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Index Flexing


The Days Ahead:
Look for consumer sentiment. It’s been weak.

The market remains resilient hovering around its year to date and all-time highs. Mind you, there’s no visible difference between resilience and torpor. They both don't move but for different reasons. The market is not being tested and holding up, it’s just not moving, as in, there’s no place to go. The NASDAQ and tech corrections look like they were plain old profit taking, so no concerns there. None of our “fear” indicators (Yen, gold, U.S. Treasuries and VIX) are flashing. Put it all down to short-staffed summer trading desks and the absence of a strong narrative.

The healthcare sector had a nice surprise on Thursday with the “Better Care Reconciliation Act of 2017”, which proposes reducing Medicaid coverage, subsidies and credits and repeals things like device excise taxes. Healthcare stocks were up 4% on the week and 16% this year. We would put the three major Trump reflation themes, (tax cuts, infrastructure and deregulation) as no longer driving the market. This bill is more about “no new regulation”, which is not quite the same thing. Healthcare is usually a solid outperforming sector of the market but for the last two years has underperformed by around 10%. This removes some of that uncertainty. We'll refrain from further comment.


1. Active Indexing:
We’re big supporters of the move to indexing. It’s cheaper, simpler and outperforms active management in efficient markets. There are millions (sic) of indexes calculated every day by the big six index providers, S&P, Russell, FTSE, Barclays, CRSP and MSCI. Keep in mind, the number of indices far outnumbers the number of listed stocks, bonds and commodities so there’s an index for any investment theme you can think of.

MSCI made the news last week because it runs the most widely followed Emerging Markets index. So any change they make to the index means that $4.3 trillion must follow suit. And the change was to include more China stocks in the index from 2018 on. Right now China is about 28% of the index. The bulk of that is Hong Kong-listed China shares. The change will be gradual with perhaps only another 2% going into China (MSCI is pretty coy about how they will do this) but this will still understate the importance of China’s market which is the second largest in the world and five times bigger than India, the next largest Emerging Market.

Why do we care? Well, investors want to run ahead of index changes because all the “forced” buyers of the index will have to commit more in coming months. This can distort markets and a good example is what happened on the same day, when MSCI said they may include Saudi Arabia in the Emerging Markets, a promotion from Frontier Markets.

So there you have it. There was no news from Saudi Arabia, whose stock market tends to follow, unsurprisingly, oil. Yet the market shot up 9%. And it was all due to a change in indexing methodology.

We expect more of these kind of changes because indexing has become such a force in investing. We're not sure index providers should have so much market impact but it's something with which we must live. And it’s something we pay a lot of attention to as we build portfolios.


2. Bond Spreads:
There has been some movement in bond spreads recently. Here’s the spread between 10-Year Treasuries and High Yield, CCC and Energy High Yield bonds. The last two (the two top lines in the upper chart) have risen rapidly.

Why? Some is i) concern about raising rates which will hit highly indebted companies first ii) more energy coming online at a time of weak oil prices and iii) some tightening of lending. We've thought for a while that high quality bonds are a better investment, which is another way of saying that we’re not paid enough to take the risk of low quality bonds. The recent retreat in spreads does not change our view.


3. No clear signals and we don't expect one:
Here’s a graph that we used about a year ago because it was signaling that stocks were cheap relative to bonds.

It simply measures stock yields, at about 2.2%, against Treasury yields at about 2.15%. It’s by no means foolproof because inflation and dividend growth can change the signals. But it suggests to us that both stocks and bonds are fairly well valued and there’s no major opportunity to overweight either. It'sanother reason why we would put our marginal dollar into Europe where, on the one-year anniversary of Brexit, indicators like Purchasing Managers’ surveys are hitting six-year highs.


Bottom Line:
One of our favorite stock market aphorisms is “prices change more often that facts.” Right now, neither are changing. Our screen on market breadth still shows one third of companies in the S&P 500 25% below their 10 year highs. So not much exuberance.

Please check out our 118 Years of the Dow chart.  

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Other:
Lyft invents buses
Why those Phoenix flights were cancelled (wonk)
Killer whales stalk fishing boats


--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.

Corporate Debt as % of GDP

Corporate debt as a percent of GDP is near record highs. Yes, we know rates are low and companies are often borrowing against cash collateral, but debt is debt. And if credit ratings are hit, then we'll have a problem. 

