Carl’s Corner – 2017

Carl Perthel Alt Text

Carl Perthel, CMT

Disclaimer: The views expressed are those of Carl Perthel, CMT. These views are subject to change at any time and The American Asset Management Group, Inc. (AAMG) disclaims any responsibility to update such views. These views may not be relied upon as investment advice and, because investment decisions for AAMG are based on many factors, may not be relied upon as an indication of trading intent on behalf of AAMG.

 

*** Carl’s Corner for July 2017 ***
After a 14%+ run-up in prices in the SP500 from the beginning of the stock market’s “favorable season,” that occurs between November-April, the past 2 months (May-June) have returned only +1.8%. May-October represents, historically, on average, a “dead zone” where price typically slows down during the summer and early fall. The good news: July is the best performing month during the six month “unfavorable” season that extends through October. What might be a catalyst for a strong July?

A new “earnings season” is rolling out now, which may buoy, or at least support, the stock market averages in the near-term. Q2 may continue to provide earnings growth, like we witnessed in Q1, albeit, possibly not as robust. According to Oppenheimer Research, improvements in corporate revenue and earnings growth in Q1 accounted for a growth in earnings at a +14.6% clip on the back of +7.7% in revenue growth.

According to FACTSET, the Q2, 2017 estimated earnings growth rate for the SP500 is 6.6%, while 76 SP500 companies issued negative EPS guidance and 38 companies have issued positive guidance. All 10 SP500 sectors have lower growth rates today, compared to last quarter, due to downward revisions in earnings estimates, led by the Energy sector.

Technically, the SP500 equity benchmark finally broke above 2,400 after stalling there between early March and late May. Typically, old price ceilings (2,400 in this case) become new support levels that allow price to consolidate before making a move higher. If price can hold the 2,400 range during the “unfavorable” season, that would be positive for the “bulls.” Currently, the SP500 is trading in a tight range between 2,400 -2,450.

Historically, August and September are the worst performing months in the stock market. The likelihood of increased volatility will rise after July, which will coincide with two other factors: the winding down of earnings season, coupled with light trading volume.

On June 29, according to the Bureau of Economic Analysis, the “third” and final reading of first quarter GDP pointed to an expansion of 1.4%, while the consensus expected reading was 1.2%, which happened to be the “second” estimate. The Congressional Budget Office and the Federal Reserve have forecasted GDP below 2% this year, while President Trump thinks 3% is possible.
GDP growth has been relatively slow over the past 8 years. Given that inflation and interest rates are still at absolute lows, low rates and low inflation mitigate the likelihood of a recession in the near term. Some of the factors contributing to slower GDP growth may be the slower U.S. population growth rate, coupled with the work force growing older and retiring, as well as a lower participation rate among women in the work force, large companies holding back on spending for research and development, and an American consumer who is saving more and spending less.

On June 14 the Federal Reserve (Fed) decided to raise the fed funds target range by 25 basis points to 1.00%-1.25%. The rate hike was attributed to realized and expected labor market conditions. In other words, the Fed is still expecting tight labor market conditions to produce stronger wage inflation that will presumably drive broader price inflation. The consensus is for an expectation of one additional rate hike in 2017. In June, the CME Fed Watch Tool assigned an implied probability of 47% to this event taking place. The process of implementing a balance sheet normalization program will start later this year with the goal of shrinking the balance sheet which has ballooned over 4 times since 2008. That’s an awful lot of shrinking since the Fed’s goal is to return the balance sheet to pre-2008 levels.

The economies in Europe, Asia and Latin America are performing well and those numbers are translating to an overall rise in their equity markets. Overseas quantitative easing (QE) by various central banks is driving their investors toward equities and away from fixed income. Global bonds are flat. QE rewarded U.S. investors from late 2008-2014.

U.S. sectors that have the upper-hand right now are financials, technology, industrials, materials and healthcare.

Carl Perthel, CMT

*** Carl’s Corner for April 2017 ***
The SP500 has seen an 11% run-up since Election Day. The “Trump Rally” slowed this month and eked out a small gain if we factor in dividends…without dividends, a slight negative in the month of March.

On the bright side, the equity markets did withstand the first Federal Reserve interest rate hike in over a year and only the second interest rate hike in nearly a decade. Secondly, the Republican legislative defeat and “black eye” for the Trump administration on trying to repeal “Obamacare” did not adversely affect the stock market. All considering, the resiliency in the equity markets validates technical strength in the market averages. What might this resiliency in the stock market be telling us?

