Weekly Update: 'You look like Nancy Pelosi'

02-16-2018

You mean maybe a younger version of Nancy? Silence … Ugh. Ugh. Ugh. No offense to Nancy or her fans, but this comment from an advisor at a dinner in Santa Monica is one this aging (but still trying!) lady has never heard before and hopes never to hear again. For the third time this year, I was back in California where I’m always fascinated by the comments I hear. I was the sole lady among a group of gentlemen in Santa Monica as we discussed volatility, politics and tax cuts. I was reminded Californians have NOT had a tax cut! In response to my assertion the middle class will see the largest percentage cuts in their taxes, it was suggested the definition of “middle class” should be regional, for middle-class wages are NOT enough to live in California. I was told more U-Hauls are leaving the state than ever and “they are NOT coming back.” Of course much discussion was about inflation—is it really rising, and is that a bad thing. I repeated what I’ve said many times since the tax cut was announced, that if we are ever going to have inflation, this should be the year. With full employment, still easy money, hoards of cash on corporate and consumer balance sheets, the massive tax cut is fuel on the fire. I also repeated my conviction that for global demographic and structural (highly indebted countries, vast technological advances) reasons, inflation is not the worry—deflation is. A gentleman agreed: “Haven’t we been crying for inflation for 5 years?” Yes! Although a Fed who fears it’s behind the curve, with possibly other central banks feeling the same, is the concern for this year.

January’s CPI surprise likely was fueled by a one-off (more below), making Empirical Research reluctant to conclude the economy is starting to overheat. Its overarching view is the recovery is not yet in the late innings. With year-over-year (y/y) core prices still below 2%, inflation’s not at a point that should prompt a faster Fed. The central bank targets PCE inflation, which has been systematically lower than CPI for years and tends to move more slowly. Even if core CPI exceeds 2% by some margin, the Fed may let it run higher for some time. Many traders think an explosion in option volatility measures was behind the sell-off, as algorithm-led trading caused a rapid unwinding of ill-advised volatility strategies. Regulators reportedly are investigating whether possible VIX price manipulation played a role. Time will tell. Regardless, the subsequent breach of technical support suggests further possible down moves, with S&P 500 support in the 2,450 to 2,550 zone. There’s been little panic selling—in fact, several California advisors were nervous that they’d heard very little from clients. Medley Global Advisors’ CEO says he didn’t hear a whisper of concern when riding his train home after one of the 1,000-point Dow-drop days; my LinkedIn advisor friend reported similar calm. The next step to calling an end to the correction will be clear evidence of indiscriminate buying. But for Yardeni Research, the melt-up scenario ended with Jan. 26’s record high, when the S&P was up 57% from Feb. 11, 2016 (that year’s low). The forward P/E rose to 18.6 from 14.8 during that period, before plunging to just above 16 last week. What a blessing if the melt-up is over! I much prefer a Wall of Worry.

All eyes are on the 10-year Treasury yield, which hasn’t closed a quarter above its 50-quarter moving average (currently 2.94%) in 32 years; it sits at 2.86% at this writing. With a doubling in Treasury issuance slated for the next 18 months, who will buy U.S. government debt when almost 50% of Treasuries already are held by foreigners who see a falling dollar and the European Central Bank moving toward ending QE? The upside risks to U.S. rates are significant. What’s behind the issuance? Fed balance-sheet reduction and fiscal stimulus via the tax cuts and spending increases (more below). Most countries try to avoid fiscal easing when the economy is near full employment, but the U.S. has done so twice in two months. This has JP Morgan upgrading its U.S. growth forecasts for this year and next, lowering its jobless rate target to a 50-year low (3.2% in 2019) and, ex-the global financial crisis era, raising its deficit projection relative to GDP to a 50-year high (5.4%). Hmm. Late in the week, I attended meetings in the San Fernando Valley that included a big group of millennials. However much I discussed recent volatility, they were all carefree. The only questions of a serious nature came from the boomers in the audience. Many people think millennials will only get serious after they are married and have children, as if we boomers weren’t the same. Not to worry. I, too, am quite forgetful these days. Now, I have been in this business for decades, been to all the states, in all kinds of markets, heard all kinds of things, and my skin is thick. But, I have to admit, that Nancy comment bit … until another advisor approached me and remarked that he almost leapt across the table at that guy when he heard it. “You’re gorgeous, by the way.” Now, that’s more like it. I think I’ll just talk to this guy.

