Stocks reversed after a hot opening today. With a quiet data week ahead, the focus is on the prospects of a government shutdown.
If this sounds familiar to you, it should. Government debt is the, often played, go-to political football.
It was only last month that we were facing a similar threat. But with some policy-making tailwinds on one side of the aisle, the fight was politically less palatable in December. With that, Congress passed a temporary funding bill to kick the can to this month.
And just three months prior to that, in September, we had the same showdown, same result. The “government shutdown” card was being played aggressively until the hurricanes rolled through. From that point, politicians had major political risk in trying to fight hurricane aid. They kicked the can to December to approve that funding.
Now, the Democrats feel like they have some leverage, and their using the threat of a government shutdown to make gains on their policy agenda. So, how concerned should we be about a government shutdown (which could come on Friday)? Would it derail stocks?
If you recall, there was a lot of fuss and draconian warnings about an impending government shutdown back in 2013. The government was shutdown for 16 days. Stocks went up about 2%. Before that was 1995-1996 (stocks were flat), and 1990 (stocks were flat).
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Stocks have now opened the year up 4%. Global interest rates are on the move, with the U.S. 2-year Treasury trading above 2% for the first time since 2008. Oil is trading in the mid $60s. And base metals are trading toward the highest levels of the young, two-year bull market in commodities.
This all looks like a market that’s beginning to confirm a real, sustainable economic recovery – anticipating much better growth than what we’ve experienced over the past decade.
If that’s the case, we should expect a big adjustment coming in inflation readings. And with that, we should expect a big adjustment coming for global interest rates. We’ll likely have a 10-year yield with a “3” in front of it before long. And that will have a meaningful impact on key consumer borrowing rates (especially mortgages).
On the inflation note, we’ve talked this week about the impact of higher oil prices on inflation and the impact it may have on the path of central bank policies (most importantly, the speed at which QE may be coming to an end in Europe and Japan).
You can see in this chart, the very tight relationship of oil prices and inflation expectations.
Now remember, one of the best research-driven commodities investors (Leigh Goehring) thinks we may see triple-digit oil prices — this year! This has been a very contrarian viewpoint, but beginning to look more and more likely. He predicted a surge in global oil demand (which has happened) and a drawdown on supplies (which has been happening at “the fastest rate ever experienced”). He says, with the OPEC production cuts (from November 2016), we’re “traveling down the same road” as 2006, which drove oil prices to $147 barrel by 2008.
Bottom line, this is an inflationary tale. If we had to search for a market that might be telling us this story (i.e. inflation is finally leaving the station), the first place people might look is the price of gold. What has gold been doing? It has been on a tear. Gold is up 8.3% over the past month.
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Yesterday we talked about the move underway in interest rates. And we talked about the media’s (and Wall Street’s) desperate need to fit a story to the price.
On that note, they had been attributing rising U.S. rates to a vaguely attributed report from Bloomberg that suggested China might find our bonds less attractive. As I said, that type of speculation and chatter isn’t new (i.e. not news). Not only was it not news, China called it “fake news” today.
But as we discussed yesterday, rates are on the move for some very simple fundamental reasons. It’s the increasing probability that we will have the hottest U.S. and global growth in the post-crisis era, this year — underpinned by fiscal stimulus. And that’s inflationary. That’s bullish for interest rates (bearish for bonds).
So, again, money may just be in the early stages of moving OUT of bonds and cash, and BACK into stocks.
But, as we’ve also discussed, the real catalyst that will unshackle market interest rates from (still) near record low levels (globally) is the end of global QE.
And that will be determined by the central banks in Europe and Japan. On that note, the European Central Bank has already reduced its monthly asset purchases (announced last October), and they’ve announced a potential end date for QEin September of 2018. This morning, we heard the minutes from the most recent ECB meeting. And the overwhelming focus, was on stepping up the communication about the exit (the end of emergency policies). And don’t be surprised if European governments follow the lead of the U.S. with tax cuts to accompany the exit of QE.
In support of this outlook, the World Bank just stepped up growth expectations for the global economy for 2018 to 3.1%, saying 2018 is on track to be the first year since the financial crisis that the global economy will be operating at full capacity.
With the above in mind, you can see in this next chart just how disconnected the interest rate market is from the economic developments.
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We talked yesterday about the move underway in market interest rates. Today the yield on the 10-year touched 2.60%. That’s the highest levels since March of last year.
For perspective, let’s take a look at the chart …
Suddenly, rates are all the media can talk about. They specialize in trying to find a story to fit the price.
With that, many have been attributing rising U.S. rates to a vague report out of China. This is from Bloomberg: “Senior government officials in Beijing reviewing the nation’s foreign-exchange holdings have recommended slowing or halting purchases of U.S. Treasurys, according to people familiar with the matter.”
