The Days Ahead: Inflation and flash Europe GDP. Government shutdown on Friday?
One-Minute Summary: One week after the Fed’s “patient” speech and we’re in very quiet markets. Stocks moved within a 0.1% range or about one tenth of what they’d done in the first few weeks of January. The stuff that lingers in the background hasn't changed. An upcoming border/budget dispute, government shutdown, a March 1st deadline on the trade talks, Brexit, slowdown in Europe.
But, as we said last week, the Fed is on hold. For what? Housing, industrials, the ISMs, trade, consumer, GDP. Most of that group has yet to catch up from the government closure so we’re probably not looking at any change for some months. We're encouraged that even Janet Yellen doesn't know where rates are headed.
Meanwhile earnings are positive with good news from retail stocks like Estee Lauder and Ralph Lauren and large companies like Boeing, Apple and Exxon. It seems like 2017 all over again with the S&P 500 up 7%, Small Company up 11%, international and Emerging Markets up 7% and even the Dow Jones Transportation index up 12%. That's the one with highly cyclical stocks like railroads, trucking, barges, airlines and FedEx/UPS giants. If they’re doing well, the rest of the economy may be slow but it’s not anywhere near recession.
1. Are we winning the trade war? Well not if you use the trade balance as a guide. So, if you're buying stuff from the U.S. and your government says “right, everything you buy from them will cost you 25% more” or if you're importing stuff from China and your government says, “right everything you buy from them will cost you 25% more”, then you're really going to question how much you want that stuff.
And that’s what’s happened to the goods trade balance in the last 12 months. Food exports from the U.S. fell from $14bn a month to $10bn. Soybeans have undeservedly become a major news item in the last few years. The U.S. used to sell around $3bn a month, with a peak of $4.3bn in 2012. Now it’s $875m. The U.S. used to sell $14bn of autos overseas. That’s now $12.2bn. The overall trade deficit in autos is now $19.7bn, up from $16.3bn.
Trade with China is down. Exports to China fell 32% from a year ago. The bilateral trade deficit will probably come in at around $416bn compared to $375bn in 2017.
It would seem that the current strategy is not working except to push the world to the brink of recession judging by a range of business surveys (h/t John Kemp). The most important date on the calendar is March 2nd when the U.S. tariffs on $200bn or Chinese goods takes place. We think there will be a deal of some sorts. But we doubt it will solve the thorny issues of IP, tech transfer and services.
The overall November figures were slightly better than previous months but imports were down sharply, reflecting weaker U.S. demand. There is lots of noise in the monthly numbers so nothing definite yet. But we believe trade will drag on growth in Q1 2019. For now, these numbers confirm our decision to lighten exposure to overseas risk assets.
2. How bad is it? It’s not. It’s tempting in this business to exercise caution. After all, bad news reads well and it’s easier to sound smarter when forecasting recessions, corrections and imminent price drops. But bears don't make money. There are ETFs for those bold enough to call market tops. One that’s been around for a while is the ProShares Short S&P 500 ETF which was launched in 2006 at $138, had a brief time in the sun peaking at $190 in late 2009 and now trades at $30. The press calls but our line of “yes, the news is terrible but investors should stick to their plan and ride this through” is met with an uninterested thank you.
There’s always data to support a recession but it’s usually wrong. One that's in the news recently is the inverted yield curve. This simply measures whether long-term bonds yield less than short-term bonds. Normally any investor is going to demand a higher rate for long term loans. “Lend me money for one year at 3% for one year” seems reasonable. “Lend me money for 10 years at 2%” less so. Because, you know, you might default, lose the piece of paper or just decide not to repay. So, when you get a chart like this, there’s a lot of harrumphing:
This is the 10-Year Treasury yield less the 3-month Treasury yield. One is at 2.7%, the other at 2.5% (bottom) for a difference of 0.2% (the 19.95bps line). Commentators show it with a 10 or 20-year chart and say something like “an inverted yield curve has predicted the last three recessions.”
Well yes, but it didn’t predict the ones in 1953 or 1988 and gave off plenty of false signals in 1959, 1960s, 1979, 1988 and 1994 to 1998. And so on. It may be better than a coin flip, we don't know. But we do know that if you acted on it and came out of the stock market every time it dipped towards zero, you missed some very hefty gains.
So what does it mean this time? Well, we like the Occam Razor principle. Don't make this complicated. It just means that short-term bonds look attractive and will probably remain so if the Fed pauses and the economy ticks along at 2%.
Bottom Line There is nothing wrong with a little market consolidation. You know, take a breather knowing that the Fed is on hold. Analysts have cut earnings estimates by around 4% for 2019 but the market seems fine with that. We'd make no changes having positioned for just this kind of market a few months ago.
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--Christian Thwaites, Brouwer & Janachowski, LLC
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