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. 

 

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Alexa, what can I buy?


The Days Ahead: Quiet data week. More M&A coming?   

Ouch. Don't let your kids grow up to be retailers. Over the last year, Macys, Target and Bed Bath & Beyond are all down 20% to 40% and even the analyst’s favorite, Costco, is barely above its 2015 level. This week it was Kroger’s turn in the cage...down almost 50%. I guess it’s all the themes of Amazon, ez-delivery, people moving back to the city, fewer car owners, less time, stricter zoning, more choice. I’ve always been hesitant on retailing as an investment. It’s brutally competitive. They seem to go through fashion cycles, margins are razor thin and companies are loaded with debt.

So, Amazon taking over Whole Foods for $13bn is either i) the inevitable rise of online retailing and general disruption ii) the merging of warehouses with stores iii) a canny play on highly desirable locations iv) premium pricing meets value discounter or iv) the result of an activist/founder face off. We're not sure if the friendly farmer’s market approach of Whole Foods will fit with Amazon’s high-efficiency brand. But we do know this: it's a symptom of finding growth in a low growth economy.

Amazon can of course afford it. It’s a $475bn market cap and so the price is less than 3% of its value. The deal increases Amazon’s sales by around 10%. Historically, failure rates of M&A are high. (Just a thought.)

Elsewhere, the Bank of England sounded a bit more hawkish, probably because sterling’s 15% drop against the dollar and Euro in the last year may have inflation consequences. U.S. economic numbers were weak. We’ve hammered this point for weeks now but when housing starts, retail sales, the NFIB small business survey and industrial production all reported lower than expected, then you have to ask “blip or trend”?  

The Bank of Japan kept rates low, despite calls to back off on QQE (the extra “Q” is for Qualitative, nice touch). The Nikkei index is running steady at a 10-year high.


1. The Fed: It was a mistake for the Fed to tighten. So why did they do it? First, they've talked about it and any climb down from three moves this year may be taken as, well, a climb down. Second, they're all trained on the Phillips curve model where low unemployment means tight labor markets means wage inflation. Third, they see ever-so-feint lights of spending and investment which, crossed fingers, may lead to the normalization of policy to which they would all like to return. Now, if we were in chess notation this would be either:

a.     ?  a bad move; a mistake
b.     ??  a blunder
c.     ?!  a dubious move or move that may turn out to be bad

And that’s it. They're the only choices. As we’ve noted before there is no inflation. Yes, it may come but there’s usually a lot of runway before inflation takes off. The Fed’s excuse would be, well, preemptive caution. Or it’s tilting at windmills.

For the windmill case, we’d look no further than the “dot plots” or Summary of Economic Projections. The Fed expects growth at 2.1%, inflation at 2%, unemployment at 4.6% and Federal Funds at 3%. These are essentially unchanged from March 2017 and a year ago except they revised growth down.

So, since the Fed embarked on its tightening cycle in December 2015, growth and inflation have been revised down. Granted, unemployment has also been revised down but by 0.3%, which is around 405,000 jobs. On a workforce of 160m. Speciously accurate, no?

The 10-year Treasury has rallied by about 40bps this year and the yield curve has flattened. Here’s the spread between 10 and 2-year Treasuries dropping like a stone:

What will happen from here? The market will test the Fed and keep rates well bid. The market sees i) low growth and inflation and ii) monetary policy as already too tight given the real Fed Funds rate, which has risen noticeably this year. If we see weak numbers over the summer, and last week’s industrial and manufacturing production were pretty bad, then the expected third rate hike won't happen. Our hopes are on Neel Kashkari.

So, we have to live with higher real rates and the prospect that some heat may come off risk assets for a while, especially after the S&P 500’s near 9% gain this year.


2. Japan: The Bank of Japan’s QQE is now around $3.9 trillion, which is a far bigger proportion of Japan’s GDP than the Fed’s program. And they own another $140bn of equities and corporate bonds. It seems to be working. Consumer confidence, employment, industrial production and chain store sales have all been strong in recent months. There have been many false dawns in Japan over the years. Not for nothing was the Japanese Government Bond known as the “widow’s trade.” But maybe this time is different.