Regarding rate hikes, it’s always been the opinion of this writer that the “market” (i.e., Adam Smith’s invisible hand), not the Federal Reserve, ultimately determines interest rates. The stock market is likely telegraphing that rates are low on an absolute basis, and a rate hike or two, or maybe even three, may not threaten equities at this time. Where else is the “bond money” going to find yield if they do not invest in equities? Stock dividends still matter. Until we see a robust economy, accelerating GDP, and wage inflation, it is likely we may continue to experience a favorable stock market to some degree, even as we enter year eight of this spectacular and unloved “bull run” in the equity markets.

Hindsight is 20-20, but it makes me wonder why the Trump administration, given its recent contentious, pre-election history with members of its own party, did not try to “collaborate” on something simpler than Obamacare? Infrastructure, for example, might have been a rallying point that both sides of the aisle could agree upon? Certainly, the Democrats and the unions and the Republicans can find some common ground on this piece of legislation? We’ll see.

The economies in Europe, Asia and Latin America are performing well and those numbers are translating to an overall rise in their equity markets. Global bonds are flat. Price action is signaling that international equities may have room to move higher.

Stateside, corporate earnings have been on the upswing for the past few quarters and the Federal Reserve seems comfortable in proceeding with “interest rate normalization.”
Upon examining sector performance over the past quarter, it is interesting to note that 3 of the top 5 sectors (Health Care, Utilities and Consumer Staples) are “defensive” in nature. Their higher relative performance vs. the SP500 during the past quarter is likely a message that the market is still positive on equities, but there are some concerns. Concerns may be attributed to a shaky political start for the Republican administration. Also, a move to “defense” may be money rotating out of financial deregulation and infrastructure themes. The top sector performer, Technology, is typically insulated from interest rates hikes, while the other top sector performer, Consumer Discretionary, is a testament to more Americans working. The thought among consumers might be the feeling of some extra cash in pocket “to treat ourselves.”

The barrel of oil has closed below $50 a few times in March and consequently; the energy sector has been affected, ultimately seeing lower returns. Energy exporters from the small, less developed nations that depend on higher oil revenues from exports are hurt economically to a greater degree, than say, Saudi Arabia (see October 2016 Notes regarding Saudi Arabia’s oil problems). But, for those countries that depend on imported oil, their economic story is just the opposite. Cheaper oil will assist in their economic development.

On March 30, according to the Bureau of Economic Analysis, the real gross domestic product (GDP) “third estimate” increased at an annual rate of 2.1% in Q4, 2016. In Q3, 2016, real GDP increased by 3.5%; therefore, Q4, 2016 is witnessing a decline from the previous quarter.

The month of April concludes the “favorable” six-month seasonal period in the equity markets that run from approximately November 1 through May 1, each year.

Carl Perthel, CMT

 

*** Carl’s Corner for March 2017 ***
“Big wheels keep on turnin’/Proud Mary keeps on burnin’/ Rollin’, rollin’, rollin’ on the river/ Rollin’, rollin’, rollin’ on the river…” Proud Mary by John Fogerty and The Creedence Clearwater Revival (1969); this year’s theme song, thus far, for the U.S. equity markets.

The Health Care sector was the worst performing sector in 2016. Now, it’s in the # 1 spot in 2017. With the specter of Hillary Clinton gone, and with the Trump administration moderating its views on Obamacare, it would appear volatility in this sector is on hiatus. The biotechnology sub-industry group, within the health sector, down over 20% in 2016, has sprung back to life in 2017, up +12%. People are living longer, therefore needing medical supplies, services, healthcare plans, drug services, etc.; all driven by new innovations. Don’t count out this relevant sector with the aging of America and the rest of the world.

For 2017, the equity markets are moving higher, in part, on decent earnings results, as we wind down our first earnings go-round. The energy sector has displayed disappointing earnings results in the past few years. Improving earnings results in this sector should give an overall boost to SP500 earnings in 2017. An increase in earnings should lower the overall equity market valuations (P/E). But at these extended P/E levels, versus historical norms, will an overall earnings boost be enough to allay the consternation of “valuations seem a bit high,” going into our 8th consecutive year of a cyclical bull market? I don’t think so…On the flip side, the market climbs a “wall of worry.” So as long as there are worriers out there, don’t fight the tape. Be aware, when the worrying stops, don’t be the last person to find a chair when the music stops playing.

President Trump, in his message to Congress last night, reiterated plans for protecting U.S. boarders, promoted infrastructure, and proposed decreasing regulation. Look for aerospace/ defense, technology, industrials, materials and the financial sectors to be the beneficiaries of these policies when agreed upon and executed. Most of these sectors, i.e., the aerospace/defense, technology, industrial and financial sectors are either matching or outperforming the equity benchmarks so far in 2017.

