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Thursday, April 26, 2018

Earnings are coming in much better than expected – more than 80% beating expectations. Yet investors are unmoved. Revenues expectations, an indicator of the true quality of earnings, are guiding higher. Yet investors yawn. Durable goods orders surged 2.6% in March, the trade deficit for goods contracted for the first time in seven months and initial jobless claims fell to 209K, the lowest level in 48 years. Yet investors are indifferent. Investors and markets seem to be intently focused on the 10-year yield and if companies can continue to grow in a higher rate environment. Today the 10 year ducked below 3%. Phew! Investors have become so used to the ultra- low interest rates that may not realize that there have been plenty of times when yields and GDP were much higher and inflation did not blink let alone overheat. Today the ECB announced they are in a holding pattern. Global demand for U.S. Treasuries is still robust given much lower rates in other developed countries and global aging populations hungry for bonds. So higher rates are still facing some fundamental headwinds. And more importantly, earnings and the economy are accelerating. Investors are beginning to remind me of my teenage daughters – when the hair is wrong, nothing is right. Please take a look at GDP, Inflation, 10-Year Yields and Unemployment all the way back to 1975.

Wednesday, April 25, 2018
Over the past 20 years the average asset allocation investor has significantly underperformed stock and bond markets and barely kept pace with inflation.

With fiscal policy set, a key question facing the economy is, will there be an increase in trend growth? The Q1 real GDP report is set to come out on Friday (4/27), and the consensus is for 2% growth. Assuming that 2%, the four-Q average GDP growth of 2.8% is well above prior year’s 2% - and that is before the fiscal stimulus hits. The impact of better ‘animal spirits’ continues in 2018. NFIB small business optimism is holding 11% higher YoY than the pre-election levels; the UMich Consumer Expectations Index is up 13% YoY; the Conference Board’s Consumer Confidence is 12% higher YoY. Better consumer confidence supports consumption but the key to a sustained consumer boom will be rising real wages.
For productivity and the economy going forward, the key is a rebound in investment to raise the capital/labor ratio, drive productivity and lift real wages. The sequencing will be that investment incentives from the tax bill generates investment in 2018 with growth improved. So far so good, as we are seeing the makings of an investment rebound in the (albeit early in the process) recent data. ISM data have recorded a sharp rise in new orders, and while still above 60, it has tampered down a bit in Q1 2018. While a volatile series, it is both hopeful overall while the recent trend bears watching. Other orders data are positive, starting with US Durable Goods up some 9% YoY in February (next release 4/26 with a 1.5% MoM increase expected). Factory orders were up 7.1% in February YoY with ex-transport up 6%. Importantly, orders have been translating into shipments, with capital goods (non-defense-ex aircraft) up 9.7% YoY in February. It is early in the game, but the seeds are being planted. For more on business investment and GDP, please look at page 71 of the Global Perspectives book. - Special Guest Blogger: Tim Kearney, PhD

Tuesday, April 24, 2018

The 10-year yield is flirting with 3.0%. The last time the 10-year yield closed above 3% was January 1, 2014. But, after leading investors on, the cad reversed direction and steadily moved downward to a low of 1.36% on July 8, 2016. The lower yields were indicative of a slowdown in global growth, which manifested itself in a five-quarter corporate earnings recession in 2015 and 2016. Now global growth is accelerating and the yield’s march higher is sincere. The Fed has been hiking rates, moving short-term yields higher. Although the 10-year has been moving up, it won’t be rushed. Hence a flattening of the curve, which is concerning to investors. Fortunately, markets have plenty of other suitors to lead them forward – namely earnings. Better than expected earnings reports have recalibrated the expected Q1 growth rate up to 20%. Economic data has also been flexing its muscles. Consumer confidence bounced back in April to near 18-year highs, home prices increased once again to notch a 6.8% YoY gain, new home sales surged to a four-month high, existing home sales rose more than expected despite lean supplies and the flash manufacturing PMI indicates the manufacturing sector is still on an upswing. Finally, the geopolitical landscape is looking less chilly with a planned U.S./North Korea summit; President Trump’s schmoozing in Europe and lawmakers aggressively pushing for a resolution on NAFTA renegotiations. The 10-year yield will continue to tease, but investors need to keep their eye on the fundamentals. Please see the latest Voya Global Perspectives commentary, The Economy and Markets Unleashed in 2018 for a complete update on the markets and fundamentals.

Thursday, April 19, 2018
The shale oil and gas revolution has made energy cheaper for U.S. manufacturers and spawned many high paying jobs. The recent drop in oil prices has caused the energy sector to cut back.

