The Days Ahead: Does politics drive stocks? No.
“Despite/because of the unpredictability of U.S. politics…” is how we could probably start any of our blogs in the next six months. We won't go over the headlines except to say that markets gave up on the “reflation” story some time ago. The prospect of tax cuts, infrastructure spend and deregulation are dimming fast. We think that markets have mostly responded to higher growth, a synchronized upturn in trade and supportive central banks. U.S. stocks also figured that no new regulation would take place…sort of a negative attribute but good enough to get things going.
We would also point out that politics take a long time to play out in markets and there’s plenty of stuff to trade on in the between times. Remember it took one full year from the “I did not…with that woman” from Bill until the Senate started impeachment and we had six weeks of not knowing who won the election in 2000, during which time the markets moved on plenty of other things. We've also seen comparisons with the Watergate scandal and market sell-off in 1973. Yes, that was wrenching but lest we forget, this is a small list of other stuff going on at the time:
1. Yom Kippur war in late 1973
2. OPEC oil embargo: oil prices rise of 400% in four months from late 1973
3. Full blown economic recession from Dec 1973 and ran to Feb 1975
4. Fed funds rate rose 7% to 14% from mid 1973 to mid 1974
5. Budget deficits increased, inflation jumped from 5% to 15%
So when you hear there is an “eerie similarity” with today and 1973, let’s not omit inflation, rates, commodities, deficits, wages, price controls and wars that hit the market. We would argue that Watergate had precious little to do with it.
1. Now, about that sell-off: We had a short-lived 1.6% correction from a record high of 2,404 on the S&P 500 last week. And the VIX climbed nearly 50%. But as we have pointed out before, VIX, at best, tells you what’s going on in real time. Investors get nervous, they buy options, VIX rises, they sell stocks, they get less nervous, they buy longs, VIX falls. Everything starts and ends with investors thinking, “shall I buy or should I sell?” Markets overreact in the short term, like this. They are much slower to react to real trouble. Anyway, we took a look at “fear” measures and here’s the chart:
It shows assets that investors run to when there’s real trouble: gold, the Yen, Treasuries and compares them to the VIX. The Swiss Franc is also a favorite bolthole but not as liquid as the others. When there’s get-me-out of here fear, as in 2008 and mid 2011, these things spike. Over on the right side, you can see they have barely moved and are way below recent peaks.
Finally, there is some insurance and protection we can use on client portfolios. It’s not possible to have the upside of stocks and none of the downside. Buying puts is far too costly. We prefer using Treasuries and TIPS, which are considerably cheaper and tend to have low correlation to stocks.
2. Quieter week for hard data: Housing starts were weak, but they’re very noisy in the short term and subject to big revisions. Industrial production was up with an expected rebound in mining. The capacity utilization numbers were mostly unchanged. Their reliability as an inflation indicator is less that it was but here’s the chart:
What's interesting to us is the lower trend lines over the last 20 years. Now, either industry is a lot more productive at using the same capacity or production trends are flat and there is no need to add more capacity. We know U.S. productivity gains are minimal so to us it’s just more data that growth is pegging along at a 2% rate without much chance of an upside or downside break.
3. Consumer Debt: There’s some news about consumer debt rising to pre-crash levels. It is but it’s not a concern.
The debt that worries us most is consumer, revolving debt to finance consumption. So, we’re less concerned about student and mortgage debt. Consumer debt, the blue column, has grown but as a percent of GDP it has fallen. So too had total household debt. There are other debt problems in the market, notably corporate debt, but it looks like consumers and households are very reluctant to take on credit.
Bottom Line: We ran our quick screen on stocks trading at over 30 times earnings or roughly 75% above the market average. It’s down to 121 from 124 last week but still dominated by the expensive mega cap names. AMZN is in a league of its own at 180x (it got more expensive). We continue to like the story in Europe where Germany reached an all-time high last week with a lot less drama.
Please check out our giant 118 Years of the Dow chart.
--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.