Weekly Update: It depends on what the meaning of the word 'is' is

08-24-2018

Despite President Trump’s warning that any move toward impeachment could send markets tumbling, past political episodes linked to incumbent presidents actually haven’t had much impact, save the S&P 500’s slump during the Watergate affair (October 1973–August 1974). But the index had been falling since January 1973 of that year, with the Watergate scandal coinciding with an oil price shock that pushed the U.S. into recession. In the case of President Clinton, the S&P climbed 30% between the January 1998 emergence of allegations about his conduct and the February 1999 defeat of the articles of impeachment. More recently, the S&P has gained around 20% since the start of the Mueller investigation, aided by Trump’s pro-growth agenda (more below) and favorable technical factors. The S&P’s 200-day moving average remains positively sloped, the S&P 600 small-cap index is at a new high and the 10-year Treasury yield remains above 2.7%—all favorable for the bullish case. If anything, low-volatility exposure has become attractive as the market pushes into the thick of what is typically a turbulent seasonal period that extends into early October.

The “crime’’ Trump is alleged to have committed is the same one that got Clinton—lying about sex. As such, it may be the most useful precedent for gauging public reaction, which ended up being quite sympathetic toward Clinton. There, too, a special counsel probe that had turned up nothing in regard to the matter it was supposed to be investigating stumbled onto an unrelated sexual indiscretion. Clinton’s impeachment, which ran from Dec. 19, 1998, to Feb. 12, 1999, was not a negative for the markets—in fact, the S&P rose 3.6% over the two months and traded higher during most of the period. It turned out voters weren’t too concerned about personal matters, especially after being conditioned to expect some vastly grander crime or misdemeanor. They especially didn’t care about sexual indiscretions on the part of a politician already known to be rakish. To be sure, if the GOP loses the House, impeachment becomes more likely for Trump. But for it to happen, Democrats would have to think it’s a politically wise move, and Trend Macro believes the Clinton episode will teach them otherwise. It’s unlikely the GOP will lose control of the Senate, where impeachment by the House is tried. If it does, it would only be by a single seat; it takes a two-thirds supermajority in the Senate to convict.

After a prolonged slump across industries, productivity is improving, with corporate tax reform and deregulation starting to feed capital formation. Cornerstone Macro believes this will be a sustainable upshift that will support margins, restrain labor costs and keep inflation moderate for years—an environment that should keep interest rates and credit spreads lower for longer. This hardly is indicative of an economy late in its cycle. Indeed, even though the expansion is now the second-longest on record, Dudack Research sees no signs of overheating. It helps that various sectors have experienced rolling recessions over the past nine years as the economy struggled to recover from the second-worst recession in U.S. history. One example: energy’s 2015-2016 collapse, which resulted in an S&P earnings recession and further slowing in already anemic economy. GDP growth averaged just 1.9% annually from early 2009 to late 2016, well below its long-term average of 3.2%. There’s no doubt the economy’s now gaining momentum. GDP expanded at a 4.1% pace in Q2 on broad-based improvement. Market sentiment that exhibits little sign of excessive optimism supports this bullish macro backdrop, helping the broad indexes to hit new highs this week. As does Dudack and many others, we at Federated expect equities will be substantially higher over the next 12 months.

Positives

  • Where are we in the U.S. economic cycle? Philly Fed coincident indexes signaled strong momentum, rising in 42 states, declining in five and unchanged in three. Separately, July core capital goods orders surged 1.4% while August’s preliminary composite Markit PMI moderated on slowdowns in hiring and new orders but overall still reflected robust growth. Also, the American Trucking Association’s gauge of freight activity jumped 8.6% year-over-year (y/y) and weekly chain store sales rose 4% y/y on the back-to-school frenzy.
  • The Fed’s in no rush This week’s minutes from the July-August meeting indicated policymakers see a number of downside risks including trade, emerging markets and housing amid “strong” economic activity, household spending and business investment. Markets interpreted the message as supportive of a Fed that won’t tighten aggressively, although a hike next month appears baked in the cake.
  • Home sweet home Reflecting the year’s biggest positive equity theme, Target’s CEO this week said the U.S. consumer environment is “perhaps the strongest I’ve seen.’’ A key reason U.S. small caps have been doing so well this year is their predominate focus on a domestic economy that’s doing much better than most global peers, with business models that are largely unaffected by trade dustups.

Negatives

  • Housing hurting New and existing home sales unexpectedly fell, the former to a 9-month low and the latter to a 2½-year low, as higher rates, higher prices and tight supply hindered activity. The fourth straight monthly decline in existing sales matched the longest down streak since January 2014, with y/y sales declining 1.5%. On a positive note, the supply of new homes rose the most since 2009, while the y/y growth rate of new home sales remained at nearly 13%.
  • Where are we in the global economic cycle? Not a single PMI was sitting below 50 anywhere in the world as the year kicked off; now almost one country in five are below 50, a large change in just a few months. On a positive note, the latest eurozone PMI held steady as gauges rose for its two biggest economies, Germany and France, suggesting spring’s soft patch in Europe may be ending.
  • Dollar strength a worry The Institutional Strategist cautions that if the dollar continues to appreciate, there likely will be a global risk-off event. It cites a developing global shortage of dollars and Fed policy that is much tighter than the rest of the world (the dollar rose following Wednesday’s release of the Fed minutes).

What else

Ready to call the secular bear? In February, the 10-year Treasury yield surpassed its 10-year trailing moving average for only the second time since the prolonged secular bull market began in 1980. There have only been two significant false breaches of the secular trend since 1900, suggesting a bond bear market is underway. On the other hand, since the end of 1970s’ stagflation, a trough in jobless claims as appears to be the case now has almost perfectly coincided with a peak in bond yields.

Auto tariffs’ big bite While a decision on whether to impose tariffs on autos and/or auto parts was delayed again, analysts at the University of Michigan and the Peterson Institute say price increases implied in the current proposals would amount to 3-5% of buyers’ income and consume all of this year‘s tax windfall. The reason: the industry is fully globalized with only half the value of vehicles sold in the U.S. sourced domestically.

Yield-curve worries overdone? With the gap between 10-year and 2-year Treasury note narrowing to around 25 basis points, talk of a pending inversion followed by recession continues to heat up. Ned Davis’ advice: calm down. For one, yield-curve warnings are leading indicators with widely variable lead times, with recessions after an inversion coming six months to two years later or longer, historically. More importantly, the curve between the 30-year Treasury yield and 90-day T-bills—Ned’s preferred variable—has narrowed but is still about 100 basis points away from inversion.

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