Weekly Update: I don't care about the presents underneath the Christmas tree

12-15-2017

As we move along this holiday season, I can’t get that Mariah Carey song out of my head. Been humming that tune a lot this week as I sit with several hundred CPAs while we cram the last continuing education credits in before the year-end deadline. It’s much colder than a normal seminar room, and my coat and scarf are not enough to keep me from shivering. This was probably purposeful as CPA CE appears to be boring. I can only surmise this by looking at the faces of the attendees since I can’t make out what the presenters are talking about, though they are speaking the English language. So I escaped to the lobby where a half dozen guys are standing around with their arms folded, or in their pockets, and an occasional slap on the back. Talking shop—some of the best white noise of the year for me to concentrate on my weekly. The market appears to be getting an early start on the Santa rally—it usually doesn’t kick in until mid-month—but the volume in advancing stocks is not providing real muscle.


While it’s not negative, the longer-term 200-day moving average shows volume in declining shares has increased. That’s a slight concern. Meanwhile, managers have reduced equity exposure into the recent market strength. This should help protect absolute gains and limit any sizable corrections.

I have been invited to share my economic outlook on day two of the CPA CE, and have been given a second hour to discuss topics of interest in our industry. An annual event, I am told that I am the most popular speaker (this may or may not be a reflection of my prowess, since for sure their subject matter is no competition at all—and their subject matter can be of interest only to CPAs!). Given this group’s propensity for numbers, it may appreciate this analysis of the market’s behavior near tops. The Leuthold Group notes that a period of distribution—the early stages of a pending reversal in an uptrend marked by lower upside volume—has preceded 11 of the last 12 bull-market peaks, with only the mild 1976-78 bear market not foreshadowed by any prior breakdown in NYSE daily breadth. The median length of these distributive phases has been 35 weeks, during which the S&P 500 has earned a median total return of 9.4%. But the more interesting action has been at the factor level. Growth strategies have beaten value strategies during 10 of the 11 distributive periods with a median total return of 12.3% for the former vs. 3.5% for the latter. Both the 1979-80 and 1999-2000 episodes saw genuine speculative blow-offs with growth returns exceeding value’s by 50-60 percentage points! The irony is that despite extremely high stock market valuations, tighter Fed policy and a U.S. economy at full employment, the distribution phase under Leuthold’s definition has not even begun. The NYSE Daily Advance/Decline line stood at a new cycle high on Monday, as did virtually every other measure of internal participation.

This year has seen record inflows into global equity and bond funds, with developed market funds the main driver. However, as a percentage of the fund classes' net asset values, emerging markets (EM) take home the win, with EM bond inflows clearly first, followed by EM equities, U.S. sovereign bonds and Japanese equities, according to Deutsche Bank. Within the major bond groups, there was much excitement around rate normalization in the post-election U.S. on hopes for more fiscal stimulus and higher inflation, causing a swift rotation out of bond and into equity funds early in the year. But question marks over the Trump administration's capabilities, together with downward surprises to inflation and uncertainties over the future course of central bank policies, quickly reversed the trend, with bond funds experiencing their steepest inflows in five years. Combined with a lower U.S. dollar, higher oil prices and the continued hunger for sufficient returns in a low-rate environment, this also helps explain the EM bond-fund rally. That said, high beta has been outperforming low beta, suggestive of a risk-on environment. And one area where you just can’t stop hearing about is the ascent of bitcoin … you know sentiment is lopsidedly bullish when your Uber driver, your parents and your bagel store cashier tell you they just bought some or are asking you if they should. I joke about the CPAs, but they are truly good people, and theirs is the language of business and what keeps the whole system afloat. Plus, I have my very own Mister CPA. If he doesn’t read my weekly, I may get a serious piece of jewelry for Christmas. If he does read this, he’s gotten off a lot easier because ... “all I want for Christmas is you!”

Positives

Is that Santa I see? November retails surprised, surging 0.8% and ex-autos, an even strong 1%, both well above consensus and, on a 3-month average basis, the most since April 2014. Most major components outside of autos showed gains, including a 2.5% jump in non-store sales, reflective of unusual strength in e-commerce. Electronics and appliances appeared to be early holiday favorites, with these stores reporting a 2.1% increase on top of October’s 1.2% rise. On a year-over-year (y/y) trend basis, sales advanced at their fastest pace in 5½ years.

Businesses bullish NFIB optimism soared to its highest level since 1983 and second-highest reading on record. The surge captured expectations that fiscal policy will create more favorable business conditions, leading to more hiring. Separately, the Duke University/CFO Magazine quarterly outlook survey rose to a 13½-year high on strengthening expectations for revenue and profit growth.

Where are we in the cycle? Industrial production rose a third month in a row in November, and Markit’s preliminary read on December activity hit an 11-month high on accelerating new orders, production and employment. The companion services measure wasn’t as robust—it slipped to a 15-month low though it remained firmly in expansion territory. Activity in the New York region also moderated but was still robust. Globally, the OECD Composite Leading Indicator edged up to its highest level in almost three years on broad-based growth.

Negatives

Inflation watch Headline PPI rose at its fastest clip in nearly six years; core prices were more subdued but still above the Fed targets. The CPI story was similar. The headline rate rose while the core rate moderated. In trade, y/y import and export prices hit 7-month highs. Ned Davis Research’s proprietary inflation indicators are signaling a 2018 breakout. Faster inflation that leads to faster rate hikes—the Fed this week made it three for the year and signaled three more next year—is a market worry.

Labor market tightens Wage pressures may not have been present in November’s jobs report but both the Employment Trends Index and JOLTS reports suggest it should be just a matter of time. The former is rising at a 4.7% y/y pace while the number of unemployed per job opening in the latter is its lowest since the series started in December 2000. The latest weekly jobless claims reflect further tightening, falling to their second lowest-reading since 1973. At 145 weeks, the below-300K streak in claims is the longest since 1970.

Inventory build slows October business inventories shrank, potentially a negative for Q4 GDP growth if the trend holds. But at a very low 1.35, the inventory-to-sales ratio suggests restocking could pick up the rest of the quarter, especially given the surprisingly strong retail sales so far, negating the slow start.

What else

Political watch Various polls show much of America thinks the tax deal won’t do them any good—a Harvard CAPS-Harris survey said 34% think their taxes actually will go up; only 21% think they will be lower. A USA Today/Suffolk University Poll said 53% don’t expect it to help the economy at all. The same poll found just 32% support the plan—the lowest level of public support for any major piece of legislation enacted in the past three decades.

Will debt be a drag? Ned Davis tallies total nonfinancial debt—government, households and non-financial businesses—at $48.6 trillion, a level it fears could slow growth as the Fed continues with normalization. Each 1-point rise in rates would equate to about $486 billion of extra debt service costs, more than enough to offset any benefits from fiscal stimulus and other pro-growth measures.

Remember the Hunts? The Great Silver Spike of 1980, when the Hunt Brothers attempted to corner the silver market, is the only historical bubble that rivals the current price action in bitcoin. Google search interest in cryptocurrency has exploded—as has its price. As of this writing, the price of bitcoin was up 47% in the past week, 181% in the past month and more than 2,100% in the past year.

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