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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


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All charts from Factset unless otherwise noted.