This past month, the FOMC Minutes were met with a yawn. The Federal Reserve members concluded that an interest rate hike could be, “fairly soon if incoming information on the labor market and inflation was in line with or stronger than their current expectations.” The term “fairly soon” is not quite a definitive timeline, is it? Looks like a March rate hike may be put off until May or June. It begs the question whether monetary policy, so prevalent during the Obama years, may now give way to fiscal policy (tax policy and government spending, e.g., infrastructure spending) as the main driver for the U.S. equity markets?

If fiscal policy acts as a stimulus for higher equity prices going forward, as it has since early November 2016, then monetary policy may not matter until fiscal stimulus produces robust economic growth. At the point of a real economic “take-off,” monetary policy may matter again as companies and the consumer fight to borrow money to enhance their sale of goods and services or standard of living, respectively. If and when this time comes, monetary policy will matter, again. Until then, because interest rates are low on an absolute basis, increasing rate hikes may take a while to strike fear into equity market participants. Low rates keep investors disenchanted with bonds, and therefore continue to drive investable dollars into equities for dividend income and capital appreciation. The low interest rate theme has kept the equity “bull market” alive and well since March 9, 2009. Happy 8th Anniversary!

According to the U.S. Department of Commerce and the Bureau of Economic Analysis, the real gross domestic product (GDP) increased at an annual rate of 1.9% in Q4, 2016 (second estimate), same as the first estimate last month. The economy as measured by the GDP is not growing. Data on personal consumption was higher, while state and local government spending and non-residential fixed investment were smaller than previously estimated. Consumption is likely broader with a stronger employment outlook, otherwise, this particular data point doesn’t make the Fed want to go out and raise rates anytime soon. What then will likely prompt the Federal Reserve to raise rates? Wage inflation.

Carl C. Perthel, CMT

 

*** Carl’s Corner for February 2017 ***
Dow 20,000! Is it a big deal? Sure. Does it matter…I think so, and here’s why. Market indexes are attracted to BIG round numbers and once there, over time, they don’t deviate much higher or lower than 10-15% after initial touches for many years. Initially, the DJIA-30 hit 10,000 in April 1999 then spent 28 months from 9,100 – 11,500; after that, the DJIA-30 did not touch 10,000 again for the next 20 months. And after that 20 month hiatus, it took the DJIA-30 until September 2006 to break above 11,500. 1972 – 1981, when the DJIA-30 touched 1,000 for the first time, shows a similar pattern for those 10 years; closing within 2.0% or less of 1,000 at year-end, in only 2 of those 10 years. All other years were below 1,000. The point: big numbers can be a sticking point on a relative basis and it takes time for the “psychological” significance in reaching a big number to wear off before indexes can move higher with vigor. DJIA-30 closed below 20,000 by January 2017 month-end.

The rally from early November 2016 is not dead, but has slowed considerably this past month. The “honeymoon” is still on for now and the market is betting that the executive branch and the legislative branch will “make America great.”

What does “make America great” look like? To start, if we turn to the performance of the U.S. sectors, the vote this past month is in for Materials. The Materials sector is the top performer through the first month of 2017. With the promise of basic industries and manufacturing coming back to America from overseas, and the likely possibility of putting up “The Wall,” between U.S. and Mexico, well…need I say more? It’s going to take raw materials to make good on these promises.

The market is rewarding other sectors in the first month of 2017, as well, including technology, consumer discretionary, and financials. Technology is typically insulated from rising rates, discretionary income is a result of higher wages and a better job market, while the financials enjoy rising rates while capturing the spread between the rates they can borrow at versus the higher rates they hope to obtain through their loans.

With the SP500 up over 9% in less than 3 months, a pullback to “blow off some froth” would be a welcoming event, from a technical view.

January showed the first estimate AND a downward revision of Q4, 2016 GDP. GDP slowed to 1.9% on an annualized rate from the 3.5% expansion in the prior quarter. Investment and consumption inputs grew. Since the “second” estimate for Q4, 2016, which offers more complete data, won’t be released until February 28; this number is to be taken with a grain of salt. Nevertheless, this initial revision is down sharply from Q3, 2016.

After two weeks in office, it has become obvious that President Trump is keeping his pre-election promises. The President’s executive orders, decisions and tweets are causing uncertainty and consternation for the global populous. As investors, let’s keep an eye on company earnings and guidance though this earnings season. Earnings and guidance are typically what the stock market responds to, rarely politics.

2017 marks another post-election year. A stock market history lesson, compliments of Stock Trader’s Almanac 2017 (Wiley): “In the past 26 Post-election years, three major wars began (WWI, WWII and Vietnam), four drastic bear markets started, recession, and continuing bear markets in 2001 and 2009; less severe bear markets occurred or were in progress in 1913, 1917,1921,1941,1949,1953,1957,1977 and 1981. Only in 1925, 1985,1989,1993,1997 and 2013 were Americans blessed with peace and prosperity.” I would add, looking at these dates, that most of the “peace and prosperity” has come within the past 30 years. Peace and prosperity are skewed in our direction at this juncture.

