Will Stocks Ever Go Down Again? – Week Ended 7/21/17

Will stocks ever go down again? This seemingly absurd question is actually the result of Google search auto-complete feature if one starts typing the phrase: will stocks ever While we obviously do not root for the market to do so, the answer to this funny question is YES as the strong rally that has gone virtually uninterrupted for the better part of 12 months will assuredly end at some point. Rainy days are part of investing and should be expected (history reveals they do not occur as often as sunny ones, which makes it a rewarding endeavor). But in a period where the market is regularly setting new all-time highs and price volatility hovering near all-time lows in spite of less than encouraging news flow (political failures and dysfunction in particular), perhaps it should not be surprising to observe that this question is being asked of Google often enough to auto-complete. In support of those favorable trends, it is worth highlighting that the S&P500 added another +0.5% last week; the Nasdaq snapped its streak of 10 consecutive positive days on Friday, but still concluded the week up +1.2% adding to the gains by both for July and YTD. Interestingly, momentum factors, those least predicated on economic fundamentals continue to do the best and lead the overall market charge higher while valuation continues to be a factor that is not rewarded by the market at present.

On the economic front where recent weekly data has been somewhat muted and fallen short of the narrative looking for economic improvement, the data last week was more positive. Soft data from corporate surveys continues to produce encouraging readings. Hard data confirmed with bank lending reaccelerating and unemployment claims declining. 2Q corporate earnings are also improving over year-ago levels roughly as expected (and beating corporate guidance by healthy margins). Housing data was also in focus last week amid a number of fresh points was strong with new starts up +8.3% in June over the month prior which had disappointed. This better housing data fits with a logical theme of pent-up demand following the housing crisis 8 years ago and the long shadows it cast until just a couple years ago. At the same time, inflation data remains benign. Abroad, animal spirits (business and consumer sentiment) in Europe continue to look up despite the ongoing uncertainty related to Brexit while China posted very positive data favoring the upside. This is all occurring at the same time central banks continue to discuss shrinking their balance sheets (a form of monetary tightening) and additional rate hikes.

In closing, its been over 270 days since the US equity market experienced a pullback of -5% or more from a recent high. This is not unprecedented, but is well longer than typical. We are keenly aware that markets will not always move unilaterally higher. With that said and despite recent strength, it is hard to characterize investors as euphoric when data reveals that investors continue to pull money out of equities and funnel the proceeds toward bonds. Low volatility suggests that while investors may be complacent (can also be dangerous), but are not euphoric (herding behavior). With so many people continuing to believe we are overdue for a big correction, that may well remain an elusive development. With all that said, the seasonally weakest months are now upon us, and it seems reasonable to suspect some unforeseen negative surprise might have the ability to reawaken fear in the short-run. But returning our focus to the fundamentals, the themes of sound economic attributes suggest the longer-running bull trend can endure a bit longer. Business cycles do not end with profits up and wages up together, and the not-too-hot but not-too-cold Goldilocks theme continues to appear in-tact.

July Continues Upward Climb; Focus on Earnings and Housing in Week Ahead 7/14/17

Domestic equities managed to establish fresh all-time highs again last week despite an economic backdrop that remains well short of robust in terms of pace. At the same time global central bankers continue to speak in a way that leaves little doubt they desire to continue on a path toward more normal monetary policy. But while the pace of economic growth may not be exciting, corporate earnings season for the completed 2Q period looks to be more encouraging, especially when compared against year-ago levels. The S&P500 climbed +1.4% last week, and is now up roughly +11% in 2017. Many continue to scratch their heads as to why, given that the promise of a more business-friendly tax and regulatory climate that coincided with the election of an all-Republican congress and Trump now seems equally ineffective as the prior Washington climate. But it is worth noting that the sectors benefiting most from the election last November have actually fared worst since the beginning of the year, suggesting markets are not as tone deaf as they might first appear. Instead, the gains this year appear to be occurring for reasons other than political reform.

Economic readings last week were highlighted by progressing global leading indicators. In the US JOLTS (a measure voluntary job separations) readings were indicative of labor market strength; still improving corporate surveys and measures of sentiment; European data showed strong auto sales, exports, and industrial production; and Chinese bank lending, government spending, and exports appear supportive of a globally sound economy. In addition, oil prices along with other industrial commodities (which do not seem to be worrying the markets the way they did between June 2014 thru mid-2015 when they were rapidly falling) rebounded sharply last week, probably indicating that global economic activity is OK. Related though, low inflation continues to challenge and mystify global central bankers, giving them pause as they desire to continue backing away from ultra-accommodative monetary policies of the last 8 years. Make no mistake, it is these same weak inflation readings and new communication from monetary authorities, that may warrant the most attention from investors as they evaluate how much longer the current economic expansion and bull market may endure. But so long as short rates are below actual inflation AND it does not drive the US dollar dramatically higher it would be hard to describe financial conditions as too-tight. From a fundamentals perspective, perhaps the most challenging attribute of the continued advance of financial markets is that the economy while OK, does not feel strong enough to justify the low levels of volatility and unarguably strong additional upward advance by equities so far in 2017.

