'Isn't that what you're supposed to do?'
I started my travel this week with numerous advisor meetings in northern New Jersey, where the traffic is thick and drivers are aggressive. Mention to a local that you’re from New Jersey and the response is, “What Exit?” On either side of the Garden State Parkway is by far the largest cemetery by headstone count that I have ever seen. Discussing this at an advisor lunch, a gentleman asked me, “How many dead people in that cemetery, do you suppose?” I guessed thousands, but my local colleague chimed in, “All of them.” One advisor says all her clients are asking, “When will this (bull run) end? They ask about recession, and they don’t even know what that means.” It used to be oil shocks would prompt a lot of recession talk. There was some in the breathless 24/7 news coverage hours and days after the drone strikes on Saudi oil fields, and several early-week meetings included discussions of the impact on inflation, the economy, market, etc. I’m not particularly a fan of this sector as there are too many factors that can move oil prices. Energy represents less than 5% of S&P 500 market cap, and its share of total U.S. consumption (gasoline, fuel oil, etc.) is just 2% of the economy, down from 8% in the early 1970s. Thanks to shale, the U.S. in fact now produces more than it needs and more than either Russia or Saudi Arabia. Our economy actually benefits from higher oil prices! (Within reason: UBS puts the sweet spot at $55-$75 a barrel on Brent crude, which was trading near $63 as of this writing, down from nearly $70 just after the attacks, in part because the Saudis now expect all disrupted capacity to be back on line by the end of the month.)
I spent the back of the week in “Mellow land,” aka southern Florida. At my first meeting with seasoned advisors in Fort Lauderdale, we discussed the folly of hanging on every word uttered by news outlets. One lady advisor recalled seeing “Worst day in 2 days!” scroll across the CNBC ticker at the bottom of the TV screen. Seriously?! “These TV programs are not in the business of distributing market news,” the gentleman advisor said. “They are selling advertising and know bad news sells.’’ We all agreed it's best to turn off the TV and focus on the longer term. In the shorter term, the past week saw the momentum-to-value rotation continue, with large inflows into equity funds and the largest flows out of government bond funds in five years. In the past 10 years, when bond yields spiked at least 50 basis points or more in a month, equities rose every time. (The 10-year yield through Friday was up 43 basis points from early in the month but has retraced somewhat since then.) The large reversal in equity factors has been one-sided, raising sustainability concerns. It’s been driven almost entirely by the short side in momentum and low-beta stocks and the long side in value, a sign short covering is playing a big role. Value stocks have outperformed growth by 6.5 percentage points this month, reversing the August trade, and Empirical Research thinks it’s possible some sort of trade-war truce could push value outperformance to 10 percentage points. But it views the current environment as a tactical opportunity that could be exhausted quickly. Of 17 10%-plus beta rotations in the last 20 years, the average up-move has been 20% over six months, JP Morgan says. Given the market is closing in on year-end, when the sensitivity to underperformance is greater, investors might feel compelled to join this trade, particularly since value’s starting position was so negative for so long. Since 1986, whenever correlations between momentum and value fell to current levels, value has tended to outperform the next 250 days (though the presence of algorithmic trading is a new, important feature).
One might think that if bond yields were truly heading higher on a sustainable basis, Utilities and REITs, both of which have benefited greatly from investors’ persistent thirst for yield, would follow suit in correcting. But Wolfe Research observes these bond surrogates have barely flinched in an absolute sense, consolidating near their respective highs as they burn off their internally overbought conditions. Running late, with traffic and all, along the New Jersey Turnpike, several cars at our exit were backing up along the shoulder of the road. A tractor trailer was flipped sideways, and my colleague expertly, but barely, fit our car through. Politics were discussed with one advisor commenting that the presidential debate vs. Trump “is going to be epic.” Musing about a Trump loss in a close election, an advisor at another meeting bets that “He’ll contest it!” A lunch with seasoned advisors clearly had views on opposite sides of the political aisle. “You have to agree that he (Trump) is intelligent.” “I don’t know that I agree with that at all.” Advisor on the right: “You give him more credit than he deserves.” Advisor on the left: “You don’t give him enough.” Advisor in the middle: “The truth is somewhere in between.” New Jersey advisors kept me on my toes, no problem. But there are several events ahead which results will be binary (welcomed or hated by the market), and for these I insist I won’t pretend to predict the future. This satisfies most, but one New Jersey advisor quipped, “Isn’t that what you’re supposed to do?
- Lower mortgage rates lift housing Builder confidence in September rose off an upwardly revised August to its highest level in nearly a year. While supply-side challenges such as labor and lot shortages remain, low interest rates and firm demand bode well for starts over the next several months, particularly in the single-family area, where confidence picked up the most. August starts and permits rose more than expected.
- The Fed is supportive Policymakers as expected trimmed the target funds rate another quarter point, but it’s not certain that the Fed will make a third such move before year-end. The central bank’s statement didn’t change much from July, and the dot plot suggested committee members were divided over the need for further reductions.
- Is manufacturing’s bottom in? August industrial production rose the most in a year as both durable and nondurable goods manufacturing posted strong gains. Core industrial production, which excludes energy, high tech and vehicles, advanced the most since April 2018, led by business equipment. However, year-over-year activity remained soft.
- CFOS gloomier Optimism about the U.S. economy among chief financial officers fell again in Q3 and for the fifth time in six quarters to a 3-year low, according to Duke University’s quarterly survey. Over half of U.S. CFOs expect a recession by next year’s third quarter, and 2 of 3 believe one will come by the end of 2020.
- Capex continues to lag Companies are taking advantage of lower interest rates and bond yields, but not to boost capital expenditures (capex). Instead, they are using the lower rates to focus on financial engineering by refinancing existing debt or issuing new debt. The latest Fed survey of the New York region showed capex and technology spending plans at multiyear lows.
- The MMT crowd is fine with this With a month left in the fiscal year, the federal government already has posted its first trillion-dollar deficit since 2012, and the Treasury projects fiscal 2020’s red ink will grow even wider. Modern Monetary Theory (MMT) advocates postulate that, as long as inflation remains subdued, there is virtually no limit on the amount of debt Treasury can sell due to our status as the world’s reserve currency, meaning deficits can keep climbing and be used to fund their multitrillion-dollar solutions to addressing climate change.
Election watch A new Cornerstone Macro investor survey shows a big shift in the consensus, with investors giving a slight edge to a progressive winning the Democratic nomination and having a real shot at becoming the next president. Such an outcome would have profound implications for public policy, the economy, major sectors of the economy and financial markets.
IPOS not overdone More than 75 initial public offerings (IPOs) have been completed in the U.S. year-to-date, versus an average 400 during the 1995-2000 tech boom (which as many investors recall, painfully went bust). The difference this time around is this year’s offerings have faster expected sales growth and lower valuations, trends that arguably can improve sustainability as these newbies mature.
In the end, they’re in the business of entertainment Media coverage was a common topic in my travels this week. One group noted how often Federated strategists appear on TV, and I shared how I used to appear a lot more before I started traveling so much. Back then, they’d be only two of us interviewed at once (vs. a split screen showing six talking heads currently). I’d make a comment, then the other would comment on what I said and the producer would egg me on in my earpiece, “Are you going to let that jerk get away with that?”