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Friday, August 31, 2018

Last year we could not stop talking about the global synchronized recovery. This year the global economic outlook is still good but has become somewhat unsynchronized with the U.S. soaring to the head of the class after enacting pro-business policies. It’s not always easy being the teacher’s pet. The Fed’s interest rate hikes and the U.S. dollar strength have had global implications, especially in emerging markets. Emerging markets have seen their currencies weaken and capital outflows surge. However, in theory a weaker currency helps increase the export outlook and therefore the economy and profits in these markets. Conversely, a significantly weaker dollar would help U.S. exports and the U.S. GDP, potentially sparking cheating accusations and a trip to the principal’s office. You can’t please everyone. As we head out for a long weekend, remember the words of Maya Angelou – “Nothing will work unless you do.” But you deserve some rest too. Happy Labor Day. Please watch Karyn Cavanaugh’s latest comments about the market on CNBC.

Thursday, August 30, 2018

The U.S. consumer is the economic game changer accounting for nearly 70% of the economy. The consumer sure did its share of heavy lifting during the economic recovery helping to bolster GDP when business spending and investment lagged. More recently, tax cuts, wage gains, home price increases, scarce layoffs and market highs are keeping consumer spending strong. As a result, Q2 GDP was revised up to 4.2% and consumer confidence soared to an 18-year high according to The Conference Board. All this spending also increased the Fed’s preferred measure of inflation, the PCE Index, up 2.3% YoY, core 2.0%, the highest levels since 2012. With so much positive consumer data, it is natural for the bears to come out of the woods calling for a correction, crash, recession, meltdown, alien invasion, etc. Sure, the global trade issue is an ongoing fly in the ointment. A few steps forward after an announced deal with Mexico were met with a step back today after an affirmation of China tariffs. No one said it would be easy. Rules, discipline, diversification are investment anti-bear spray. And of course, an eye on corporate earnings which are the true driver of markets. Take a look at inflation and the PCE index on page 60 of the Global Perspectives Book and note that the Fed has been waiting many years to finally hit its inflation target.

Wednesday, August 29, 2018

Fed Governor gave an address at Jackson Hole that has been declared ‘dovish’ from many corners; I prefer to call it ‘modest’. That is, modest in its understanding of the Fed’s ability to discern the future and hence in its ability to set monetary policies. He lays out the historical shortcoming of predicting ‘stars’ that have guided monetary policy: the r* (equilibrium real interest rate) and u* (the natural rate of employment). I find the most interesting comment to be “Navigating by the stars can sound straightforward. Guiding policy by the stars in practice, however, has been quite challenging of late because our best assessments of the location of the stars have been changing significantly” In some ways, it is about as straight forward a statement there can be, yet it underscores that the Fed does not have much of a lodestar to guide policy. This does appear to be a longer-term problem for the Fed: first there was the Bretton Woods fixed exchange rate system (where as Nobel Prize winner Robert Mundell taught the exchange rate was the monetary policy rule); then came a breakdown of the Philipps Curve rules until Paul Volker broke the back of inflation thanks in large measure to monetarism. This has given way to a ‘slack’ model augmenting a neo-Phillips Curve approach. As I have written before, it is a credible monetary policy that anchors expectations. That is, if the FOMC is seen ready to take steps to keep inflation in check then businesses will move slowly before raising prices. It’s a virtuous cycle. Governor Powell cites Greenspan’s risk management rule as “if we see inflation moving, then we’ll do something”, or what is a string of ‘one more meeting, and we’ll reassess’. He places much importance on anchored expectations. He downplays the importance of slack, and notes they see no signs of an inflation acceleration above 2%, nor an ‘elevated risk of overheating’. A modest, hopeful message. One more meeting indeed.

