Client Note May 2021

June 8, 2021

After a brief pullback in early May, the S&P500 continued is upward grind, managing to eke out a slight gain, .66%, for the month.  Foreign shares did much better with Europe up more than 4% on the month.  Precious metals were the big winners with gold up 7.6% and silver gaining 7.8%   Precious metals outpaced other commodities, which generally fell during May.  Lumber is almost 25% below its peak in early May.  After an initial rise, bond prices were flat as interest rates stabilized. 

We may be seeing the initial switch back to technology and small-cap stock outperformance after a few months of underperformance.  Technology shares fell sharply early in the month and despite a solid rebound ended down 1.2% on the month.  However, since mid-May, the value-over-growth meme that we have seen the past few months has begun to reverse.  Small stocks and tech have begun outpacing cyclicals/value.   I expect this to continue through the summer.   Stocks remain in an uptrend.  Technology and small companies are seeing prices revived; gold has caught back up to equities and interest rates have been easing.   Sentiment indicators have moved from short term negative to neutral.  For me, this means the market has room to move up as it climbs a ‘wall of worry’ regarding inflation.  Once no one is worried, and everyone has ‘bought in’, THEN we need to be concerned as there will be fewer buyers left to buy.

The main, seemingly only topic, in the news is inflation and the employment situation.  The current narrative is that inflation is being caused not only by supply chain issues, but also by wage pressures.  The idea behind wage pressures is that, if wages continue to climb, prices for goods and services will increase as well, resulting in inflation. 

There is littlereason to think that the pace of wage increases coming out of the recession will continue to climb at the current pace after this summer.   We still have more than 7 million fewer people working than at the end of 2020.   During the recession low wage areas like food service and hospitality bore the brunt of the layoffs.  As people leave unemployment benefits, their new wages will be very similar to the benefits they have been receiving.  Some may earn less.  We are now seeing the peak of wage gains and expectations.  Upward pressure will ease over the summer hiring season ends and bottlenecks dissipate.

The key idea is that wages and prices dropped dramatically and have now rebounded.  This base effect, comparing last year to this year is very substantial.  The error is assuming this pace of gain will continue. The rate of increase in employment, wages, inflation and possibly, earnings will likely level off and slow.  How stock prices react in that environment will be interesting.  Sustained higher stock prices due to low inflation/low interest rates, or will slower growth be seen as a risk to earnings and thus stock prices.

Adam Waszkowski, CFA

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Client Note April 2021

May 10, 2021

The close of April brings us 1/3 of the way through 2021.  After a very rapid start in January and subsequent pullback, April was a strong month across all asset classes.  For the month, the S&P500 gained 5.8%, gold gained 3.8%, corporate bonds gained 1% and long-term Treasuries gained 2.4%. Stocks in Asia have weakened while European shares have been catching up to the US.  Portfolios gained in April and the average Moderate portfolio is up 6% year to date.

We are still in a “value over growth” market, where traditional industries like materials, industrials, financials, utilities are outpacing the growth areas like technology and biotech.  We had been in a market were large-cap growth” (aka technology, aka FAANG) and small-cap stocks had been dominating, but since mid-February markets have been driven by dividend paying stocks and other cyclical areas.  This will likely continue until evidence that we are not going to grow as rapidly as investors currently believe.   Friday’s massive miss in unemployment (1million new jobs expected; 266,000 actual) may be the first data point that could show a much more moderate pace of growth going forward.

The still high expectations of rapid growth see inflation data as evidence that the economy is about to run red-hot.   If we read below the headlines, we can see that commodity prices like lumber are being driven by more than US housing demand.  A years-ago beetle infestation in Canada has limited US lumber imports; sawmill shutdowns due to Covid, AND housing have been sources of supply disruption.  The combination has pushed prices to extreme levels.  China is the world’s largest consumer of raw materials.  China’s early control of Covid-19 and truly massive stimulus spending (approximately 10% of GDP in 2020) has underpinned demand for such commodities and agricultural products.    This makes much more sense than inflation driven by US aspirations to get back to pre-Covid levels, which saw sub-2% growth for several years.  In addition, supply chain disruption due to a varied array of local shutdown conditions across the US has made year over year comparisons and identifying specific bottlenecks a challenge.   Currently, China’s credit impulse is on the wane, while US stimulus takes the reins in 2021.  US stimulus usually takes longer to impact the economy, however.  In the longer run, the US needs to maintain our reserve currency status—by creating enough US dollars for the rest of the world to use—but that is a topic for another day.

