Weekly Update: 'Hey carebot, how about another margarita?'

06-30-2017

I spent the week before our Independence Day traveling through Washington, D.C., and Richmond, where as much as anywhere else, the discussion revolved around politics. We had a great meeting with a financial advisor who showed off his golf-day photo with (then not-yet President) Trump. What’s he like in person, I asked? “He’s delightful.” Another advisor reported his client sold everything in one of his accounts just two weeks ago because “he hates Trump.” At yet another meeting, an advisor said his client went all into cash just after the election. Later, still in D.C., several advisors had clients who are really concerned “because they don’t like Donald.” I continue to maintain investors give politics way too much credit for moving the market. That said, the Philly Fed’s Partisan Conflict Index, which tracks the degree of disagreement based on keyword searches of major U.S. newspapers, has had 4 of its 5 highest readings ever since the election. Whenever it’s been above 100, the S&P 500 has risen at an 11.7% annual rate, double the pace when the index is 100 or below. Ned Davis sees two potential explanations: partisanship abets gridlock, which the market loves; it also contributes to pessimism, which helps the market to rally when fears (usually) prove to be unfounded. Again, and new to the last month, I had no comments that rising inflation will be a problem, what with weak oil and a flattening yield curve.

Citing the same pattern before nasty corrections in 2015, 2011, 2008 and 2000, Cornerstone Macro says a rising market with weakening breadth typically isn’t good. It likens this market to an annuity: steady as she goes, up slightly and then up again, a slight setback and then an up day, and another, and another, gently higher, benignly higher, North by Northeast, ever higher, always higher, up and to the right, tick, tick, uptick, uptick … B-O-R-I-N-G! I was asked numerous times this week how will it end. I insisted that we want to root for low inflation because a Fed that is convinced it is behind the curve could accelerate its tightening/balance-sheet reduction campaign, beginning the end of the economic cycle and this bull run. Fedspeak this week reinforced the market-friendly lower-for-longer view. Credit conditions—a good predictor of forward earnings, which hit a record high last week—also remain supportive, with investment-grade and high-yield bond spreads at fresh cycle lows, signaling that oil and energy weakness have not impacted credit. The increasing use of artificial intelligence (AI) and automation are among factors deterring inflation. I’ve been saying for some time that I fear AI may be a big jobs destroyer. But a note on Japan from one of my sources has me thinking differently. A poster child for an aging demographic—its overall and working-age populations are declining at the fastest rates of all countries—Japan is the most automated economy in the world, with AI-spawned robots doing all sorts of jobs. There even are carebots—robots specifically designed to assist the elderly. Yet even with all these robots, Japan’s jobless rate is 2.8% and it confronts a chronic labor shortage. The lesson: instead of hurting economies, AI may be increasingly vital in a world where the old-age dependency ratio—the number of elderly relative to working age—is set to soar.

Aging demographics clearly were a factor in this week’s decision to delay a Senate vote on the Republican alternative to Obamacare. With President Trump vowing not to touch seniors’ Medicare or Social Security, Republicans turned to Medicaid in their replacement plan as a way to take on entitlements. But the depth of the cuts turned off key moderates, making passage unlikely. It’s not just burgeoning entitlements that are generating budget concerns. The Pension Benefit Guarantee Corp. estimates the current hole in U.S. pension funds at $3.85 trillion, almost 20% of GDP. The longer interest rates remain ultra-low and benefit cuts are refused, the more difficult this problem becomes. At politics ground zero, in D.C., I was thanked at the end of a group meeting for sharing a balanced perspective—“so refreshing when everyone comes in here with an extreme biased view.” They have a sense of humor about it, though. I was told about a recent survey that found 90% of respondents won’t marry outside of their political party, vs. 30-40% historically. Nothing fancy for our holiday week; we’re just driving to a Delaware beach with the extended family. When I told this to Trump’s one-day golf buddy, he laughed at me. “Why don’t you just go to Erie?” Ha, ha. Funny guy. Have a great week, I’m off to veg. “Hey carebot, how about another margarita?”

Positives           

Consumers feeling good June’s unexpected increase in Conference Board confidence—the first in 3 months after a post-election surge—lifted the 6-month and 12-month averages to their best levels since 2001. Current conditions drove the improvement, and also were a factor in the final read on Michigan sentiment, which rose more than expected and remained near cycle highs.

