The Days Ahead: Housing and retail sales
One Minute Summary Low inflation numbers from both consumers and producers meant bonds rallied from the 3% level. We haven’t seen the 10-Year Treasury decisively break 3%. We don't put a lot of store in that number. It’s a nice round number but it’s not really relevant to the average Treasury buyer. We were pleased to see the bond market absorb a very large refunding week of $166bn in bills up to 30-year bonds.
There are a few technical moves going on. Small Cap stocks had a good week. They’re up about 5% this year compared to the S&P 500 at 2%. The S&P 500 also managed to bounce off its 200-Day Moving Average. Emerging Markets tracked sideways. The combination of dollar strength, some highly indebted companies and Argentina and Turkey trying to salvage their currencies by ramping up short-term rates, sentiment took a hit. Turkey’s weighting in the Emerging Markets index is only 1.3% but it’s enough to give some concern.
The biggest winner of the week were energy stocks, up around 4%. We think stocks are still trying to gauge where bonds are headed and where the next big catalyst will come from. We're not entirely sure ourselves except we’d say (stop us if you've heard this) growth is not particularly robust, inflation is low, the Fed’s going to raise rates slowly and all that can be undone with a single Tweet. We're still looking at protection and getting paid for some months of a sideways market.
1. What's going on in with inflation? Not much. The Fed thinks inflation is easing up hence the well-telegraphed three to four rate increases this year. We had a minor scare in January that Average Hourly Earnings (AHE) were rising too fast. But subsequent reports put paid to that notion and the January number was revised down.
Inflation is probably the single most important driver of bond yields. Obviously, if you're paid a fixed coupon and fixed maturity, inflation eats into real returns. Equities, of course, are a very good inflation hedge until inflation gets out of hand and consumer demand flattens (the 1970s). Treasury Inflation Protection Bonds (TIPS) are also great hedges and we use them. But they don't provide much current income.
The inflation story since 2009 has mostly been “it’s just around the corner.” Half the Fed thinks that way and most sell-side economists enjoy a healthy living predicting inflation surges. The given reasons boil down to:
- Unemployment is low. Wage inflation must come soon.
- QE flooded the market with M2 money and there’s a decent and lagged connection with money supply and inflation.
- The twin trade and budget deficits will push up prices.
But inflation just seems to be stubbornly in the 2% range and has had trouble even breaching that in the last decade or so. Here’s the latest inflation numbers reported on Thursday:
The core CPI (so take out Food and Energy) is up 2.1% and headline inflation is 2.4% with a lot of that driven by higher energy prices (up 13% to 20%) and the base effects of very low cell phone and medical expenses a year ago. We talk about this a lot but the story hasn't changed.
What does this mean? We ran some very long inflation numbers here and would stick with our view that inflation will not take off and that the current 10-Year Treasury rate, which has flirted with 3% for a few weeks, will stay in a 2.8%-3.1% range for a while. The bond bull market may be over but there is no big uptick in yields coming.
2. “Good earnings, guys.” So you’re a CEO hanging up on a great earnings call (unless you're Elon Musk in which case you send them over to YouTube) after you reported a 25% earnings increase. You’re looking ahead to a permanently lower corporate tax rate, lower cost of capital and pretty friendly regulations. So your choices are:
- Pay higher salaries or bonuses
- Hire more people
- Kick up the capex
- Go do some M&A
- Increase your dividends
- Announce some share buybacks
Now there are some pretty fierce arguments about the merits of each of these, especially the last one. In the “they're great, stop complaining” camp there’s Cliff Asness at AQR and in the “they kill prosperity” camp there are, well pick your number, but one of the more rational ones is William Lazonick at UMass.
We'll not get into the merits because we're only really concerned about how the choices affect stock prices. And here, there is a clear winner: stock buybacks. Apple was the latest to announce a $100bn buyback and its stock rose 14% in a week. Not all share buybacks are received with the same enthusiasm. Some stock buybacks are basically self-liquidation exercises, with IBM being the most famous example. It spent $50bn of its $130bn market cap on buybacks and the stock fell 29%.
What we don't see is much hiring. We watch the NFIB survey, which asks employers if they're going to hire more people in coming months. Here’s the chart:
Last week’s NFIB report was a cracker. Optimism increased, profits up and nearly 60% announced hiring plans. But recently those plans have not resulted in increased employment. Usually when that green line (good time to expand) goes up, employment growth follows soon after. But not in the last few years. In 2017, the “good times” line jumped very high but there’s been no follow through in bigger job numbers.
What this means to us is that companies are keeping margins and profits as high as possible and are very reluctant to add to fixed expenses. The tax fix was meant to change all that but for now the benefits are mainly accruing to shareholders.
Bottom Line: Eyes on the dollar. It has reversed in recent week and is now pretty much unchanged year to date. More strength will be bad for Emerging Markets and U.S. stocks. Bad news on the trade front will send it up.
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