Oil prices reached $69/barrel and look poised to climb higher. Word on the street is that Saudi officials are targeting $80 or even $100 per barrel. Well, duh. Of course, they want higher prices. They have large fiscal deficits that need to be paid. However, they should be careful what they wish for. Higher prices will further stimulate supply from the U.S. shale producers who are already producing record levels and expected to double their output by 2023. Unfortunately, shale producers are currently running into a traffic jam - insufficient pipelines to move all of the oil they produce. In addition, workers are getting hard to find. However, higher prices will allow them to devote more resources to address these issues. OPEC is no longer calling all the shots. Please follow oil rig count on page 76 of the Global Perspectives Book.
Watch Karyn Cavanaugh's latest appearance on CNBC's Squawk Box as she discusses tax cuts and economic growth.

Wednesday, April 18, 2018
Despite declining import and export growth, recent GDP growth is reported at a 6.7% annual rate. China is attempting to tame excesses and sidestep a “hard landing”.

While China took a pretty remarkable step to stem the trade war risk by opening its markets by a bit, the follow-on talk that China could respond to tariff and Section 301 threats by weakening their currency has taken on a bit of water. The Treasury issued a report on Friday that recent moves in the CNY are in the right direction for US exporters. It is a fair argument, seeing how the Chinese exchange rate has appreciated by 10% over the past year. However, the OECD estimates that the Purchasing Power Parity value of the exchange rate is CNY 3.55/$ which would mean another 80% appreciation of the Yuan. Therefore, in some sense, devaluation talk is a poke at the U.S. bear – and it is a risky strategy as a sustained devaluation could lead to capital outflows and perhaps even capital controls on China.
Unfortunately, there is a misperception about China’s exchange rate (relative) fix. To wit: a fixed exchange rate is not only monetary policy, it’s the monetary policy rule. Edging away from the fix over the past 20 years is the first step to having a free-floating currency, but that is not something that can be quickly achieved. It’s not even desirous for the Chinese authorities; imagine the impact of a relentless move towards CNY 3.5/$. It will not happen quickly because it cannot happen quickly.
In its report, Treasury spread the commentary beyond the traditional swipe at China. No countries were labeled ‘manipulators’ (a slap at fixed exchange rates in general), but rather were noted for persistent and large surpluses. China was joined by India, Japan, Korea, Germany and Switzerland. Major caveat: the report only focused on trade in goods, though “the US has a surplus in services trade with…including…China, Japan, Korea…Switzerland.” For more on China’s economy, please look at page 49 of the Global Perspectives book.

Tuesday, April 17, 2018
Taxes matter. High U.S. corporate income taxes have spawned a recent wave of tax inversion deals.

Earnings season is shifting into full speed and company earnings calls are crediting the strong global economy, corporate tax cuts and higher interest rates (especially for Financials) for their robust growth in earnings. These earnings are cheering and calming investors. This will be the sixth consecutive quarter of year over year earnings growth and will set the bar high for 2019. However, the effect of the tax cuts is still in its infancy. Sure, 400 companies have announced pay raises but that is just an appetizer. Job creation and business investment to increase productivity and sustainable higher GDP growth are the main course. Monetary policy has kept interest rates low but has created big deficits and done little to juice economic growth. Now fiscal policy is at bat. Big corporations provide big headlines, but keep an eye on the small businesses; they are the backbone of the U.S. economy. Please watch corporate tax rates around the world on page 74 of the Global Perspectives Book. Don’t forget: today is the U.S. tax filing deadline – time to test your powers of deduction.

Friday, April 13, 2018
Wide variations in sector returns have generally been the norm; this year information technology and healthcare are the leaders; energy and telecommunications are the laggards.

Consumer sentiment slipped a little in April because of worries over a trade war with China and the possibility of higher interest rates. However, the reading is still near multi decade highs due to strong employment and higher economic growth as the tax cuts weave their way through the economy. Meanwhile, earnings season is now underway and expectations are high at 18.6% growth. Some of the big banks reported this week and beat estimates, but investors don’t seem to be too impressed yet. Energy sector earnings are once again expected to post the highest year-over-year earnings growth and finally over the last month, have started to see some of the recognition they deserve. Every sector except real estate is forecasting double-digit earnings growth. A solid earnings season is just what this jumpy market needs to calm it down. Historically most market gains occur during earnings season. It’s not luck, it’s fundamentals. Fundamentals drive markets. Happy Friday the 13th and don’t forget to heed the words of Grouch Marx, "A black cat crossing your path signifies that the animal is going somewhere."

Please watch performance by sector on page 18 of the Global Perspectives Book.

