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

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

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


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


Other:

How economic populism works

Declining home ownership

The Whipsaw Song


--Christian Thwaites, Brouwer & Janachowski, LLC

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


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

All charts from Factset unless otherwise noted. 

A Touch of Reality

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

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

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

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


Here's what else is going on:


1. Jobs, jobs, jobs

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

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


2. Emerging Markets

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

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

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


3. U.S. Stocks

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

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

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


Bottom Line

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


Other

• Should index funds be illegal?

• Pizza and fried chicken

• We lost a Fed Governor


--Christian Thwaites, Brouwer & Janachowski, LLC

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


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

All charts from Factset unless otherwise noted.

 

The Fed Fights Back

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

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

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

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

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

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


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

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

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


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

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


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

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

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


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


Other:

Congress to Fed: Get in line

Robots serving tea 60 years ago

Falcons on a plane


--Christian Thwaites, Brouwer & Janachowski, LLC


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

All charts from Factset unless otherwise noted. 

Time to Spread the Risk

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

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

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

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

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

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


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

USA real GDP growth

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


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

mexican INMEX and peso

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


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

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

Global 10Y Treasury Yields

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


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


Other:

Carter on giving up his peanut farm

Does a strong dollar slow economic growth? (Yes)

What $20m in cash looks like


-- Christian Thwaites

Chief Strategist
Brouwer & Janachowski, LLC

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


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

All charts from Factset unless otherwise noted. 

Is the Bond Bull Market Really Over?

CONFERENCE CALL REPLAY

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

Thanks to those of you who attended live!

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


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

Over to Washington

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


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

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

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

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

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

 

Meanwhile, this caught our eye last week:

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

Brouwer and Janachowski

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


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

Brouwer and Janachowski

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

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


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


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


Other:

A tall graph on the Dow


--Christian Thwaites, Brouwer & Janachowski, LLC

 

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

All charts from Factset unless otherwise noted. 

The trend no longer a friend

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

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

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

1.     Lower pay roll taxes boosts consumption

2.     Lower corporate taxes boost earnings

3.     Infrastructure spending is a’ comin

4.     But at the expense of the deficit

5.     Which will cause the Fed to raise rates

6.     Which helps the banks but which also…

7.     Strengthens the dollar

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

 

Here’s what else caught our eye last week:

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

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

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

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

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

 

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

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

 

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

 

Other:

Business unbackwards – no, we don't know either

Pros and Cons of universal basic income

Blood transfusions to make you younger

 

 

--Christian Thwaites, Brouwer & Janachowski, LLC

 

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

All charts from Factset unless otherwise noted.

 

 

[1] H/T David Ader

A Confident Start to the Year

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

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

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

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


What Was Important Last Week


1. Fed Minutes

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

2. Not-bad job numbers

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

Brouwer and Janachowski 1 192017nonfarmpayrolls3yearshourly

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

3. Modestly Improved Economic Data 

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

Brouwer and Janachowski ISM

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

4. Old Economy/New Economy

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

Brouwer and Janachowski - Slow Death of Big Box Retailing

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

Brouwer and Janachowski - Valuations and Dividends

Bottom Line

  • Expect small and mid cap stocks to regroup.
     

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

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



Christian Thwaites - Brouwer and Janachowski
 

- Christian Thwaites

Chief Strategist
Brouwer & Janachowski, LLC


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

All charts from Factset unless otherwise noted. 

Signing Off For 2016

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

 

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

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

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

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

We would sum up post-election markets as: 

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

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

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

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

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

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

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

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

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

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

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

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

 

Other:

The perils of compounding

 

--Christian Thwaites, Brouwer & Janachowski, LLC

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

All charts from Factset unless otherwise noted. 

[1] H/T Steve Blitz at Real Money

[1] H/T BMO and Ian Lyngren

Quiet End To A Noisy Year

 

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

 

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

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

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

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

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

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

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

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

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

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

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

 

Other:

The seating chart when Trump met the Valley

Facebook says sorry for messing up statistics (four times)

Silicon Valley cools on delivery start-ups

 

--Christian Thwaites, Brouwer & Janachowski, LLC

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

 

A Quiet Look At History

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

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

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

A Quiet look at history

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

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

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

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

Back to the present

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

1. A lower Euro

2. Stronger bond markets

3. Stronger equities (because of #1)

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

 

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

Bottom Line

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

 

Other:

Philippines-style law enforcement

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

Global policy uncertainty

 

--Christian Thwaites, Brouwer & Janachowski, LLC

 

 

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

All charts from Factset unless otherwise noted. 

Stocks Pausing for Breath

The Week Ahead: The market is positioning for year-end. Again, stocks to take a breather. Italy may surprise.

The broad story of the last few weeks is: growth around the corner but also more deficits and inflation. Hence the rise in equities with the S&P 500, Russell 2000, Dow Jones and Nasdaq reaching all time highs together on November 30th for the first time since December 31st 1999. Of course, we all remember what happened next with the Nasdaq spectacularly crashing by 70% over the next three years. Don't worry. There is no sign of a bubble in stocks this time.

And the deficit and inflation fear explains the rise in Ten-Year Treasury yields from a mid-year low of 1.4% to 2.4%. Of course, nothing has changed yet. Growth was better in Q3, but that was expected. Inflation was unchanged at 1.7%, way below the Fed’s target. And employment numbers came in at the steady rate of 178,000 a month. The same rate, pretty much, as the last three years.

1.     There is a big difference between what markets expect and what happens: here are some of the major concerns in the Obama presidency and what actually happened.  

