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The “No Respect” Trade

The Days Ahead:
U.S. looks tired. Keep eyes on Europe and dollar.

This is a mid-week update due to travel schedules. Hold the applause. We had our first big correction this week. Well, it was 2% over two days which in past years would have been a “hold page 6” story. But because the VIX (volatility) has been moribund, it got more attention than it deserved. The VIX jumped 35%, which, again, sounds like a lot, but we’ve never paid much attention to that index unless it’s in the 20s and moving fast (buy us beer and we’ll tell you why it’s a rotten index.)

So why? Markets are kind of efficient until they aren't. No real new news (fake or other) came down the road. But the realization that infrastructure, tax and regulatory reforms may have to wait while Congress burns momentum on a health care act, is seeping in. Economic data was thin but what there was, disappointed. First up were existing home sales. New housing starts get most of the attention but we watch existing home sales because:

a) that’s where a lot of private wealth is stored (it’s around 30% of household net worth and 50% larger than equities, the second big asset)

b) if you're selling your house it’s usually a sign of confidence

c) it’s a good indicator of where people think interest rates are heading

d) existing home sales are nearly six times larger than housing starts

You would think that with consumer confidence on the rise (well at least among the old folk), people would start to buy houses. But inventories and sales fell. We’ve argued that the economy has little chance of breaking out of its 2% growth range and Q1 is almost certainly going to be well below that. We won't know until April 28th but don't hold your breath.

Anyway, Treasuries rallied to 2.3%. You would have made nearly 5% if you had timed the 30-year bond. (But, you know, that's not investment advice.) Remember the recent high was 2.6% and the charts show that Treasuries have gone nowhere since mid-December. So, yeah, the reflation trade looks a little tired. But nothing to get wound up about.


1. Meanwhile in Europe: We've mentioned that Europe gets the Rodney Dangerfield treatment. Investors have been underweight for years but this year European stocks have rallied strongly up about 4% in local terms and nearly 7% for a U.S. investor. Compare that to the S&P 500 at 4.8%. The Euro has recovered strongly and bonds have remained pretty much unchanged despite the overblown political risk. When we put up some basic valuations on European stocks, this is what we see:

Now there’s a lot more to Europe than a valuation story but those numbers on the right hand side (so 9.3%, 15x, 5.4% and 3.5%) compare well to the U.S. market at 14%, 18x, 5% and 2%. Also, we ran some numbers showing

a) that 622 stocks, or 48%, in Europe are more than 25% below their all-time high. In the U.S. it’s 30%.

b) 612 companies, or again around 48%, yield more than Europe sovereign bonds. In the U.S. it’s also 30% against the 10-Year Treasury.


2.  What's with the Dollar? After its post-election rally and talk about pricing multi-nationals out of business, the dollar rally looks well and truly stalled. It’s down around 4%. Here’s one reason why:

This is the spread between U.S. Treasuries and German Bunds. They are at their widest in over 30 years. Why? It’s down to i) Central Bank policy differences (the ECB is easing, the Fed is not) ii) inflation differences (the U.S. is around 2%, Europe is at 1.5%) and iii) early stage growth from a lower level rather than slower growth from a mature level. Anyway, that’s all very supportive of a stronger Euro and probably, although they won't say so, what the U.S. Treasury wants.


3. Corporate America to Bank Lending: “Yeah, we’ll let you know." We looked at the Bank Officers recent tightening/easing survey and advanced actual C&I (Commercial & Industrial) loans by a quarter.

It’s not great. Loan officers report a gradual tightening and three months later, loans drop. This hasn't quite happened yet but we’ve just seen a drop in the upward growth of loans. We'll have to see if this recurs in the Q1 survey due in May. Either way, makes you wonder what all those corporate go-get-‘em surveys are actually going to do.


Bottom Line: Recent market nerves will probably subside. Energy stocks are soft, down 10% since December. But the market is getting used to that. We're looking at Europe hard and are looking to increase our allocation.


Other:

When the Fed and the President clashed (the Fed won)

U.S. is not happy

It's a 2% world, Jim, pretty much as we expected


--Christian Thwaites, Brouwer & Janachowski, LLC


Please note that this discussion of our investments and investment strategy (including our research and investment process) represents our investments and investment strategy at the date of this commentary, and is subject to change without notice.  We cannot assure that the type of investments discussed in this commentary will outperform any other investment strategy in the future, nor can we guarantee that such investments will present the best or an attractive risk-adjusted investment in the future.  This is for general informational purposes only; references to an individual security should not be construed as a recommendation to buy or sell that security.  The securities mentioned in this commentary are only several of the successful as well as unsuccessful investments by us, and do not represent all of the securities we have purchased, sold or recommended.  Although we deem reliable the sources of the statistical and other information referred to in this commentary, we cannot guarantee the accuracy or completeness of any statements or numerical data.  Past performance is no indication of future results.

All charts from Factset unless otherwise noted.

The Reflation Deflation Tussle

The Week Ahead:
A quieter week on the data side. Look to Europe.

Last week was heavy on data with the Fed taking center stage. Housing, inflation, industrial production, and retail spending came in at or slightly below expectations. Producer prices were a little high at 2.2% but some of that is because we’re in the middle of a four-month stretch where oil prices are rising nearly 100% year on year. On Friday, we also had the so-called Quadruple Witching day when four types of options expired. But this happens like clockwork every quarter, so you would think the market prices this sort of stuff in. The upshot of the week was that the Atlanta GDP Now forecast was again revised down to 0.9% growth for the first quarter. The Fed thinks it’s going to be 2.1% for the year and the administration thinks it’s going to be 3%. So there’s that reality/belief gap going on.

Stocks held up well with the S&P 500 hitting another all-time high on Wednesday but giving some of it back by the end of the week. Emerging Markets had another strong week. They're up 12% this year. Germany and Japan, while both below their all-time highs (Japan especially) also had good weeks and are up 10% and 13% this year.


1.     Oh yes, they did: The Fed signaled the latest increase clearly and loudly over the last few months. You know, dropped hints, speeches, dot plots. So, when they announced the 25bp increase, bonds rallied with the 10-Year Treasury yield down 10bp. While the move seemed hawkish, everything else around it was on the dovish side.

  • First, Neel Kashkari, (yes the same one who smashed up a train but is quite a decent Governor at the Minneapolis Fed) dissented…the first dove dissent in almost three years. Keep an eye on him. It’s possible he’s the next Fed Chair.  
     
  • Second, the infamous (short may they live) dot plots barely moved for 2018, clustering around a 2% Fed Funds rate.
     
  • Third, no mention of any balance sheet unwind. 
     
  • Fourth, they revised up economic growth by a whopping 0.1% in 2018. That’s $16bn of growth in a $19 trillion economy. Or one SNAP. Or what Americans spend on ice cream. Anyway, it seems suspiciously accurate and irrelevant.

The big question: is the Fed dovish? The chart says, “Yes”. It shows the change in nominal GDP and the Fed Funds rate. The gap between the two is 2.5% right now. The last two times they were this “easy” the gap was around 3% to 5% but, crucially, for much shorter periods. It doesn't mean that they are about to tighten. It just means we’re in an easy phase and they don't last forever.


2.     Meanwhile, the winner this year: Emerging Markets. Recent articles here and here, remind us that this asset class has less to do with the dollar or relative valuations than 1) sovereign creditworthiness 2) commodity prices and 3) the growth differential between developed and emerging market economies.

On the first, look at the spread between Emerging Markets sovereigns and the U.S. They are falling, so check to that one.

On the second, we’d note the oil price we discussed above but add in copper (+17%), nickel (+13%), steel (+54%) and Iron Ore (+62%). And on the third, we’d point to a) U.S. growth at 2% providing there’s a strong tail wind and a big spike in Q2 through Q3 and b) Emerging Markets, which are still at the 5% plus region. So the first two are done. The third seems to be happening. And across all, we see more optimism than we've seen for years.


3.     Deflation or reflation? As we’ve noted before, the market is hoping on reflation, which is the deregulation, growth, lower taxes trade. That story got a bit of jump last week with the Fed, inflation levels in shelter and housing and the quit rate on the JOLTS report. The deflation forces are a strong dollar, lower oil prices and budget cuts. And the deflation forces got a bit of boost as well last week with two bills.

