Weekly Update: Surely, one of my 4 millennial children can spare a Jackson

05-25-2017

I spent part of the week in the Chicago area, where I always enjoy visiting. The people are hospitable, funny and more than happy to share their opinions. In all my advisor meetings, we discussed the lack of inflation and the stubbornly low 10-year bond yield. When I remarked that I’ve heard forecasts for the 10-year to rise to 4% in 6 months for 2½ years, one advisor responded he’s been hearing that for the last 6 years! This week’s Fed minutes took note that inflation metrics have pulled back, but policymakers viewed the slowing as “transitory” and used the same word to describe Q1’s growth slowdown. A June move is all but certain; the real question is whether it’s a “dovish hike”—something investors once welcomed but not anymore as it seems a revival of reflation forces will be necessary to sustain the S&P 500 north of 2,400. A repeated worry everywhere I go is that millennials can’t or won’t pick up the slack as older workers retire in droves for the next 10 to 20 years. We’re going to need them to, given that from 2025 to 2050, the Census Bureau projects the over-65 population to almost double to 1.6 billion globally vs. just 34% overall population growth the same period. At one advisor meeting, when the discussion turned to millennials, a gentleman groused, “Yes, they are the most highly educated waste of space. They want to work just 40 hours a week, without breaking a sweat.” Whoa!

At this writing, the markets are at new highs again. It helps that we appear to be experiencing synchronized if unspectacular global growth. All eurozone PMIs were strong in May, while in the U.S. the composite PMI recovered lost ground from the start of the year (more below). Among the 46 ACWI component markets, 85% of manufacturing PMIs have positive momentum, 91% are above their rising 200-day moving averages, more than half have positive trailing earnings growth and nearly 100% have positive forward earnings growth. But also it's worth noting that a small number of stocks are driving the upswing. Six stocks account for half of the technology-laden Nasdaq’s year-to-date gains—Amazon, Apple, Facebook, Google (now Alphabet), Microsoft and Netflix—and their impact on the S&P is being felt as well. Their combined market value of around $2.8 trillion is larger than but a handful of global stock markets and more than the GDP of most countries. The other 494 stocks in the S&P are not really confirming the bull trend; the percentage of names above their own 65-day moving average is a discouraging 48%. Going back to 1957, that ranks in the 40th percentile of all readings and is associated with anemic market returns, Renaissance Macro says. Based on the percentage of stocks above their 10-day moving averages, a breadth thrust—common at the beginning of major up-legs since the March 2009 lows—hasn’t occurred since February 2016, the longest stretch since the 2009 bottom. Declining correlations may be making it easier to pick winners and losers but at a risk of unsustainably weak breadth, making it difficult for stocks to sustain this move into record territory, Ned Davis Research says.

This split between big and smaller names also can be seen in earnings. While S&P earnings-per-share (EPS) have been strong, National Income and Product Accounts data that represent earnings across a broad range of businesses indicate small and midsize corporations are struggling. Why? The tighter labor market, tightening bank lending standards, weaker productivity and constrained nominal revenue growth. These issues pose a risk to the overall economic outlook, as these weaker links slow spending, hiring and capital expenditures. Cornerstone Macro says this eventually could weigh on activity and S&P EPS. At 2 ladies-only client events where I spoke this week—a lot of millenials in attendance—the audiences didn’t appear to be worried about the markets or politics. Professional women, they know they should be saving and investing more but budgets are tight. One said she would like to please have a beer once in awhile. I was impressed with their poise, professionalism and intelligence. But at my Milwaukee client event this morning, we were discussing the workforce again and concerns that even if the younger people are taking gig jobs, they may not want to take the many $21K-a-year jobs in health care. Or craft jobs. After it was over, one gentleman repeated that numerous manufacturers around Milwaukee have many job openings that they can’t fill. “I’ll bet you don’t know why,’’ he said. “They failed the drug tests,’’ I replied. He was surprised that I knew, but I hear this all over—a problem that’s not limited to just millennials. Another gentleman, opining about one of his children who is artsy and has no money, said wouldn’t it be great if we boomers could know the day we were going to die. We could spend all our money by the day before and on the last day, ask to borrow 20 bucks from our children!