I expect forward-looking estimates of growth in the US to decline to more normal levels and at the same time, interest rates and inflation expectations to decline moderately.  Interest rates have been sideways now for almost 10 weeks. I will be looking for further confirmation of this in economic data into the end of the quarter.

 

Adam Waszkowski, CFA

 This commentary is not intended as investment advice or an investment recommendation. Past performance is not a guarantee of future results. Price and yield are subject to daily change and as of the specified date. Information provided is solely the opinion or our investment managers at the time of writing. Nothing in the commentary should be construed as a solicitation to buy or sell securities. Information provided has been prepared from sources deemed to be reliable but is not guaranteed by NAMCO and may not be a complete summary or statement of all available data necessary for making an investment decision. Liquid securities, such as those held within managed portfolios, can fall in value. Naples Asset Management Company, LLC is an SEC Registered Investment Adviser. For more information, please contact us at awaszkowski@namcoa.com.

Client Note February 2021

March 2, 2021

February was a bit of a roller coaster, as the S&P 500 gained 6.5% into mid-month, then fell back 3.5% to end with a monthly gain of 2.7%, and year to date at 1.6%.   Gold continued its drawdown, losing almost 10% year to date.   Interest rates have been rising for over a year now.  The rise in rates, news of commodity gains (rising for year as well), and thus inflation concerns are in the headlines which likely means we are likely to see a reversal in these trends of some degree soon.

With our current and recent equity exposure overweight energy and technology we have been able to offset the negative impacts of bonds and precious metals, providing year to date gains for moderate and aggressive portfolios.  Conservative portfolios will likely get in the game as interest rates pull back.

Inflation, ‘reflation-trade’, and the rise in interest rates lately is very much in the news.  All have been rising since the market crash in Spring of 2020.  Recent readings remain below pre-covid levels.  In September 2019, the CPI index was rising at 1.75% annual rate and the 10-year Treasury bond yielded 1.7%.  Today we see 1.4% inflation and 1.41% on the 10year Treasury.  CPI has been at 1.2%-1.4% since August.    While the inflation rate has remained relatively flat, market interest rates after initially lagging inflation have caught up recently.  This recent surge in rates catching up, is what is in the news.  

What drives market rates are expectations of inflation.  Vaccine roll-out and a dramatic decline in deaths and hospitalizations is allowing for predictions of robust growth to gain traction.  The assumption is that mass vaccinations will allow people to return to work, earn and spend money, growing the economy to pre-covid levels (2007-2019 GDP averaged 2.3% annually).  I have doubts as to how quickly we will get back to pre-covid employment levels.    Here in Florida, we have had in-school teaching since August and bars and restaurants fully open back in September.  Since then, the Florida unemployment rate dropped from 7.3% to 6.1% in December.  The US unemployment rate went from 8.4% to 6.7%.   There may not be significant improvement in employment nationally for quite some time.  But in the very near term, a new round of stimulus will go out in March and impact short term spending and income statistics just as the first stimulus did, potentially giving us a false read on how strong incomes and spending are, and thus an ‘overshoot’ on inflation and interest rates.

Inflation is a slow moving, long term phenomenon.  Over the long term, stocks and gold hold their value against inflation.  For income investors the days of the bond mutual fund are over.  Buying short term bonds to hold to maturity then reinvesting the principle into another bond as rates rise is a short to medium term strategy.   The rise in rates has overshot inflation, and longer term were likely to remain range bound between 1.5% and .9% on the 10-year treasury. Right now, I am not seeing any scenario of rapid uncontrolled increase in inflation or interest rates.

