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No denying the winning streak

The Week Ahead:
No denying the winning streak. But keep an eye on jobs.

We're writing this end of day on Wednesday, so two days before our normal deadline. Travel commitments. U.S. stocks hit another record high mid week but failed to close at their highest level. The S&P 500 has returned over 7% year to date and 11% in the last six months. It’s the twelfth all-time high in the Trump presidency and that's out of 28 trading days. You have to go back to McKinley to have seen that before (h/t Cameron Crise at Bloomberg).

Along with the highs, we have seen the VIX volatility measure at around 11. It briefly reached the mid-20s last year at Brexit and election time but has since then been a sideline of a sideline.

This week was more about Fed speak and the President’s speech to Congress. The Presidential speech was short on detail but that does not really matter. U.S. businesses right now are enjoying the very high probability of regulatory relief, lower taxes and more confidence. If there were any real concerns about negotiating pharma prices or moving to the next step in Dodd-Frank, they have evaporated.

The Emerging Markets and European markets forge on. Emerging Markets are about relative valuations (they’re cheaper than the U.S.) and diminished concerns about the dollar. Europe is about better growth, ongoing QE and lower, or at least manageable, political risk.

1.  Fed talk: last week was more about throwaway lines from Fed Governors. It’s important to note that there are four ranks of Fed Governors: i) the Chair and the Vice Chair ii) the permanent members of the FOMC, which includes the NY Fed iii) the voting members of the FOMC and iv) participants at the FOMC, which includes non-voting regional Fed chairs. It doesn't really matter what the last group says but it sure does if any of the others do. This week, William Dudley at the New York Fed felt that rates could go up sooner because confidence and animal sprits are on the rise. Short rates promptly surged. Here they are as of Feb 28th and March 1st:

Now in the world of T-Bills that is a very aggressive move. Some may be due to the Treasury keeping supply of T-Bills low ahead of next month’s debt ceiling debate. You know the one where Congress says it’s a good idea to default on the debt and the financial markets say, “no. not a great idea” so the Treasury buys some insurance by selling longer dated debt ahead of the debate. There was a sell off in longer dated bonds as investors thought there was a strengthened case for a March increase.

2. But growth is still weak: We saw the revised Q4 2016 number come in at 1.9%, which was below expectations. The big disappointment was trade, which cut some 1.7% from growth as imports grew 10%. If we’re to hit anything like the claimed 3% growth, then we must fine about $600bn from either the consumer or investment sector because it’s unlikely to come from government or the trade sector. That would be asking the consumer to grow spending by around 4.6% which seems highly unlikely, especially given numbers like this:

This shows consumer confidence growing nicely (the blue bars) but with a very large difference between the over-55 group, lower line, up 25% since the election, and the under-35 group, the upper line and down 22%. The younger group has a much larger propensity to consume than the older group so if they ‘ain’t feeling it, it’s tough to see how all this growth will come about.

3. Meanwhile there are good indications on the global level. Here they are:

The way we read this that is macro economic risk has fallen (think less likelihood of deflation and political risk) and the surprise indexes are up (things like inflation and rates). They are up big in Emerging Markets and trending much better in Europe. This makes us very positive on the non-U.S. markets, which U.S. investors neglected in the last few years.

Bottom Line: Earnings season is over. It was a strange one as growth was insufficient to move results much in the fourth quarter yet earnings were up 5% compared to estimates of 3%. So we have animal spirits, the reflation trade back and (marginally) higher rates ahead of us. Game on. But we also have some insurance with Treasuries and TIPS.


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