Weekly Update: 'It's not even the same category.' True that!

07-21-2017

Since it is most difficult to get a quorum for meetings in July, I spent several days this week in Continuing Education seminars to maintain my CPA accreditation. Funny how the presenters are speaking English and yet I haven’t a clue what they are saying. I was once a competent CPA, but now I am a market strategist. It’s not even in the same category …. The reverberations were intense this week as speculation swirled that the Senate debacle on Obamacare replacement may finally doom Reince Priebus, the White House chief of staff who had urged movement on health reform before any other issue. The failure's so profound that many Republicans now worry about steep electoral losses in 2018—and the eventual resurrection of a single-payer option. (I strongly believe this will be the end result.) Washington’s attention is quickly turning to tax reform, which is where Republicans always wanted to be. A tax bill can pass because it’ll likely follow the budget reconciliation process requiring only 51 votes, and Republicans have the votes. Desperate for a win, Republicans are willing to compromise. IESB suspects Paul Ryan and Kevin Brady—the two leading GOP tax writers—reluctantly will abandon or water down their border adjustment-tax plan to advance a pro-growth tax-cut bill. While straight, revenue-neutral tax reform is unlikely, look for Congress to use dynamic scoring and budget baseline changes. Tax reform is not currently priced into the market and the bar is pretty low. But the calendar to get there before year-end is short. Summer recess looms, and September only has a dozen legislative days.

Nothing on the summer calendar has the ability to upset trading until late August’s Jackson Hole Symposium, FBN Securities says. Equity volatility remains depressed, with the rolling 3-month intra-day range on the S&P 500 among the lowest in history; earnings-to-date have been supportive, with margins holding at healthy levels; and there’s little evidence of global credit market stress. At the annual gathering of central bankers and economists in Wyoming, ECB President Mario Draghi is expected to signal his intention to start tapering bond buying. This would be followed by September’s Fed meeting, where policymakers are almost certain to start selling bonds. Draghi this week took a tone eerily similar to that recently offered by the Fed’s Janet Yellen, remarking that the economy has strengthened and while inflation has failed to ignite, upward pricing pressures inevitably will return. Stocks could be vulnerable if either the economy steps backward or market participants dump risk if the first real tightening in nine years gets underway. On the other hand, global banks in aggregate remain very accommodative, and inflation—more appropriately the lack thereof—remains a strong counterweight to aggressive action, Draghi’s and Yellen’s comments notwithstanding. Core PPI, core CPI and core PCE have been hovering between 1.6% and 1.8% year-over-year (y/y), and crude oil’s upward pressure on 2016 prices has dissipated. While a weaker dollar usually offsets deflationary trends, the dollar continues to trade in a tight +/- 5% y/y band where it’s been since late 2014, minimizing the impact of its recent weakness on import prices. Indeed, this week saw y/y import prices ease to their slowest pace since November.

Preliminary open interest on stock future contracts has increased the past two days by the most since mid-May, indicating many institutions are raising net exposure. This risk-extension exercise could continue as long as forward P/E multiples reside below their early March peak—FBN Securities says the S&P would need to hit 2,505 before matching winter’s higher P/E levels. Portfolio managers still have a hoard of cash at their disposal, in part because investors aren’t as complacent as the low VIX suggests. Indeed, over the past month, they’ve pulled $29 billion out of equity mutual funds and ETFs and poured $23 billion into bond mutual funds and ETFs. Further, Evercore ISI’s proprietary hedge fund survey has pulled back noticeably to a slightly defensive position. As for Capitol Hill, the death of the health bill was in the view of research consultant firm IESB an unmitigated disaster for President Trump, who last year said it’d be easy to replace Obamacare with “something terrific.” Now markets have to wrestle with the likelihood his famed negotiating skills don’t work in the shark-filled waters inside the Beltway. Coincidentally, the book "Devil's Bargain: Steve Bannon, Donald Trump, and the Storming of the Presidency" was released this week, filled with quotes and anecdotes that seem quite prescient. Trump thought governing was going to be easy: "I deal with people that are very extraordinarily talented people,’’ he told author Josh Green, just after wrapping up nomination. “I deal with Steve Wynn. I deal with Carl Icahn. I deal with killers that blow these [politicians] away. It's not even the same category. This"—he meant politics—"is a category that's like 19 levels lower. You understand what I'm saying? Brilliant killers." I have four children, and when they were much younger I received endless advice on how to raise them, none of which I asked for. I would always say that unless you had four or more children, you didn’t have the experience to give me useful advice. So here’s Trump, an inexperienced politician trying to govern, dealing with “the swamp people.” And he thought this would be easy … LOL!

