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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. 

One Inch Punch

The Days Ahead: Bonds likely to stay firm.

April has two things going for it. Rebalancing at quarter end and tax rebates. We think that mostly explains the rally in bonds and easing back of stocks. But there’s also little news around. We read the Fed Minutes where three things caught our eye:

1) The Fed is now thinking about the great unwind of the balance sheet following the massive QE bond buying of 2008 and 2014 (we knew that).

2) Some Fed members said stocks, emerging markets, high-yield bonds and commercial real estate had all risen “significantly” and (there was no “and”, they just said it)

3) Yet, oh so casually, swept aside the weak economic numbers (you know, little things like auto sales and mortgage applications) saying they all may come back because confidence is up and there might be some fiscal stimulus ahead.

This all kind of reminds us of Bruce’s One-Inch-Punch but without the desired effect or excitement. As we have said before, there’s a growing gap between “soft” data (things you say you're going to do) and “hard” data (things you actually do). The Fed is putting up a good front of knowing what it’s doing but this is a group who are 75% confident that the Fed Funds two years from now will be between 0.75% and 5.5%! In what they say will be a slower economy. Yes, really. Not making this stuff up.

The Fed is way ahead of itself in thinking the economy needs tightening and the bond market tends to agree. The 10-Year Treasury has held up well in the 2.3% to 2.4% range and inflation expectations are down.


1. Jobs: As if to hammer this all home, we had a terrible NFP number on Friday. New jobs came in at 98,000. Consensus and the ADP numbers were around 200,000. It was the seventh worst number since mid-2011. Here’s the chart:

That's hourly earnings at the bottom, up 2.6% YOY. But industries like retail and health care services, which are 25% of the labor force, saw wage increases of 1%. So, you know, jobs that pay less than half the national average. The unemployment rate fell to 4.5%. You can take this as the Fed hitting its target. Or that labor force participation, low quit rates, past month downward revisions, all still point to a precarious job market. Treasuries rallied so the market probably thinks more like us.


2. Emerging Markets LatAm version: We've liked the asset class for the last year based on relative valuations, reforms, dollar retracement and a general reflation catch-up. Peering under the Emerging Market hood, Mexico is around 3.6% of the index. Sentiment has improved markedly in the last few weeks.

The peso is up 15% from January’s low and stocks are up 13% (or 27% for a U.S. investor) from their post-election lows. This is a remarkable story and is down to i) trade talk histrionics abating ii) consumer confidence rising and iii) the protests at the privatization of the gasoline industry fading. We think there is more catch-up likely given Mexican stocks have underperformed the broad Emerging Markets index by 13% over the last year.

And here we would insert a warning. Emerging Markets have posted a 10% correction in almost every year since 1990 (h/t Caesar Maasry at Goldman Sachs). That's about twice what it is for U.S. stocks. What can trip a correction? Political risk, local and global, trade wars, China credit, 59 Tomahawks, bricks in walls or just a few missed economic numbers. On balance, we like Emerging Markets but just wanted to get the “we told you so” out of the way. Final note: even for our All-Equity portfolios, we don't own more than a 8% weight.


3. Is Tech Expensive? Yes. But then it often is. We took the PE on the S&P 500 and divided it by the PE on the S&P tech sector. The result is the dark red line below, which shows the tech sector selling at a 20% premium to the market. So on that measure, it’s rich. And it rose from about 5% to 20% richer in the last year. But wait. These numbers i) exclude companies with negative earnings (around 15% of the total) ii) include companies that prefer to think of themselves as retailers (so Amazon, Expedia, Netflix, Tesla) and iii) companies that want the tech aura but are, well not really, tech (so Corning, Visa, MasterCard etc).

Back in the true ‘90s bubble, tech stocks traded at eye-watering premiums of 2.5x. So, it’s cheaper now. But another way to look at it is, what’s the tech weight in the S&P 500? We ran the numbers. It was 35% back in the peak years. The average is 15% and it’s now 22%, or its highest since 2001. We'd argue that it’s even higher because of the loss makers. Put all those together and we’d say, yep, it’s expensive.

We've been saying for a while that there are no bargains in U.S. equities right now. The high PEs are somewhat justified by low rates. But still, worth keeping an eye on.


Bottom Line:
Stocks have no immediate catalyst and may drift. Dollar weakness continues. Meanwhile, Alcoa, as always, kicks off the earnings season on April 24th.


Other:

What was he thinking? Fed Governor leaks.

Blackest paint ever.

How ads at YouTube work. It’s a bot.


--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.

 

“Ian Paice on the drums”


The Days Ahead:
Bond repositioning week. Europe very solid.  

 

The dreaded drum solo. Those old enough will remember the 20-minute interlude that felt like hours in ‘70s and ‘80s rock concerts. There wasn't much to do except wait it out. Markets feel like that. U.S. bonds and equities have done very little in the last month. The S&P 500 peaked in early March and the 10-Year Treasury has bounced between 2.3% to 2.6% since December. Stocks are staying put until something more definite happens (tax cuts, demand, inflation) while bonds find it hard to believe the “get-ready” Fed talk…and last week saw a number of Fed Governors walk back their more hawkish positions.

 

Remember the New Year predictions? All those ‘fraidy cat bonds “bad” and stocks “over-done” reports. Well, the stock hype now faces some real challenges and recently we saw something we would not have expected…bonds outperforming equities.

Yes, it’s a short time frame and probably just come quarter-end window dressing from pension funds loading up on bonds after the stock rally. Anyway, to us it means stock earnings have some catching up to do and until then we prefer Emerging and International markets. As for bonds, we would note that Fed Funds futures into January 2018 have barely moved since the March 15th hike, which means the market doesn't see much change in outlook.

And volatility? No one took us up on the beer challenge but we’d leave it that risk appetite is quite high with BAA and High Yield spreads at multi-year lows. Vix is a lagging indicator and probably won't turn until the credit cycle turns (h/t Cameron Crise).

 

1.  Emerging Markets again: Yes. It’s still the best performing major asset class this year, up 12% and big moves in India and China. We wrote a few weeks ago why we like Emerging Markets but we would add this chart...we’ll talk you through it. 

It's the middle and lower part we like. It shows that Emerging Markets PEs are below their 2015 peak while the U.S. is at the very top of its range. And the bottom chart shows the ratio of U.S. and Emerging Markets’ PEs with Emerging Markets at a near 20% discount to the S&P 500. It also seems sensible to buy into a market with a seven-year flat line than one bouncing around all-time highs.

 

2. Ho-Hum on the Economic Front: GDP was revised up a bit, but the Atlanta Fed GDP Now can't seem to break 1%. Consumer confidence was up but it’s easy to say “Yes, I feel confident” if your stock portfolio is up but not so easy if your wages barely moved. Consumers have yet to step on the gas for increased spending. 

Yes, those last two blue bars are the first back-to-back declines since 2011. It’s another example of “soft” data (so confidence, intentions, expectations) pulling ahead of “hard” data (so production, sales, investment). That gap can close two ways (one of which would be ugly), and until there’s more direction on which, we may not see much action in equities.

 

Bottom Line: Fundamentals usually trumps technicals but the market is up on high expectations and isn’t ready to give up on the optimism trade. So technicals may have their day. We have a duration extension in the Barclays Agg index this week, which may throw up some trading anomalies. Meanwhile, enjoy Ian Paice on the drums.

 

Other:

FBI Director’s anonymous Twitter account hacked in 4 hours

De-stressing the Army sniper way

Job polarization study

 

--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 “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