Paraphrasing Stock Trader’s Almanac 2017 (Wiley): “… the first two years of a president’s term is marked by stock market performance lags versus years 3 and year 4. After a president wins the election, the first two years are spent pushing through as much policy as possible. Adjustments to new policies may result in bear markets, recessions and war. As year three approaches, presidents and their parties get anxious about holding on to power and begin to prime the pump in the 3rd year, fostering bull markets, prosperity and peace.”

February is the weakest month of the seasonally “favorable” 6 month period from November – April. A pullback this month after this spectacular run up in price since early November may provide a buying opportunity. The promises of tax cuts, deregulation and an infrastructure build-out will take a bit longer in time and funding than the time it takes to sign an executive order. Will the market be patient? Time will tell…

Carl C. Perthel, CMT

 

*** Carl’s Corner for January 2017 ***
Like the Dickens novel, A Tale of Two Cities, the U.S. stock market, bond market and U.S. Dollar can all be summed up with Dickens’ famous quote, “it was the best of times; it was the worst of times.” All three asset classes in calendar 2016 experienced large price runs, both up AND down. It made for lots of volatility, relative to calendar 2015 where each of these asset classes were relatively “trendless.”

In summary, the bond market was expecting 4 rate hikes in 2016 and got only one. But the anticipation of that one rate hike in mid-summer took a 19% gain (best of times) in the long bond, to a -1.2% loss by year end (worst of times for bond “bulls.”) The stock market was down -10% (worst of times) by mid-February 2016, up only 2% (without dividends) by early November, but ended up +10% by year end (best of times for equity “bulls,”) while the U.S. Dollar was negative (-6.39%) by early May, but finished +3.16% by year end, gaining almost +10% in the last 8 months of 2016 (best of times for Dollar “bulls”). Volatile!

The results of the U.S. Presidential election spurred the stock market higher with the perception that tax cuts, deregulation and an infrastructure buildout was on the horizon; resulting in a 7.5%+ move in the equity benchmarks since November 4, right before the election. The specter of a stronger economy with accompanying rising interest rates has pressured to bond market lower, while strengthening the U.S. Dollar.

The question is whether perception will translate to reality. Newly elected presidents typically have a 100 day honeymoon period. It’s likely the stock market may give the new administration a “hall pass” until the spring before its starts cashing in on its expectations. For now it is “wait and see.” The volatility of president-elect Trump may match the markets.

Followers of Carl’s Corner and AAMG clients were reminded, in the November 2016 “Markets Unplugged” call, that the November-January time frame favors higher stock prices. The market has proven “true to form” again and equity investors have been rewarded. A +7.5% return since the beginning of November makes the -10% return in the first six weeks of 2016 seem like a distant memory, does it not?

The third estimate for Q3, 2016 GDP came in at 3.5%, a substantial increase of 1.4% over and above the third estimate from Q2, 2016. The Bureau of Economic Analysis press release cited, “the GDP Q3 increase is due to positive contributions from personal consumption expenditures, exports, private inventory investment, nonresidential fixed investment and federal government spending.” The stock market is reflecting stronger GDP growth with rising stock prices in the energy, basic materials and industrial sectors.

The big sector winner since the pre-election run-up in equity prices from November 4th has been the financial sector. The group is up over 19% since then. The hope for tax cuts, deregulation and higher interest rates (which allow financial institutions to profit from spreads on their loans) are the likely reasons investors have seen this “parabolic” move in the financial sector. Let’s see if perception matches reality in the quarters ahead. In any event, stronger domestic economic numbers, like GDP, provide concrete support for the possibility of a stronger economy.

Stronger economic data support inflation and a move away from deflation. A quandary has developed between the U.S. Dollar and the Commodity Index. Both indices have been moving higher together since late April. Typically, a higher Dollar will eventually put downward pressure on commodities, since commodities are priced in U.S. dollars. If these inputs for manufacturing (commodities) become more expensive due to the rising U.S. Dollar, then commodities become less attractive to investors. But, if global demand and stronger global economies present themselves, then commodities should fare well. Let’s give a very slight nod to commodities at this juncture.

On a relative price basis, small cap issues continue to outperform large cap issues, likely due to the perception that “Made in America” will be resurrected and perhaps due to a strengthening U.S. Dollar that puts larger multi-nationals at a disadvantage compared to smaller U.S. companies. “Value” in the large and small cap space is still outperforming “growth” at this juncture, while U.S. issues are outpacing international stocks. International and emerging market equities are outperforming international and emerging market bonds.

Happy New Year!

Carl C. Perthel, CMT