The Great Goldilocks Debate Continues – Week Ended 6/23/17

For a second consecutive week, US equities wobbled but concluded on the right side (positive of course) of the ledger with the S&P500 adding +0.2% amid what many investors and the financial media continue to highlight as mixed signals. Bears are saying the decline in bond yields and plunge in oil prices are screaming recession. And, the Citi surprise index has plunged while contending at the same time a lack of inflation means lack of demand. They also argue the Fed is tightening too aggressively and too early in light of these less than robust data points indicate is necessary. Meantime, Bulls are saying goldilocks conditions, not-too-hot and not-too-cold growth and low inflation, continue to pave the way for steady economic expansion. They cite leading indicators continue to increase and unemployment claims remain low; house prices are rising and corporate earnings are poised to continue the 1Q experience of general outperformance relative to both expectations and the year-ago period.

Stepping back from the commentary, the data last week indeed remains a mixed bag. The US yield curve continued to flatten last week while company surveys report a steady and optimistic tone from businesses; oil continued to move lower (and broke the threshold for a technical bear market) but copper and iron ore began to improve. Corporate spreads remain steady (suggesting credit risk is not rising meaningfully as it did last year during the oil selloff), but economic data from China was mixed. US retail continues to be a tale of two extremes as Amazon continues to prosper and innovate while more traditional outlets suffer and try to play defense. More short-term positive was that US housing activity seems to be improved following the weak reading that captured attention last month. And on the US policy front there remains at least the appearance that Congress is still attempting to move its agenda of healthcare and tax reform forward despite the expectation by many that a toxic Trump presidency will torpedo any actual progress on hoped-for pro-growth fiscal policy (this was observed through the outperformance of the healthcare sector last week). Another positive was a report that US banks are in very strong and healthy shape following release of recent stress test results.

At the end of the day, what remains most clear is that the days of easy US monetary policy are ending and the market seems to retain at least some hope (even amid rising skepticism) that fiscal policy can successfully pick up the baton. Additionally, while the US economic and financial market cycle is now among the longest in history (it was 10 years ago in June that the US housing crisis began to unfold and morph into a full-blown global financial crisis lasting through Spring 2009), economic conditions and animal spirit sentiment outside the US and particularly in Europe are earlier in their recovery phase. This improvement abroad provides a tailwind in an ever more globalized economy and investors are viewing the recent crash in oil prices as an issue of oversupply rather than one of weakening demand. Bottom line: for the moment we believe the bulls continue to retain the upper hand in this goldilocks story; the bears have not yet began to head for home and recession risk still seems all but imminent. Still, investors must acknowledge that a market pause or more meaningful pullback seems well overdue in the short-term following complete hiatus since the beginning of 2017. Complacency born by persistent low volatility is a recipe for short-term surprise should unexpectedly weak data present itself.

Enjoy the upcoming 4th of July holiday and be on the watch for our latest quarterly newsletter to come in the first part of July.

A Week for Both the Bulls and Bears – Week Ended 6/16/17

The second full week of June, which yielded more flat market performance with the S&P500 barely changed at +0.1%, seemed to offer a little bit of something for everyone. Volatility and the daily trading range observed was up a touch relative to the sleepy pattern investors have grown accustomed to so far in 2017, but remains low by historical standards. Perhaps the most notable development throughout the week was the Fed decision to raise short-term interest rates by another +0.25% bringing its target up to between 1.00% and 1.25%. This hike came despite some recent readings suggesting softer than anticipated and desired inflation. With that, the bearish camp can find support for their case in observing the continued flattening of the yield curve (inverted yield curves have served as a reliable leading recession indicator), weakness in oil, or the recent reversal in what has been the high-flying tech sector so far this year. The glass-half-full crowd might instead choose to focus on the rotation by the market into Financials (often described as the transmission of the economy) despite flatter yield curve, the weakness in gold stocks, or the resiliency from the Industrials sector. Whatever side you find yourself, the market continues to send mixed signals.

From a fundamentals perspective, we already highlighted perhaps the biggest development with the Fed rate increase last week, although the decision was well telegraphed and of essentially no surprise to market participants. Outside of that news, there was a package of stronger data around the world including key manufacturing indexes, Eurozone and Canadian employment, bank lending in China, Indonesia imports, and retail sales in Singapore. Those insights would tend to suggest then that recently cooler inflation readings despite continued labor market tightness are due to more transitory factors such as sliding oil prices on too much production and technology disrupting other goods and services pricing structures than an indication of a slowing economic environment. On the weaker front, some recent housing metrics in the form of new permits and mortgage have been disappointing relative to the time of year, as well as slumping auto sales; these are two sectors of the US economy that have significant trickle-down impacts so downshifts in activity are worth noting.

