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Quiet End To A Noisy Year


The Week Ahead: Quiet time ahead of the year-end. Expect little price action. 


Stocks took a breather this week. Unchanged on the week but still up 8% since the election. Let’s be clear. Markets are discounting and counting on lower personal and corporate taxes, repatriation of overseas earnings, deregulation and an investment boom. It’s the reflation story writ large.

But none of this has happened. As details emerge, disappointment is inevitable. Just this week we saw disagreement on whether an import tax would be a great idea, a terrible idea or just a trial balloon. When more of these discussions open up to details, expect more sideways action. But there was one more big show in town before the year closes… 

The Fed Did It: They raised rates by 25bps. This is only the second rate rise in eight years and was fully expected by the market. What was not expected was: 

  • The FOMC showed (in the infamous dot plots) that they see three rate   rises next year. That's up from two in September.
  • But they also barely changed their growth and employment estimates. They now forecast 2017 growth and unemployment at 2.1% and 4.5% against 2.0% and 4.6% in September. They didn't change any long-term projections. Even the new numbers are the same estimates from June. How much does a 0.1% increase in GDP mean? Eighteen billion dollars. Hardly seems the effort.
  • Chair Yellen also walked back from the “high pressure economy” remarks of just a few months ago. By this she meant let the economy run with fiscal stimulus to bring back some of the output gap, which is still evident in the under-employment numbers. 

    So put these together and we saw three reactions. Stocks took a step back, Treasury yields jumped 10bps and the dollar climbed. First, here’s the dollar, which is now at a 13-year high. 

And here’s the 10-Year Treasury with the rapid increase over the last few weeks. 

So what next? The bond sell off in Treasuries looks overdone. Not so much for corporate where spreads have tightened by about 45bps since the election.

This seems odd. If the market fears inflation, current bonds become cheaper to service but future borrowing costs rise. Which hits earnings. So, either Treasuries are over sold or corporate bonds have a correction ahead of them. Or both. 

Meanwhile the economy: We’re winding into the last few data points of the year. Last week saw inflation running at 2.1% with some big components like housing up over 3%. Expect more upside in inflation because of the base effect from low oil prices in early 2016. Housing starts were down nearly 20% but it's one of those notoriously volatile series so don't pay too much mind. Industrial production was soft but related to weather and the auto sector. 

Stocks: We've written enough on how stocks have roared ahead. So we’ll make one final point. This too looks very fast. We notice these days that market returns are more compressed. What used to take months to climb now takes weeks or even days. Not a time to be out of the market. 

Bottom Line: We think that bonds will recover as stocks take a breather. The next markets to work may be international and especially Emerging Markets but not while the dollar is ascendant. 



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--Christian Thwaites, Brouwer & Janachowski, LLC

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