A tall, powerful, aggressive woman
I went back to Seattle this week, where I enjoyed glorious sunshine two out of three days. Locals joke about the many rainy days, though a well-preserved lady attributed her lack of wrinkles to the clouds and moisture. “My California friends look so rough,” she laughed. For the first time in my many travels here, which were confined to downtown Seattle and nearby Bellevue, I was treated to meetings in the charming Queen Anne and Ballard neighborhoods. In its early days, Ballard housed many Scandinavians due to the maritime feel and fish & forest economy. These proper people will only say “hello” and nothing more as they pass you by. Scandinavians like to give each other personal space, and so backslapping, hugging, kissing and touching the arms are more common between close friends and family. No advisor I met here is worried about inflation, at all. It could be the deflationary effects of technology (more below), whose influence is everywhere. This area is home to big Amazon, Facebook, Google, Microsoft, Zillow, etc., operations. Ballard houses lots of “brogrammers”—young computer nerds with a kind of fraternity/boys only, no-girls-allowed attitude and without the social graces of traditional boys clubs. That’s a shame, because they have a lot of money.
Every significant stock market decline and recession over the last 70 years has been preceded by the Fed pricking the bubble by raising short-term rates. It begins with prices going up for consumer and home loans. After hitting a low of 3.35% on a 30-year fixed-rate loan in September 2016, mortgage rates have been creeping up and now stand at 4.34%, near a 4-year high. The Mortgage Bankers Association (MBA) says the average rate is an even higher 4.64%. This is starting to hurt—January pending home sales were down sharply and February’s number is expected to be worse. February housing starts and permits plunged (more below). And the latest National Delinquency Survey from the MBA reflected a big and widespread rise in the FHA delinquency rate, excluding the effects of the hurricanes. Uh oh. On the consumer side, the personal savings rate is stuck in a historically low 2-3% range, overdue credit card debt is at a 7-year high and credit cardholders in arrears jumped nearly 11.5% in Q4 2017. What?! Further, at 45.3% of GDP, nonfinancial corporate debt is just behind the record high 45.4% during the financial crisis. The Institutional Strategist says 40% of earnings-per-share growth since 2009 was due to share buybacks; since 2012, the number is an astounding 72%. Much of this buying has been funded through low-rate loans and bond issuance. If this gravy train dries up, the single biggest source of demand for U.S. stocks also dries up. Gulp! The debt picture isn’t any prettier on the government side. Even before accounting for tax reform, the Congressional Budget Office says yawning deficits will push interest payments to 2.9% of GDP by 2027, the highest share since 1995 and nearly double what it is now. All of this has raised the interest-rate sensitivity of the economy to the point that even a smaller-than-normal backup in rates could have a meaningfully negative impact.
On the other hand, even as rates have started to rise, they remain historically low and manageable relative to rising incomes and wealth. The ratio of household net worth to disposable personal income hit a record high of 6.8 at year-end 2017, as household asset growth swamped debt growth, jumping 66% since Q1 2009 to $114.4 trillion. This consisted of $80.4 trillion in financial assets and $34.0 trillion in nonfinancial assets, both record highs. Also setting record highs: public and private pension and defined contribution plans at $23.2 trillion; the market value of stocks directly held by households, $17.9 trillion; and mutual funds, $8.7 trillion. As for the government, net interest payments represent 6.6% of outlays, less than half of what it was in the mid-1990s, as the Treasury took advantage of the low-rate environment to roll over debt into longer-term maturities. At 5.8 years, the average maturity of outstanding debt is close to its longest since 2001. Back in Seattle, my advisor at one client event greeted me with this warning: “We are Trumpophobic here.” At another client event, my host told me that “90% of Seattle hates Trump.” At least they are not worried about inflation (save housing prices) or interest rates. The Amazon effect? Thanks to the abundance of technology companies, everyone is young here! Though not paid particularly well, they’ve got lots of options! And dogs! One downtown Amazon building has a 20th floor outdoor dog park. In Seattle, there are roughly 25K Amazon jobs, expected to rise to 71K by 2019. A downtown advisor lamented the loss of his current view as two skyscrapers are being built around him. Dictionary.com defines Amazon as a fabled tribe of female warriors; or a tall, powerful, aggressive woman. Pittsburgh is in the final 20 for Amazon HQ2. We’ve got lots of strong, young girls.
