Weekly Update: What a time to be alive!

11-10-2017

I spent the early part of the week in Seattle, where at a meeting before a group of well-to-do end clients, there was a lively discussion about this progressive city’s $15/hour minimum wage. An owner of a grocery store that’s been in the family for decades lamented the difficulty in hiring and keeping workers, while a lady noted small businesses there were cutting staff in response to the requirement. Another lady thought millennials, very conscious of social issues, were boycotting Amazon as the company gobbles up the market share of local businesses. Hmm. A young millennial in the group agreed with me that very many in her generation will only buy from Amazon. I ended the week in Dallas, where a fun group was cursing about millennials (boomers have mixed feelings, I guess, based on their own experiences with these young people) as I discussed this generation’s likelihood of fueling economic growth as they marry, have children and buy homes. After the meeting, a real estate professional told me he’s seeing a growing number of millennials purchase homes not because they are having children, but because they want a back yard for their dogs! What a time to be alive! While sentiment surveys suggest growing complacency—the Investors Intelligence bull-bear ratio is at a 30-year high, exceeding 2000 and 2007 peaks—seasonality should have the market’s back through year-end. FBN Securities surmises many institutions will ride the coattails of their benchmark the next eight weeks before jettisoning risk aggressively. Indeed, after hitting a high of 96%, the stock exposure of respondents surveyed by the National Association of Active Investment Managers has plunged to 60%, a low for 2017. It appears managers are selling into strength, which makes sense as we are reading more and more about this market’s vulnerability as it melts up. With mounting concerns about a possible early 2018 correction, it seems the smart money is attempting a front run by lightening up now.

Walking down the hallway in a Seattle office, I saw two advisors through their glass walls, standing at work before their computers. (I’m with the cool people now.) The valet guys at the downtown garage were having their Uber eats. And a lady was just elected mayor, beating out another lady with the purple hair. Cool, cool, cool! At a client event, a likely non-Trump supporter asked my opinion on President Trump taking credit for the stock market’s record high (see below). Tax reform is the Republicans’ big test, and an already formidable environment didn’t get any easier with this week’s Democratic victories in Virginia and New Jersey. A wave election against Republicans may be forming, a possibility the market has yet to price in. While failure to pass reform (not that we're calling for this at the moment) may be considered a “crisis event,” Ned Davis Research says crises historically have created sharp but short-term sell-offs that almost always were followed by strong rallies. Why? A crisis shakes out a lot of weak holders of stock, leaving stronger hands to firm the market. Further, the market has come to believe there’s nothing permanent about a Fed tightening as the central bank almost always reacts quickly to stop a panic. This is a far cry from mid-2013, when just talk of tapering caused the long end of the bond market to sell off nearly 140 basis points. Last week, yields actually fell even as the Fed’s balance sheet meaningfully contracted for the first time in the post-crisis era. To be sure, challenges loom. For one, the stock market has been bolstered by persistently positive economic surprises the past couple of years, making future surprises less likely to have the same supportive impact. For another, we are beginning to see signs of narrowing leadership, with the percentage of stocks reaching new highs declining even as the market rises.


The yield curve further flattened this week to levels last seen in the early stages of the global financial crisis. Most equity investors have disregarded this trend, but if it continues, it almost assuredly will introduce unwanted skittishness into the trading environment. A yield-curve inversion (short rates above long rates) has foreshadowed a recession with near flawless predictive prowess for the past 50 years. Not that an inversion is imminent; historically it’s taken about a year to go from current levels to an inverted curve, with the market rallying in the interim in every occasion. What’s behind this flattening? A Fed ready to hike again and inflation’s failure to reignite. The former has rates rising on the short end, while the latter has them wobbly on the long end. Some traders also blame slow money growth amid stingy bank lending and Fed balance-sheet reduction. I finished my visit to Seattle speaking before a large women’s event. Our host reported that many more companies are being started by women entrepreneurs, and during the Q&A, I was asked if I believed this would repair the “women earning 75 cents on the dollar vs. men” problem. My generation faced this problem, but I strongly believe our daughters are increasingly being compensated purely on merit and their daughters will see “75 cents” as a history lesson. What a time to be alive!

Positives

Bullish for holiday sales Consumers are picking up the spending pace heading into the holidays, bolstered by an improving labor market that lifted the Conference Board’s Employment Trends Index to a record high. The Manheim Used Vehicle Value Index rose in October at its fastest year-over-year (y/y) pace since May 2010, the latest ICSC/Goldman Sachs weekly chain store sales index jumped the most since June 2016 on stronger seasonal demand and September consumer credit increased considerably more than expected. Early November Michigan consumer sentiment dipped off October’s 13-year high but remained elevated, with its second highest reading since the start of this year.

Bullish for capex The Business Roundtable’s quarterly CEO survey found 94.5% were upbeat, up from 69.6% just before the election. This series tends to be a good indicator of growth in capital expenditures (capex), especially equipment spending. The Fed’s Q4 senior loan officer survey suggested capex is accelerating as commercial & industrial loan standards loosened for the sixth straight quarter.

Where are we in the economic cycle? The average of business conditions surveys by the New York, Philadelphia, Richmond, Kansas City and Dallas Federal Reserve Banks reached a 13-year high last month. Elsewhere, intermodal container and truck tonnage railcar loadings are at new highs, lifting the Dow Jones Transportation Average into record territory along with the Dow—a bullish signal.

Negatives

Inflation watch Although monthly job creation appears normal in this expansion, when total employment is normalized and indexed to previous economic peaks, job growth in this cycle has been the most anemic and the slowest of any cycle since 1950. This may help explain the lack of wage growth and stubbornly low inflation—average hourly earnings actually decelerated in October and have remained stuck in a 2% to 3% y/y range, nowhere near 4%+ levels associated with demand-pull inflation.

Housing prices pinch The NAHB/Wells Fargo Housing Opportunity Index fell to its lowest level in nine years as chronic inventory shortages continue to put upward pressure on home prices. The combination of new and used homes on the market is only enough to satisfy 4.5 months of demand—one of the lowest levels on record.

Where are we in the economic cycle? Major equity benchmarks have been reaching record highs at the same time that P/E ratios have been trending lower, thanks to the earnings rebound. But a risk entering 2018 is this joint market and earnings strength is creat­ing complacency, leaving the market vulnerable to disappointment as earnings momentum recedes, with forward earn­ings growth currently running far below trailing earnings growth. 

What else

This week’s Trumpism “The reason our stock market is so successful is because of me. I've always been great with money, I've always been great with jobs, that's what I do. And I've done it well, I've done it really well, much better than people understand and they understand I've done well." –President Trump on Air Force One en route to Asia, as reported by CNBC.

‘What a time to be alive’ has its detractors In Seattle, we had a deep, dark conversation with a seasoned advisor, a once college professor, who submits that “AI is the end of the world.” He believes the tech behemoths are moving to make their own communication platforms that will render the internet obsolete, and that Amazon is “building its own economy” as we speak. 13D Research reports that the top 8 tech companies spend $73 billion each year on R&D, more than the rest of the sector—roughly 400 publically listed companies—combined. It suggests tech giants not only dominate today, but are poised to own the industries of the future.

The coolest companies let you bring your puppy to work Skyscrapers are going up everywhere in booming Seattle, where my wholesaler let me snap pictures of the all-glass Amazon globe, next to its two downtown headquarter buildings. This structure, I was told, is for employees only, to relax—filled with trees, plants and walls of ivy. What does a cool company offer its employees? A dog park on the roof. Amazon came up quite a bit during my visit.