First, the American Health Care Act, which from a strictly economic point, cuts the deficit by over $300bn over 10 years. In the next two years alone, they would cut government spending by twice the amount the Fed just raised their growth forecast.

Second, the America First budget, which takes off around $30bn in discretionary spending in year one alone (back to those Fed forecasts again) and some pretty fierce cuts of 6% to 18% in Agriculture, Commerce, Education and Health. Put together, these are the only detailed bills we’ve seen from the administration. The talk of huge tax cuts and growth policies has dimmed.

Apparently, both are dead on arrival. But as a Season 7 addict of the Walking Dead, the dead are a menace. 


Bottom Line:
We mentioned the recent low volatility in the U.S. market last week. Well, it’s in Europe as well.

 

And that’s despite a run of European elections. But Europe looks attractive mainly because it’s coming from such low expectations. Remember, markets have some of their greatest returns when they turn from truly awful to not-as-bad-as-we-feared. Which pretty much sums up ex-UK Europe.


Other:

Brand-new mission statement from Treasury

Mt Etna erupts

How a woman would handle the Korea BBC interview


--Christian Thwaites, Brouwer & Janachowski, LLC


Please note that this discussion of our investments and investment strategy (including our research and investment process) represents our investments and investment strategy at the date of this commentary, and is subject to change without notice.  We cannot assure that the type of investments discussed in this commentary will outperform any other investment strategy in the future, nor can we guarantee that such investments will present the best or an attractive risk-adjusted investment in the future.  This is for general informational purposes only; references to an individual security should not be construed as a recommendation to buy or sell that security.  The securities mentioned in this commentary are only several of the successful as well as unsuccessful investments by us, and do not represent all of the securities we have purchased, sold or recommended.  Although we deem reliable the sources of the statistical and other information referred to in this commentary, we cannot guarantee the accuracy or completeness of any statements or numerical data.  Past performance is no indication of future results.

All charts from Factset unless otherwise noted.

 

Hey, where’s my stimulus package?

The Week Ahead: Eyes on the Fed. Don't expect much.

Politics took a back seat last week and Central Bankers took center stage again. The Fed continues to make it clear that if they see positive growth measures, they will hike in March (the Fed meets this week). In our view, growth metrics do not convince. We see reasonable job numbers (see below) but ISM labor conditions, the trade deficit, consumer credit and inventories continue to point to more of this so-so recovery. So, on balance surprises more to the downside than upside.

Stocks tracked sideways last week. They’re down 1.2% from their peak a few weeks ago but still up 5% this year. International and Emerging Markets continue to hold their gains, with a strong showing in Germany. And the long bond yield climbed about 12bps. There seems to be resistance to rise much above 2.6% for any sustained period. We think for most of this year we will trade in a range 2.4% to 2.8%.


1. Talking of Central Bank speak: the European Central Bank stood firm on rates and indicated it is not likely to ease further. The chart shows the policy rate at 0% even though inflation in the Eurozone climbed to a cyclical high of 2%.

The ECB has a tough job mainly because tying together the needs of Germany, Italy, France and Spain (the big 4) is a compromise exercise. Inflation in Germany is around 0.2% but in France and Italy more like 1.5%. Then there’s the base effect of low gasoline prices a year ago putting upward pressure on prices (a similar story in the U.S.) so they have to work on the harmonized ex-food and energy prices. Put it all together and we’re likely to see easy money for a while, which is one reason (along with some decent earnings), we like European stocks right now. And just to be clear, European stocks have a large financial weighting at around 23% compared to the S&P 500 at 15%. Any (yes, any) upward change in rates will send those financials sharply higher.


2.  We have to talk jobs: Friday’s job report was likely to be better than recent months if for no other reason that March numbers have come in higher than expected in four of the last five years. Here’s the chart:

So, this is what we know. The labor force continues to grow by around 1.1m or 0.7%. It grew by 340,000 last month. Non-Farm payrolls grew 227,000 (so not enough to absorb new entrants) and 2.2m in the last 12 months. So far so OK. But wage growth barely moved (it’s that creeping yellow line at the bottom) and most of the job growth (but not this one it must be said) is in low paying jobs like retail and leisure, which are 21% of the labor force. Again, put all this together, and we think this so-so recovery will run. Yes, it’s in its seventh year but it has barely broken a sweat in that time and trundles along at a less than inspiring 2%.


3.  And so to bonds: Treasuries traded better on the jobs numbers, so the 227,000 number was priced in. We'd argue that the lower revisions to Q1 GDP ( the Atlanta Fed is particularly good at this) the low earnings number and absence of inflation make bonds a reasonable bet. Yes, front-end rates can rise but the following can mitigate a bond sell off: high real rates, more issuance of longer dated Treasuries, credit spread compression and lower term premiums. So bond bears can write their doomsday plays, we stick to the facts. 

We came across an interesting chart the other day and recreate it here:

 

It shows the growth of Federal Debt and the 10-Year Treasury note. The suspension of the debt ceiling in 2015 meant the Federal Debt grew at around 5%, spiking in October 2016. There is a good fit with the 10-Year Treasury, which ratcheted up back in 2010 and again recently. So if debt growth tapers off, we may have seen a near-term peak in rates.


Bottom Line:
The longer the health care debate continues, the longer the delay of any stimulus package. The market expects something so stocks may just hit the snooze button for now. We have not had a serious correction in months and volatility is weirdly absent. Not saying it’s coming but, you know, eerie.


Other:

Germans really like the Euro

Farm closures coming

Street says sell Snap  


--Christian Thwaites, Brouwer & Janachowski, LLC


Please note that this discussion of our investments and investment strategy (including our research and investment process) represents our investments and investment strategy at the date of this commentary, and is subject to change without notice.  We cannot assure that the type of investments discussed in this commentary will outperform any other investment strategy in the future, nor can we guarantee that such investments will present the best or an attractive risk-adjusted investment in the future.  This is for general informational purposes only; references to an individual security should not be construed as a recommendation to buy or sell that security.  The securities mentioned in this commentary are only several of the successful as well as unsuccessful investments by us, and do not represent all of the securities we have purchased, sold or recommended.  Although we deem reliable the sources of the statistical and other information referred to in this commentary, we cannot guarantee the accuracy or completeness of any statements or numerical data.  Past performance is no indication of future results.

All charts from Factset unless otherwise noted.

 

No denying the winning streak

The Week Ahead:
No denying the winning streak. But keep an eye on jobs.

We're writing this end of day on Wednesday, so two days before our normal deadline. Travel commitments. U.S. stocks hit another record high mid week but failed to close at their highest level. The S&P 500 has returned over 7% year to date and 11% in the last six months. It’s the twelfth all-time high in the Trump presidency and that's out of 28 trading days. You have to go back to McKinley to have seen that before (h/t Cameron Crise at Bloomberg).

Along with the highs, we have seen the VIX volatility measure at around 11. It briefly reached the mid-20s last year at Brexit and election time but has since then been a sideline of a sideline.

This week was more about Fed speak and the President’s speech to Congress. The Presidential speech was short on detail but that does not really matter. U.S. businesses right now are enjoying the very high probability of regulatory relief, lower taxes and more confidence. If there were any real concerns about negotiating pharma prices or moving to the next step in Dodd-Frank, they have evaporated.

The Emerging Markets and European markets forge on. Emerging Markets are about relative valuations (they’re cheaper than the U.S.) and diminished concerns about the dollar. Europe is about better growth, ongoing QE and lower, or at least manageable, political risk.


1.  Fed talk: last week was more about throwaway lines from Fed Governors. It’s important to note that there are four ranks of Fed Governors: i) the Chair and the Vice Chair ii) the permanent members of the FOMC, which includes the NY Fed iii) the voting members of the FOMC and iv) participants at the FOMC, which includes non-voting regional Fed chairs. It doesn't really matter what the last group says but it sure does if any of the others do. This week, William Dudley at the New York Fed felt that rates could go up sooner because confidence and animal sprits are on the rise. Short rates promptly surged. Here they are as of Feb 28th and March 1st:

Now in the world of T-Bills that is a very aggressive move. Some may be due to the Treasury keeping supply of T-Bills low ahead of next month’s debt ceiling debate. You know the one where Congress says it’s a good idea to default on the debt and the financial markets say, “no. not a great idea” so the Treasury buys some insurance by selling longer dated debt ahead of the debate. There was a sell off in longer dated bonds as investors thought there was a strengthened case for a March increase.


