Weekly Update: Men are from Mars, women are from Venus and millennials are from ...

12-08-2017

… ethereum. This was my last week for travel in 2017, and it was a special one. I unveiled my active-passive presentation at an advisor meeting in Dallas. Researched extensively, I believe it is a balanced review and, I’m just saying, many asked for a copy of my slides. Then off to do several client events in Wilmington, N.C., before finishing the week at my biggest event of the year in front of the Lancaster Chamber of Commerce. Got to do something special … a new pair of shoes! This time from Paris. Our guests in Wilmington were charming! At our evening event I may have mentioned my shoes. Several ladies came by afterwards, having bet on the designer. Christian Louboutin? Yes! At the Investors Roundtable luncheon in Wilmington, the subject of bitcoin came up as its price powered through $16,000, up $4,000 in just two days. Is it the current day Tulip Mania? Well, I singled out a handsome millennial, as I often do, to make a point about following this massive generation as we consider investments. He stopped by after my talk to explain why cryptocurrencies are the future and a fine investment. An owner of several vape shops, he described the superiority of ethereum (another cryptocurrency) vs. bitcoin, using English words in a way that sounded foreign to me. “But how can cryptocurrencies be legitimate when there are hundreds of them?” I asked. He explained that the best ones will rise above the others, “you know, like Apple did,” he patiently explained to this boomer. As one who has said many times that it behooves all of us as investors to study the millennial generation, I think I better dig much deeper into this cryptocurrency phenomenon.

Following strong performances through much of the year, most global markets have consolidated over recent weeks as a leadership reversal has taken hold (not unlike what we’ve seen in the U.S.). Importantly, near-term weakness is still playing out in the context of uptrends and a supportive global backdrop, creating the potential for buyable pullbacks. While correlations are lower across the board, a sign 2018 may see a greater degree of performance dispersion—i.e., things may get “harder” from here—the global economy is exhibiting signs of acceleration, not deceleration (see below). In the U.S., where December historically has the smallest drawdown of any month, the Santa Claus Rally typically kicks in after Dec. 15. This reacceleration tends to pause in mid-January, then pick up again into February. That said, upside volume has been failing to confirm recent market highs, suggesting a correction could lie ahead in 2018 if this trend continues. The flattening yield curve also continues to get a lot of attention, with the spread between 2-year and 10-year Treasury yields its narrowest in a decade. The Fed’s gradual rising-rate path, a lack of inflation and extremely low overseas rates are making it near impossible for longer-dated Treasuries to move meaningfully. If this flattening trend continues, JP Morgan says an outright inversion could come within the next two Fed hikes, an out-of-consensus view that we don’t share at Federated.

At this time a week ago, the market was selling off despite the tax bill’s advance on worries former National Security Adviser Mike Flynn may spill the insider beans on the Trump administration. But the risk of impeachment remains remote and the latest developments in the Mueller investigation appear unlikely to have any impact on the tax debate. If there is a major bombshell from Mueller, the biggest impact is unlikely to be on the markets but on the midterm elections and policy agenda for 2019. To date, the tax reform proposals before Congress do not appear to be as comprehensive as those passed in the Reagan era, although the concept of lowering tax rates, eliminating loopholes and accelerating depreciation are similar. The financial media’s done little to analyze tax reform and tends to replay comments by political partisans totally divided on whether the wealthy or the middle class will be helped or hurt. Trump’s point about a possible 22% corporate tax rate is key. Congress can save more money implementing it immediately than with a 20% rate taking effect in 2019. The savings could be used to pay for compromises such as the interest deduction and AMT fixes. The Senate, however, believes having expensing in place in 2018 with a higher corporate tax rate will incentivize capital spending. This is the biggest fight of the tax reform conference and the president likely will have to make the call. I always enjoy my visits to Lancaster—this year marked my 10th appearance at the chamber. My host, who knows me well, introduced me, wondering what shoes I was wearing. During Q&A, half the questions were about bitcoin. Back in Wilmington, I happened to mention my shoes again, shamelessly soliciting compliments from the group. A gentleman whispered that he knew why I wear these heels. “To appear taller,” I said. “Ha,” he replied, “you are just showing off those legs.” I took no offense (maybe it’s a generational thing?). Au contraire. C’est divin! Merci beaucoup!

Positives

Jobs solid Nonfarm payrolls surprised, rising an above-consensus 228K in November on outsized gains for manufacturing, construction and professional services. The average workweek also rose, while the unemployment rate held at a 17-year low of 4.1%. ADP private payrolls also increased more than expected and, on a 12-month basis, at their fastest pace in nearly two years. Challenger layoffs, meanwhile, remained near 1997 lows.

Where are we in the cycle? Philly Fed state leading indexes suggest economic activity will increase in 46 states through next spring, with accelerating growth across a greater number of states. The companion U.S. index corresponds to 3% GDP growth, indicating 2017’s momentum will carry into 2018. The story's the same overseas, with October’s global manufacturing PMI near a 7-year high and consistent with 4.9% annualized production growth. The data suggest this cycle has a ways to run.

Capex is picking up Nondefense capital goods orders ex-aircraft, or core business orders, climbed again in October and, on a year-over-year (y/y) basis, are rising at their fastest pace since June 2012. This is reflective of stronger demand for capital expenditures (capex) and increased factory activity. In the Business Roundtable’s CEO survey, capex plans for the next six months were at a 6½-year high.

Negatives

Cracks in sentiment? Like nearly all of the regional manufacturing surveys, the ISM services gauge for November weakened more than expected, as did Michigan consumer sentiment for December. That said, all of the indexes remain at levels indicative of solid growth. This bears watching as the recent volatility could be due to adjustments related to the one-off effects of September’s hurricanes, or could be signaling a slowing into the New Year.

Where are we in the cycle? October’s trade gap widened significantly above forecasts on flat exports and a jump in imports. Meanwhile, November’s auto sales fell a second straight month following September’s storm-replacement spike while the Mainheim used-car price gauge declined for the first time in eight months. The reports suggest Q4 may be pressed to match the prior two quarter's 3% growth.

Inflation watch Despite a tightening labor market, Q3 hourly compensation rose a subdued 2.7% annualized as unit labor costs turned negative. This morning’s jobs report similarly showed robust job growth has yet to translate to any wage inflation, with y/y wages up only 2.5%. This implies continued downward pressure on core PCE inflation, which could be good for the markets if it keeps the Fed on easy street. Policymakers meet next week and are expected to raise the target rate a quarter point.

What else

The two faces of oil Nov. 30 was a historic day for oil markets, with OPEC, Russia and others cementing the extension of the “Declaration of Cooperation” that capped production to support higher prices. But Cornerstone Macro notes it also was a historic day for U.S. crude oil production, as the Energy Information Administration reported the largest single monthly increase in domestic production in the lower 48 states since January 1984. These countervailing supply forces are why many expect oil prices to remain relatively range-bound between $50 and $60 per barrel range in 2018, roughly half their cycle peak of $112/barrel in 2012.

Don’t fear midterms Midterm years have gotten a bad rep due to some outlier years. But since WWII, the average midterm-year gain's been 6.7%. In the last three midterm years, the S&P 500 has posted double-digit increases. The midterm year is now tied for second-best in the 4-year presidential cycle.

How about a smaller tree this year? The average price of a Christmas tree has shot up to $75, Deutsche Bank says, more than double the price just four years ago. The bank sees this as a precursor to what it believes will be the No. 1 concern in 2018: rising inflation.

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