We'd note that foreign investors' fund flows correlate strongly with the USD/JPY rate since the start of Abenomics, but that investors' Japanese equity positions up to the end of April were the lowest since mid-2012. They might be missing something:

Japanese large and mid-cap stocks have performed well against the S&P 500 and, in the bottom chart, the S&P 500 remains nearly 25% more expensive than Japanese equities using a simple EV/EBITDA measure. We like Japan and have noted some of our managers moving their allocations up.


Bottom Line: We're somewhat relieved to see the Nasdaq correction. It's off around 5% from its highs. As we discussed last week, it's not a bubble but simply profit-taking. We're reminded that the ETF tracking the Nasdaq was launched in 1999, promptly doubled, then fell 76% and took 17 years to recover. We're not seeing anything remotely like that. There’s more noise than signal in the market right now.

Please check out our 118 Years of the Dow chart.  

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Other:
Now there’s an Act for Covfefe
Maybe Janet Yellen does not want to be Chair
Vegetarian, Vegan, Breatharian

--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.

 

All you need to know about today's inflation numbers

All you need to know about today's inflation numbers

Nothing on core...lowest since May 2015

Owners's Equivalent Rent (i.e. housing) at 3%.

And your cell phone just got cheaper

See BLS report

Subscribe here for our investment updates

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. 

Short Volatility: a winning strategy

If you were short volatility over the five year, well, well done. You made 8 times your money. If you thought markets would be volatile and fearful and you were long volatility, well, you would have lost 99.9999% of your money. 

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.

 

Asian Exports as Proxy for Emerging Markets

The run up in exports continues in Asia markets. South Korean exports (which are reported at month end) are up 24% year on year. 

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.

 

Those Tax Cuts

We're posting the graph from our call this morning. This shows federal income and corporate tax receipts in nominal and real terms. Whenever there are tax cuts, it takes four to six years for receipts just to get back to their starting point. So, no, it would seem as tax cuts do not pay for themselves. 

 

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.

Away from the headlines, earnings are looking very good.

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The Days Ahead: Healthcare, tax bills, elections.  

What promised to be a turbulent week ended quietly. Coming into Monday, we expected an uptick in European stocks following the French election. Our money is still on Macron for Round Two but we also think a Le Pen victory may not be the catastrophe many expect. Unsettling yes, but not the complete wind down of the near 60-year old EU project. On other news that didn't happen, the U.S. did not pull out of NAFTA, or repeal healthcare or shut down the government. So, you know, one less thing.

We're tempted to launch into a critique of the tax plan presented to the world on Wednesday but the White House curiously deleted the transcript of the press release. In one page and, impressively, four fonts, it was a manifesto of reducing income tax rates (but no information on the bands), doing away with AMT (good to see a friendly face again), lower corporate taxes and elimination of tax deductions (including 401(k) but then that was not mentioned again, so perhaps they didn't mean it), Oh, and the whole repatriation-of-overseas cash thing. Ok, you got me monologuing. But in case we get too excited about tax cuts, it’s worth taking a look at what happens if they do pass.

Yes, in real terms, tax revenues plummet which means cuts don't really pay for themselves. They may increase growth if they hit the counter-cyclical spot dead on. And if credit demand is lax elsewhere, they may not change rates much. But they most certainly do not pay for themselves.

Anyway, the market probably thought that the legislative load was already pretty high and so paid it little concern. The more we think about it, the post-election rally seems to be about the absence of new regulation and taxes and less about new favorable regulation and taxes. So if either of those comes through, the market would respond well.


1.     And weak economic growth arrived dead on time: Friday’s first look at Q1 GDP was always going to be a head-banger. First-quarter growth has been weaker and lower than the annual average for years now. It seems to be in the seasonality adjustments over at the BEA. We knew that Q1 was tracking low but the consensus was ahead of us and the news of 0.7% growth sent bond yields lower. Here’s the chart:

You can see the Q1 underperformance sticking out pretty clearly. We can dance around the numbers pointing to a big drag from inventories and housing but the U.S. is an economy where consumption accounts for 69% so the 0.2% in personal consumption growth (the lowest since 2009) shows a distinct lack of animal spirits. This may change in Q2 but the report explains the rally in Treasuries as, yet again, growth lags expectations.