Adam Waszkowski, CFA

 This commentary is not intended as investment advice or an investment recommendation. Past performance is not a guarantee of future results. Price and yield are subject to daily change and as of the specified date. Information provided is solely the opinion or our investment managers at the time of writing. Nothing in the commentary should be construed as a solicitation to buy or sell securities. Information provided has been prepared from sources deemed to be reliable but is not guaranteed by NAMCO and may not be a complete summary or statement of all available data necessary for making an investment decision. Liquid securities, such as those held within managed portfolios, can fall in value. Naples Asset Management Company, LLC is an SEC Registered Investment Adviser. For more information, please contact us at awaszkowski@namcoa.com.

Give your Portfolio a Non-Correlated Gift this Year!

Adding a non-correlated investment theme to a portfolio may be the perfect holiday present this year to consider.

In addition, ESG type investments have become popular because investors want to know the property they own will have a positive impact on the local community and the broader environment. This allows real estate investments to align with what matters most to investors and their families.

One example, is what McLemore is doing in northern Georgia.  Adhering to a strong ESG program, McLemore and its management team strives to provide a profitable return by balancing the Company’s economic goals with good corporate citizenship:

  • Economic Development Incentives: The Company has worked with local and state officials to secure millions of financial incentives.
  • Employment: The Company is targeting over 1,000 new full-time employment opportunities within Walker County, Georgia.
  • Good Stewardship: The Company has remodeled and rebuilt an existing golf course, which now includes the “Best Finishing Hole in America since 2000” by Golf Digest magazine.
  • Visitors: The Company is attracting many more visitors into Walker County, Georgia, where they can enjoy existing parks and protected wilderness areas, including Cloudland Canyon State Park, the Crockford/Pigeon, Mountain Wilderness Area, and many others.
  • The Company is the owner and operator of the McLemore Community, which is an upscale residential golf community that is in the process of developing a Hilton Curio Collection hotel, resort and conference center as well as other amenities. The McLemore Community sits on approximately 825 acres of real property, is located on Lookout Mountain, Georgia and currently consists of the
    many planned components, click here to view the McLemore Executive Summary Overview Deck 10.28.20.

This blog post nor any links above are a solicitation of securities, that may only be performed by a private placement memorandum.  To view McLemore Due Diligence files, including their Private Placement Memorandum and learn more “How to Invest” type information, click here. This offering is for Accredited Investors only. 

The Positive Impact of ESG Investing

ESG type investments have become popular because investors want to know the property they own will have a positive impact on the local community and the broader environment. This allows real estate investments to align with what matters most to investors and their families.

One example, is what McLemore is doing in northern Georgia.  Adhering to a strong ESG program, McLemore and its management team strives to provide a profitable return by balancing the Company’s economic goals with good corporate citizenship:

  • Economic Development Incentives: The Company has worked with local and state officials to secure millions of financial incentives.
  • Employment: The Company is targeting over 1,000 new full-time employment opportunities within Walker County, Georgia.
  • Good Stewardship: The Company has remodeled and rebuilt an existing golf course, which now includes the “Best Finishing Hole in America since 2000” by Golf Digest magazine.
  • Visitors: The Company is attracting many more visitors into Walker County, Georgia, where they can enjoy existing parks and protected wilderness areas, including Cloudland Canyon State Park, the Crockford/Pigeon, Mountain Wilderness Area, and many others.
  • The Company is the owner and operator of the McLemore Community, which is an upscale residential golf community that is in the process of developing a Hilton Curio Collection hotel, resort and conference center as well as other amenities. The McLemore Community sits on approximately 825 acres of real property, is located on Lookout Mountain, Georgia and currently consists of the
    many planned components, click here to view the McLemore Executive Summary Overview Deck 10.28.20.

This blog post nor any links above are a solicitation of securities, that may only be performed by a private placement memorandum.  To view McLemore Due Diligence files, including their Private Placement Memorandum and learn more “How to Invest” type information, click here. This offering is for Accredited Investors only. 

Client Note August 28 2019

August has been a volatile month.  Since August 2, the SP500 has seen 5 moves of 3-4% in both directions for a net, -3%, through today.

Gold, gold miners and long treasuries (TLT) continue to do well putting portfolios into the green for August.  For August, gold +9%; miners +15%, TLT +11%.  Prior to this almost 12 month run in these areas, it was commonly known that ‘gold is languishing”; and “rates will go up”.  Now, its “gold hits 5-year highs”, and “rates seen to continue to fall”.  Often by the time the media reports it widely, the trend is nearing completion.