Thursday, April 12, 2018
Among workers who reported, total savings and investments — not including their personal residence or defined benefit plans — are far below what they will need to retire.

The CBO (Congressional Budget Office) upped their growth projections for 2018 to above 3% based on the pro-business tax cuts. But the CBO tempered the upbeat forecast with predictions of higher deficits that will impede growth in 2019 and beyond. The higher deficits will be due to tax revenues that will not keep pace with spending increases, as well as higher debt repayment costs. Interest rates have been expected to rise for years now, so an increase in debt service, which is currently 6% of the budget, is not new information. History has shown that lowering taxes generally increases economic activity and hence usually increases revenues. However, after only one quarter the jury is still out on the economic growth that will be provided by cutting taxes. (By the way, the latest information from the IRS indicates the top 20% of earners pay 87% of the taxes in the U.S. and the bottom 60% of earners don’t pay any federal tax.) The elephant in the room that needs to be addressed is spending. Social security and Medicare account for more than 50% of federal budget spending and that obligation keeps accelerating as the U.S. population ages. In 1900, the life expectancy was 47-years-old. When social security was invented in the 1930’s the retirement age was 65 and life expectancy was 61. Social security was not so much of a long-term obligation as it was a going away party or perhaps a long weekend hall pass if you had good genes. No wonder the government was so generous. But now that we easily live 25 or 30 years in retirement, social security is not sustainable in its current form. And even if social security remains intact, it hardly pays for a fun and vibrant retirement. Twenty-five years is a long time. Compare that to any other 25 year time period in your life and ask yourself if you would be happy if during that period, you only had playing internet BINGO, watching Wheel of Fortune and eating dinner at 4:00 pm to keep you busy each day. If that doesn’t motivate you to save for your retirement, nothing will. See page 90 of the Global Perspectives Book for some more motivation.

Wednesday, April 11, 2018
Despite declining import and export growth, recent GDP growth is reported at a 6.7% annual rate. China is attempting to tame excesses and sidestep a “hard landing”.

Markets continue to be roiled by rumors of a trade war between the USA and China, with the global economy growing - though a bit off the boil from Q4 2017. For his part, Chinese leader Xi took the pot off the boil slightly by a conciliatory speech meaning to open their markets a bit. There had been some speculation that China will respond to tariff and Section 301 threats by weakening their currency. This is a tall order: the CNY has appreciated by 11% since December 2016 to CNY 6.31/$. The OECD estimates that the Purchasing Power Parity (PPP) value of the exchange rate is CNY 3.55/$, hence a devaluation would reflect swimming against a strong stream. If – and this remains at the level of talk – the Chinese do try devaluation, a 4% cut probably will not be enough to make a major dent. However, if a sustained devaluation becomes real, capital flows would be affected (think the Asia crisis of the late 1990s), potentially bringing on more capital controls. Chinese short-term rates are about 4%, hence requiring quite a rate cut.

In the high-inflation 1970’s, the concept of ‘bond market vigilantes’ was born where the bond market punished the Fed when its policies were too easy (and vice versa). Over the past few weeks, we have seen the growth of stock market vigilantes, where the market is clearly sensitive to the risk arising from trade wars. Clearly, markets will remain on edge, given that pronouncements from DC are not forecastable, nor are WTO decisions nor actions from China or third parties. Until markets can get some visibility on this issue, measures/counter measures and the like, continue to expect volatility, undergirded by a strengthening global economy and positive market fundamentals.

To see how China’s economy has fared over the past 7 years, please look at page 49 of the Global Perspectives book.

Friday, April 6, 2018
Total payrolls, including all non-farm employment, have inched steadily upward with private job creation leading the way.

The headline non-farms payroll report was slightly disappointing this morning. Only 103,000 jobs were added to the U.S. economy in March after a blockbuster February of 326,000. The manufacturing, professional services, education and healthcare sectors were the winners and construction and retail were the losers. However, the strong labor market trend is solidly intact and modest wage gains of .3% were in line with expectations. Investors remain focused on trade concerns and China’s latest reactions to the U.S. proposed tariffs. Throughout all the market volatility, the Fed has been relatively silent. The Fed is no longer the market backstop, prepared to jump in when needed, when markets get wobbly. The market has been unleashed and investors are attempting to find their sea legs. The economy has also been unleashed – in a positive manner with pro-growth tax and regulation cuts. It is now up to both the economy and market to live or die by the sword of capitalism. Please watch the robust job creation trends on page 63 of the Global Perspectives book. Please check out our latest Quarterly Commentary: The Economy and Markets Unleashed in 2018.

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