There’s nothing new about this notion that China could find our bonds less attractive. It has been ongoing chatter for the past decade.
What’s driving interest rates is simple. It’s the increasing probability that this year we will have the hottest U.S. and global growth in the post-crisis era. And with that, commodities prices are rising.
And contributing to all of this (not in a small way), is fiscal stimulus, within which, a corporate tax cut should finally get wages moving higher. This is all inflationary. And this is all bullish for interest rates (bearish for bonds).
So, as I said last week, despite the quadrupling of the stock market, money may just be in the early stages of moving OUT of bonds and cash, and BACK into stocks.
With that, let’s take a look at a longer term picture of rates…
The chart above is a look at the nearly 40-year downtrend in interest rates. You could argue this downtrend broke in 2013, when the Fed said it would begin dialing down it’s QE program (the taper tantrum). But rates went on to make new lows, as the economy continued to flounder under the inability of central banking firepower to get the economy out of stall speed growth. Alternatively, you could argue this multi-decade downtrend in rates broke on election night (2016), when the idea of big, bold (do whatever it takes to get the economy moving) fiscal stimulus was introduced in the U.S.
The question is, if we do indeed get hotter growth, and we get a pick up in inflation, at what point will that formula stop feeding into hotter markets and hotter growth, and start choking off recovery through higher rates. I suspect it could be a couple of years away, given the ground the economy needs to make up for lost time.
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Interest rates are on the move today. So is oil. And the latter has a lot to do with the former.
For much of the past quarter we’ve talked about how disconnected the interest rate market has been from the stock market and the economy.
With stocks putting up 20% last year, the economy growing at close to 3% and unemployment at 4%, and with FIVE Fed rate hikes now in this tightening cycle, the yield on the 10-year Treasury has defied logic.
But as we’ve discussed, we should expect that logic to be a little warped when we’re coming out of an unprecedented global economic crisis that was combatted by an unprecedented and globally coordinated monetary policy. And that continues to create dislocations in financial markets. Specifically, when global central banks continue to print money, and indiscriminately buy U.S. Treasurys with that freshly printed money (i.e. the dollars the trade for it), they will keep market rates pinned down. And they have done just that. Of course, that helps fuel the U.S. and global recovery, as it keeps borrowing and service rates cheap for things like mortgages, consumer loans, corporate debt and sovereign debt.
But last month, we talked about where the real anchor now exists for global interest rates. It’s in Japan. As long as Japan is pegging the yield on the 10-year Japanese government bond at zero, they will have license to print unlimited yen, and buy unlimited global government bonds, and anchor rates.
What would move Japan off of that policy? That’s the question. When they do abandon that policy (pegging JGB yields at zero), it will signal the end of QE in Japan and the end of global QE. Rates will go on a tear.
With that the architect of the stimulus program in Japan, Shinzo Abe, said today that he would keep the pedal to the metal, but indicated a possibility that they could achieve their goal of beating deflation this year.
That sent global rates moving. The benchmark 10-year yield jumped to 2.54% today, the highest since March of last year.
Another big influence on rates is, and will be, the price of oil. As we’ve discussed, the price of oil has played a huge role in the Fed’s view toward inflation. And that influence (of oil prices) on the inflation view is shared at other major central banks.
On that note, oil broke above $63 today, the highest levels since 2014.
Remember we looked at this chart for oil back in November, which projected a move toward $80.
With oil now up 26% from November, here’s an updated look …
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Heading into the end of last year, we talked about the regulatory scrutiny starting to emerge toward the big tech giants (Facebook, Apple, Amazon, Netflix, Google… Tesla, Uber, Airbnb…) – and the risk that the very hot run they’ve had “could be coming to an end.”
These companies have benefited from a formula of favor from the Obama administration, which included regulatory advantages and outright government funding (in the case of Tesla). That created a “winner takes all” environment where this group of startups and loss-laden ventures, some with questionable business models, were able to amass war chests of capital, sidestep enduring laws, and operate without the constraints of liabilities (including taxes, in some cases) that burdened its competitors.
With the screws now beginning to tighten, under a new administration, and with the tailwinds of economic stimulus heading into the new year, I thought 2018 may be the year of the bounce back in the industries that have been crushed by the internet giants.
Among the worst hit, and left for dead industry, has been retail.
Last year, retail stocks looked a lot like energy did in the middle of 2016. If you were an energy company and survived the crash in oil prices to see it double off of the bottom, you were looking at a massive rebound. Some of those stocks have gone up three-fold, five-fold, even ten-fold in the past 18 months.