The point is not to mock the predictions. More to show that we're dealing with a wide range of uncertainties. This is the oversimplified version of the Trump era:

The point is not to mock the predictions. More to show that we're dealing with a wide range of uncertainties. This is the oversimplified version of the Trump era:

2.     Meanwhile some good numbers: on growth and employment. Third quarter GDP growth was revised up to 3.2% from 2.9%, with the all important personal consumption number at 2.8% from 2.1%. It looks like this: 

We saw better numbers on personal income and then, on Friday, the latest job numbers. Here they are: 

The unemployment rate is down to its lowest rate since 2007 and the economy seems able to produce enough jobs to keep the Fed happy. It’s not enough to dent the labor participation rate, but that's another story. One striking part was the very low growth in earnings, which rose only 2.4% over the year. So less good for the consumer.

So, this what the Fed faces for its final meeting in Dec 14th: 

So, the only unknown is not whether the Fed increases, but its effect on longer-term rates, which leads us to…

3. The Bond market may have done the Fed’s work: the rapid increase in Treasury yields is unprecedented. Here’s the chart: 

Note that U.S. yields moved almost independently of global rates. This means that spreads between U.S. Treasuries and prime borrowers like the German government have widened to their highest level in 30 years.

Now we know markets can test rationality longer than investors can stand, but it seems to us investors have oversold. It has simply come too fast too quickly. It's a classic case of the “prices changing more than facts”. Not to rain on any parade, but it is unlikely Washington can deliver on fiscal stimulus, tax breaks and faster growth all in the next six months.

4.     Oh and OPEC: agreed to cut production last week by about 1.2m barrels a day. Oil rallied. It’s now up 90% or so from February lows. But, remember, $50 oil is usually enough to trigger a supply response from marginal U.S. producers. So, we don't expect the price level to hold for long.

Bottom Line: We’ll leave you with a final chart, which shows bond and equity yields. 

All this suggests is that in a period of low inflation, when bonds yield more than equities, they are cheap and vice versa. It’s not infallible but again suggests the rapid stock buying and bond sell off may be overdone. 

Other:

The world economy in 60 seconds

Seattle minimum wage succeeds

Uber loses $2bn on revenues of $1.4bn

--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.

 

 

 

 

Give It Time

The Week Ahead: Expect stocks to take a breather. The Treasury market counts. 

Pessimists own bonds. Optimists own equities. This old definition surfaced in the last few days. The rout started in government bonds. Ten-Year Treasuries rose from 1.6% to 2.3% and the 30-Year Treasury hit 3.0% for the first time in a year. 

But corporate spreads did not widen. So, post-election sentiment seems to be inflation up, borrowing costs higher, inflation and a solid outlook for businesses and equities. We'll admit to practicing cautious optimism, which leaves us somewhat on the fence. Why?

MARKETS MOVE FAST: here are some of the 10-day price swings we’ve seen. Get ready. 

What to make of these? 

1.  Some of these are classic hedge trades. In many models and algorithms, if safe assets weaken (Treasuries), the model sells down. This weakens the asset more. Turtles all the way down.

2.  We suspect many hedge funds and short money are working their way out of positions taken ahead of the election. As few people predicted the outcome, our bet is that many traders lost money. 

3.  Many investors missed the equity move in 2016. This was a last chance to get back in ahead of year-end. Last week, $21bn flowed into equity ETFs (and 20% of that into small cap and tech) whilst $4bn came out of bond ETFs. 

4.  Some trades made little sense. Fine, if you think inflation’s a risk, then buy into stocks and TIPS. But gold usually follows inflation fears and that fell. And if you think your currency is about to reflate, you would sell against the stronger currencies. But no. Here’s the dollar in recent days: 

That’s a 7% to 13% increase against some of the country’s major trading partners. Sure, it helps the inflation outlook but expect some major hurt for S&P 500 companies. Remember, 40% of S&P 500 company sales are overseas. 

AND INFLATIONThe consensus is that taxes will fall, consumers spend and infrastructure investment creates inflation. A couple of views on this. First, yes, increased inflation is not a good sign and an uptick usually precedes a recession. 

But last week’s inflation numbers were very benign at 1.6% and 2.1% for core (i.e. no food and energy). There are signs of rapid increases in healthcare inflation but it’s tough to see where across the board, higher and growing inflation will come from. Here's the broader Producer Price inflation from midweek. 

Inflation could increase from these levels and, indeed, given low base effects from 2015, we expect some 2% prints over the next few months. But holding it back are some pretty strong forces:

The Fed, which has only intermittently allowed inflation to surpass 2% in the last 25 years.[1]

Fiscal spending in the U.S. in 2009 utterly failed to create inflation.

- Dollar strength

A high level of corporate and household debt. These have grown 32% and 27% in less than three years. Any change in debt servicing is likely to curb spending on everything from discretionary to corporate buy backs. 

WHERE DO RATES GO? Clearly they have backed up fast in the last 10 days. Janet Yellen repeated on Thursday that any rate increases would be gradual. We believe her. The market is looking ahead to greater issuance, a possible and inflationary trade war and general all around unpredictability. Pessimists at work. We'll save you another graph, except to say the sell-off looks overdone.

BOTTOM LINE: We're generally fine with the exposure to U.S. stocks and especially U.S. small cap stocks. We have liked the domestic part of the economy for a while and small and mid caps had underperformed for a while coming into 2016. The Treasury market remains a short-term concern but we don't believe we should trade into a weak market. 

 

OTHER:

TPP hegemony passes from U.S.

The cost of deportation

Takes a while, but SEC gets their man

--Christian Thwaites, Brouwer & Janachowski, LLC

 

[1] See Kessler commentary here

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.