2. But growth is still weak: We saw the revised Q4 2016 number come in at 1.9%, which was below expectations. The big disappointment was trade, which cut some 1.7% from growth as imports grew 10%. If we’re to hit anything like the claimed 3% growth, then we must fine about $600bn from either the consumer or investment sector because it’s unlikely to come from government or the trade sector. That would be asking the consumer to grow spending by around 4.6% which seems highly unlikely, especially given numbers like this:

This shows consumer confidence growing nicely (the blue bars) but with a very large difference between the over-55 group, lower line, up 25% since the election, and the under-35 group, the upper line and down 22%. The younger group has a much larger propensity to consume than the older group so if they ‘ain’t feeling it, it’s tough to see how all this growth will come about.


3. Meanwhile there are good indications on the global level. Here they are:

The way we read this that is macro economic risk has fallen (think less likelihood of deflation and political risk) and the surprise indexes are up (things like inflation and rates). They are up big in Emerging Markets and trending much better in Europe. This makes us very positive on the non-U.S. markets, which U.S. investors neglected in the last few years.


Bottom Line: Earnings season is over. It was a strange one as growth was insufficient to move results much in the fourth quarter yet earnings were up 5% compared to estimates of 3%. So we have animal spirits, the reflation trade back and (marginally) higher rates ahead of us. Game on. But we also have some insurance with Treasuries and TIPS.


Other:

The world of Alex Jones

Active managers on passive managers

Race for autonomous cars is over. Silicon Valley lost


--Christian Thwaites, Brouwer & Janachowski, LLC

Questions or Comments?
Email me: cthwaites@bandjadvisors.com


Please note that this discussion of our investments and investment strategy (including our research and investment process) represents our investments and investment strategy at the date of this commentary, and is subject to change without notice.  We cannot assure that the type of investments discussed in this commentary will outperform any other investment strategy in the future, nor can we guarantee that such investments will present the best or an attractive risk-adjusted investment in the future.  This is for general informational purposes only; references to an individual security should not be construed as a recommendation to buy or sell that security.  The securities mentioned in this commentary are only several of the successful as well as unsuccessful investments by us, and do not represent all of the securities we have purchased, sold or recommended.  Although we deem reliable the sources of the statistical and other information referred to in this commentary, we cannot guarantee the accuracy or completeness of any statements or numerical data.  Past performance is no indication of future results.

All charts from Factset unless otherwise noted. 

Many Highs, Fewer Certainties

The Week Ahead:
Investors are optimistic. International looks strong.

Stocks edged higher…again. Although there will come a time when that won't be the opening of our weekly blog, for now U.S. stocks are riding the reflation story. Last week there was enough talk about tax changes from the newly minted Treasury Secretary to give stocks a rally (as we write this Thursday evening in a balmy New York). The news was mainly about middle-class tax breaks passing before the August recess and the diminishing likelihood of a “border tax” which importers, and especially retailers, clearly dislike.

Remember what supports this rally: i) corporate and ii) personal tax cuts iii) deregulation iv) infrastructure and v) a general pro-business agenda. Congress will likely kick infrastructure into 2018. We believe tax reform may not pass until late 2017, effective for 2018, especially as there are core opponents of any federal debt increases. If nothing passes for a few months, this does not yet impair the broadly positive investment story.

Here’s where it may be helpful to recall the last time big tax changes were in the air. The 1980 post-election rally spluttered out in early 1981 and fell 30% in the next 18 months. The first batch of Reagan tax cuts (the one that reduced top rates of income tax from 75% to 50%) passed in August 1981, some seven months after he took office. Not much happened. Then came the Tax Responsibility Act in late 1982, which reversed many of the tax cuts. That’s when the market took off and rallied 250% in three years. The second big round of tax cuts didn’t come until 1986. Here’s what the market did:

 

So the path was: i) tax cuts coming so big rally but ii) they were slow to pass so a big correction and then iii) they came but the market didn’t like them as they ballooned the deficit and so the market corrected more and iv) the tax cuts were partly reversed and the market took off. Now, we are not in the 1980s. But it suggests that markets won't wait forever for some fiscal action, time is not boundless and tax cuts have to be deemed responsible.


1. Global Equities: continue to move higher. The following chart shows just about all the developed economies’ stock markets lumped together. They have reached a record high. All those vertical shades are recessions in Japan, Germany and the UK. We left out U.S. recessions because they overlap but are not as frequent or as durable.

So, four points from this. One, the climb back from the double bear markets was long and tortuous for global stocks. The U.S. did fine but many markets are only just getting back to 2000 levels. Two, below the headlines all is not what it seems. Out of the roughly 1,600 stocks in the above, only 246 have hit record highs. Third, within the broad U.S. universe of all stocks, about 30% are loss-making (think the Twitter, Tesla, SalesForce, Alcoas of the world but many smaller companies) and, finally, even with a robust earnings season behind us, there are still four major industries (Autos, Transportation, Telecom and Energy) which have shown four quarters of successive earnings declines.

H/T UBS and John Authers of the FT.


2. We’re looking for ways to judge the market: and came up with this one. It measures the market capitalization of the S&P 500 to U.S. nominal GDP. The numbers are a bit tough to get one’s head around but U.S. GDP is around $18.3 trillion and if you had $20.3 trillion you could buy every major company on the New York Stock Exchange (assuming the anti-trust folks were looking the other way).

Now, in hindsight, a number below 0.8 was a buy signal and above 0.9 a sell. We’re at 1.04. This is not a definitive metric of course. But it does show what we know: stocks are no longer cheap. The outlook remains positive but a correction may come.


Bottom Line:
U.S. Treasuries had a good week with the yield dropping to 2.38% from 2.50%. Mortgages also had a good week although that may be down to technical reversal from a poor January. For now, all markets seem on a positive momentum.


Other:

Changing the way exports are counted

More on the world’s biggest IPO

People debate about how to measure inflation


--Christian Thwaites, Brouwer & Janachowski, LLC

Questions or Comments? Email me: cthwaites@bandjadvisors.com


Please note that this discussion of our investments and investment strategy (including our research and investment process) represents our investments and investment strategy at the date of this commentary, and is subject to change without notice.  We cannot assure that the type of investments discussed in this commentary will outperform any other investment strategy in the future, nor can we guarantee that such investments will present the best or an attractive risk-adjusted investment in the future.  This is for general informational purposes only; references to an individual security should not be construed as a recommendation to buy or sell that security.  The securities mentioned in this commentary are only several of the successful as well as unsuccessful investments by us, and do not represent all of the securities we have purchased, sold or recommended.  Although we deem reliable the sources of the statistical and other information referred to in this commentary, we cannot guarantee the accuracy or completeness of any statements or numerical data.  Past performance is no indication of future results.

 

All charts from Factset unless otherwise noted.

 

What Were They Thinking

The Week Ahead:
Quieter economic week. The dollar holds the key.  

Stocks had a good week…again. The S&P 500 was up around 2.6% bringing the post-election rally to 12%. Is this all about unbound enthusiasm for economic policies that are months away from implementation? Not really. The first leg in the market was simply removal of uncertainty. This accounted for the first rally. Stocks then stayed in a holding pattern from mid-December to early February. It was the same for bonds. First, the initial spring upward of rates from 1.8% to 2.6% then a gradual pull back to 2.4%. If you were invested in a 25-year Treasury, the price fell from $130 to $109. It’s now $114.

So the first leg was all about uncertainty removal. The second leg is all about policy, re-regulation and a faith in reflation. This is where it gets tricky. U.S. stocks are pricey. If it turns out that the sound and fury signify, well, not very much, stocks are going to have a tough time holding these levels. It’s interesting to note that Small Company stocks have not had the second leg rally. And that International and Emerging Markets have strongly outperformed U.S. stocks this year. This makes sense. The strong dollar, reforms and some good numbers from Germany, South Korea and China all point to a healthier outlook for non-U.S. markets. Here’s the chart:

This shows all non-U.S. markets against just the U.S. market. In the last 10 years, U.S. stocks have returned around 60%. Non-U.S. stocks around 0%. But if you look closely at the top right, you can see this has begun to reverse. Year to date, International stocks have kept up with the U.S. while Emerging Markets have pulled ahead. We think this will probably continue.