Similarly, if you’re a big-brand bricks and mortar retailer, and you’ve survived the collapse in global demand–and a decade long stagnation in the global economy–to see prospects of a 4% growth economy on the horizon, there’s a clear asymmetry in the upside versus the downside in these stocks. These are stocks that can have magnificent comebacks.
Remember, back in November we talked about the comeback underway in Wal-Mart and the steps it has made to challenge Amazon (you can see that again, here). In support of that thesis, the earnings numbers that came in for retail for the third quarter were strong. And now we’re getting a glimpse of what the fourth quarter will look like, as several retailers this morning reported strong holiday sales, and upped guidance on the fourth quarter.
Just flipping through a number of charts on retail stocks, the bottom appears to be in on retail – with many bottoming out in the September-November period last year. Since then, to name a few, Ralph Lauren is up 26%, Michael Kors is up 36%, Under Armour is up 42% and Footlocker is up 64%. The survivors have been comebacks as they’ve weathered the storm and now are blending their physical presence with an online presence.
By the time you get a ETF designed to bet against the survival of bricks and mortar retail, the bottom is probably in. That ETF, the Decline Of The Retail Store (EMTY), launched on November 17 and has gone straight down since.
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We’ve talked this week about the potential for hotter demand and hotter economic growth for 2018.
Now, what’s been a big drag on this goal of achieving a hotter economy, has been wage growth. That has been the glaring indicator, throughout the past decade, that the economy has been sluggish and vulnerable – and in need of fiscal stimulus.
Though the data on job additions and unemployment have been strong, workers have had little-to-no leverage in commanding higher wages. We had more evidence of that in this morning’s job report. December wages came in at just a 2.5% annual change.
You can see in the chart above, the weak wage pressures coming out of the depths of the crisis. That’s despite an unemployment rate that has fallen from 10% to 4% – what appears to be a tight job market. In a tight job market, employees should be able to command higher wages. That hasn’t been the case. That’s because the job market has been riddled with underemployment. And underemployment has been driven, by both job seekers and job producers, from low confidence in business conditions and in the economic outlook.
This is where the new tax bill comes in.
The Tax Foundation has said the corporate tax rate cut should double the current annual change in wages. And since the tax bill has been signed, we’ve already seen huge companies cut bonus checks to employees. If it does indeed, finally, create upward pressure in wages, then the inflation picture (which has been dead) becomes a big focus for the year.
The latest inflation reading (the Fed’s favored core PCE) is still well below the Fed’s 2% target. Wage pressures will get inflation moving. And among the biggest beneficiaries in this scenario will be commodities.
Remember, we looked at this chart of broad commodities earlier this week…
And if inflation starts moving this year, this is another chart that has a big move in store (bonds)…
As I said earlier this week, despite the quadrupling of the stock market from the 2009 bottom, money may just be in the early stages of moving out of bonds and cash, and back into stocks.
We kicked off the New Year continuing to discuss the theme of a hot stock market ahead (again) and a hotter than average economy (finally). Stocks continue to comply, with a big start – led by Japanese stocks today, up 2% on the day and up 4% on the year already.
It’s important to realize, the economic crisis was global. The central bank response was globally coordinated, led by the Fed. And, as we discussed early last year, everyone should hope Trumponomics works, because the global economy will benefit in coordination. And that’s what we’ve been seeing over the past year.
Of course, now we’re getting policy execution on that front, and we’re seeing the rising tide of the U.S. economy lifting all boats.
How high will that tide rise? As I said yesterday, if we add pro-growth policies that are being executed out of Washington, to an economy with near record low unemployment, cheap gas, near record low mortgage rates, record high consumer credit worthiness, record high household net worth, a record high stock market and near record low inflation, it’s hard to imagine the economy can’t do better than the long term average (3% growth) this year.
Let’s take a closer look at that economic growth picture.
Remember, in typical recessions, we should expect to get a big pop in growth to follow, due to policymaker responses to the slowdown and the natural upturn in the business cycle. In the Great Recession, we haven’t gotten it — after TEN years.
For the more than 50 years of history prior to the global financial crisis, U.S. economic growth averaged 3.5% (rolling four quarters). We’ve since averaged just 1.5% (over the past ten years). With that underperformance, the U.S. economy has foregone about $3 trillion dollars in real GDP growth, from being knocked off path by the global economic crisis. We’re due for a period to make up that ground.
On Tuesday we talked about the prospects of a return of “animal spirits” this year, for the first time in a long time. This is what can drive a period of economic growth that does better than the long term average. This animal spirits kicker may be the real theme of 2018.
But what is it?
Economics is about incentives. Economists think you’ll make rational decisions, with the incentive to best serve your interests. But emotions come into play. These emotions might cause you to be more risk-aversein times where policies incentivize you to take more risks, and vice versa.
