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Wednesday, February 21, 2018

I expect U.S. GDP growth to be above trend in 2018 and approach 3%. With continuation of pro-business policies, we may see the investment boom needed to turn productivity and trend growth higher. The consensus view appears to be that U.S. trend growth has slipped below 2% (the “New Normal”), driven by productivity growth around 0.5% over the past few years. CEA Chair Kevin Hasset published a report recently which notes that the capital/labor ratio has shrunk for the first time in the post-war era at the end of the Obama Administration. That is, the amount of capital (think tools) that workers have at their disposal was reduced. Clearly, you can’t grow productivity while you are taking tools out of the hands of workers. The tax bill plus deregulation is the combination to support a rise in capital investment and likely productivity. Importantly, the first few glimmers of this process are taking place: orders are up, shipments are rising. It’s all good, except we don’t know how the Fed will respond to growth above trend and an unemployment rate seemingly set to move below 4%. I expect that the Jerome Powell FOMC will move cautiously. Taken together, I believe there will be three Fed hikes in 2018, and that conditions will have to change radically (higher inflation or much weaker growth) to see two or four rate hikes. - Special Guest Blogger: Tim Kearney

Friday, February 16, 2018
Housing has turned the corner; housing starts are advancing fitfully, existing home sales have surged and the supply of existing homes for sale has moderated.

Will interest rates and their seemingly relentless march higher derail the red hot housing market? Average 30-year mortgage rates moved up past 4.38% this week. This is the highest rate level since April 2014, but it’s doubtful that higher rates will have much effect on housing. That’s not to say that affordability is not an issue. According to the Case Shiller 20 metro area index, prices have been rising steadily between 5% and 6% since the end of 2014 and prices are now nearly even with the 2006 housing bubble highs. First-time home buyers are struggling to jump in and comprise only 34% of home purchases, although first timers surged by 1 million new buyers in Q4 2017. The biggest issue surrounding housing has been the lack of supply. The short supply of homes for sale has been driving up prices and limiting sales. So today’s new housing starts report of a 9.7% increase to 1.33 million new homes in January is welcome news. In addition, building permits – a precursor to housing starts – were up a robust 7.4% in January and national home builders’ optimism remains near an 18 year high. The best jobs market in 15 years and pro-growth policies that have unleashed economic growth are stimulating housing demand even at higher prices. So even though mortgage rates have ticked up, they are still historically low and spring will likely feel like summer when it comes to the housing market. Please watch housing prices, sales and supplies on page 66 and page 67 of the Global Perspectives™ Book.

Thursday, February 15, 2018

February’s Spike in Volatility
Was Short-Lived

What did investors learn
over the past week and a half?


  • Interest rates spiked after a solid jobs report and an even better ISM services report.
    • Volatility spiked in concert with equity markets getting hammered. A lot of dumb money bet the wrong way on volatility got wiped out fast.
      • A lot of dumb money bet the wrong way on volatility got wiped out fast.
      • A lot of dumb money that had no plan for this inevitable correction panicked and sold hard into falling markets, just in time to lock in magnificent losses.
      • Positives:

        • Interest rates spiked after a solid jobs report and an even better ISM services report.
          • Who knew? Fantastic economic growth is reflecting in rising rates, rising wages, plentiful jobs, and strong corporate earnings.
            • I will be darned – despite even higher rates today, volatility is going down and equity markets are recovering, albeit with a little less euphoria.
              • Oh my gosh – the markets went back up all by themselves without any help from the Federal Reserve. Almost like normal should be.
              • What did we learn?

                The bottom line is that those investors with a plan did not react to a temporary spike in volatility. Sticking with the plan positioned investors to make future gains. That a good economy with elevated interest rates, higher volatility, and a Fed that stays away during these times is, well, normal. Congratulations, you are a strong and smart investor.