Positives

Services perkier Markit’s initial U.S. services PMI rose to a 4-month high in May, with respondents noting "improving economic conditions and greater willingness to spend among clients." The Richmond Fed’s services gauge soared, jumping to its highest level since January 1997 as both retail and non-retail service firms reported stronger revenue growth. Employment picked up on the back of renewed pressures on operating capacity. However, the service providers’ optimism about the 12-month outlook remained subdued.

More signs of Q2 GDP rebound The Chicago Fed National Activity Index rose in April by the most this year, suggesting accelerating growth as the 3-month moving average hit a 28-month high. The diffusion component also had its best reading since December 2014, indicating broad-based strength in the nation’s economy. The Philly Fed State Coincident Indexes weren’t as bullish as growth narrowed slightly across states although it remained above its historical average, both for states and the U.S. overall. The latest Atlanta Fed GDPNow estimate has growth tracking at a 4.1% annual rate for Q2, although that could trend down with Friday’s revision.

China Watch The remarkable run-up in debt since the financial crisis prompted Moody’s to downgrade China’s sovereign debt a notch. However, China’s debt remained highly rated, its PMI readings remain positive (albeit weak) and despite its inverted yield curve, it continues to experience growth. In sum: this week’s headline news wasn’t really new.

Negatives

Lean supply slows housing On top of last week’s unexpected decline in starts, April new and existing home sales also disappointed, with new home sales declining more than expected by the most in 2 years. Tight inventories again were cited as a key factor as home prices continued to rise, with the FHFA index up more than 6% year-over-year, in line with other price gauges. Longer-term trends remained positive, however, with 12-month average new home sales at a 9-year high and April’s annualized existing sales near recovery highs.

Manufacturing soft patch Markit’s initial read on May marked its fourth decline in a row, as activity reached its lowest level since last September. Manufacturers reported that “domestic clients had adopted a wait-and-see approach to investment spending.” The Richmond Fed’s regional gauge plunged on the month, falling the second most on record to its lowest reading since last October as factory activity in the region stalled. However, the Kansas City Fed reported expanding activity in its region. Auto inventories aren’t helping production, holding near their highest levels since the recession’s end despite April’s slight decline. Nor is continued export weakness in trade, as reflected in this morning’s jump in April’s trade gap.

Another loose brick for brick-and-mortar stores Online clothing and accessory shopping’s share of purchases hit 21% last year, Cowen & Co. says, suggesting online growth in this category—long a strength of traditional retailers—is set to accelerate, with price competition likely to intensify. When online sales hit 20% of purchases in a given retail category, Amazon’s growth usually kicks into higher gear, according to Cooper Smith of research firm L2. Smith told MarketWatch that “20% is when Amazon steps on the gas.”

What else

Political Watch Like the March “skinny” fiscal 2018 budget, this week’s full Trump budget almost certainly is a nonstarter in Congress—95% likely not to happen, Evercore ISI says, as certain as it gets about U.S. policy and political issues. The real news is the budget lays out what likely will dominate discussion over the summer as Congress, not the White House, actually makes fiscal policy. This year’s debate could be enormously complicated given large disagreements not only between the 2 parties but within the GOP as well. Once passed, it will obviate the health-care reconciliation instructions contained in the fiscal 2017 budget (meaning Republicans will have to either pass repeal/replace before the new 2018 budget or give up on health care).

Political Watch Speaking of health care, Senate Majority Leader McConnell has his doubts whether any repeal-and-replace plan can win 50 votes and if it does, whether conservatives in the House would accept it. This has Republicans in a Catch-22: they proclaim that Obamacare is failing, but they cannot come up with a replacement. And that poses a real risk to the GOP in the 2018 midterm elections.

Not forecasting anything, but Pence could get things done That’s the take from IESB, who says the vice president is so comfortable on Capitol Hill where he served 12 years in the House that he would be able to get Trump's agenda enacted more easily than Trump could. Pence is close to Paul Ryan and Reince Priebus and at ease with Senate Republicans. Even Democrats, who loathe his positions on social issues, have generally positive things to say about the man and his trustworthiness. He’s a solid, boring, no-drama Midwesterner who is in total sync with Republican Party ideology. Incredibly, that is precisely the description of Gerald Ford, who took office in 1974 after Richard Nixon resigned.