Friday, August 24, 2018

With the market at all-time highs, many investors on the sidelines face a psychological barrier. No one wants to jump in at the peak. So investors are now questioning how long the market can climb. In short: a while. Earnings drive markets and current 25% growth levels may not be sustainable, but growth rates for 2019 are about 10%. The Fed is not worried about inflation and will raise rates very cautiously. Economic growth has been vastly underestimated. The new tax code is not merely a sugar high. U.S. GDP has shifted to a higher gear based on higher business investment. Today’s durable goods report was a miss with headline orders down 1.7% on notoriously volatile aircraft orders. However, a surge in business investment was affirmed with core durable goods orders up 1.4% MoM, 7.2% YoY and June core revised up to .9%. This bodes well for a potential positive revision to Q2’s 4.1% GDP and the Atlanta Fed just posted a 4.6% GDP estimate for Q3. Investor psychology unfortunately motivates behavior, which may be detrimental to a portfolio. There is more than $10 trillion in cash on the sidelines, barely keeping up with inflation. The current bull market’s climb is a testament to the underlying strength of the economy and earnings. Yes, there are risks but the market’s ability to plow through them in the past should increase investor confidence, not rattle them. Please see the Dalbar study regarding investor behavior on page 77 of the Global Perspectives Book.

Thursday, August 23, 2018

Let’s add housing to the wall of worry. The wall is already crowded with worries regarding Fed rate actions, dollar strength, political drama and the biggest worry of all – trade battles, particularly with China, the second biggest economy in the world. Although nationwide mean home prices rose 4.5% in July helping household wealth, many of the latest housing numbers have been less than spectacular:

  • New home sales trended down 1.7% in July to the slowest pace in nine months, although still up 12.8% year over year.
  • Existing home sales were down for the fifth month in a row and are down 1.5% from a year ago.
  • Housing starts have barely budged and the annual number of homes being built is only 1.168 million, far below the 2006 peak of 2.273 million.
  • Hindered by affordability and limited inventory, first time buyers account for only 32% of home sales.

A wobbly housing market is indeed a concern. However, demand is still strong because unemployment keeps falling and mortgage rates are not rising significantly faster. In fact, mortgage rates are down for the third week in a row. Although some potential home buyers have decided to sit on the sidelines and take a breather, it is supply that is the problem when it comes to housing. Limited supply is slowing sales, relentlessly driving up prices and reducing affordability especially for first time home buyers. The strong economic outlook will continue to fuel demand and housing price increases until supply meaningfully increases. Please view the latest housing stats on page 67 of the Global Perspectives Book and read the latest comments about the overall robust global economy.

Wednesday, August 22, 2018

Consider that the USD is up against all currencies, basically, save the JPY this month. So if we consider some conventional measures of monetary policy as expressed in the marketplace, we see that conditions have tightened: yield curve famously has been flattening, 10-year UST yields have slipped from 3% to 2.8% and commodity prices are falling. There have been no big movements in prices over the past month. ISM Prices Paid, Core PPI, Core PCE Deflator and PCE Deflator all underperformed expectations (though it can be classified as a plus/minus 0.1% YoY in the main). Clearly, US growth numbers continue to be strong which aids currencies. The Atlanta Fed GDPNow forecast for Q3 is 4.3%. ISM new orders remain at 60, capacity utilization is 78% and unemployment rate is 3.9%. The issue is stagnant wages; July real average hourly earnings were off 0.2% YoY, part of a long ebb. This is not an outlier; the Atlanta Fed Wage Tracker likewise shows stagnant wages. What to make of this? I’ll propose that dollar strength has come around as markets have digested a December hike and still strong growth. I suspect this channel will stand down. While the Fed may have room to hike in December, I doubt that the Fed will sneak in much more unless we see wages moving higher. With developed country growth continuing, the global engine is available for EM to stabilize and begin to move back higher.

Tuesday, August 21, 2018

Tomorrow the current bull market will be the longest on record. It will be 3,453 trading days without a 20% correction in the S&P500 Index. However, the current bull market is not the highest in terms of market returns. This bull market started on March 9, 2009 and is up more than 320%. The prior longest bull run was November 1990-March 2000, accompanied by returns of 417%. But the current bull market is the highest in terms of earnings growth. Earnings are up more than 1600% since the low. And earnings are not showing signs of slowing down. In fact, projections for the current year have moved up in the last month, not down. Aggressive Fed action could slow the bull but most bull markets are killed by recessions. The robust path of the U.S. economy, driven by tax cuts is breathing life into our current bull and calling an end would be premature, similar to the demise of retail that was widely broadcast last year. Lo and behold, the consumer discretionary sector is up more than 15% YTD after posting 25% earnings growth in Q2. So don’t count this bull out yet, 3,453 may just be the new 2,000. Age is just a number. Please see page 15 of the Global Perspectives Book for the history of the current bull run, which is up more than 80% from the prior peak in 2007.