1.  Rates: Chair Yellen gave a cautious testimony to the Senate. It seems like the Fed is waiting to see what economic policy brings. This is the key line: “Among the sources of uncertainty are possible changes in U.S. fiscal and other policies...productivity growth, and developments abroad”. That's one unknown, one known (productivity growth is way below its 30 year average) and one “who knows what’s up with the EU. But we do know this. With all the talk about rate increases, borrowing costs are low - really, really low.  Here they are:

That bottom line shows the 10-Year Treasury less the latest, raw inflation rate. It’s negative. If real borrowing costs are negative, any positive rate of return makes business sense. This is another reason U.S. companies have a reason to remain bullish. Debt is cheap and the investments hurdle low.


2. What the cuss were they thinking: It’s not often we talk about individual stocks but this was too good to pass up. So Kraft Heinz, which was cobbled together a few year ago from, er, Kraft and Heinz, and which is 50% owned by a private equity firm and Berkshire Hathaway, launched a bid for Unilever on Friday. There are three things going on here. 1) The hostile bid was triggered by a weak sterling, so good if you raise money in dollars 2) there was going to be a lot of debt around as Kraft Heinz is worth around $117bn and Unilever $140bn and 3) it was going to be the mother of all contested take overs because Kraft can't find growth to save its life and its net income is one quarter of what it was a few years ago.

By Sunday, it was all over and Kraft Heinz retreated with some nonsense about “utmost respect”. Here’s the graph:

The reason this gets into the blog is to ask: is Warren losing it (probably not) and are we going to get a run of mega cross-border mergers, because that’s top of the market stuff.


Bottom Line:
Earning season is 90% done. It's the first time since 2014 that we have seen two consecutive quarters of positive growth. One forgets how deep was the energy and financial earnings recession in 2015 and 2016. Again, look at international markets for bigger moves.


Other:

How economic populism works

Declining home ownership

The Whipsaw Song


--Christian Thwaites, Brouwer & Janachowski, LLC

Questions or comments? Email me: cthwaites@bandjadvisors.com


Please note that this discussion of our investments and investment strategy (including our research and investment process) represents our investments and investment strategy at the date of this commentary, and is subject to change without notice. We cannot assure that the type of investments discussed in this commentary will outperform any other investment strategy in the future, nor can we guarantee that such investments will present the best or an attractive risk-adjusted investment in the future. This is for general informational purposes only; references to an individual security should not be construed as a recommendation to buy or sell that security. The securities mentioned in this commentary are only several of the successful as well as unsuccessful investments by us, and do not represent all of the securities we have purchased, sold or recommended. Although we deem reliable the sources of the statistical and other information referred to in this commentary, we cannot guarantee the accuracy or completeness of any statements or numerical data. Past performance is no indication of future results.

All charts from Factset unless otherwise noted. 

A Touch of Reality

The Week Ahead:
Yellen at the Senate. Look for a policy clash.

Stocks had a good week, up around 2% from the bottoms we saw on Tuesday. But then bonds had a good week too with a strong 10-Year Treasury auction at 2.3%. Remember this is the same bond that topped out at 2.6% in December, so the total return for a long bond since then has been around 2.1%. And international stocks fared well with German, Italian and Swiss stocks all up around 3% this year and Asia and Emerging Markets stocks up between 3% and 8%. For the first time in many years, it has paid to own international stocks.

You would think with all the hyperactive politics, markets would run scared. But they seem inured to much of the news flow. Our guess is that it’s all too fast and possibly inconsequential. Now, we’re not downplaying the importance of an executive/judicial face off. Far from it. It’s just that markets like the sound of “phenomenal” tax reforms (Thursday) and more deregulation (also Thursday) more than Nordstrom (Wednesday) and the One China Policy (Friday….but it’s hard to keep track).  

Most of the post-election themes remain. U.S. equities rose then leveled off. The same with bonds, except in the other direction. Financials and cyclicals rallied and leveled. In other words, markets are prepared to give the benefit of the doubt by not selling off but not quite ready to jump to another level based mostly on unfulfilled expectations. Two markets have changed direction, however. First, Emerging Markets because they’re producing some strong numbers regardless of the U.S. (see our note here). Second, the dollar, which lost about 2% since January 1st.


Here's what else is going on:


1. Jobs, jobs, jobs

Mixed signals from the labor market. Claims were low, as they have been for some time. That’s all good and they are an excellent real time indicator. But more and more people are self or part-time employed or simply not eligible for benefits. So they don't file claims. You can get good claims numbers with less people not bothering to show up to register for something they can’t get. It’s not the job of the BLS to track them but it does make us a little skeptical about the low level of claims. And we saw that in the JOLTS (Job Openings and Labor Turnover Survey) report.

The number of job openings is flat. And the number of “Quits” is back to 2015 levels. Think of the “Quits” as the “take this job and shove it” measure. The more confident you are about finding another job, the more likely you are to quit. In a recession, you stay put. In a boom, you find a better job. Anyway, they are down a bit although they lag the employment numbers by a month.


2. Emerging Markets

We’ve written about Emerging Markets for a few weeks now. We like them more and more. This week we saw China exports rise by around 8%, twice the consensus and the first big positive number in two years. Here it is:

We looked at Emerging Markets compared to U.S. stocks. For most of the last seven years any investment in Emerging Markets was hardly worth the candle, as shown here...

…which we would summarize as “down bad, up good”. What's interesting here is that the up-line has reappeared strongly since the post-election sell off. This is an interesting chart as the bounce back has tested the bottom and come back strongly. As we have said before, we’re not chartists but others are and they pay attention to stuff like this. For us, we like the fundamentals of Emerging Markets and the chart helps overall sentiment. And on the fundamentals, productivity is up, yields are strong and earnings are growing.


3. U.S. Stocks

There is plenty of market commentary about growth/correction/massive downturn. We'd argue that those nearly always reflect how they position their book. If you’re short, you talk the doomsday game. If leveraged long, it’s Release the Hounds. We're fans of history and so looked at the real earnings yield. Bear with us.

We take the price earnings of the S&P 500 and flip it to create an Earnings Yield (yellow line). That tells us how much companies are earning relative to firm value. It should be a decent multiple of a risk-free rate. We then subtract inflation so we have a real yield to compare to the nominal Treasury yield. If this number gets much below 2%, it can indicate a market sell off, as it is did in 2000 and 2008. It’s now 3.8%, which is not as cheap as it was but not in risk territory.

Anyway, put all this together and we’re in favor of placing a marginal dollar into Emerging Markets. They've not risen as fast and may be in line for resurgence.


Bottom Line

Reporting season is 70% done. At the beginning of the quarter, analysts expected 3% growth and companies are reporting 5%. It’s all good, but look at international markets for bigger moves.


Other

• Should index funds be illegal?

• Pizza and fried chicken

• We lost a Fed Governor


--Christian Thwaites, Brouwer & Janachowski, LLC

Questions or Comments? Email me: cthwaites@bandjadvisors.com


Please note that this discussion of our investments and investment strategy (including our research and investment process) represents our investments and investment strategy at the date of this commentary, and is subject to change without notice.  We cannot assure that the type of investments discussed in this commentary will outperform any other investment strategy in the future, nor can we guarantee that such investments will present the best or an attractive risk-adjusted investment in the future.  This is for general informational purposes only; references to an individual security should not be construed as a recommendation to buy or sell that security.  The securities mentioned in this commentary are only several of the successful as well as unsuccessful investments by us, and do not represent all of the securities we have purchased, sold or recommended.  Although we deem reliable the sources of the statistical and other information referred to in this commentary, we cannot guarantee the accuracy or completeness of any statements or numerical data.  Past performance is no indication of future results.

All charts from Factset unless otherwise noted.