This “emotion override” has been the problem over the past decade. The Fed gave us all abundant incentives to go out and borrow and spend, to stimulate the economy. But the scars of the housing crash, joblessness and overindebtedness were too great. People saved. They paid down debt. That didn’t trust the outlook. The Fed wanted us to take risk and they got risk aversion.
It has taken a regime change and an ultra-aggressive fiscal stimulus and structural reform response to finally break that mindset. The execution on tax cuts looks like the catalyst that has gotten more people off the fence, and believing in a rosier outlook. But I don’t think anyone would argue that confidence is broadly running hot (animal spirits) – much less, in a state of euphoria (which would justify concern of a top in markets and the recovery).
Robert Shiller (Yale economist) describes animal spirits like this: There are good times when people have substantial trust… They make decisions spontaneously. They believe instinctively that they will be successful.”
We’re not there yet, but we may begin seeing it/feeling it this year. And with that, we may see some hot growth over the coming years.
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Global markets have started the year behaving very well, supporting my view that we’re in the early innings of an economic boom, and we should get another big year for global stock markets.
But, as we discussed heading into the end of 2017, that view isn’t shared by Wall Street or the Fed. For 2018, the Fed is looking for just 2.5% growth. And Wall Street is looking for just 6% growth in stocks (according to this WSJ piece). That’s less than the long term average return on the S&P 500.
Both continue to, somehow, ignore (or underestimate) the influence of fiscal stimulus, which is hitting into an already fundamentally improving economy.
Wall Street was looking for 3% growth in stocks last year. We got almost 20% (better in the Dow). And the Fed was looking for 2.1% growth last year. It will be closer to 3% for full year 2017.
They thought Trump couldn’t get policies legislated. Now we have big tax cuts, meaningful deregulation, the beginnings of a government spending program (started by natural disaster aid), and a massive incentive for companies to repatriate trillions of dollars.
If we add that to an economy with near record low unemployment, cheap gas, near record low mortgage rates, record high consumer credit worthiness, record high household net worth, a record high stock market and near record low inflation, it’s hard to imagine the economy can’t do better than the long term average (3% growth) this year.
As we’ve discussed, we’ve yet to experience the explosive bounce in economic growth that is typical of post-recession environments. This is set up to be that kind of year — maybe something north of 4%, which should finally move the needle on inflation. If that’s the case, despite the quadrupling of the stock market from the 2009 bottom, money may just be in the early stages of moving out of bonds and cash, and back into stocks.
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We are off to what will be a very exciting year for markets and the economy.
Over the past two years I’ve written this daily piece, discussing the bigslow-moving themes that drive markets, the catalysts for change, and the probable outcomes. When we step back from all of the day to day noise that has distracted many throughout the time period, the big themes have been clear, and the case for higher stocks has been very clear. That continues to be the case as we head into the New Year.
As I’ve said, I think we’re in the early stages of an economic boom. And I suspect this year, we will feel it — Main Street will feel it, for the first time in a long time.
And I suspect we’ll see a return of “animal spirits.” This is what has been destroyed over the past decade, driven primarily by the fear of indebtedness (which is typical of a debt crisis) and mis-trust of the system. All along the way, throughout the recovery period, and throughout a quadrupling of the stock market off of the bottom, people have continually been waiting for another shoe to drop. The breaking of this emotional mindset has been tough. But with the likelihood of material wage growth coming this year (through a hotter economy and tax cuts), we may finally get it. And that gives way to a return of animal spirits, which haven’t been calibrated in all of the economic and stock market forecasts.
With this in mind, we should expect hotter demand and some hotter inflation this year (to finally indicate that the global economy has a pulse, that demand is hot enough to create some price pressures). With that formula, it’s not surprising that commodities have been on the move, into the year-end and continuing today (as the New Year opens). Oil is above $60. The CRB (broad commodities index) is up 8% over the past two weeks – and a big technical breakout is nearing.
This is where the big opportunities lie in stocks for the New Year. Remember, despite a very hot performance by the stock market last year, the energy sector finished DOWN on the year (-6%). Commodity stocks remain deeply discounted, even before we add the influence of higher commodities prices and hotter global demand. With that, it’s not surprising that the best billionaire investors have been spending time building positions in those areas.
This year is set up to handsomely reward the best stock pickers.
For help building a high potential portfolio, follow me in our Billionaire’s Portfolio, where you look over my shoulder as I follow the world’s best investors into their best stocks. Our portfolio of highest conviction, billionaire-owned stocks is up close to 50% over the past two years. And 25% of our portfolio is in commodities stocks. You can join me here and get positioned for a big 2018.
