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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.

Thursday, February 1, 2018

Productivity is doing more with less. It is generally gauged by measuring output, but wages also factor into the equation. If wages spike while output remains constant, productivity would decline and vice versa. Productivity grew by 3.2% from World War II until 2000 – coincidently when the number of women entering the workforce peaked. Then, despite the internet, productivity from 2000 – 2007 trended lower, around 2.6%. And since 2007 productivity has been a meager 1.2%. Productivity is needed for economic growth, thus the low GDP readings over the last 10 years should not be surprising. One of the reasons for low productivity has been lack of capital investment by businesses. When companies invest more in long-term equipment, structures, and intellectual property it makes their workers more efficient and increases output per worker hour. With the advent of easy Fed money, companies could be lazy, skip the investment and still boost share prices with dividends and share buybacks. The last three quarters of GDP have exhibited the nascent reawakening of business investment, but today’s 4th quarter productivity reading was an unexpected loser at -.10%. Yes, the quarter over quarter numbers are volatile. Maybe it’s the shortage of skilled workers; maybe it’s capital spending that is still too low; maybe it was skewed by a year-end spike in wages (the EIC employment cost index just reached a 7.5 year post crisis high); maybe it’s a calculation issue since our service driven economy is more difficult to measure than manufacturing. But after an encouraging 2.7% in the third quarter, a productivity drop of -.10% was a stark reversal. I expect somewhat of a revision and higher growth going forward as tax and regulation cuts spur businesses to make the needed investments to compete long-term. Meanwhile, the ISM manufacturing index remains robust at 59.1%, initial jobless claims dropped last week, consumer confidence remains near a 17-year high and the ADP private payroll report was a significant positive surprise, showing an additional 234k new jobs added to the economy in January.

Please view productivity and the employment cost index on page 65 of the Global Perspectives™ Book.

Wednesday, January 31, 2018
The U.S. manufacturing report has rebounded after a month of contraction; the latest eurozone and emerging markets reports also indicate expansion.

The Q4 GDP report raised some of the key, vexing issues facing the outlook: can the U.S. break out of the low-growth “New Normal” that has afflicted the economy for at least 10 years? As noted last week, the ever skeptical IMF is on the U.S. short-term, tax-cut bandwagon – while implicitly calling for an extension of the cuts – as they upgrade the U.S. outlook to 2.7% in 2018 (was 2.3%) and to 2.5% in 2019 (was 1.9%). The short-term effect on growth is being baked into markets. Noted economist Robert Barro believes that changes to corporate and individual tax rates can increase real GDP by 1% in 2018 and 2019. The path forward is clear: capital investment is the sine qua non of better growth. The Council of Economic Advisors has written that the capital/labor ratio growth (how much capital each worker has available to be put to work) has fallen to zero for the first time in history.
So the keys to follow are confidence measures, new orders, capital goods shipments and other investment measures. A return to historical levels of capital per worker could add a near full percent per annum on the growth rate, per the CEA. So far we seem to be on that track, but one year is not enough to break out of this slow-growth, “New Normal." When considering this landscape, remember that stronger growth will lead to higher interest rates and higher bond yields. Fear not higher interest rates – the risk for markets is that they fall back to 2% due to continued economic underperformance. Please take a look at page 9 of the Global Perspectives™ book for more information on ISM Manufacturing.

Tuesday, January 30, 2018

Parents generally teach their children to be careful and offer good advice - look both ways before crossing the street, don’t run with scissors, always wear a seatbelt. So investor caution is natural. Nine years into a bull market, the retail investors who have been reluctant to get into stocks have finally starting dipping their toe into the equity pool. Yesterday, the market had a rare down day and today the media headlines are questioning if this is the end of the bull market. Yikes. They point to rising yields – which may make bonds more attractive when compared to equities. This interest rate talk may be spooking investors, but a 10-year yield of 2.7% is hardly competition for stocks and rising yields are indicative of a rising economy – an economy that will likely surprise on the upside now that tax cuts have unleashed growth. After four weeks of basically straight up, it is normal to see markets go down. For the first time in a decade both the economy and market are surging. It turns out that the “new normal” sub two percent economy was a fallacy, just like waiting an hour after eating to go swimming. If you have a well-diversified portfolio, don’t overreact. Let the fundamentals (corporate earnings) do the worrying for you. Those earnings don’t look too concerned. The bull is still running. Fourth quarter earnings season is 30% complete and growth so far is better than expected, more than 12%. Review yesterday’s Global Perspectives™ Investment Weekly for a little perspective on how much the market has run so far this year.