As we approach Labor Day and the seasonally worst time of the year (Sept/Oct) I am watching for the SP500 to at least stay over 2850, and if we can get over 2940 it opens the door to climb further-but until then markets are under pressure.   Small cap, international stocks are still well below their highs.

Recently it appears the when the US Dollar weakens, US stocks fall while ex-US are more stable.   If the Fed continues to acknowledge further Fed funds rate cuts are likely, this can weigh on the Dollar—unless Europe et al jump ahead and push rates lower via more bond purchases.   So, we may see relative outperformance from ex-US stocks.

Of the individual names purchased recently, one has bee sold out.  IPHI was falling as the sector and general market was climbing, falling below a recent low in July.  The loss was less than 5%.  Cannabis remains under pressure.  Curaleaf reported 200%+ gain in year over year revenue and today saw a drop of 9% at the open, followed by a 23% climb!  This may mark a turn for the sector, but a reversal of these gains will see us abandon this sector in the near term.

The yield curve inversion has been big news.  The 10-yr treasury yield crossed below the 2-yr yield on 8/13 and again on 8/27.  While many other curve inversions have been occurring, this pair, coinciding with a 700 point down day on the Dow has gotten much attention.  The past 3 recessions have occurred as this curve normalizes, that is un-inverts and re-steepens.  I first pointed this out in my quarterly Observation piece January 2019.

 

Adam Waszkowski, CFA

Yield Curve Inverts (again, and continuing)

Yesterday, and this morning, the yield on the 30-yr Treasury bond made its all-time historic lows.  This is extraordinary, especially given the vast amount of stimulus and low unemployment rate.

However, the news on the teevee seems to be harping on the Yield Curve Inversion regarding the 10-yr and 2-yr treasury rates.   This is old news.   Yield curve inversions have been everywhere over the past several months, yet barely a mention from the mainstream financial press.  What I was expecting when I turned CNBC on late in the day was the never-before-seen rate on the 30-yr going below the Fed Funds effective rate.   Additionally, the classic ‘inverted yield curve’ is when the 10yr treasury rate goes below the Fed Funds rate (which tracks closely to the 90-day t-bll), which almost occurred January 2019 and again in March.   This inversion first took place May 23rd well into the stock market swoon that began on May 1.

Below is a chart of the Fed Funds rate, 2-,5-,7-, 10-, and 30-yr rates.  In a normal environment the curve steepens from low short-term rates to higher long-term rates.  Inflation expectations and time value of money are what drives this structure.  So, when we see longer term rates move below shorter-term rates it is at a minimum, unusual.  Analysts generally agree that when this normal structure changes, that changes in the economy and markets are afoot.

Yield Curve Inverts - Rates below Fed Funds

As you can see, yields have been falling since late summer 2018.  This coincides with many data points (durable goods, autos, housing starts, etc.) that peaked and began to move down, indicating slower growth (still growing but slower and slower).   It was the last rate hike (light blue line) where the structure began to invert, and March 2019 when rates began to invert strongly.   There was very little reporting about the 2-/5-/7-yr rates going below the Fed rate.   The reason behind the lack of attention is that the stock market was doing well.   If stocks are up, any negative news is spun as “investors brush off X”.   Ignoring information that doesn’t agree with what we see or would like to see is a form of confirmation bias.

In 2007 Bernanke raised rates right through the 10-yr yield to slow down the real estate bubble.  Powell has raised rates and ended QE, making effective rise in the Fed rate much higher and faster than past, going against other central banks, leading to a very strong dollar.   Powell’s statement in July and fair economic data today, make a rate cut in September unlikely, despite market rates screaming to lower.

As I have mentioned before in my Observations, while there will be a recession again in the US, when it occurs is difficult to predict.  The last 3 recession were immediately preceded by a re-steepening of the yield curve.  Stay tuned!

Fed Does a 180

Prior to December 1, the Fed had widely broadcast that it intended to raise it benchmark rate 3 more times in 2019.   At the December meeting, they lowered that to 2 times in 2019.  In January after the horrid December stock market fall, the Fed changed once again, removing expectations of further rate increases.

