Economic Data Continues to Point to an Economy that is Good, Not Great
What a week it has been! Domestic and geopolitical politics are seriously heating up, we’ve seen phenomenal bitcoin volatility all while the equity markets continue to grind higher and higher even after the quick pullback in trading today. That slippage reflects not only the delay in the Senate tax reform vote, but also the revelation that former Trump national security adviser Michael Flynn pled guilty today to lying to the FBI about conversations with Russia’s ambassador and disclosed that he is cooperating with the special counsel’s office. All of this should make for an interesting weekend and what transpires over the next few days is poised to set the tone for the market next week.
In reviewing the week, on Tuesday the Senate Budget Committee just barely passed the Senate’s version of tax reform, a 12-11 vote that was unsurprisingly along party lines. U.S. equities surged on the news with the S&P 500 gaining 1%. For most of the year, shares of lower-taxed companies have been outperforming those of higher-taxed companies, which told us that the market was skeptical that tax reform could become a reality. Sentiment has been changing recently as shares of higher taxed companies are now outperforming.
A plan to vote on the bill early on Thursday was scratched due to a serious of problems, including nonpartisan assessment of the plan that found the plan would add $1 trillion in budget deficits over the next 10 years. Who ever thought this was going to be easy? By this morning there was still little clarity, and as we mentioned above with the news of Michael Flynn’s guilty plea, things have gotten even murkier.
Wednesday’s equity moves were all about sector rotation, with those stocks that have provided the most leadership year-to-date, such as the FAANG stocks, getting hit the hardest while the weaker performers gained for the most part. We even saw this in the clicks versus bricks battle as traditional retailers such as Sears (SHLD), Macy’s (M) and J.C. Penney (JCP) gaining at least 12% recently while Amazon (AMZN) has lost ground. We chalk that up to Thanksgiving through Cyber Monday results for those brick & mortar retailers being not as bad as feared, but Tematica’s Chief Investment Officer, Chris Versace, and I hashed all that out on this week’s Cocktail Investing Podcast. Exiting Wednesday, the Nasdaq lost 1.3% and tech fell 2.6%, its third worst day of the year. That being said, the Nasdaq has made more record highs in 2017 than in any year prior, even 1999!
Sentiment continues to be incredibly bullish with the spread between bulls and bears in the Investors Intelligence poll at 47.2 percentage points, just shy of the record spread in 1987 of 50 points. Apparently, no one is concerned that we have a potential government shutdown on December 8th if the Democrats decide to gift President Trump and the Republicans some serious coal in their stockings this year. I can imagine many a retail CEO is praying that saner heads prevail as holiday shopping would likely get a tad less rosy if D.C. gets into an end-of-year rumble. Then there is that pesky North Korean nuclear missile situation that delivered yet another yawn reception from U.S. equities.
This has me somewhat compelled to once again share the chart that has me continually shaking my head. Talk about unchartered territory.
A recent report from JPMorgan’s head quant Marko Kolanovic showed how exposed various categories of investors are to equities relative to history. First off, margin debt is at a record high, so that’s clearly in the 100th percentile. Sovereign wealth funds and systematic strategies are also at all-time highs at the 100th percentile. U.S. mutual funds and hedge funds are in the 98th percentile while U.S. households in the 94th percentile. The only time households have been more exposed to equities was back in 2000. Near record high sentiment and equity exposures at the highest or near highest ever seen. Who’s left to buy if the market gets jiggy this holiday season?
With all that bullishness, volumes have seriously declined over the past decade. Average equity trading volume on the NYSE in 2017 is down about 51% from 2007 levels. During that time, the market cap for the NYSE has gained 28%. The U.S. stock market capitalization is today about 135% of GDP, the highest level we’ve seen since 1999/2000.