2.     Expectations the other way in Europe: The ECB recommitted to QE although at a lower level than April. This is some two-and-a-half years after the U.S. stopped its bond purchases. Growth is picking up and in some places, Spain and most of Eastern Europe, is over 3%. Inflation is low and is the chief reason that the ECB will stay off the monetary brakes. Meanwhile, here's stock market and economic sentiment on the rise:

European stocks are up around 8% year to date and 10% for a U.S. investor. We have high conviction for Europe. Regional surveys, retail spending and inflation have held up well. It’s a challenging time for Eurosceptics and we would argue that investors have been underweight for too long.


Bottom Line: Away from the politics, U.S. earnings have powered ahead, up 12% this year. And it’s not all in one sector: Financials, Materials and Tech are up over 15%. Revenues from energy are up 32%. So while U.S. and Europe politics will remain front and center, earnings are delivering in spades.



--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.

Two hits, two misses.

The Days Ahead: Get set for a heavy week of politics.

Headlines this week were the U.K. snap election, elections in France and the slow fuse of the “hard vs. soft” economic data debate. We can deal with the first quickly. The decision to hold an election was opportunistic in a system of fixed term governments. The opposition is in disarray and Prime Minister May will strengthen her hand in the upcoming Brexit negotiations. She will almost certainly win. The opposition Labour party is fighting its cause from the left, not the center. Curiously they voted for the election so, yes, Jim, turkeys do vote for Christmas. The Tories are campaigning under the inspirational banner of “Strong and stable leadership in the national interest” which as catch phrases go lacks some punch. Anyway, add another election to the European roster this year.

Meanwhile at home, it was mostly quiet in U.S. stocks with a continuation of the 2% trading range we’ve seen since mid-February. Corporate earnings were mostly in line. What surprised us was Goldman Sachs (GS), which showed a big drop in trading and earnings (but less in earnings per share). The shares are unchanged from 10 years ago. The other was IBM whose quarterly income peaked four years ago and share price has underperformed the S&P 500 by 50% for five years. Why single these out? Because both are heavy Dow Jones Industrial (the index we hate) components and were expected to do well in the reflation trade.


1. Two hits, three misses: The U.S. economy has yet to hit its stride from the expected post-election gains. Housing sales and industrial production (IP) did better than estimates. House sales and manufacturing did worse. The Fed’s beige book was all rather subdued. They used the words “modest” and “weak” 136 times compared to 107 times in January. Which was not the way it was meant to go. Of these, we would point to the IP numbers.

The line to look at is the green line, which is straight manufacturing and excludes volatile stuff like utilities and mining. It hooked down in March and is a classic case where strong readings in sentiment a few months ago should have panned out by now. They haven’t. It's another reason that the Atlanta GDP Now forecasts sit at 0.5%. They were over 3% six weeks ago. That, in turn, partly explains the bond market, which has held its gains over the last few weeks and trades at 2.2% down from 2.6% in March. The price gains alone from a 10-Year Treasury are 3% in the last three months. Put all this together and i) we’re buyers of the high-quality end of the U.S. bond market and ii) don't expect any rushed action from the Fed.


2. Meanwhile in Europe: The data is upbeat. We saw Eurozone construction up 7%, consumer sentiment up, various PMIs higher and CPI unchanged, which means the ECB will continue QE. Europe’s current account also increased sharply. Germany is now the world’s largest creditor and surplus country, having overtaken China in 2016. Now you don't invest in economies just because they have a current account surplus…it’s no more than a measure of excess savings. But it does explain the strength of the Euro, which we expect to remain strong, and the improvement of Europe’s hard hit economies.

Of course all eyes are on the French elections, which will go to a second round. For all the volume over the politics, French stocks and bonds have held up well.

Stocks are up over 5% year to date and 8% to a U.S. investor. Bond yields have risen this year from 0.6% to 1.0% but most of that change took place in January. Financial markets for one seem untroubled by the outcome or, more likely, reason that a pro-business Macron will emerge the winner on May 7th.