 

The Fed Fights Back

The Week Ahead:
Watch the dollar. It's the key to Emerging Markets.

We won't recap all the news items this week. There were too many and even the markets, with one finger over the trade button, were caught wrong footed several times. But of note were 1) bank deregulation coming because according to a new official:

“…. we’re not going to burden the banks with literally hundreds of billions of dollars of regulatory costs every year.  The banks are going to be able to price product more efficiently and more effectively to consumers.”

…which is pretty rich and 2) Congress said that the Fed must cease all negotiations on regulatory standards and 3) the Administration’s new trade adviser said the Germans are manipulating the Euro for their own gain. Now, if we learned one thing in 36 years of investing, it is that you cannot go around telling markets they are wrong because you disagree with them. The dollar duly sold off.

Of the three, by the way, number 2 is far the most worrying. Every generation learns painfully that an independent central bank safeguards inflation and the economy. If it comes under political pressure, you can bet that markets will fall fast. So far, the Fed has remained quiet but their statement last week warned clearly about inflation risk.

Meanwhile, financials had a good week (all that deregulation) and helped carry the S&P 500 to an all-time high. The stand out for risk assets was Emerging Markets, which are now up 6.6% for the year, nearly three times U.S. stocks. In a busy news week, this caught our eye:


1. Jobs: For an economy that had blowout numbers in consumer and business confidence in the last few months, the 227,000 increase in non-farm payrolls in January left us underwhelmed.

The unemployment rate, the line in the middle, rose and average hourly earnings grew at their slowest rate in almost a year… and on an unchanged workweek. That’s puzzling because minimum wage increases took effect in several states. Vermont increased minimums by 5% and five sizeable states increased by 10% to 25%. Those will hit the data eventually but nothing yet.

We would also point out that the gap between the official unemployment rate (4.8%) and the underemployment rate (9.4%) remains historically wide at 4.6%. It used to run less than 3%. That, and the participation rate, tells us that some parts of the labor market will either a) return as confidence and jobs increase or b) have permanently shifted to part time or c) exited the workforce. The Administration believes A. Anyway, we think this means no rate hike in March.


2.  Remember what’s driving the market: We've mentioned before, the reflation trade rests on deregulation, infrastructure spending, tax cuts and fiscal stimulus. There has been some chat on a border tax but precious little on the fiscal side. Time is running out. A fiscal stimulus like infrastructure must be approved, financed, planned and built. Call that 12 months at least. There is a quicker way. In 2001 and 2008, the Bush tax cuts provided tax rebates of $300 to $500 dollars, payable right into bank accounts. If that were happen today, it would cost about $70bn or 0.5% of GDP. Useful enough for growth, except look what happened back then: 

Yes, pretty much what you would expect. Savings went up and retail sales increased. But then fell back. It was a classic case of bringing consumption forward a few months and then back to normal. Both were done near the beginning of a recession and, darned if we can find any evidence that they did much good.


3. Emerging Markets: We’ve liked Emerging Markets for a while. The old Emerging Markets story was about massive raw material exports and infrastructure spend. So Brazil sold oil and China sold iron ore and built stuff. We're simplifying. Now it’s about domestic and indigenous growth. For that to work deregulation must take place and currencies have to stabilize. There are growing signs that is exactly what it happening.

China is cracking down on capital outflows and is likely to be the beneficiary of bilateral or regional trade agreements if the U.S. makes good on threats to leave as many trade deals as it can. Asian currencies generally have stabilized so mitigating any U.S. rate increase and Korean and Australian exports showed impressive numbers in the last few weeks. 

Those exports are headed somewhere and seem to us consistent with a “Buy EM” trade. Emerging Markets, remember, underperformed the U.S. since 2009 but stayed in line for most of 2016 until the election. They stumbled then but have recently outperformed. We think that's likely to continue.


Bottom Line:
Market volatility is remarkably low. The VIX is well below 12, although it’s such a flawed index that we rarely pay it much attention until it gets into the 30s. About half of the S&P 500 companies have reported with 52% beating sales (tough to do) and 55% beat earnings (easier). At this rate, the quarter is shaping up to be one of the best in three years.


Other:

Congress to Fed: Get in line

Robots serving tea 60 years ago

Falcons on a plane


--Christian Thwaites, Brouwer & Janachowski, LLC


Please note that this discussion of our investments and investment strategy (including our research and investment process) represents our investments and investment strategy at the date of this commentary, and is subject to change without notice.  We cannot assure that the type of investments discussed in this commentary will outperform any other investment strategy in the future, nor can we guarantee that such investments will present the best or an attractive risk-adjusted investment in the future.  This is for general informational purposes only; references to an individual security should not be construed as a recommendation to buy or sell that security.  The securities mentioned in this commentary are only several of the successful as well as unsuccessful investments by us, and do not represent all of the securities we have purchased, sold or recommended.  Although we deem reliable the sources of the statistical and other information referred to in this commentary, we cannot guarantee the accuracy or completeness of any statements or numerical data.  Past performance is no indication of future results.

All charts from Factset unless otherwise noted. 

Time to Spread the Risk

The Week Ahead:
A big earnings weak. Political news may surprise.

The Dow Jones Industrials finally hit 20,000 last week. Slow hand clap all round. It’s a deeply flawed index with 30 not terribly representative stocks with a weird methodology. Goldman Sachs, with a market value of $94bn, for example, carries eight times the weighting of GE, a $265bn company, merely because Goldman’s share price is $236 and GE’s $30. Anyway, we’ve got there and now we can stop fussing about it.

More important was the record on the S&P 500, which was up 1.1% on the week and 2.5% year to date. The S&P 600 small cap index, which readers remember is something we have liked for a while, was up nearly 2% and flat year to date. But it had risen much faster in the post-election period. Meanwhile the 10-Year Treasury peaked mid-week but rallied by Friday to reach 2.42%.

There hasn't been too much to move Treasuries out of a narrow range for the last week. The “reflation” trade is mostly on. That’s the one where animal spirits are on the rise, lower taxes help companies and people, and we’re building infrastructure. So good for financials, materials, commodities and TIPS.

The deflation trade, however, lurks right behind. That means low housing demand, spare capacity here and overseas, rock-bottom rates in Europe and Japan, a strong dollar and low inflation expectations.

That’s good for bonds, staples, REITs and Treasuries. We're going to need more data to see which side we land. On balance, we’ll go with “reflation” but with some risks to the downside.


1. Those animal spirits: were nowhere in sight in the Q4 GDP numbers that came out on Friday. Full year growth was the slowest in five years and the fourth quarter was up 1.9%, below Q3. The key constraint was foreign trade, which pulled 1.7% off growth.

USA real GDP growth

There was a large contribution from an inventory rebuild but that has been weak for most of the prior six quarters so due for a rebound. Personal consumption, which is 68% of the economy, was weak, especially in housing. Durable goods orders were up strongly so perhaps we can look though the Q4 numbers and see a positive trend into the New Year.


2. We have to talk: the political headlines dominated much of the news. We won’t go over all of them here except to say that the market has been taking much of it in its stride. Talk about breaching trade agreements, foreign relations and unspecified changes to healthcare would have seriously rattled markets a year ago. This time it’s a case of barking and moving caravans. 

mexican INMEX and peso

The performance of the Mexican peso and stock market was really impressive last week. This may be a case of markets bottoming out on bad news, and that certainly seems to be case here. Mexico represents about 4% of the Emerging Markets index, which is up 6% this year. We think that i) Emerging Markets’ debt problem is overblown and servicing costs manageable ii) if “reflation” is on, then materials and commodities work well and iii) if U.S. trade becomes a problem, then China will play a strong regional role.


3. If you missed our conference call: we discussed whether the end of the bond bull market was over. The answer is “No”.  The quick version was that to have a fully fledged bond bear market you need four things to happen: 1) fast rising inflation 2) full employment 3) wage pressure and 4) increasing supply. We'll argue that all four are not flashing red or even on a worsening trajectory. Yields may back up to 2.7% but if growth stumbles along at 2.5%, which is more than we've had for nearly two years, it’s tough to see yields heading north fast. Anyway, do take a listen if you want the full version.

