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Can This Keep Going?

The Days Ahead: U.K. election, Fed and ECB meeting and Comey. Something for everyone.

It was a covfefe filled week. We all know what that means. The same as brillig or frumious. But we’ll summarize. A strong stock and bond market, more disappointing economic numbers and feuding Fed governors on the importance of inflation and jobs. 

Do we have to talk politics? No. Oh, all right. The exit from the global climate agreement was, of course, news. As was Europe explicitly distancing itself from the U.S. (“…the times when we can…count on others…are over”). Oh, and the U.K. Tory government is making a hash of its reelection chances so sterling dipped. But we’re not sure if all this is a symptom of gaff-prone dysfunction or something more serious.

Markets seem to believe that nothing serious has happened yet and stayed calm and up. Some of the trading was month-end rebalancing. Long bonds were up 3% in May and stocks up 1.2%. There are many investment models that automatically rebalance to maintain constant bond and equity exposure…think risk parity (so Bridgewater and its acolytes), balanced funds and just about every target-date fund. So every time they rebalance, one would expect a pick-up in the asset class that lagged. And that’s most of what we saw until Friday when the weak payroll numbers came out.

We've seen a run of weaker data for a while now: housing, consumer confidence, earnings, trade, ISM manufacturing and lower inflation. There always seems to be a reason: weather, seasonal adjustment, wireless plans, car leases. We agree that taking stock of the economy in real time is hard and subject to revision. But the trend also seems that we’re having a real problem keeping momentum in the economy. The latest “GDP Now” estimate from the Atlanta Fed has growth trending below 3%. And Q2 growth was meant to recover sharply from the 1.2% of Q1.


1. Now to jobs: This is the last report before the June 14th meeting where the Fed will update its economic projections and probably raise rates. Friday’s number was not good. Here it is:

It’s a busy chart but the new jobs number came in at 138,000 compared to most estimates of 200,000. Then wage growth slipped to 2.4% from April and labor force participation fell. Earlier in the week we also saw i) a lower inflation number with the core PCE (the one the Fed follows) at 1.5% compared to the Fed’s 2% target and ii) disposable income growth of 1.2% which, to us, does not tell of a labor shortage and wage inflation, despite what the NFIB survey says.

Anyway, the 10-year Treasury promptly rallied hard to 2.16% and is at its lowest level this year. We think all this means that the Fed will go ahead with a June hike (they can't back out now) but puts a September increase on the table.

For the last year, the Fed governors have been hopelessly contradictory of each other. A cynic may say that they’re angling for the Chair spot or just like the attention. But the one to follow, in our mind, is Governor Lael Brainard and here’s a recent speech where she correctly questions the old link between inflation and employment. And for the bond market? We see low rates at the long end for some time. So will stay with our allocation.


2. Our Overseas Tour: Clients will know we’ve been positive on Emerging Markets and the Eurozone for a while. But we also like Japan. It too has been a backwater for some years but has risen by 33% in the last year and, for a U.S. dollar investor, by 37%. Japanese smaller companies have done even better. As with our chart last week, the technicals look positive too:

The fundamental questions are 1) will the yen depreciate more to help equities 2) will economic reform carry through (lots of false dawns on this) 3) will labor reform continue and 4) will Japanese companies deliver a more robust ROE than the 8% of the last year (the S&P 500 is at 14%). On balance, we like the outlook and have taken a more positive position in the last few months. 


3. Boring banks: Financial stocks came roaring out of the election. Higher growth, higher rates and deregulation were the themes of the day and financials rose 30% in short order. But all that seems passé these days. Here's the updated chart for 2017:

They have underperformed the market by about 8% this year. Why? Trading volume is down, net interest margins stuck and loan demand weaker than a few months ago. Financials are not a growth industry and tend to reflect the wider economy so blue-sky optimism always looked far-fetched. So, kind of a boring industry but, you know, better than gun slinging.


Bottom Line: We ran a quick screen on S&P 500 stocks to see if there was much difference in the YTD performance of stocks with high overseas sales compared to those with low overseas sales. Well, there is a big difference. Companies with more than 50% of their sales overseas have risen 13% this year compared to companies with less than 10% of their sales overseas at 3%. On one measure at least, the disengagement of the U.S. from international roles does not seem a concern.

Please check out our 118 Years of the Dow chart.  

 

Other:

 Census Bureau on who owns the assets and income

“I didn’t probe into it. It didn’t occur to me.” Tears at Theranos

Study shows bankers who trashed the economy were promoted!

 

--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.