Positives

Business sentiment robust The NFIB index rebounded last month to its second-highest reading since November 2004, with the 3- and 12-month index averages reaching their highest levels since 1984. This suggests a sustained trend of rising small business optimism, aided by the best earnings trends since June 1988. A record 32% of surveyed firms feel it is a good time to expand. The tight labor market is showing up in wages as 31% of firms said they raised pay, the most since December 2000, and 24% plan to do so, the most since December 1989.

Consumer sentiment robust Main Street appears to be ignoring Wall Street as the weekly Bloomberg consumer comfort index jumped in the latest week to a new cycle high and the University of Michigan’s initial take on February sentiment soared well above consensus to its second-highest level in 14 years. The Bloomberg survey was led by the best assessment of the economy in 17 years and the best buying climate in 18 years, while the Michigan survey was fueled by robust readings on both the current conditions and expectations components.

Housing sentiment robust Rising mortgage rates don’t seem to be bothering builders, as NAHB sentiment held near a 13-year high and January starts jumped to their second-highest level of the expansion. Multifamily units led but single-family starts also were strong. Notably, permits surged, signaling significant work in the pipeline.

Negatives

If we’re ever going to get inflation, this would be the year Headline and core January CPI rose 0.5% and 0.3%, respectively, lifting their respective y/y rates to an above-consensus 2.1% and 1.8%. However, nearly 60% of January’s core increase was related to apparel, which did not experience typical post-holiday markdowns after unusually strong December sales. PPI inflation also came in above forecasts, while import prices surged 1% month-over-month, lifting the y/y change to 3.6%. Energy was the driver, but non-petroleum prices also were strong.

Consumption cools, although … January retail sales unexpectedly fell and the prior two months were revised down, suggesting Q4 is likely to be revised down and momentum may be slowing into the new year. Core sales ex-autos were flat as the post-hurricanes’ surge faded, and control sales ex-autos, food, energy and building materials also were unchanged. Still, on a y/y trend basis, sales were running well above their average annual gain for this expansion, with Ned Davis Research’s propriety gauge of core spending hitting its fastest pace since September 2006.

Industrial production slips It unexpectedly declined in January and December’s gain was slashed in half. Mining drove the decrease, while manufacturing was flat as declining auto sales slowed motor vehicle production. Utility output also slowed on January’s milder weather. Early February readings were more robust, with the Philly Fed unexpectedly jumping on a surge in new orders. The Empire slipped but was still deep into expansion territory.

What else

Surplus, schmurplus January budget surpluses such as this year’s $49.2 billion are not uncommon due to the calendar shift of some payments. Fiscal year-to-date, the deficit is $175.7 billion, up nearly 11% from a year ago. And with tax reform and the new, higher spending budget deal now in place, the deficit is expected to approach $1 trillion this fiscal year and top it 2019! Many are concerned a mounting deficit will create upward pressure on interest rates and inflation, causing the Fed to accelerate its policy normalization path.

Bitcoin bonanza A bitcoin invasion is underway in Wenatchee, Wash., where hydroelectric dams harness the flow of the Columbia River, giving north-central Washington some of the cheapest power in the U.S. That has made the largely rural area known for its apple orchards a magnet for bitcoin miners who use powerful specialized computers to generate cryptocurrencies—a process requiring vast amounts of electricity to run and cool machines.

LA’s fine … The sun shines most of the time, as Neil Diamond croons in one of my favorite songs, but the feeling is NOT “laidback.’’ There are palm trees but the rents are certainly NOT low! There’s congestion almost everywhere. Californians are prepared to sit in lots of traffic, all day, every day, both ways. Consequently, in order to be on time for our meetings, we were compelled to leave the hotel each day two hours early.

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