The chart below shows just how much U.S. yields are above comparable sovereigns. Any further increase will put even more pressure on the dollar, which will suck in imports very quickly. 

Global 10Y Treasury Yields

4. Earnings: we're about a third of the way through earnings. What was notable last week was some M&A activity, good news from Caterpillar in China, and revenue beats from Microsoft and Intel. About 65% of companies have beaten earnings and 52% have beaten revenues. The latter number is far more important. Earnings can be managed. Sales, mostly, can not.


Bottom Line:
This week we have the Fed meeting and a jobs report on Friday. The market is floating on hope right now. Nothing wrong with that, but it certainly pays to spread the risk around.


Other:

Carter on giving up his peanut farm

Does a strong dollar slow economic growth? (Yes)

What $20m in cash looks like


-- Christian Thwaites

Chief Strategist
Brouwer & Janachowski, LLC

Questions or Comments?
Email me: 
cthwaites@bandjadvisors.com


Please note that this discussion of our investments and investment strategy (including our research and investment process) represents our investments and investment strategy at the date of this commentary, and is subject to change without notice.  We cannot assure that the type of investments discussed in this commentary will outperform any other investment strategy in the future, nor can we guarantee that such investments will present the best or an attractive risk-adjusted investment in the future.  This is for general informational purposes only; references to an individual security should not be construed as a recommendation to buy or sell that security.  The securities mentioned in this commentary are only several of the successful as well as unsuccessful investments by us, and do not represent all of the securities we have purchased, sold or recommended.  Although we deem reliable the sources of the statistical and other information referred to in this commentary, we cannot guarantee the accuracy or completeness of any statements or numerical data.  Past performance is no indication of future results.

All charts from Factset unless otherwise noted. 

Is the Bond Bull Market Really Over?

CONFERENCE CALL REPLAY

Investment Outlook for 2017: Is the Bond Bull Market Really Over? 

Thanks to those of you who attended live!

In case you missed it (or if you want to listen again) here is a recording of the conference call. We discussed the latest run up in stocks and decline in some bonds and what it means for your investments in 2017. 


Questions / Comments?
Email us: marketbeat@fundmastery.com

Over to Washington

The Week Ahead:
More sideways moves. The market will look to Washington.


Markets seem a little non-plussed of late. In the last ten days, stocks have traded in a 1.5% band and have really gone nowhere since mid-December. And it’s largely the same with the benchmark 10-Year Treasury, which peaked at 2.60% at roughly the same time and is now 2.42% or some 2% greater in price.

The industries that performed well in late 2016, such as financials are mostly flat, while healthcare, caught in the cross hairs of a very public debate, has massively underperformed the broader market. Two areas that have picked up this year are international equities, up 1.7% and emerging markets, up 3.7%, which compare well to the S&P 500 up 1.1%.

What’s happening? Well, in short, business confidence remains high while consumer and market confidence has begun to erode. To some extent, this was inevitable. The “buy the rumor” phase of the market ran quickly in the post-election weeks.

“Sell the news” has not happened but investors are waiting to see if the administration will first move on healthcare, NATO, drug costs, trade, taxes or regulation. Or something else.

Trump, as with any new administration, will have the most traction to make changes in the first 100 days. After that, the risk of “business as usual” surely emerges.

 

Meanwhile, this caught our eye last week:

1. A round of decent economic numbers: starting with Industrial Production, which rose above consensus, helped by a large jump in utility production. Here’s’ the chart:

Brouwer and Janachowski

The important part of the chart is the move into positive territory after 14 straight quarters of decline. Much of the improvement is down to the huge cut back in oil and gas, which fell by over 60% (it’s the lower U-shaped line). It’s now down just 10%, which is enough to move the overall number to 0.8% growth.  On the job side, claims fell to 234,000 from a three-month average of 253,000. If this goes on, the some pressure on wages, which the Fed publicly fears, will result.


2. What does the bond market think? Bonds are caught between the inflation trade, inevitably bad for bonds, and the deflation norm of the last six years. While the market reacted quickly to the election, we by no means subscribe to the “end of the bond bull market” theme. 

Brouwer and Janachowski

The quick way to think about the spread between 10-Year and 2-Year Treasuries, is that when the upper blue line is trending down, the market worries about low growth, deflation and ultra low rates. As it trends up, the market sees more growth and a steeper yield curve.

The recent retracement is simply deflation concerns coming back. And that makes sense. The economy is still a 2% growth machine, not a steady state 3% grower. Wage growth is slow. The strong dollar is a form of monetary tightening. Housing markets are flat. So with all this, the Fed may not be as anxious to rush into three rate hikes this year.


3. The Obama Years: we looked at the market returns under various Presidents (h/t FT). In the post-war period, the Clinton years were the best for stocks. They were up 209%. Second was Obama with 180%. Third was Eisenhower with 129%. The best one term President was Bush I with 51%. We offer this knowing that Presidents do not control the stock market and many other factors play into economic and business success. Obama entered office at the depth of the financial crisis so returns grew from a very low base. But, it’s tough to see the markets performing nearly as well in the short term.


Bottom Line: We are in a breather stage. There’s no big theme but earnings are coming is solidly. We expect around a 6% earnings increase. Company outlooks are keeping quiet about what happens next. It’s over to Washington.


Other:

A tall graph on the Dow


--Christian Thwaites, Brouwer & Janachowski, LLC

 

Please note that this discussion of our investments and investment strategy (including our research and investment process) represents our investments and investment strategy at the date of this commentary, and is subject to change without notice.  We cannot assure that the type of investments discussed in this commentary will outperform any other investment strategy in the future, nor can we guarantee that such investments will present the best or an attractive risk-adjusted investment in the future.  This is for general informational purposes only; references to an individual security should not be construed as a recommendation to buy or sell that security.  The securities mentioned in this commentary are only several of the successful as well as unsuccessful investments by us, and do not represent all of the securities we have purchased, sold or recommended.  Although we deem reliable the sources of the statistical and other information referred to in this commentary, we cannot guarantee the accuracy or completeness of any statements or numerical data.  Past performance is no indication of future results.

All charts from Factset unless otherwise noted. 

The trend no longer a friend

The Week Ahead: All eyes on earnings and CEO outlooks.

Some quick trivia on the markets. First, the S&P 500 opened and closed exactly unchanged on the day last Tuesday. The last time that happened was in January 2008. Second, the world’s worst index, the Dow Jones Industrial index, managed an intra-day high of 20,000. But so far this year it has only moved in a 1.0% range, which is the lowest since 1896.

What does this mean? Clearly investors are not ready to jump into the reflation and off-to-the-races story. Remember the narrative[1] since the election is:  

1.     Lower pay roll taxes boosts consumption

2.     Lower corporate taxes boost earnings

3.     Infrastructure spending is a’ comin

4.     But at the expense of the deficit

5.     Which will cause the Fed to raise rates

6.     Which helps the banks but which also…

7.     Strengthens the dollar

But none of this has happened. The market is floating on expectations and has been sideways since mid December. The S&P 500’s close on Friday was around 2,272. On December 13th it was 2,271. Treasuries, however, continued to weaken through the end of the year but have since settled in at 2.4% or 20bps below their high. Holders of the 10-Year Treasury benchmark bond have seen the price drop from $99 to $94 and back up to $96.

 

Here’s what else caught our eye last week:

1. Stocks nervous: In his first major press conference, President-elect Trump threw out a casual remark about pharmaceutical companies "getting away with murder". Guess what happened?

Boom. That was enough to write off $60bn from the S&P 500’s third largest industry. The point is that, despite the meta theme of all-good, details are somewhat in short supply. Companies fully expect to take their turn in the Trump barrel and when that happens, investors take fright. Expect more of this.  
 

2. But meanwhile: we have always followed the NFIB or National Federation of Independent Business, not least because small companies with less than 50 workers employ around 50% of the labor force. Last week we had a blow out number on their optimism and “Good time to expand” index.

Blog 2 01-16-2017 Optimism 1_DJII-USA.jpg

The overall index rose to its highest since 2004 and was certainly the biggest one month jump on record. The lower line shows that 23% consider that “Now is a good time to expand”, which is nearly double the level of the post-recession period. If this optimism continues, then we’ll see more spending and hiring. But, note confidence and spending are not the same. On Friday, the University of Michigan consumer confidence survey dipped a bit and retail sales disappointed.