Sentiment isn’t the only thing riding high as the Conference Board’s consumer confidence index has gained for the past five months to hit a 17-year high. This coming at a time when the unemployment rate is at 4% and the savings rate is at a 10-year low of 3%. A high level of confidence and a low savings rate smack of a consumer that has done a darn good job of satiating any sort of pent-up demand, something we typically see near the peak of a cycle.
Speaking of indicators of peak satiation, was anyone else scratching their head over the expose article titled “Domino’s Tracking App Tells You Who Made Your Pizza—Or Does It?,” on the front page of the Wall Street Journal on Wednesday. Seriously? The utter trauma that a tracking app may not be accurate when it tells you who is making your pizza or gives the time to delivery is worthy of the front page? Talk about the curse of an affluent society. When something like this gets the front page, we’ve got to be near some sort of a peak!
While we are looking at peaks, Bitcoin has doubled in the last two months alone and has appreciated in value to a degree that makes the famous tulip bulb bubble look pedantic – and that’s coming from someone who is seriously fascinated by the potential of cryptocurrencies. This week we saw a pullback as Bitcoin tumbled about 20% then recovered a touch. This area is still in its infancy and not a place for the faint of heart. Bitcoin has a history of racing to peaks, then pulling back with each successive low higher than the one before and the next high surpassing the previous, but the ride along the way can be dizzying.
The data from Europe this week was quite mixed with German retails sales declining 1.2% in October versus expectations for a gain of 0.3%. Swiss retail sales also took a hit, falling 1.5%. Denmark says its economy actually contract by 0.6% in the third quarter, the worst showing since 2011. On the other hand, German unemployment declined for the fifth consecutive month. Euro area inflation came in at 1.5% year-over-year versus expectations for 1.6%.
The U.S. Labor market continues to vex employers, or perhaps we should call them would-be employers as this month’s Beige Book from the Federal Reserve found that across the country companies are reporting challenging labor shortages which are pushing them to raise wages. Put another notch in the going-to-hike-rates column for the Fed this December, and we’ll look for confirmation in the forthcoming JOLTS report later this month. On the plus side, the Beige book found that retailers are generally more optimistic heading into this holiday season, a confirming data point after we saw fewer promotions Black Friday through Cyber Monday than were offered last year.
The revised GDP for the third quarter from 3.0% to 3.3% showed corporate profits gaining 18.4% quarter-over-quarter on an annualized basis which looks great but digging into the details paints a less rosy picture. The story is very sector specific, as domestic financial profits gained 67.3% which nonfinancial domestics experienced just 4.5% year-over-year improvements. Keep in mind that the S&P 500 has gained over 22% during this time – multiple expansion anyone?
This week’s data on U.S. trade is bound to throw a serious monkey wrench into estimates for Q4 GDP as the trade deficit expanded to $68.3 billion in October versus expectations for $64.1 billion. Despite this year’s falling dollar, the AMEX Dollar Index (DXY) is down 9.1% since the start of the year, exports declined 1%. Following weaker than expected October spending and consumption data, economists, both public and private slashed 4Q 2017 GDP expectations. While the ever up beat Atlanta Fed GDP Now survey fell to 2.7% from 3.4% the prior week, JPMorgan slashed its forecast to 2.5% from 3.0%.
Bottom line for the week is the economic data continues to point to an economy that is doing good, not great, but we are seeing indications that the 2017 global acceleration may be weakening. Nothing to get overly stressed about just yet, but it is on our radar. The economic activity boost from the natural disasters appears to be waning as well so Q4 and into 2018 isn’t likely to keep a 3 handle. The market continues to give mixed messages and remains in heady territory, but we’ve seen this play out before and it can continue well past anything that resembles sanity. It is unlikely that we’ll see any meaningful pullback before the end of the year, barring some insanity from any one of the crazies around the world bent on wreaking havoc with the western world.
Enjoy your eggnog, (why oh why can’t we have that all year?) look for those more elusive deals on line this year and enjoy the magic of the holiday season as we keep an eye on things for you.