Friday, August 17, 2018

The market is wrapping up a roller coaster week, which ultimately looks like it will end flat. It was not just the Turkish currency crisis that was weighing on investors. Global growth concerns specifically regarding China were front and center. China’s fixed investment, industrial production and retail sales all undershot expectations. In addition, China’s high flying tech stocks were hammered, increasing unease. However, let’s end the week with the significant positives investors often choose to ignore. The Chinese government is embarking on massive stimulus – cutting rates, loosening credit and increasing government spending 10% YoY. The Chinese stock market is also somewhat disconnected from the economy and not indicative of an overall economic decline. Here in the U.S., productivity surged to the highest level in three years, 2.9% in Q2. Productivity is simply output-hours worked. Companies have finally been upping their capital investment, providing workers with the tools needed to become more efficient. Higher productivity is needed for sustained higher GDP growth, and although the four quarter moving average productivity remains around 1.3%, this is a promising first indication for a potential break from the below trend 2%ish GDP environment plaguing the economy since the recession. Retail sales surprised on the upside and rose to their highest level ever, up .5% in July to $507.5 billion, affirming the strength of the consumer. Indeed, consumer discretionary multiline retailers reporting earnings this week have been generally smashing expectations. Despite tariffs, small business optimism bounced back to an NFIB reading of 107.9, the second highest ever. Finally, the leading economic indicators index rose .6% in July indicating the U.S. economy continued its brisk pace, moving into the second half of the year. So as you take off for a well-deserved weekend, please stow negativity underneath the seat in front of you or in an overhead bin. Please follow productivity on page 65 of the Global Perspectives book.

Thursday, August 16, 2018

Yes, I bring back a retro term to describe the perennial lackluster Eurozone. Germany’s growth has been a bright spot but it is hard to get excited about yesterday’s report of its quarterly (annualized) 1.8% GDP growth when America grew at a 4.1% clip. The WSJ reports “Germany has pulled off an impressive feat”, said Oliver Rakau, chief German economist at Oxford Economics. “In contrast to the performance of its Eurozone peers, growth has picked up slightly in the second quarter”. Talk about a downer. I guess if you set the bar low enough anything is good. The simple fact is that the success of the U.S is squarely attributable to pro-business fiscal policies emanating from slashing tax rates and crushing blows to the regulatory framework. In other words, these pro-business policies have unleashed growth. I feel bad for the European people since their leaders do not clearly articulate that every single time pro-business policies are enacted more growth and more jobs result. Eurosclerosis will continue until the European Union gets the memo that U.S. pro-growth policies have made them uncompetitive on the world stage. Please read our 2018 Forecast: Pro-Business Economy Unleashes Growth for further insight.

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Wednesday, August 15, 2018

Emerging market currency turmoil is at top of mind this week, led but not limited to the Turkish lira. The August currency swoon is a tiresome trope but tiresomeness is nonetheless still a problem. The past couple of months has been especially hard on the Turkish Lira (down 30%) but not limited to it considering that the USD has risen by 3.4% against the Euro too. While it is often said that EM currencies do not float they sink, generally they do not sink without some weight put on them by either the global economy or their own weak spots. In the case of Turkey, Russia and Iran sanctions from the U.S. are not helping. Nor is the global pressure (likely also Fed induced) from commodity markets.

There are other signs of Fed excess tightness beyond the stronger dollar and faltering commodities, not least the flattening yield curve. In this case, it seems policy induced as ten- year UST yields haves been stable despite a pick-up in CPI inflation to 2.9%. I see this as a resulting clash of a tight fed pulling down on yields meeting the need for yields to move higher due to higher trend growth, hence this stalemate. In addition, while there has been much discussion about the flattening yield curve, it is not clear that it has been enough to drive the U.S. into recession. The Fed has presented an alternative recession probability model based on the near-term slope and should be free from some of the complications relating to the term premium. As such, it sees a 15% recession probability over the next 12 months versus a 20% probability implied by the ten-year minus two-year model. Certainly global PMIs are still showing expansion, albeit at a slower rate, but with some major emerging market countries stumbling. - Special Guest Blogger: Tim Kearney, PhD

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