In the coming week, investors will be most focused on the continuation and story being told by corporate America through 2Q earnings. The early days of that data dump have been positive and appear on pace to be +11% over the same interval last year; but if reported earnings can even further surprise to the upside it would make the bull case and current level of equity valuations easier to justify. In addition to corporate earnings, we will get a number of fresh data points on the housing sector. Housing remains an important component of the US economy from the perspective that not only does the construction of new homes support a significant number of jobs, but the movement of people to new living arrangements also has large trickle-down impacts for other industries within the economy. At this point, it seems reasonable to project that the momentum is with more optimistic participants through the balance of 2017 and into next year. It not lost on us however that a meaningful pullback by financial markets has not been experienced in well more than a year and a seasonally weaker portion of the calendar is now upon us through mid- to late-September. Combine that with more hawkish speak by central bankers, or watering down the proverbial punchbowl, we may have the catalyst that creates a short-term scare. We are not advocates of market timing, so that awareness of seasonal vulnerability and one potential threat serves more as a reminder that any pullback (overdue) should probably be viewed as just that; not the beginning of the end of this current economic cycle. As one market technician recently put it, structurally bullish but short-term cautious.

Entering a New (Mixed?) Monetary Environment – Week Ended 7/7/17

Global markets were roughly unchanged last week (S&P500 +0.1%), but volatility picked up as investors appear to be increasingly focusing on a more hawkish Fed and other key central banks talking that direction as well. This tone shift is probably appropriate based on sound economic readings being more normal including (actually low) unemployment rates, steady inflation, and reasonable economic growth; conditions that cannot be described as anything like a crisis or warranting of extraordinarily accommodative monetary policies in which they were implement. But the prospect of diminishing monetary stimulus introduces anxiety for those who firmly believe that asset prices have largely moved over the last 8 years due only to that central bank support. In recent weeks, US equities have struggled for direction, but do feel to be awakening from an extended period of very small intra-day trading ranges. In similar fashion, international markets have also slowed their pace of robust progress that was enjoyed through the first five months of 2017. Interestingly however, the conflicting narrative for economic conditions coming from rising equity prices (suggesting economic improvement) but slipping bond yields and flattening yield curves (which would suggest weakening forward outlooks) appeared to revert a bit last week and in short-term support to the more bullish case.

On the economic front, the big news out last week was the much better than expected employment report for June. Not only was the headline number of jobs added very strong, but there were upward revisions to prior month readings; the details of the report were equally encouraging with the average workweek increasing as well as workforce participation. In addition, surveys of corporate managers across a variety of industries broadly reflect a favorable environment not just in the US but abroad as well. At the same time however, oil prices continue to plumb low levels; two years ago the narrative on negative price action from oil was slumping global demand and created spillover caution and worry over what it suggested about the broader economic climate. Today the markets seem to be maintaining the perspective that falling prices are a function of too much supply rather than a more troublesome indicator. Yet, the price bears watching as it historically has translated into higher borrowing costs for much of the high-yield issuer universe and increased their refinancing risk. We also see

Bringing it all together, what appears most clear is that we are at the onset of a new monetary environment; more mixed than witnessed over most of the last 8 years wherein everything seemed to error on the side of being too easy. More immediate term, corporate earnings season for the now complete 2Q looks to commence this week as well; many anticipate that it will be another quarter where, not unlike the favorable 1Q period, will show companies posting results that well exceed year-ago levels. More uncertain is how reported earnings will stack up against analyst expectations which have been ratcheted up after the 1Q observation that year-ago levels still make for relatively easy comparison (so how much of a beat is already priced-in?). And while the US Fed has been telegraphing its desire to normalize monetary policy for well more than a year, the jury is out on how markets will react to the change in tone and how soon it might morph into action from the ECB (Europe: perhaps the 2nd most influential central bank in the world). We should be careful to remind ourselves that rate increases should not be viewed as a negative when done prudently or carefully as seems to be the appetite; in direct response to improving economic growth and in prevention of too strong price inflation. So long as central bankers do not collectively create an environment wherein financial conditions are excessively tight such that it restricts growth or causes something to break, higher interest rates and returns on money are a good thing for investors. With global real short rates still well-negative (below the pace of reported inflation), it is hard to argue that financial conditions themselves are anywhere near tight; rather the regulatory environment and uncertainty are arguably what has created tight financial conditions and to a large extent limited the effectiveness of monetary policy. From that perspective, it is important that fiscal policy become more sensible (not restricting the ability to borrow for those who show the ability and desire to repay, while excluding access to those who are clearly not in a position to do so). Rising rates are generally in response to an improving growth outlook.