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Ch-ch-ch-ch-changes
(Turn and face the strange)
Ch-ch-changes
Don’t want to be a richer man
Ch-ch-ch-ch-changes
(Turn and face the strange)
Ch-ch-changes
Just gonna have to be a different man
Time may change me
But I can’t trace time
– Changes (David Bowie)
As the late, great David Bowie sang to us, the change and strange continued this past week, including in the equity markets. Things started out with a bang on Monday as the S&P 500 had its largest final two hours reversal in nearly 7 years, falling almost 2% throughout the day before managing to close slightly in the green after news that the offices of Michael Cohen, President Trump’s lawyer, were raided by the FBI in New York.
Inflation concerns returned to the forefront with Tuesday’s Producer Price Index report showing continued acceleration in prices across a wide range of categories. We’ve all seen the headlines concerning rising oil prices, so it was no surprise to see rising energy prices. Food has also been rising, while ex food and energy has risen the most on a year-over-year basis since 2011. Service inflation was the strongest on a year-over-year basis since late 2009. Transportation and Warehousing acceleration rose nearly 5%. The only fairly stable component has been trade services, which is retailing and wholesaling.
All the barbs being tossed around concerning trade wars have led Brent oil futures to trade at the highest levels since 2014, gaining 6.28% in the first two days of the week alone, its best two days since late November 2016. Tech also benefited on Tuesday from Facebook’s (FB) CEO Mark Zuckerberg testifying in front of the Senate as investors liked how he handled himself – from Harvard dropout to billionaire getting grilled in front of the U.S. Senate, strange and changes as Bowie said.
The Fed Remains in “Transitory” Mode
The Federal Reserve released its FOMC minutes for the March meeting on Wednesday. They revealed that the committee unanimously agreed that the outlook had picked up in months, inflation is rising and more tightening is warranted. Nearly all agreed that rates should be increased at the current meeting, but that policy would remain accommodative despite the hike and that the future tightening path should be gradual. The committee noted that while the first quarter data has been coming in weaker than expected (not so strange to us), this was determined to be transitory.
Call me crazy but we’ve been hearing that disappointing growth has been caused by “transitory” forces for years – strange how that “transitory” has serious staying power. And it seems the one thing not to change is the Fed being a cheerleader for the economy.
We’ve been hearing a lot about the potential for rising wage pressures, but the FOMC has a slightly different take. Their analysis is that while the labor market does appear to be tight, rather than raising wages to attract new hires as many expect, businesses are changing job requirements to better fit the pool of available talent, offering training or more flexible work arrangements. Rather wage pressures, instead, the workforce is being increased by bringing those currently on the sidelines into the active labor pool. That certainly supports our Tooling & Re-tooling investment theme, and implies that the Federal Reserve may not see the labor market quite as tight.
This time around the FOMC minutes referred to the impact of potential trade wars as being a source of, “downside risk to the U.S. economy,” but “did not see steel and aluminum tariffs, by themselves, as likely to have a significant effect on the national economic outlook.” The statement also addressed the impact of tax cuts, “participants generally regarded the magnitude and timing of the economic effects of the fiscal policy changes as uncertain, partly because there have been few historical examples of expansionary fiscal policy being implemented when the economy was operating at a high level of resource utilization.”
We translate this as it is highly unusual to implement stimulative tax cuts when the economy is already running about as fast as it can, so there isn’t much in the way of prior examples from which to glean insight. We are also in unprecedented and strange times with the Fed shrinking its balance sheet by around $600 billion while the Treasury is set to increase its issuance by $1 trillion to fund the deficits as the Fed is raising rates.
Related: Hearing the Sounds of Uncertainty
Hump Day Brought On Continued Change
Wednesday also saw core CPI rise to a 2.2% annual rate, the 3-month slowed to 2.8% annualized and the 6-month is at 2.6%. The New York Fed’s Underlying Inflation Gauge reported the highest level since July 2006 – that is definitely a change.
Stocks closed Wednesday near the day’s lows, but much better than the pre-market action predicted. House Speaker Ryan announced he will not seek re-election this Fall, a meaningful change for his party, which didn’t garner much of a reaction from the market but it is a tough blow for Republicans in the November mid-term elections.
Thursday the markets closed at their best levels since March 21st on the news that President Trump is assessing re-joining the Trans Pacific Partnership (TPP) negotiations and seemingly ignored the more hostile tone from Secretary of Defense Mattis concerning actions against Syria. By the end of the week, trade tension had eased markedly as we are now hearing that there may be no new tariffs between China and the U.S., a welcome change for the markets.
That’s a lot of change.
We have a new team at the Fed that is decidedly less dovish and appears disinterested in the stock market’s reactions to its decisions – that is big change after the tenures of Greenspan, Bernanke and Yellen, who all appeared to prefer strong market performance in their CVs. The narrative of coordinated global growth is changing as the U.S. and Canada are unlikely to reach even 2% real GDP, the Eurozone is cooling in part thanks to the significant appreciation in the euro and Asia is no longer accelerating. The eurozone just experienced three consecutive months of declining industrial production and saw exports slide 2.3% and imports down 3.1% in February. China’s exports dropped 2.7% year-over-year in March.
Despite this, Q1 year-over-year earnings growth is expected to reach +18%, which is a record 6% higher than it was at the start of the quarter. That is a high bar, which we suspect means fewer companies are likely to beat as they did during the previous low-bar earning. After last year’s record low volatility, the market is on track this year to have 100 or so trading days with at least a 1% range in the S&P 500. The years in which this has last occurred? 1974, 2001, 2002, 2008 and 2009 – I’d say that’s not exactly indicative of a bull market.
The major markets are reflecting the changing environment with the 50-day moving average for the S&P 500 having rolled over quite convincingly and the CNN Money Fear and Greed Index now registering Extreme Fear. The percent of bulls from the Investor’s Intelligence poll has dropped to 42.2%, the lowest level since just before the 2016 election.
More change and likely even more strange is to come in the weeks and months ahead.
Turning to the Week Ahead: April 16 to 20, 2018
Next week we’ll hear about how the Consumer is doing with the Retail Sales Report, which is expected to see an increase of 0.4% after having declined -0.1% and the Bloomberg Consumer Confidence Index coming out on Friday. We’ll get a reporting on housing with the NAHB Housing Market Index, Housing Starts and Building Permits. We’ll also get a feel for how the corporate sector is doing with Business Inventories, Industrial Production, Capacity Utilization.
Earnings season really kicks into gear as we hear from companies such as Bank of America (BAC), Charles Schwab (SCHW), E*Trade (ETFC) and Goldman Sachs (GS) in the financial world . We’ll get insight into the consumer from tech powerhouse Netflix (NFLX), consumer goods giant Johnson & Johnson (JNJ), and consumer credit firm American Express (AXP). We’ll get insight into just how much is getting moved around – a good proxy for economic growth – from transports CSX (CSX) and Schlumberger.