Positives

More good than bad housing news June starts and permits rose well above expectations; May was revised up, too. While the reports’ strength lay in the volatile multifamily category, single-family starts ended a 3-month string of declines, lifting the 12-month average to a 9-year high. The firming suggests impact from higher interest rates is ending. July builder sentiment did drop to an 8-month low as rising lumber and home prices hurt affordability. But the index was still up a robust 8% y/y.

U.S. recession nowhere in sight June’s jump in housing permits drove an above-consensus 0.6% increase in July’s Conference Board leading indicators, up a seventh straight month to match their high for the year. Other positives included the manufacturing ISM’s new orders component and tighter yield spreads. The gauge’s renewed strength after a spring slowdown suggests momentum’s building as the economy heads into the year’s second half.

Global recession nowhere in sight Stronger global growth is showing up in manufacturing PMIs, with 97% of surveys that Wolfe Trahan tracks above 50—a sure sign of broad-based reacceleration that’s unlikely to fade anytime soon. Breadth measures of the OECD leading indicators also reflect widespread improvement, with two-thirds of individual-country indicators above their long-term averages of 100, even though there’s been some moderation in advanced G7 economies.

Negatives

Wither the consumer Last Friday’s disappointing June retail sales report, the latest in a string, is another indication that consumer spending growth is hardly the catalyst that many thought it might be, given full employment and growing personal incomes. How much of this may be the online effect and how much may be just a pause before the back-to-school season should become clearer in the next few months. But for now, consumer spending certainly is not sufficient to significantly push GDP growth.

Regional air pockets The Empire services gauge contracted in July for the first time this year on worsening expectations, even as hiring and wages picked up and capital expenditures grew. And the companion manufacturing outlook slipped to its worst level since the election, although New York-area factory activity was still expansionary. Mid-Atlantic manufacturing deteriorated as well, as the Philly Fed survey declined on new orders and shipments. However, it remained firmly in positive territory.

Contrarian negative There’s little to worry about and that may become a problem. The latest Investors Intelligence figures put bullish sentiment in the 90-100th percentile range. Historically, such levels have resulted in below-average returns (not negative, but below average) eight to 13 weeks forward.

What else

Full employment with low inflation can coexist and is bullish ISI observes that the last four lows in the jobless rate have been in the same rank order as the last four lows in jobless claims. So, since claims are now well below their prior lows (they fell 15K this week), the jobless rate now seems likely to move well below its prior lows. So what’s up with low inflation? During the 1970s, GDP ran above potential for over a decade, helping explain why rapid inflation became entrenched. But it’s now run below potential for a decade, helping explain why low inflation has become entrenched.

Political watch Not only are there not 50 Republican Senate votes on anything health-care related, there may not be 50 votes on anything. And yet, there is almost no mathematical chance that the GOP can lose the Senate in the midterms regardless of the Obamacare and tax outcomes, Cowen & Co. says. With 52-48 GOP-control, 10 Senate Democrats are running for re-election in Trump-won states, while only two Republican seats really are in jeopardy (Dean Heller of Nevada and Jeff Flake of Arizona). So worst-case scenario, Senate is 50-50.

China watch China said GDP growth accelerated to almost 7%, putting "hard landing" fears on the back burner. However, there was a troubling plunge in nominal GDP growth, from 16.3% in Q1 to 6.7% in Q2, Strategas Research notes. Weighing on China’s growth rate is its geriatric demographic profile. Its fertility rate dropped below the replacement rate in 1995 and is expected to remain below it through the end of this century, with its population growth rate projected to turn negative in 2033.