The Fed has claimed to be data-dependent and the major economic data points have been indicating slowing growth for most of 2018, and more so since Q2 2018.   The Fed may have realized it overtightened, having raised the Wu-Xia Federal Funds Shadow Rate (Atlanta FRB) by more than 5%.  This was the fastest rate of increase in almost 40 years.

Now the Fed’s balance sheet normalization plan is being questioned and pundits are calling for an early cessation.   In November 2017 the median targeted estimate for the Fed’s balance sheet was just under $3 trillion.   The balance sheet peaked at $4.5 trillion and is currently a tick under $4T.  At the beginning of 2008 it was $800 billion.

So, from a target Fed Funds rate of 3% and Fed balance sheet of $2.75T, to a ‘normalized’ rate of 2.25% and a Fed balance sheet of $4 trillion.    The last few recessions we have seen the Fed raise rates right into economic weakness, only to cease then ease as the recession begins.   With that kind of track record its no wonder people believe the Fed to either be behind the ball, or the outright cause of recessions.

The irony is that the US may have crossed the Rubicon regarding diminishing returns from cheap credit (low rates) aka velocity of money.   While over the past 40 years we have lowered the cost of credit to induce consumption, each recession we must lower the rate below the previous recession lows.  And while we ramp up credit expansion to boost the economy (borrowing more and spending more today) each time, we are getting less and less growth for each dollar borrowed/spent (velocity continues to decrease).  And when there is low velocity, in order to create growth, exponentially larger amounts of money (credit) are required.

I have seen a few reports discussing the idea that low rates decrease future potential growth.  Essentially low rates fail to attract capital, reducing investment, reducing future productivity gains which reduces overall growth.

We have seen the Fed essentially stop tightening (balance sheet runoff should continue to at least this summer) the next step will be for the Fed to ease again, indicating a recession has begun.

Observations and Outlook July 2018

July 5, 2018

Selected Index Returns Year to Date/ 2nd Quarter Returns

Dow Jones Industrials    -.73%/1.26%        S&P 500   2.65%/3.43% 

MSCI Europe   -3.23%/-1.27%         Small Cap (Russell 2000)   7.66%/7.75% 

Emerging Mkts -7.68%/-8.66%     High Yld Bonds  .08%/1.0%

US Aggregate Bond -1.7%/-.17%       US Treasury 20+Yr -2.66%/.07%  

Commodity (S&P GSCI) 5.47%/4.09%  

The second quarter ended with a sharp decline from the mid-June highs, with US stock indexes retreating about 4.5% and ex-U. S markets losing upwards of 6%.  This pulled year-to-date returns back close to zero in the broad stock market indexes.  The only areas doing well on a year to date basis are US small cap and the technology sector.  Equity markets outside the US are in the red year to date languishing under the burden of a strengthening US Dollar and the constant threat of a tit-for-tat Trade War.  Areas of the market with exposure to global trade (US large cap, emerging markets, eurozone stocks) have had marginal performances while areas perceived to be somewhat immune to concerns about a Trade War have fared better.

Additionally, the bond market has only recently seen a slight reprieve as interest rates have eased as economic data has consistently come in below expectations—still expanding, but not expanding more rapidly.   Job creation, wage growth, and GDP growth all continue to expand but only at a similar pace that we have seen over the past several years.  The stronger US Dollar has wreaked havoc on emerging market bond indexes have fallen by more than 12% year to date.  And in the U.S., investment grade bond prices have fallen by more than 5% year to date, hit by a double whammy of higher interest rates and a widening credit spread (risk of default vs. US treasuries) has edged up.

On the bright side, per share earnings continue to grow more than 20%, with second quarter earnings expected to climb more than 20%, thanks in large part to the Tax Reform passed late in 2017.    As earnings have climbed and prices remain subdued, the market Price to Earnings ratio (P/E) has fallen making the market appear relatively less expensive and sentiment as measured by the AAII (American Assoc. of Individual Investors) has fallen from near 60% bullish on January 4th to 28% on June 28th, a level equal to the May 3 reading when the February-April correction ended. The Dow is approximately 800 points higher than the May 3 intraday low.