 

3. International: highlighting the sideways move in domestic stocks, we compare it to International stocks.

International stocks are up 2.3% this year against the U.S. of 1.5% and Japan and emerging markets up nearly 4%. Some of this is catch up, some better prospects for overseas large cap companies and some a reversal of the one-way trade in the dollar. The yen has gained some 3% against the dollar in the last week or so.

 

Bottom Line:
Some of the post-election trends are taking a breather. Inflation expectations are on the rise. Only 6% of companies have reported so far but 70% of those have come in above estimates. Eyes will be on earnings.

 

Other:

Business unbackwards – no, we don't know either

Pros and Cons of universal basic income

Blood transfusions to make you younger

 

 

--Christian Thwaites, Brouwer & Janachowski, LLC

 

Please note that this discussion of our investments and investment strategy (including our research and investment process) represents our investments and investment strategy at the date of this commentary, and is subject to change without notice.  We cannot assure that the type of investments discussed in this commentary will outperform any other investment strategy in the future, nor can we guarantee that such investments will present the best or an attractive risk-adjusted investment in the future.  This is for general informational purposes only; references to an individual security should not be construed as a recommendation to buy or sell that security.  The securities mentioned in this commentary are only several of the successful as well as unsuccessful investments by us, and do not represent all of the securities we have purchased, sold or recommended.  Although we deem reliable the sources of the statistical and other information referred to in this commentary, we cannot guarantee the accuracy or completeness of any statements or numerical data.  Past performance is no indication of future results.

All charts from Factset unless otherwise noted.

 

 

[1] H/T David Ader

A Confident Start to the Year

THE WEEK AHEAD
Bonds still under pressure.
Stocks waiting for earnings.

Stocks had a good start to the year, large caps up around 1.7% and outperforming small caps for the first time in months. Technology stocks had a good week but they had lagged since November so there was a natural catch up.

What's interesting about the market is that there is precious little to go on. It’s too early for earnings season so CEOs can't talk about positive sentiment. And no company has announced big plans based on any policy change.

The market does have an air of confidence about it, however. That’s an elusive but powerful concept. Certainly, management and consumers “feel” better than they have for a while.


What Was Important Last Week


1. Fed Minutes

The FOMC published the December minutes. Curiously, there were six mentions of expansionary fiscal policy, which, they felt, justified a cautious outlook and a rise in rates. To us, this is extraordinary. The Fed manages employment and inflation. We have not one iota of information on any tax or spending policy. Their economic outlook makes little sense. A 0.1% increase in GDP for 2017 (which is $18bn!) and a slow down in 2018. We expect very modest rate rises in 2017.

2. Not-bad job numbers

December is a funny month for jobs. Many seasonal jobs aren't counted. Still, we saw 156,000 new jobs and a minor increase in the unemployment rate.

Brouwer and Janachowski 1 192017nonfarmpayrolls3yearshourly

The interesting number is the 2.9% increase in average hourly earnings. We've been looking for this for a while because earnings have been stagnant for years. Now, this does carry some inflationary risk and Treasuries sold off a bit. But we think that may be the unwind of tactical trades. Shorting Treasuries has been the “obvious” trade since mid-December. The balance we’re looking for is wages to increase spending but not inflation. For now, the balance is in favor of spending.

3. Modestly Improved Economic Data 

Notably from the Purchasing Managers Index for manufacturing and services. We put together a GDP-weighted index of the two to reflect the much higher importance of services in the economy. 

Brouwer and Janachowski ISM

Any number above 50 is positive and we saw the highest number since mid-2015, just before the energy recession took hold. We think both numbers reflect very positive post-election confidence. 

4. Old Economy/New Economy

There’s a lot of nonsense written about the death of industries from technology, robotics and automation. But in one area, the old way of doing things seems doomed. Here's a chart of the relative performance of Macy’s, Sears and Kohls, where investors lost between 30% and 70% of their capital in the last two years. 

Brouwer and Janachowski - Slow Death of Big Box Retailing

But compare that chart to this one below, which shows the steady, seven-year unbroken increase in dividends from stocks. Currently, the S&P 500 yields just under 2%, which seems to us a good valuation compared to bonds. 

Brouwer and Janachowski - Valuations and Dividends

Bottom Line

  • Expect small and mid cap stocks to regroup.
     

  • Bonds may remain under pressure as we near the new administration formally taking office.
     

  • Stocks will trend for a while until earnings season comes up.



Christian Thwaites - Brouwer and Janachowski
 

- Christian Thwaites

Chief Strategist
Brouwer & Janachowski, LLC


Please note that this discussion of our investments and investment strategy (including our research and investment process) represents our investments and investment strategy at the date of this commentary, and is subject to change without notice.  We cannot assure that the type of investments discussed in this commentary will outperform any other investment strategy in the future, nor can we guarantee that such investments will present the best or an attractive risk-adjusted investment in the future.  This is for general informational purposes only; references to an individual security should not be construed as a recommendation to buy or sell that security.  The securities mentioned in this commentary are only several of the successful as well as unsuccessful investments by us, and do not represent all of the securities we have purchased, sold or recommended.  Although we deem reliable the sources of the statistical and other information referred to in this commentary, we cannot guarantee the accuracy or completeness of any statements or numerical data.  Past performance is no indication of future results.

All charts from Factset unless otherwise noted. 

Signing Off For 2016

The Week Ahead: Only five trading days left. It will be quiet.

 

It has been a quiet week. It usually is this time of year but it feels as if equity investors just want to guard their unexpected returns (no one saw a 10% increase in the S&P 500 a year ago) or nursing recent losses in the bond market. The S&P 500 is just below its all-time high of December 13th. 

We'll use this final blog of the year to share some observations on 2016.

The Economy:  We had a revision up to Q3 GDP growth. This is how it looks now:  

You can see why the Fed would like this. It's the best quarterly growth since 2014. We particularly like the big jump in GDI or Gross Domestic Income, which should be the same as GDP but never is. But, and this is a big BUT, most of the growth was down to i) increased farm exports and a ii) build up of inventories after nine months of running them down. Neither is sustainable. And personal consumption, which is 68% of GDP, was slower in Q3 than Q2. The durable goods numbers and personal income disappointed. The Fed can talk up the economy all it wants but the core measure of inflation they use (PCE) still struggles to rise above 1.5%. 

We would sum up post-election markets as: 

1. Tax cuts are nice for people and companies. But we don't know how much they'll be and if there’s much of a multiplier.

2. The repatriation tax is a red herring. It’s a one-off for a few major multinationals.

3. Deregulation plays well with companies who feel encumbered by such things. It’s more important for smaller businesses. We have yet to see if they benefit.

4.The fear of higher deficits shows up in Treasury bond prices.

5. Inflation fears are overdone. A jump in inflation from 1.5% to 2.0% is welcome. There’s almost no risk that we’ll see an acceleration in inflation.

And with that, we’re comfortable with the performance of equities, particularly domestic facing small and mid-cap issues. 

Some long-term views: We're fans of history. And street wisdom. One favorite is that rapidly moving markets overshoot and do not correct by moving sideways. And that's the case with Treasuries, where they are shown against a 100-month moving average[1]

It’s rare that they have pierced the moving average. Yes, we can construct graphs ten ways to Sunday but this fits with our thesis that markets have done some major discounting. Facts and data need time to catch up.

Is the market overvalued? There is no real risk to “buying at the top”. Stocks have an upward bias and the economy rarely falls in nominal dollars. So one way to measure stocks is to divide the value of stocks to the value of the economy for a “normalized” valuation[1]. The lower blue line is the S&P 500. The upper line is the S&P 500/GDP “normalized” ratio. We can see it was overvalued in 2000. Today it’s high but not worryingly so.

Finally a sobering thought. U.S. stocks have a deserved reputation for performance, innovation and leading-edge products. So you would think tech would be at the forefront of stock performance, right?

Not so. The humble “Consumer Staples” sector has outperformed the tech sector for nearly 20 years. So, beverages, food and household products have done better than the mighty tech sector. Sometimes, slow and steady really does win. 

