The Days Ahead: Jobs numbers, Fed meeting, more big earnings
One-Minute Summary We mentioned last week that it was going to be a bottoms-up sort of market, trading on stock stories rather than macro. And so it was. Boeing (biggest stock in Dow, which is one reason that index didn't reach record highs), suspended guidance. Facebook did its thing of record sales and fines. Anadarko, a $35bn oil E&P company, was put in play. SAP, Germany’s largest company by far, up 18%. Microsoft, at record highs and, as of writing, back on top as America’s biggest company and sole member of the $1tr club. And so on. All good solid stuff, which is what we wanted to see as we start hitting a tougher time for year-over-year comparisons.
Stocks hit a record high. They've now fully retraced the near 20% correction, which started last February and reached bottom in December. Those who look at the S&P 500 total return index (the one that includes dividends) or used a 60/40 portfolio, reached all-time highs a few weeks ago…yes, dividends are important. The Dow Jones Industrials and Dow Jones Transportation indices, neither of which should be used for portfolio measurement, are about 1% and 3% off their record highs.
What's holding stocks up? A very favorable yield environment. The Fed won't do anything next week. After that, the market will look for a more definite trend. We're in an abnormally low volatility phase right now. You would think with trade, Washington, embargoes, Brexit and all, we’d all be nervous. But for now investors are taking the Fed’s lead.
Breaking news on GDP: we wrote most of this on Thursday night thinking the Q1 GDP sneak peek would be a “hold the back page” story.
So, doncha know, it came in at 3.2% when everyone, including us, thought it would be a 1% affair. You would think if it was the “blockbuster report [showing that] policies are unleashing the vitality of the American economy” (yes, the Commerce Department said that), the 10-Year Treasuries would plummet. But they rallied.
Why? Well one reason is that the report is not all that it appears. Trade and inventory growth accounted for half the growth. We see inventory builds as essentially borrowing growth from the future. It’s unlikely that companies will be happy to keep high inventory on hand. Housing, personal consumption and the core PCE inflation were all weak. So, we’ll have to see if this can continue.
1. Housing on recession watch. No. This is a bit of an ongoing theme because a few months ago, the warning lights were on for a recession. We've covered some of the early signs of a recession here, with claims, and here with some other major indicators.
Housing is always a prominent recession indicator. The way we think about it is to separate housing sales from housing starts and new sales. That’s because while home sales are a very big number, the most recent was 5.2m, down 5% on the month and 5.5% from a year ago, sales don't create much economic activity. Yes, people redecorate and earn commissions but that pales against the economic output from building, fitting and equipping a new house.
So, it’s housing starts and new home sales that interest us.
After some concerns back in December, it looks like housing is firming up again. Here are the new home sales from early in the week.
The level of 692,000 (it’s an annualized rate) is a near peak from the recession lows and was well above forecast. We'd also note that the median price is down nearly 10% from a year ago. But i) prices are volatile and may rebound and ii) the SALT limits hit high-price areas like the Northeast and overstate the national trends.
This is good news. Sure, low rental vacancies are helping but normally people don't buy a new house unless they feel pretty secure about jobs and pay. We also like the fact that new home sales are still catching up with existing home sales. After the crash, distressed sales were everywhere, which meant home builders focused on higher priced units. But now, there is more affordable housing especially in the Southeast, which accounts for 58% of all new sales (h/t Calculated Risk).
So, housing is one area of our recession watch that is on solid ground.
2. How’s that inverted yield curve going? Well, as the song says, I just looked around and it was gone. Back in December there were real concerns the curve was inverting and that suggested a recession. Our point was that, yes, inverted curves preceded recessions but the timing was way off and, as we like to say, “being early and right is the same as being wrong”. So we didn't think it meant much. But now look at it:
The spread has more than doubled since its 8bp low back in December, when markets were pricing in a full recession. It’s the 2-Year Treasury, which has fallen in yield, from around 2.6% to 2.3%. That suggests there is i) more deflation in the air (certainly possible given recent dollar strength) or ii) the Fed will cut later this year (unlikely) or iii) the recent economic data has been poor (it hasn't) or iv) the 2-year is pricing off German bunds, which are back below 0% (possibly).
You can see we’re not exuding unqualified confidence on this one. We'd say some of it might be seasonal (always a good copout) or that the market is just pricing in a prolonged Fed-on-hold and doesn't expect much move in long-term rates. But for sure, it shows a fast fading of recession fears.
Bottom Line: Despite the recent rise in stocks, valuations remain solid. Some 204 of the S&P 500 companies trade 20% or more below their all-time highs and despite a stock market average valuation of 17x, there are 160 companies trading below 14x. The top 10 companies, with a heavy tech weighting and 22% of the market, trade at an average of 22x. That's a good indicator for the next year.
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--Christian Thwaites, Brouwer & Janachowski, LLC
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