With reduced bullishness, increasing earnings, and expanding (albeit slow) GDP growth, there is room for equities to move up.  Bonds too have a chance for gains.  The meme of Global Synchronized Growth which justified the November-January run in stock prices and interest rates has all but died, given Europe’s frequent economic data misses and Japan’s negative GDP print in the first quarter.   This has taken pressure off interest rates and allowed the US 10-year Treasury yield to fall from a high of 3.11% on May 15 to 2.85% at quarter end.  I would not be surprised to see the 10-year yield fall further in the coming weeks.  Muted economic data with solid earnings growth would be beneficial to bonds and stocks respectively.

In my January Outlook I mentioned how the rise in ex-US stock markets followed closely the decline in the US Dollar.   The Dollar bottomed in late February and has gained dramatically since April.  This has been a weight around European and emerging market share prices and has been at the core of the emerging market debt problems mentioned above.  Fortunately, the Dollar’s climb has lost momentum and appears ready to pull back, likely offering a reprieve to shares priced in currencies other than the US Dollar.  It may also aid in US company earnings. So, while global economic and market conditions have changed since January, hindering prices of most assets, I believe we will see an echo of the 2016-2018 conditions that supported financial asset prices globally.   A declining dollar, muted investor bullishness, slowing global growth all should conspire to allow stock, bond and even precious metal prices to rise over the coming weeks, at least until investor bullishness gets well above average and the expectation of new lows for the US Dollar become entrenched again.

Looking Ahead

As second quarter earnings begin in earnest in mid-July, expectations are for approximately 20% climb in earnings.  A large portion is estimated to be due to tax reform passed late in 2017.  With market prices subdued and earnings climbing, the market’s valuation (Price to Earnings ratio) is looking more attractive.  While not cheap by any metric, this should give investors a reason to put money to work.  In the first quarter, analysts underestimated profits and had raised estimates all the way into the start of earnings season.  This is very rare.  The chart below shows us that generally analysts’ estimates decline going into earnings season.  Estimates start off high and then get lowered multiple times usually.   Second quarter of 2018 is setting up to be another rare event where we see again earnings estimates being raised into reporting season.
factset earnings 7 2018

The downside to the effect tax reform is having on earnings will be seen in 2019.   When comparisons to 2018 and 2019 quarterly earnings start to come out (in late 2018) the impact of lower taxes on the change in earnings will be gone.  In 2019 we will only see the change in earnings without the impact of tax reform.   Earnings growth will likely come down to the upper single digits.   How investors feel about this dramatic slowing in 2019 will dictate the path of stock prices.

Quantitative Tightening (QT) will dominate the headlines towards the end of the year.  Over the past 9 years central banks have pumped more than $12 trillion in liquidity into financial markets.  The US Fed stopped adding liquidity and has begun to let its balance sheet shrink, removing liquidity from financial markets.    During 2017 and 2018 the European Central bank and Bank of Japan more than made up for the US absence.   Europe and Japan are scheduled to reduce and eventually cease all new liquidity injections during 2019.  Combined with the Fed’s liquidity reductions, global financial markets will see a net reduction in liquidity.   This will have an impact on markets.  It is argued whether this will cause bond prices to fall (rates to rise) or it will have an impact on equity markets.   I believe it is likely this will impact both areas and the likelihood of falling bond and stock prices at the same time is significant.

US Dollar liquidity is another topic just starting to show up in the press.   The rise in 2018 of the US Dollar after a long decline has taken many market participants by surprise.  The “short US Dollar” and “short Treasury” trades were the most popular at the beginning of the year and have been upended.  It is often that once ‘everyone’ knows something, like that the US Dollar will continue to weaken, its about the time that area reverses and goes against how most are positioned.   The mystery really was given rising interest rates in the US and a stronger economy, why was the US Dollar weak to begin with?  Now the causes of a stronger Dollar are the weakness in Eurozone and Emerging market growth.    But which came first, the stronger Dollar or the weaker economies?