Wednesday, February 14, 2018

The CPI came in higher than expected - to hit 2.1% YoY on the headline and 1.8% YoY on the core measure. At first blush on Wednesday I thought I’d find the markets reduced to ashes, but then I reminded myself the core CPI inflation rate has averaged 2% since late 2015. More important from the Fed’s Phillips Curve framework, real average weekly earnings are up by just 0.4% and that’s off from 0.9% YoY in December. So if the market gyrations were coming in a straight line from the unemployment rate to higher wages to inflation to a more aggressive Fed, then I’d expect to see some evidence of tightening being priced in somewhere - but I just can’t find it yet. The dollar index remains 5% below December levels. Oil prices have slipped this year, yes, but remain 20% above late-September levels. Gold prices are up from the Q4 lows and stand 4% above the one-year moving average. And the likelihood of a fourth rate, while a bit more likely, still remains low. Taken together, it’s a combination I think we all love. To wrap it up, both the NFIB Small Business Indices were like valentine's cards to the economy, as its Optimism Index hit a 30+ week high and a 45-year high on “it’s a good time to expand." Clearly there’s room for inflation to disappoint, but at barely 2% it still looks like there’s no need to see the FOMC hitting the panic button. There’s going to be higher volatility after the spate of unusually low volatility, yes. But the markets never do promise us a rose garden.

Tuesday, February 13, 2018
Projected market volatility spikes in times of crisis then drops as fears subside. Current levels are below average, but the Fed’s path to normalization of rates may lead to more typical volatility levels.

The market soared yesterday. Does that mean we are in the clear when it comes to the recent bout of distasteful volatility? Nah. However, that should not be a negative for investors. Although the last few weeks have been extreme, volatility is normal. The new Fed chairman, Jerome Powell, stated that the Fed will remain alert but the Fed put is over. The sugary sweet high provided by Fed stimulus sated markets temporarily but true economic growth was missing from the recipe. So now we have higher economic growth, accelerating corporate earnings and in turn higher interest rates. Inflation is still reflating or normalizing and the Fed is committed to caution. The inflation numbers to be released tomorrow will likely confirm this path. Investors should be savoring a market backdrop where earnings growth - the fundamental driver of markets - has been upped from 9% to 18% for 2018 over the last six months. Just don’t expect volatility to go back to the artificially low levels complacent investors took for granted. Please watch the volatility index (VIX) on page 25 of the Global Perspectives™ Book.

Friday, February 9, 2018

In order to prepare for retirement, experts advise creating a realistic spending plan. Okay, that’s pretty straightforward. Except of course, healthcare costs which seem about as easy to predict as next week’s Powerball numbers. Experts then advocate creating a winning drawdown strategy that will automatically cover your fixed retirement costs. This strategy must be mindful of market volatility because early drawdowns in down markets will disproportionately affect future income, interest rates which will affect bond values, tax changes which will figure into the optimal timing of asset liquidations and the time you expect to remain in retirement i.e. when are you going to die. Okay, while you are doing that, I’ll be in my garage rebuilding my car’s transmission and devising a plan to recycle used cat litter into environmentally friendly jet fuel. In addition to their own basic retirement needs, one in five Americans will be affected by a disability or special need and half of Americans will find themselves in the position as a caregiver. It’s okay to ask for help. You don’t have to be the smartest person in the room but it helps to know who the smartest person is and seek their guidance. Retirement income plans are even more complex than asset accumulation and are one of the only things that can’t be fixed with duct tape.

Please take a look at two extreme drawdown scenarios on page 91 of the Global Perspectives™ Book and reread the Global Perspectives guidance on the recent market volatility.

Thursday, February 8, 2018

Are you an investor or a trader? If you are a trader, you probably have been chewing your fingernails off over the last week. But if you are an investor, you should not be worried. Normal markets exhibit pull-backs and corrections multiple times a year. Sit back and relax on your diversified sofa, leisurely file your nails and recite your ABC’s. A – accelerating corporate earnings continue to accelerate as companies keep guiding higher. B – broadening manufacturing in the U.S. and Europe is keeping the global economy humming. C – consumer strength is the game-changer in the economy. Consumers are enjoying the best jobs market in decades with 4.1% headline unemployment, the lowest new jobless claims in 45 years, and a near record 5.8 million job openings. The ISM non-manufacturing surprised on the upside surging to 59.9% and consumer sentiment is near post-recession highs. Yields are finally reflating to normal, reflecting higher growth. The latest shake out may take a couple days or a couple weeks. No one knows when the recent volatility will subside. But one thing is sure, the stocks that investors complained are too expensive are now on sale. Please watch Doug Coté’s latest comments on the market.