Optimism soars The Michigan gauge of consumer sentiment hit a 14-year high this month, aided by gains in the assessment of current conditions among the bottom third of households where the tax cuts have begun showing up in paychecks. Corporate America sentiment also is strong—the Business Roundtable CEO Economic Outlook Index surged to a new high, driven in large part by optimism over tax reform. Hiring and capital expenditure plans also set records. And the NFIB Small Business Optimism Index reached its second-highest level ever, with a record 32% saying now is good time to expand.
Where are we in the cycle? After a mid-winter lull, industrial production perked up in February, rising the most in four months with strength in manufacturing and in particular business equipment. Worldwide, global industrial production now stands at a 6-year high and the global OECD Composite Leading Indicator increased for the 23rd straight month to its highest level in three years. The share of individual countries in expansion territory remains elevated at 64%, well above the 50% threshold typically associated with global recession.
Manufacturing jobs jump February’s 1.8% year-over-year (y/y) jump in factory jobs, the biggest in almost eight years, outpaced total payroll growth for the first time since 2012. There’s little sign of a slowdown anytime soon—the manufacturing workweek for production and nonsupervisory workers is 42.2 hours, matching its longest since 1945. Additionally, manufacturing overtime is at 4.7 hours, the most since April 2000. Early indications suggest this momentum has carried over into March, with robust Philly Fed and Empire regional readings showing stepped-up hiring.
If we’re ever going to get inflation, this would be the year Abetted by the weaker dollar, import prices rose a seventh straight month, pushing the y/y rate to 3.5%. However, import prices represent a relatively small share of overall inflation. The more influential CPI & PPI moderated and were up modestly, respectively, causing the 10-year Treasury yield to stall. SIS Global posits that inflation is “theoretically’’ impossible without accelerated M2 growth—this broad measure of money supply has been slowing despite strengthening employment. And Empirical Research sees little historical correlation between inflation and wages, which have moved up somewhat but remain well below levels typical for this stage of a cycle. It believes disruptive technologies remain a dominant, countervailing force.
Retail sales soften They slipped a third straight month in February, with delayed tax refunds a likely culprit, similar to last year as the IRS cracks down on fraud. Severe winter weather in the Northeast also may have played a role. Still, the lackluster performance suggests consumers are not that eager to spend, even though their paychecks are growing as tax reform kicks in. The biggest drag came from vehicle sales, down a fourth straight month. Sales ex-vehicles rose 0.2%, half the consensus. Still, on a y/y trend basis, retail sales were up 4.3%, while discretionary retail sales varied between 4.2% and 5.3%. All indicate some loss of momentum, nothing worse.
Too early to sweat the housing slump February housing starts and permits fell to much lower-than-expected annualized rates of 1.236 million and 1.298 million, respectively. The drop-off was almost entirely in the multi-unit sector, as y/y single-family starts were up nearly 3% while permits dipped for the month but were still up nearly 5% y/y. This volatile metric is prone to seasonal affects, particularly in winter. Builders remain confident. While the Housing Market Index slipped a third straight month, it remains near its highest level since mid-2005.
Independent! The Institutional Strategist expects that within a year, the U.S. will pass both Saudi Arabia and Russia to become the world's No. 1 producer of crude oil. It’s currently producing at a pace of almost 10.4 million barrels per day, exceeding 1970’s U.S. oil production record of 10.3 million. A recent Dallas Fed Energy Survey said almost half of oil & gas CEOs expect a “substantial” increase in the number of rigs if crude remains between $61-64 a barrel.
Amazons! Only nine S&P 500 companies have produced 20% revenue growth in 2016 and 2017, and they are expected to generate a 20%+ sales increase in 2018 as well. Four of these stocks are FANGs—Facebook, Amazon, Netflix and Alphabet (ticker: GOOGL).
Only in Seattle The “Seattle Freeze” is a phenomenon in which residents pretend to be friendly but form only the most superficial of social connections, a circumstance observers say is being fueled by the rapid growth of Amazon and its accompanying influx of mostly young, male technology workers who don’t have time to be interested. Soon they may be able to relax as Seattle expects to get an NHL expansion team in 2020, bringing major league hockey back to the first city outside of Canada to win the Stanley Cup (the Metropolitans in 1917).