Friday, January 26, 2018

The Wall Street Journal today has the headline from above but it is too modest. Tax overhaul is ripping through the global economy.  As I predicted a week after the tax overhaul on December 28 in a blog titled The Calm Before the Storm, “….the blue chip of blue chip country just slashed their prices and every other country in the world woke up to find themselves at a massive competitive disadvantage. Global tax rates are about to fall like dominos.”  President Trump is in Davos, Switzerland turning the World Economic Forum on its head by giving a tutorial on capitalism and pro-growth economic policies. Here is a sampling of the impacts in the U.S from the WSJ article:

  • “Along with announcing its repatriation of cash held overseas last week, Apple Inc. pledged to invest $30 billion in the U.S. that it had held abroad, despite having to pay $38 billion under a one-time tax on those accumulated foreign profits.”
  • “Already, analysts expect the legislation to provide a 7% to 8% boost in aggregate per-share profits for the companies in the S&P 500 this year, said Joseph LaVorgna, chief economist Natixis.”
  • Acquisitions for equipment new or used for cash – an asset purchase – get an immediate discount.  “The cost of deals structured in this manner have a turn for the better,” New York tax consultant Robert Willens notes, “You’re getting a full 21% discount."

There is more – a lot more – such as Treasury Secretary, Steve Mnuchin, saying on CNBC in Davos that small business has the biggest tax break since the 1930’s. 

Watch Doug Coté on CNBC December 28 discussing how tax overhaul is tearing through the global landscape.

Thursday, January 25, 2018

The answer is NO, especially if you are investing for retirement. Retirement investing is particularly intricate because the goal in not just total return, it’s lifetime income. Interest rates are historically low making savings accounts, cd’s and bonds somewhat unattractive for investors needing substantial growth. Most CD’s are still paying sub 2% interest. Investors will have to assume some equity market risk in order to help amass a nest egg sufficient to sustain them for perhaps thirty years or more. But wait…once in retirement, investors may need to navigate drawdown options as they continually deal with market volatility, inflation, liquidity needs, credit, and interest rate risk. It can make you tired just thinking about it, so you better start saving early. And enlisting the help of someone skilled in creating long-term streams of income may be advantageous. Diversification and discipline will typically serve you better than hot stock tips.

Please see the average savings needed for retirement on page 90 of the Global Perspectives book.

Wednesday, January 24, 2018
The U.S. manufacturing report has rebounded after a month of contraction; the latest eurozone and emerging markets reports also indicate expansion.

The IMF now predicts the fastest global growth in seven years of 3.9%. It’s too early to take a victory lap given that growth pre-GFC averaged 5%, but it’s progress. The IMF is crediting the U.S. tax cuts to increase our growth to 2.7% from the 2.3% in its last report, along with a better outlook for Europe (to 2.3%) and Japan (to 1.2%). IMF Chief economist Maurice Obstfeld warned that the Fund doubted that this was the beginning of a New-New Normal - that is an up move from the near two decade long slow growth era. His is a fair point; will this be a modest, short-lived bump-up or a change to a stronger growth regime? Clearly this is the key question: if we don’t break higher, we probably are in a pessimistic New Normal of sub-2% growth.

Looking at recent U.S. data, we see break-outs in economic confidence, ISM Manufacturing, cap goods orders, shipments, Leading Economic Indicators and manufacturing production. We may be seeing a move back to sustained 3% GDP growth; the Q4 GDP report is out Friday with consensus at 3.1%. Net/net, I’d score the macroeconomic background as very favorable and pointing towards sustained, better growth. I believe our measure of the cycle is correct; we may be heading into a better growth trajectory rather than recession. The onslaught of deregulation and tax cuts are building on an economy which doesn’t seem to face major imbalances (except, perhaps, Bitcoin-mania). There is room for better growth in the coming quarters, unlikely at a pace which would push the Fed to hike faster. It’s a good background for risk assets.

Please take a look at page 9 of the Global Perspectives™ book for more information on ISM Manufacturing.

Tuesday, January 23, 2018
Over 90% of the world’s consumers reside outside the U.S., making global trade imperative for growth. The global growth slowdown corresponds with an overall slowdown in trade..

Tell me if you heard this one before…the market just reached an all-time high. It’s not deja-vu. The S&P 500 really is up more than 6% so far this month and shows no sign of abatement. The government shutdown barely caused the market to blink. The pro-growth tax cuts have unleashed optimism, economic forecasts, and corporate earnings projections. To date 80% of the companies reporting earnings for Q4 have beat estimates and the estimate for Q4 2017 growth is 12.4% (Thomson Reuters estimate as of 1/22/2018). When it comes to top line revenues, 87% of companies have beat estimates. What could possibly go wrong? Well, one risk to the market could be global trade. Global trade is the grease that keeps the world’s economic engine running. Any significant disruption could impact markets. President Trump just slapped tariffs on imports of solar panels and washing machines. Protectionist policies inhibit free trade and are generally a bad idea, but the administration is claiming to combat unfair foreign practices primarily attributable to China in order to create a more level playing field for American companies. This is a very narrow market segment but it will be interesting to see if fair trade practices can be negotiated without dinging global trade flows. In the meantime, diversification and regular rebalancing to lock in gains could help investors if we ever see some bumps in the market. Please keep an eye on global trade on page 47 of the Global Perspectives™ Book and note that global exports and imports have been moving higher over the last year.


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