As observed in our update a week ago, perhaps the most unsettling attribute of recent market dynamics is the flattening yield curve. In that vein, the Fed decision and relatively hawkish press conference did not help. Either forward growth and/or inflation expectations need to lift for the yield curve to steepen when the Fed is in the process of propping up short-term rates. Further, stocks are admittedly not cheap, but it is important to also note that neither are bonds, real estate, or about anything else that is investable. If the financial crisis and unprecedented level of monetary stimulus applied in its aftermath in pursuit of stabilizing the economy has done nothing else, it has created a lot of money that generally remains underutilized and unproductive on corporate balance sheets or being hoarded earning decidedly less than inflation. It is from that perspective that valuations cannot be viewed as a timing tool, because significant sums of that money remain in search of more productive or opportunistic uses. Further, this logic probably also goes a long way toward explaining why the Fed continues to communicate a plan of additional rate increases, albeit at a still slow pace. After all, this has never been a normal economic or rate cycle, but the economy is strong enough now to pursue normalization (very slow but incremental steps away from extraordinary accommodation). In the short run, we suspect that what is a more difficult seasonal stretch of the year, coupled with mixed data and hawkish speak from the Fed will produce some anxiety for the markets, but that is unlikely to mark the end of this cycle.

Stocks Churn As Eyes Were Centered on Comey Testimony Week Ended 6/9/17

Broadly, US equities were mixed for the week ended June 9, but remain higher after 7 trading days in June. The S&P500 slipped -0.3% at the same time as the Dow added +0.3%; meanwhile the tech-heavy Nasdaq which is outstripping virtually all other US market barometers so far in 2017 slipped noticeably on Friday and logged a -1.6% dip for the week (still up +15.3% YTD). Perhaps more notable however is that overall market volatility remains depressed and might best be characterized as sleepy. Some feared heading into the week that a hotly anticipated testimony by former FBI Director James Comey might reveal a smoking gun, active conspiracy, or attempt to obstruct justice by the Trump administration and be the straw that breaks the new Presidents back (the testimony delivered on none of those accusations). And, that story did capture most of the attention and discussion for the week. We also witnessed political populism return with the significant loss of representation by the conservative party in the UK following its election, which all else equal results in a more uncertain geopolitical environment and fattens Brexit tail risks. But consistent with the overall theme of recent months, it remains hard to see much of anything upset the financial markets.

Last week we wrote in our monthly commentary that fundamentals such as economic readings and corporate earnings matter most for any investor with timelines beyond the shortest of term (not political noise or media headlines attempting to provoke emotion). In that regard it was another week that kept alive the more constructive case that building for much of the last 12 months: slow but steady improvement not just here in the US but around the globe. Admittedly, that pace of improvement continues to disappoint depending on who you talk with. But the global economic landscape and outlook has much improved; employment continues to trend higher; and industrial production remains firmly in expansion in countries like Germany and China. US bank lending also continues to advance and corporate earnings estimates for the remaining quarters of 2017 are being revised higher suggesting the huge year-on-year progress reported for the 1Q will continue. Mortgage equity withdraw (the act of monetizing equity in your home value) is on the rise again after being virtually dormant since the financial and housing crisis in 2008, and acts as another support for the powerful US consumer. Unfortunately, the week was not without some soft data points as well that give ongoing concern including the recent slide in commodity prices including iron ore and oil prices; typically commodity prices should be expected to rise as economic growth is accelerating. In a related way, inflation expectations are slipping as the Fed is expected to raise interest rates for the 2nd time this calendar year (usually an inflation fighting tool); this will continue to gain attention especially as it would otherwise naturally cause the yield curve to further flatten or move toward inversion (an ominous and early recession signal).

While soft data (surveys, consumer, and business sentiment) continue to suggest a supportive backdrop for the economy, corporate earnings, and thereby financial markets, one of the biggest mental obstacles for investors to overcome and remain constructive remains the age of the current bull market. Additionally, following roughly 15 months of a strong rally by domestic equities without a meaningful correction, the valuation of domestic equities is not cheap. In that regard, foreign which has generated attractive performance here in 2017 but lagged badly for several years, looks to have additional and significant room to run assuming that foreign political complexities (European referendums and elections) do not steal what appears to be an upturn in economic progress. As we look to the weeks ahead, the pace enjoyed by investors in recent months seems overdue for a pause and we are also entering what is typically a softer period of the year from a seasonality perspective. That said, when reviewing the confluence of data, skeptical sentiment, and slow but steady pace, it would suggest this economic cycle is not at a near-term risk of dying and more gas is still in the tank.