3. People are worried that U.S. equities are overvalued: This has been a constant for months and received more attention on Friday when Paul Tudor Jones, a one-time hedge fund manager, flashed a variation of a chart we use from time to time. Here’s our version:  

Jones looked at the black line and said, because it’s higher than it was and approaching 2001 levels, the market is overvalued. All it does is take the value of the U.S. market and divide it by the value of the economy. It’s obtuse. The value of the market is a balance sheet item and GDP is an income item. Stocks are not the sum of the economy. Nor are they representative of the economy. The value of Facebook, Google, Hewlett-Packard and Apple are 11 times larger than the GDP of Santa Clara County but that doesn't mean much because they sell and operate everywhere. It’s the same for U.S. stocks and GDP.

We're the first to admit that the market is no bargain (here) and there is no one, none, zero, predicative metric which will tell you that the market is overvalued or undervalued. But we would point to the earnings yield relative to inflation and BAA corporates, the yield and the earnings outlook, and state that stocks are nowhere close to bubble territory. And that’s why we keep to the quality and dividend growth end of the market.


4. But the CR is a worry: Yes, the Continuing Resolution vote. You know, the one that keeps the government open, is up next Friday April 28th. That could come with a new healthcare vote, or not. Or more talk of fiscal and tax changes. Unlikely. Bonds will trade nervously this week.


Bottom Line: Europe and U.S. politics will be front and center. But earnings and outlooks will drive stocks. International remains our best short term market.
 

Other:
Italian bank accepts Parmesan as collateral
How minimum wages affect restaurants in San Francisco
Beaver herds cattle
 


--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. 

It's good to have you back.

The Days Ahead:
European elections. Bonds sill taking the headlines.

This was always going to be a quiet week. School holidays and Easter week, when most of Europe closes for at least two trading days, means volumes were low and large positions unwound. So, when the high profile pivots from the president on trade, China, rates and Yellen all hit, markets dived for cover. Welcome back to the bond bull. First up:


1. Whoa, on the 10-Year Treasury: We've always held to the old saw that bond investors are pessimists and equity investors optimists. Bondholders want to get paid back and shareholders just wanna get paid. In 2017, we viewed the bond market as looking over at stocks rising on the back of reflation, fiscal stimulus, tax...you know, all the nice stuff equities like, and blowing one big raspberry. So, when the 10-Year Treasury dropped below 2.3% it got our attention. This is what it looks like over the last year:

Now there are some strong tactical stories going on in Treasuries. Here’s a partial list:

  1. Investors taking advantage of the low issuance of T-Bills to go long. Here and here.
  2. Japan lowering its purchases of U.S. bonds and notes. Here
  3. Major short positions…Treasury shorts have been the major pain trade of 2017.

Add to that the geo-political risk and potential gridlock in a quiet trading week and we were set up for surprise. The chart shows the recent decisive move below the resistance point of 2.3%. The next chart stop is 2.0%. So far this year, long Treasuries have risen around 3.4% making them among the best performing fixed income instrument.

What does it all mean? It’s not quite a flight to quality, nor a fear trade. It’s somewhat seasonal and tactical. And none of this has changed our Fed view. But in the short term, we think bonds are very well supported.


2. Nothing either way on the Economic front: The core-ex food and energy Producer Price index fell a bit to 2.3%, some of which was held down by lower transportation costs, which are, of course, a second derivative of oil costs. It’s not a concern for now but medical costs jumped (they are the green line) and they could spill over into the CPI and consumer spending.

Elsewhere, the Job Openings report held few surprises and the NFIB survey (a measure of small company confidence) showed the best measure in earnings in nearly two years. 


3. U.S. Equities: We saw the first back-to-back weekly decline in the S&P 500 since January. We ran the numbers on how many companies are due to report earnings increases over 10% this quarter (we excluded loss-making companies because that exaggerates the improvement). How many? 101 out of 500. And they are across industries, not just the obvious energy and finance companies. In fact, the only standout is the airline industry, which will report much lower earnings because of dollar strength and higher fuel costs. Oh, and throwing passengers off planes.

We generally expect earnings to be their highest since 2011 and for companies with more than 50% of sales outside the U.S., growth could be as high as 15%.


Bottom Line: European stocks will be in the front line over the next few weeks. Meanwhile, U.S. Treasuries and the dollar are the main event.  


Other:

How Private Equity works

First London to China train (sorry freight only)

Man who predicted 36,000 Dow runs the CEA. It fell 35%.


--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.