Consumers’ improving mood is starting to carry over to spending The ICSC-Goldman Sachs Retail Chain Store Sales Index rose last week by the most in 3 months, pushing the year-over-year (y/y) change to 1.8%. Consumer spending also nearly doubled in the final revisions to Q1 GDP, which was up two ticks to 1.4%. In April, furniture and home furnishings sales hit a record $193 billion and, on an inflation-adjusted basis, hit a record $1,965 per household, doubling since November 1999. May consumer spending did decelerate after robust gains in March and April, but that largely was because inflation also slowed, reducing real vs. unit sales, as core PCE came in at a 1.4% y/y rate.

Regional upticks The Chicago PMI, which was expected to pull back slightly in June after accelerating the prior 4 months, surprised by jumping to a 3-year high and its first reading above 60 since the fall of 2014. New orders also hit a 3-year high, and order backlogs were their highest since July 1994, suggesting demand-related congestion in the supply chain. Elsewhere, the Richmond Fed’s manufacturing index signaled a modest acceleration in factory activity as shipments and new orders rebounded and the 6-month outlook improved. In Texas, the Dallas Fed’s general business index hit a 3-month high on increasing services activity.

Negatives

Housing plateauing? Pending sales, a good indicator of future sales, fell for the fourth time in 5 months in May, lowering the y/y rate to -1.7%. The National Association of Realtors (NAR) believes the recent softness indicates a "possible topping off in sales" as constrained supply cannot satisfy demand and rising prices are locking out prospective buyers, particularly in the lower end of the market. While April’s survey suggested price increases are moderating, the S&P/Case-Shiller home price index has now risen continuously for more than 5 years amid solid demand, short supply and favorable credit conditions. The NAR still expects existing sales to increase 3.2% in 2017.

Capex plateauing? While capital spending (capex) by nonfinancial corporations has been hovering at a record high over the past year thanks to robust corporate cash flow, headwinds loom. Cornerstone notes a lot of the unusually strong capex in Q1 was due to a surge in oil-related expenditures after last year’s price recovery. This likely will weaken now, just as the auto sector is cutting production due to slowing sales. Notably, May durable goods orders fell on a sharp decline in capex orders. The NEMA Electroindustry Business Confidence Index for Current Conditions also fell for a third straight month in June to its lowest level since November, reversing the post-election bounce and potentially a harbinger for a modest pullback in capex in the months ahead.

Wage growth remains a drag Income from wages and salaries rose only 0.1% in May, suggesting April’s 0.7% surge may have been an outlier. Stagnant wages have been a key factor in holding back consumer spending.

What else

A mid-year assessment Halfway through the year, the S&P, the TLT (a long-bond ETF) and gold are all up by roughly the same amount—8-9%, making for an odd backdrop as these asset classes rarely move in lockstep. As for the equity market, the summer calendar is a headwind but historically a strong first half bodes well for the second half—since WWII, when the S&P’s first-half gain was 7% to 12%, the market went on to record an average gain of 5.1% in the second half, with a positive second-half performance 87% of the time, CFRA Research says. Flows and positioning suggest skepticism, with a mild summer pullback/consolidation possible.

Valuations are rich by Buffett standards The so-called Buffett ratio, which represents the market value of U.S. stocks divided by GDP, rose to 1.72 during Q1, nearing its record high of 1.80 during Q1 2000. The similar ratio of S&P market cap divided by the composite’s revenues rose to 2.00 during Q1, matching the previous record high. We are reminded that lofty valuations aren’t necessarily a good short-term market indicator.

Malthusianism has nothing on this The Voluntary Human Extinction Movement (VHEMT) believes human extinction is the best solution to problems facing the Earth’s biosphere and humanity. Its motto is, “May we live long and die out,” and its Facebook page sells T-shirts declaring: “When You Breed, the Planet Bleeds.” The pace of human breeding indeed has slowed, but for reasons that have nothing to do with VHEMT. Around the world, humans are not having enough babies to replace themselves, Yardeni Research notes. With a few significant exceptions—India and Africa—working-age and total populations are projected to decline in coming years in most of Asia, Europe and Latin America. Not so in the U.S., though the pace of growth is projected to slow significantly.