Weekly Update: A boogieman in the bushes?



I spent several days in Dallas this week, where I heard concerns about the market’s valuation and future path. Advisors at 2 separate meetings said they’re holding cash and waiting for a pullback on worries stocks are too expensive. Twice I heard that “clients are most afraid of losing money’’ and “preservation is their No. 1 goal.’’ This is a nice Wall of Worry, as ample cash on the sidelines could help drag the broader indexes upward, aided by sentiment indicators still well inside of neutral, forward earnings at either record or cyclical highs in 10 of 11 S&P 500 sectors, the most earnings surprises since 2009, the best revenue guidance in over 3 years and the narrowest trading range since the dog days of last summer. Stocks tend not to go down materially amid a lack of volatility. Indeed, FBN Securities says since September 2001, the S&P has secured 311% of its gains when volatility is as low as it is now. At another advisor meeting, we had a lively discussion about the future for jobs with artificial intelligence (AI) taking over—“Where will consumer demand come from if people can’t get decent wages?” I suggested that even stagnant middle-class wages could stretch further with the disinflationary advances in technology we’ve enjoyed as consumers. One advisor, also an experienced trial lawyer, concluded long ago that “this (legal) job was protected from AI.” Millennials were well represented in the room, where I was reminded again there’s no rush to marry or buy a house.

It’s too early to worry about inflation, though that is everyone’s worry as they anticipate Fed hikes. At a client event in Dallas, I was asked where the price of oil is going. My response, “I came to Texas to ask YOU that!” There are so many variables related to the price of oil that no one knows where it is going, and I never take notes on such prognostications. But it was a timely question, as the Energy sector did not respond well to its recent oversold condition, fading after its initial bounce as stockpiles are growing again. Renaissance Macro reminds us the boom/bust cycle historically suggests that after the first move off a low, the asset listlessly trades in a large range with little volatility. The severe mid-2014/early-2016 industry recession coincided with a 76% plunge in the price of oil. Amazingly, Texas and other oil-producing states remained resilient, more diversified than they were during the mid-1980s. Most impressive is how rapidly the industry restructured operations and financing to cut costs and shore up profitability. That can be seen in the remarkable roundtrip in the yield spread between high-yield corporate and U.S. Treasury bonds. It rose from 2014’s low of 253 basis points on June 23 to a high of 844 on Feb. 11, 2016, and then back down to 333 as of Friday last week. Also quite remarkable is that U.S oil field production only declined 12% during the latest oil recession despite an 80% drop in the U.S. active oil rig count. Innovations keep making it cheaper to find and extract oil, forces that could inhibit upward price pressures.

Another reason it’s too early to worry about inflation: an aging population and the long-term declining participation of prime-age men. This combination has kept the employment/population ratio well below its pre-recession level, even though the U.S. economy is at full employment based on a range of measures, including headline 4.4% unemployment (more below) and a discouraged-worker share that’s back to pre-recession lows. This suggests a structural change—one that is providing greater stability of inflation and inflation expectations relative to the whole post-war period, giving Fed officials a better chance to avoid spawning an outright recession even if the labor market heats up further. This may help explain why, even after this week’s stand-pat Fed signaled 2 more rate increases this year, the futures market was only pricing in one. Ned Davis Research notes the Fed has never raised rates into an economy growing at just over a 1.4% real rate, the level of the last 6 months. Moreover, with productivity back in negative territory (more below), core PCE at its lowest point in a year (more below) and the energy complex leading a rollover in commodity prices, the Fed is having difficulty fulfilling the second part of its dual mandate. My last meeting in Dallas included thoughtful concerns about a property bubble that may be brewing—numerous apartment buildings were going up just outside the office window where we met. Could mortgage lending be getting lax again? Is there another derivatives blowup waiting in the bushes? This is a concern of mine as well, but I shared news that auto loans are getting stricter as auto loan delinquencies have reached levels not seen in over 8 years. I love Texans and their hospitality. They were worried this visit. What is the next boogieman in the bushes? I don’t know, but the wall I see again is not Trump’s, it’s Worry’s.


April jobs report shakes off March worries The 211K increase in nonfarm payrolls answered some of the questions posed by March’s soft print. First, the slowdown was transitory, with the average monthly gain over the last 3 months now at 174K, just a slight slowing over the past year’s 186K pace. Second, the drop in March’s jobless rate to 4.5% was not an aberration; the rate fell further to 4.4%, tying the low of the past expansion. And third, a decline in the participation rate dents hopes for those expecting a further cyclical pickup in participation; there’s been a structural shift that isn’t likely to reverse anytime soon.

Services gauges suggest acceleration New orders, business activity and new export orders rose to elevated levels in April as the ISM nonmanufacturing index rebounded sharply, easily beating consensus. Markit’s services PMI also rose more than expected. The increases in these 2 sentiment measures for the largest sector of the economy indicate Q2 growth is off to a good start.

Manufacturing moderates but off very healthy levels The pace of growth in April’s ISM remained above-trend and broad based—16 of 18 industries reported expansion. Robust production and new orders portend further production gains in the next few months, with new export orders nearly topping 60, a sign of external demand momentum and improved export prospects. Similarly, even as the Markit PMI slipped to a 7-month low, it easily remained expansionary and its 12-month outlook improved. Finally, March factory orders advanced a 5.8% on a year-over-year trend basis, the most since September 2014.


Consumers took a break, not a long vacation While below expectations, April auto sales rose slightly month-over-month for the year’s first monthly gain. Still, the softness relative to a strong 2016 suggests vehicle sales have likely peaked. Elsewhere, a late Easter also helped boost April chain-store sales, though on a 2-month basis, they were below a year-ago. And March consumption was flat, likely due in part to delayed tax refunds. Taken together, the data suggests consumer spending is on track to rebound after hitting a wall the first 3 months of the year.

Productivity weakens It declined at a 0.6% annual rate in Q1 as business output rose at its slowest pace in a year while hours worked increased at a faster pace. Five-year average productivity is now close to its slowest pace since 1983 and a fraction of its historical mean of 2%.

It’s too early to worry about inflation Core PCE prices rarely decline but fell last month by the most since September 2001. While this moderation in inflation pressures at the end of Q1 is noteworthy, it doesn’t change the longer-term modest upward trend, which should allow the Fed to continue with gradual policy normalization this year. 

What else

Political Watch President Trump is proving that he’s astonishingly persistent. He made life miserable for Paul Ryan and House GOP leaders, demanding they produce an Obamacare repeal-and-replace bill, and then he got personally involved in the arm-twisting. The message, IESB says: bet against Trump at your own peril.

This gives a whole new meaning to Fedspeak In 1996, the average Federal Open Market Committee (FOMC) participant gave 4 speeches per year. This year, the average FOMC participant is on track to give 14 speeches, Deutsche Bank says. In fact, the entire committee is on track to talk more this year than ever before.  

Luckily the Mister is an accountant The 1040EZ form, the easiest of the IRS forms, consists of 46 pages of instructions. But today’s entire tax code is believed to be more than 7 million words, up from just 11,400 in 1913. To put that in perspective, an English translation of Tolstoy’s “War and Peace” has almost 562K words and the Bible 773K words—to read through the tax code once, the equivalent would be like reading the Bible 9 times!