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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