Wednesday, February 7, 2018

The January non-farm payroll report was a bit of a joy to behold, indeed. Payrolls of 200k outperformed and December was revised upward. Both the unemployment rate and labor force participation remained unchanged. But the big star of the day was average hourly earnings of 2.9% with December upgraded to 2.7%. About time, I’d say. The report set off alarm bells throughout the markets, with the bond market beginning to see what it expects: a working Phillips Curve. But frankly, bond yields have been steadily rising since mid-2016, and especially from Q4 2017. This looks like the sort of normalization that we should expect to see: if indeed higher growth is on the way higher bond yields will be on the way – in a good way. The swing up in yields from the September lows are a 44bp increase in real yields to 0.7% with implied CPI up 36bp to 2.1%. So bond yields are consonant with a 2% inflation rate and a sub-1% trend growth rate. If the economy moves to a higher growth trajectory (which is my expectation), then bond yields will continue to rise.

And more growth appears to be on the way. Start with the Atlanta Fed NowCast is calling for a 5+% Q1. There are a couple of arguments against that sort of growth, from poor seasonal adjustments in Q1 to the likelihood that net exports will be a drag as capital is drawn back to the USA to the fact this is a volatile series. By comparison, the consensus seems to be 2.5% Q1 GDP growth. Note also that the NY Fed Nowcast is also printing above 3% for Q1. Taken together, we have early indications that an upswing could be in the making.

Tuesday, February 6, 2018

It has been good – maybe too good – with a shift to an economy that has unleashed growth. Unabashed growth has been missing in action and has come back with a vengeance. That is a double edged sword, which is great for businesses and consumers but not so great when it precipitates interest rates storming back – to well…normal. In the last week ending with yesterday’s selloff, the broad market gauge of the S&P 500 was off by over seven percent as the 10-year U.S. Treasury yields suddenly surged with enthusiasm catching the market “off guard.” There will be confusion, but even though there are two sides to a story there is only one side to the facts:

  • Liquid equity markets sold off the most, that is, U.S. Large Cap and EAFE International equity were hit the hardest. Worse than even Emerging Markets.
    • High quality fixed income had positive returns – we call fixed income the sailboat’s “keel” or ballast in a well-diversified portfolio – long U.S. treasury bonds were up nearly one percent for the day verses negative four percent for equities.
      • Markets were priced for the status quo: volatility and bond yields staying low. The volatility index (VIX) surged over 115% to 37.3 yesterday.
        • Semiconductors, banks, and biotech have been especially hard hit but were not alone.
          • New Federal Reserve Chairman Jerome Powell was sworn in on Monday replacing former Fed Chair Janet Yellen. Don’t expect any help for the market from this Fed.
          • Volatility Jumps in February (see image above)

            Here are some things to keep in mind amid the uncertainty:

            • Economic fundamentals are solid across the board including strong corporate earnings, a strong consumer, and double digit capital equipment expenditures.
              • Monday’s exceptionally strong ISM non-manufacturing services report might have been the spark that led to concern of an overheated economy, but strong economic growth is unequivocally good news.
                • The pro-growth tax cut package passed in December by the U.S. Administration is having the intended impact of spurring economic growth.
                  • 2017 was the best year since 2009 for international markets, further illustrating that a globally diversified portfolio is a prudent investment plan.
                    • It is normal for markets to correct 2-3 times per year. In times like these, it is our advice to “Stick to The Plan When Markets Correct – It’s Normal.”
                    • While times like these put investor fortitude to the test, trying to time markets is pure folly (see our many discussions about the “Folly of Gaming Diversification.”) Instead of losing patience and selling at what may be near the bottom of a downturn, investors are advised to stick with long-term investment plans created during less-fearful times.

Friday, February 2, 2018

The U.S. economy added 200K jobs in January, more than expected and a robust start to 2018 after a strong 2017 which averaged 181K jobs per month. But the big story is long-anticipated wage gains.  Worker pay grew at the fastest rate since 2009, up .34% for the month and 2.9% for the year. In employment news, the 10 year UST yield surged above 2.8%, causing the yield curve to steepen. As a result, the market turned south.  Wait a minute.  Why the crocodile tears? Over the last six months the biggest investor concerns have been a flattening of the yield curve, a stagnant economy, and lack of wage gains. Economic growth and higher interest rates go hand in hand. Investors should want higher rates. However, investors seem to be worried about the pace of the yield upticks and the potential for the Fed to get more aggressive. Meanwhile, earnings growth rates for Q42017 have been moved up to 14% and Q12018 estimates have been revised up to 16.7%. Top line revenues have also been steadily moving up. These earnings are the backbone of the market so maybe worried investors should take the day off and worry about their Super Bowl snack lineup instead.

Please view the monthly non-farms payroll report on page 63 of the Global Perspectives™ Book.


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