Bottom Line: Expect a quiet run to the year-end. We have the new job numbers in the first week of January. After that, all eyes on what happens on the fiscal side. The Fed will caution from the sidelines. 

 

Other:

The perils of compounding

 

--Christian Thwaites, Brouwer & Janachowski, LLC

Please note that this discussion of our investments and investment strategy (including our research and investment process) represents our investments and investment strategy at the date of this commentary, and is subject to change without notice.  We cannot assure that the type of investments discussed in this commentary will outperform any other investment strategy in the future, nor can we guarantee that such investments will present the best or an attractive risk-adjusted investment in the future.  This is for general informational purposes only; references to an individual security should not be construed as a recommendation to buy or sell that security.  The securities mentioned in this commentary are only several of the successful as well as unsuccessful investments by us, and do not represent all of the securities we have purchased, sold or recommended.  Although we deem reliable the sources of the statistical and other information referred to in this commentary, we cannot guarantee the accuracy or completeness of any statements or numerical data.  Past performance is no indication of future results.

All charts from Factset unless otherwise noted. 

[1] H/T Steve Blitz at Real Money

[1] H/T BMO and Ian Lyngren

Quiet End To A Noisy Year

 

The Week Ahead: Quiet time ahead of the year-end. Expect little price action. 

 

Stocks took a breather this week. Unchanged on the week but still up 8% since the election. Let’s be clear. Markets are discounting and counting on lower personal and corporate taxes, repatriation of overseas earnings, deregulation and an investment boom. It’s the reflation story writ large.

But none of this has happened. As details emerge, disappointment is inevitable. Just this week we saw disagreement on whether an import tax would be a great idea, a terrible idea or just a trial balloon. When more of these discussions open up to details, expect more sideways action. But there was one more big show in town before the year closes… 

The Fed Did It: They raised rates by 25bps. This is only the second rate rise in eight years and was fully expected by the market. What was not expected was: 

  • The FOMC showed (in the infamous dot plots) that they see three rate   rises next year. That's up from two in September.
     
  • But they also barely changed their growth and employment estimates. They now forecast 2017 growth and unemployment at 2.1% and 4.5% against 2.0% and 4.6% in September. They didn't change any long-term projections. Even the new numbers are the same estimates from June. How much does a 0.1% increase in GDP mean? Eighteen billion dollars. Hardly seems the effort.
     
  • Chair Yellen also walked back from the “high pressure economy” remarks of just a few months ago. By this she meant let the economy run with fiscal stimulus to bring back some of the output gap, which is still evident in the under-employment numbers. 

    So put these together and we saw three reactions. Stocks took a step back, Treasury yields jumped 10bps and the dollar climbed. First, here’s the dollar, which is now at a 13-year high. 

And here’s the 10-Year Treasury with the rapid increase over the last few weeks. 

So what next? The bond sell off in Treasuries looks overdone. Not so much for corporate where spreads have tightened by about 45bps since the election.

This seems odd. If the market fears inflation, current bonds become cheaper to service but future borrowing costs rise. Which hits earnings. So, either Treasuries are over sold or corporate bonds have a correction ahead of them. Or both. 

Meanwhile the economy: We’re winding into the last few data points of the year. Last week saw inflation running at 2.1% with some big components like housing up over 3%. Expect more upside in inflation because of the base effect from low oil prices in early 2016. Housing starts were down nearly 20% but it's one of those notoriously volatile series so don't pay too much mind. Industrial production was soft but related to weather and the auto sector. 

Stocks: We've written enough on how stocks have roared ahead. So we’ll make one final point. This too looks very fast. We notice these days that market returns are more compressed. What used to take months to climb now takes weeks or even days. Not a time to be out of the market. 

Bottom Line: We think that bonds will recover as stocks take a breather. The next markets to work may be international and especially Emerging Markets but not while the dollar is ascendant. 

 

Other:

The seating chart when Trump met the Valley

Facebook says sorry for messing up statistics (four times)

Silicon Valley cools on delivery start-ups

 

--Christian Thwaites, Brouwer & Janachowski, LLC

Please note that this discussion of our investments and investment strategy (including our research and investment process) represents our investments and investment strategy at the date of this commentary, and is subject to change without notice.  We cannot assure that the type of investments discussed in this commentary will outperform any other investment strategy in the future, nor can we guarantee that such investments will present the best or an attractive risk-adjusted investment in the future.  This is for general informational purposes only; references to an individual security should not be construed as a recommendation to buy or sell that security.  The securities mentioned in this commentary are only several of the successful as well as unsuccessful investments by us, and do not represent all of the securities we have purchased, sold or recommended.  Although we deem reliable the sources of the statistical and other information referred to in this commentary, we cannot guarantee the accuracy or completeness of any statements or numerical data.  Past performance is no indication of future results. All charts from Factset unless otherwise noted. 

 

A Quiet Look At History

The Week Ahead: Another all time market high. Fed will raise rates. It's in the prices. 

U.S. equities continued the reflation story. Just as a reminder this is how it goes: 1) a relaxed U.S. fiscal policy 2) lower corporate and personal taxes 3) repatriation of overseas earnings 4) deregulation and 5) a general price increase in a full employment economy. 

We saw the S&P 500 reach another all time high. Small cap stocks, with their domestic facing business, also roared ahead. They are now up 27% this year compared to the S&P 500 of 10.5%. Before we head into the week’s events, this is a good time for a long-term view. 

A Quiet look at history

First off, here’s a 67-year look at the U.S. economy. We live in a $18.6 trillion economy. Last week’s growth showed a 3.2% gain. This year alone, the U.S. economy increased nearly $700bn, which is like adding the GDP of Switzerland with change to spare. Meanwhile, U.S. stocks grew in line. 

Now we know that the very long term does not address an investor’s needs in the next year or so. Markets can set back for prolonged periods. But a couple of points we take from the above: 

1. The U.S. economy, at $18.6 trillion, can defy a lot of political and economic tinkering. It’s big. It has its own momentum. It grows pretty much regardless of what party, tax regime or policy in in place. 

2. Inflation was a ten-year problem in the 1970s. But long-term inflation in the American economy is around 3%. Today we are at less than 2%. If there is any “resurgence” in inflation, it will be from a very low level to a low level. 

Back to the present

Last week the ECB committed to more bond buying through to the end of next year. The market was initially disappointed because the amount dropped from €80bn a month to €60bn, but the total committed was much larger than before and adds another €540bn to the ECB balance sheet. Think of the Fed’s QE and double it. So with lower for longer you would expect three immediate things:

1. A lower Euro

2. Stronger bond markets

3. Stronger equities (because of #1)

Which is all well and good but European equities are living off aggressive monetary policy and a play on a U.S. bounce. But they are also facing political unrest (Italy last week was the latest but not the last), no fiscal policy and a suffering banking sector. So, while European markets are up 5% since September in local currencies, for the U.S. investor it looks like this: 

 

So, we are still wary of allocating more into non-U.S. markets.

Bottom Line

We expect U.S. Treasuries to back fill in the next few weeks. They look oversold and short-term international bonds even rallied last week. Last week’s claims numbers reached a record low as a proportion of the U.S. general and working population. It's a dead cert the Fed will raise rates later this week. But the market has priced it already. 

 

Other:

Philippines-style law enforcement

Another take on the President-elect’s conflicts of interest

Global policy uncertainty

 

--Christian Thwaites, Brouwer & Janachowski, LLC

 

 

Please note that this discussion of our investments and investment strategy (including our research and investment process) represents our investments and investment strategy at the date of this commentary, and is subject to change without notice.  We cannot assure that the type of investments discussed in this commentary will outperform any other investment strategy in the future, nor can we guarantee that such investments will present the best or an attractive risk-adjusted investment in the future.  This is for general informational purposes only; references to an individual security should not be construed as a recommendation to buy or sell that security.  The securities mentioned in this commentary are only several of the successful as well as unsuccessful investments by us, and do not represent all of the securities we have purchased, sold or recommended.  Although we deem reliable the sources of the statistical and other information referred to in this commentary, we cannot guarantee the accuracy or completeness of any statements or numerical data.  Past performance is no indication of future results.

All charts from Factset unless otherwise noted.