Below we can see the relationship of the US Dollar (UUP) and the TED Spread which is the difference in short term rates in the US and Europe.  The recent spike in funding costs (rates) parallels the rise in the Dollar index.  The rapid Dollar rise in 2014 was partly responsible for the Earnings Recession we saw in 2015.  There’s about 6 months to a year lag from when the Dollar strengthens to its impact on earnings.

ted spread july 2018

Ironically, part of the Tax Reform passed is a cause of poor Dollar liquidity (higher short-term rates result) and the strengthening Dollar.  The ability for US firms to repatriate earnings from abroad at a lower tax rate is causing Dollars to move from Eurozone back to the US.  Additionally, the $1 trillion plus budget deficit the US will run in 2018 and on into the future is also soaking up liquidity.  Repatriation, US deficits, and Fed tightening are all pushing the US Dollar up, and will likely see the Dollar stronger in 2019, which may impact US earnings in 2019.

Finally, there is China.   China is the largest consumer of raw materials.  Besides US PMI, the China Credit Impulse impacts base metals and other raw materials that other emerging market economies export.  When China is creating more, new credit we can see a rise in prices and in the growth of raw material exporting countries and a rise in US PMI with about a 12-month lag.  The chart below indicates that beyond the first half of 2018 the impact from the past China impulse will be fading.   This fade is happening at the same time global Central banks will be withdrawing liquidity and the US Dollar likely strengthening.   This scenario doesn’t bode well for risk assets in 2019.

china credit impulse pmi

Adam Waszkowski, CFA

April Recap: Narrative Changes

Stocks rose a fraction of a percent, gold fell 1%, and the bond index fell 1% in April, continuing the very choppy sideways price movement we’ve experienced this year.   The month ended just below middle of the price range we’ve seen since the market top on January 26th.

Over the past few weeks, earnings have been spectacular, growing over 20% on an annual basis.  Unfortunately, stock prices have not reacted well to this great news.  Earnings season appears to have a ‘sell the news’ feel to it.  This could support the notion that stocks were priced to perfection going into reporting season.    The decline in prices and increase in earnings has reduced the market P/E (Price to Earnings) multiple, which could allow stocks to rise back to January levels.   Tax Reform has accounted for about 1/2 of the earnings growth.  There are two issues going forward.  One is that continuing

to grow at that pace will be difficult since we cannot cut taxes every year (and the tax changes to individuals are front loaded—the reductions we have seen will fade in the coming years). Secondly, earnings’ growth slowing, even from 20% to maybe 12%, can be seen as a negative: “slowing earnings growth”.   Surprising positive economic data because of tax reform needs to show up immediately, otherwise, the ‘hope’ baked into stock prices may be removed in the coming months.

Through the month of April, the narrative of ‘global synchronized growth’ has changed as European economic data has come in softer than expected and the US economy has pressed on.  So now we see the US as a main driver of global growth.  In the very short term, this narrative change has given the US Dollar a boost up.   Over the past few months, ‘dollar short’ and ‘rates higher’ have been very popular trades and have begun to unravel.   A stronger dollar will do harm to future US corporate earnings, make $-denominated emerging market debt more difficult to pay back, and serve as a headwind to ex-US assets (emerging, Asian and European stocks and bonds).  And slower growth will not support higher rates for longer term bonds.

The change in the growth narrative/data has been substantial enough for the Federal Reserve to remove from its FOMC Statement, “The economic outlook has strengthened in recent months.”   Often the Fed will change a word or two in certain sentences.  They could have change it from ‘strengthened’ to ‘remains strong’ or ‘continues to expand’.  Instead they dropped it altogether.   This is influencing perceptions of how many times more this year the Fed will raise short term rates.  In the WSJ today the front-page headline, “Fed is On Course for Rate Increases”.  Given the boldness of this headline, its odd to see in the article an inference that even if inflation was stronger, the Fed wont raise rates more than already indicated, which is twice more this year.  There is a dichotomy in the Fed’s statement: taking out the growth story but keeping to the idea that rising inflation is OK, or even good.  Last time I checked, slowing growth and rising interest rates weren’t a good combination: stagflation.   The Fed needs to review the difference between ‘cost-push’, and ‘demand-pull’ inflation.

AAII sentiment for the week ending May 2 came out this morning and Bullishness declined, and Bearishness increased.  This is as expected given that stocks were down over those survey days.  Bullishness isn’t quite as low as I’d like to see for a good bottom, but if stocks can undercut February’s lows, we should see Sentiment get negative enough to support a rally in stock prices going into the late Spring.

Adam Waszkowski, CFA