earnings projections for double-digit growth this year and next. The final numbers for Q4 2016 show S&P operating earnings-per-share (EPS) jumped 21%, its best quarter in 3 years, and that on a 4-quarter total basis, EPS grew almost 6%, the first increase since Q1 2015. The current reporting season appears on track to deliver the strongest earnings growth in 22 quarters, with top-line growth also picking up, albeit aided in Q1 by sharp year-over-year (y/y) comparisons in rebounding petroleum and financial sectors. With global GDP on the rise—the IMF this week raised its growth forecast for 2017 to 3.5%—revenue growth is expected to contribute a much greater share to the bottom line going forward vs. the roughly one-third contribution over the past 5 years.

Breadth and sentiment indicators are sending oversold signals, suggesting most stocks already have experienced their correction/consolidation after peaking in late December and early this year. Fundstrat notes that while the S&P advanced nearly 7% in the early months of 2017, sector leadership was notably defensive and concentrated—excluding the 10 best stocks (18% of market cap), the S&P is up only 2% year-to-date. On the upside, Oppenheimer says a rally above 2,380 resistance to reverse the S&P’s near-term trend of lower highs since early March would confirm a resumption of the advance. I finished the week speaking before a group in an historic building at the University of Charleston, W.Va., overlooking the Capitol. I received some very thoughtful questions including, “What do people get wrong and what do they get right?’’ I replied, “They get it wrong when they focus too much on every nuance coming out of D.C. and they get it right when they turn off the television and focus on the longer term.’’ I had driven 4 hours down I-79 to reach Charleston, unable to check the markets. So when I joined my local wholesaler, I asked him, “What did the market do today?’’ before I commenced my speech. “I don’t know,’’ he quipped. “I’m more of a long-term investor.’’ Amen! At the end, a gentleman who was not satisfied with my reply during Q&A about the growing federal debt continued discussing this unprecedented, unanswerable situation as others were waiting to talk to me. Finally, he let me go, and the next gentleman focused on the positives, pointing to my heels. “Those shoes are really rockin’.’’

Positives

Housing fundamentals point to continued improvement March existing home sales jumped well above consensus, raising the y/y increase to nearly 6%. Although housing starts dropped more than expected on the month, some of the weakness was offset by upward revisions to February, leaving the average pace of starts for Q1 ahead of Q4 2016. Building permits for March jumped, and both the 6-month and 12-month averages for starts and permits advanced, with starts at their highest levels since at least April 2008. Similarly, April’s builder sentiment survey slipped but was still very strong, with the 3-month average at its highest level since August 2005. Given housing inventories remain depressed, residential investment should continue to grind higher.

More positive capex signs Both the headline Philly and Empire PMIs fell markedly in April, though they were still easily expansionary. However, capital expenditures (capex) expectations reached their highest level since February 2000 in the Philly survey, and capex plans hit a 2-year high in the Empire survey. A look at the final numbers on calendar 2016 show S&P companies generated a lot of cash but are spending even more of it, including $657.1 billion on capex.

China Watch Monthly Q1 reports suggested Chinese activity had picked up, aided by a sharp acceleration in government spending and continued high social financing growth. March’s trade report also showed Chinese merchandise exports surged 23.2% y/y to a record high and that imports jumped even more, 27.2% y/y. The sum of the 2 rose 24.9% to a new record high. President Trump’s softened stance on China trade should only serve to help the outlook for Chinese exports.

Negatives

Manufacturing slowed in March Underneath industrial production’s solid headline rise was declining manufacturing output, the first in 7 months. A lot of it was due to auto weakness—motor vehicle and parts fell 3%, consistent with a slower pace of auto sales. A separate Markit gauge of early April activity also showed some softness, with both manufacturing and services declining but still expansionary. March’s increase in industrial production was entirely the result of a surge in utilities output, underscoring the unusual weather patterns that distorted monthly comparisons across a range of economic indicators in Q1.

Where are we in the economic cycle? Y/y payroll growth has fallen nearly 1 million jobs from its February 2015 high, a decline of more than 30%. Moreover, the rate of payroll growth this March stood at a 4-year low of 1.5%. Although falling payroll growth does not always signal a recession is imminent, 13D Research notes the historical record since 1960 shows recessions always have accompanied a payroll growth rate that falls below 1.55% after coming to a peak. 

Lack of loan growth perplexing Commercial & industrial loan growth fell 8% in March to its lowest level since June 2010, according to the Fed. Consumer loan growth also has been slowing substantially and was flat for the month. In fact, bank lending y/y growth is slowing in every category.

What else

Everyone is looking for inflation The 1960s was the heyday of the Phillips Curve, a theory that says an unemployment rate below 4.5% appears to be associated with rising inflation, with the pickup accelerating when the jobless rate falls below 4%. The 1970s, however, did not treat the Phillips Curve kindly, as the core inflation rate shot up to 10% with virtually no movement in unemployment. While continuing to underpin much of the thinking on inflation at the Fed, the empirical evidence suggests there is no obvious relationship between core inflation and prior movements in unemployment. This latest cycle saw the core inflation rate run between 1-2.5% as the unemployment rate marched from about 4% to 10% and largely back again.

Political Watch IEBS says the least popular GOP lawmaker by far is Paul Ryan, with a 29% approval rating among all voters. The most popular politician in America? Bernie Sanders, with a 61% approval rating.

I want to be 100, so should I eat eggs or kick out the Mister? Over the long Easter weekend was news that the eldest person in the world died at 117, severing human kind's last living link with the 1800s. The secret of Italian Emma Moreno's long life was a diet of 3 eggs a day since she was 20, 2 of which were eaten raw; avoidance of most fruit and vegetables; imbibing regularly in a little tipple of brandy; and kicking her abusive husband out 79 years ago and staying single ever since.