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Yellen nails it.

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The Days Ahead: Japan GDP and U.S. Factory Orders

Most of the week was waiting on the tax changes. The Fed Beige Book, which summarizes all the regions, was a sort of steady as you go report. Inflation expectations remain low. Some employment pressures but wage growth was flat and where there was some, employers tended to use bonuses or non-wage compensation (think benefits), which don't show up in the wage calculations. New house sales jumped, mostly because of new inventory in the Northeast. They're about 8% of all new houses compared to the south of 56%, so not a big move at the national level.

On Friday, the market tried to make sense of the Flynn news. I tend to think markets are not good at politics. They have a tough time trying to understand the financial implications of a cabinet change, investigation, a guilty plea or just daily dysfunctionality. Even the normally sedate German market faded 3% on stalled coalition discussions, most of which depend on a minor revision to health care providers (see, we’re not the only ones). In the U.S., the 10-Year Treasury had an unusual bout of volatility. For the last month, it has traded between 2.30% to 2.38%, which is a price change of less than 12c on a $100 bond. On Friday, it looked like this:

…which is about 10 times the price move. Has anything changed? Not really, but it shows i) Treasuries are a very good risk-off trade ii) uncertainty comes and goes iii) one of our favorites, “Prices change more than facts, don't confuse the two”. We'd say this is a time when the facts have not changed much.

1. Another record:

Stocks briefly hit another all-time high with only a minor correction on Friday. The Dow hit another thousand mark, at 24,000 on Thursday. It last did this in October. But as we've mentioned before, it's a lousy index and only takes a 4% move to break through another thousand handle.

One interesting point was that among the top performing stocks last week were Macy’s, L Brands, Kroger and Newell Brands. Sound familiar? Three are retailers. L Brands does the Brendel and Bath & Body Works among others and Newell does Rubbermaid, Sharpies and Mr. Coffee. And they're down around 40% each so far this year but up 10% to 15% last week.

We don't think they suddenly became better businesses in a week. It’s far more likely that these are classic “pain trade” when investors have to reverse their view. In these cases, it was likely short covering as volumes leapt four times (h/t Cameron Crise).

2. Thank you and good bye:

Well not quite yet but Janet Yellen gave her valedictory talk to Congress. She highlighted debt (high and about to get higher), productivity and inequality as things to worry about. She’s right on all three and the tax reform won't change any of those. The drop in the corporate tax rate is meant to make U.S. companies more competitive, increase wages, jobs and capex. It won't do any of those. And if anyone knows any CEO who said, “You know, I would be so ready to give employees a wage increase if it weren’t for those darned corporate taxes”, let me know.

As we've mentioned before, the S&P 500 companies pay an effective tax rate of 21%. For tech companies it's 10% and they pay around 17% of the S&P 500’s tax bill but make 21% of its EBITDA. No wonder they corrected last week.

janet yellen.jpg

Anyway, thank you Chair Yellen. Mr. Powell, you have big shoes to fill.

3. It's that time of year again:

When strategists put out their next year forecasts. Although, rather like Holiday decorations, it seems to come earlier every year. We'll write ours up in a couple of weeks but here's some history.

Blog 3 12-1-17 S&P 500 Price Index Annual Returns 1929 to present_SP50-USA.jpg

This shows the S&P 500 return every year since 1929. If you want your forecast to be broadly right, then pick the long-term average of 7.6% and you’ll be correct more than not. But that average includes the down years. There were 27 down years, or 30% of the time, and the average down year was 14%. The average up year was 17.6% putting the 2017 number, at 18.2%, bang in line.

It’s asking a lot for another 18% year in 2018 but with fundamentals, U.S. and global growth and still easy monetary policy, we’d forecast another up year.

Bottom Line:
We've had a great run on equities for all the right reasons. We're willing to stay with it but expect some strange trading patterns over the next few days. Year-end profit taking and positioning may take center stage.


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--Christian Thwaites, Brouwer & Janachowski, LLC

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