Last year this time, as we ended 2016, and looked ahead to 2017, it was clear that the dominant theme for the year ahead would be Trumponomics.
We had a global economy that had been propped up by central banks for the better part of eight years, and growth that was proving to be dangerously slow — with growing risks of a stall and another downward spiral.
That was clear in the summer of 2016, when global interest rates started to diving deeply into negative territory. That meant people were happy to pay governments for the security of parking their money in government bonds.
There was a clear lack of optimism about economic conditions and what the future may look like.
That changed with Trump’s election and his commitment to launch an assault on economic stagnation.
It flipped the switch on the lack of optimism that had been paralyzing business activity. And that optimism has led to a hotter economy this year than most expected, despite the lack of substantial policy action (which we didn’t get until later in the year).
So what will next year look like?
As we discussed yesterday, we have tax cuts that should drive corporate earnings and warrant another double digit year for the stock market (close to 20%).
And that doesn’t take into account the impact to corporate earnings from personal tax cuts, a healthier job market with employees that can command higher wages and companies that are confident to take cash and invest in new projects. So, by design, we have incentives coming into the economy for 2018 that will boost demand. And another pillar of Trumponomics, infrastructure, will be the focus early next year, which will fuel more jobs, more economic activity.
All of this and the Fed is projecting just 2.5% growth next year. And Wall Street and the economist community tend to anchor their forecasts on the Fed. But the Fed doesn’t have a very good record in forecasting – especially in recent history.
They overestimated growth and the outlook throughout much of the recovery period. Instead we got stagnation.
But in the past 18 months or so, they flipped the script. They became the “new normal” believers that we’re in for long-term slower growth.
With that, they underestimated the outlook for 2017, even with the prospects of fiscal stimulus coming (they ignored it, and continue to). They were looking for 2.1% growth. It will be closer to 3% for the full year 2017. And next year, while they are looking for 2.5%, we could have something closer to 4%. That’s my bet.
Remember, we’ve talked about the fundamental backdrop, with the addition of fiscal stimulus, that could have us in the early stages of an economic boom period. I think we’ll feel that, for the first time in a long time, in 2018.
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This morning we got a report that smallbusiness optimism hit the second highest level in the 44-year history of the index.
Here’s a look at that history …
optimism
Remember, last year, following the election, this index that measures the outlook from the small business community had the biggest jump since 1980 (as you can see in the chart).
Why were they so excited? For most of them, they had dealt with a decade long crisis in their business, where they had credit lines pulled, demand for their products and services were crushed, healthcare costs were up and their workforce had been slashed. If they survived that storm and were still around, any sign that there could be a radical change coming in the environment was a good sign.
A year ago, with a new administration coming in, half of the smallbusiness owners surveyed, expected the economy to improve. That was the largest agreement of that view in 15 years.
They’ve been right.
Now with an economy that will do close to 3% growth this year, still, about half of small business owners expect the economy to improve further from here.
No surprise, they are more than pleased with the tax cuts coming down the pike. They’ve seen regulatory relief over the past year. And, according the chief economist for the National Federation of Independent Businesses, small business owners see the incoming Fed Chair (Powell) as more favorable toward business (and market determined decisions) than Yellen. And he says, “as long as Congress and the President follow through on tax reform, 2018 is shaping up to be a great year for small business, workers, and the economy.”
This reflects the theme we’ve talked about all year: the importance of fiscal stimulus to bridge the gap between the weak economic recovery that the Fed has manufactured, and a robust sustainable economic recovery necessary to escape the crisis era. This small business survey tends to correlate highly with consumer confidence. Consumer confidence drives consumption. And consumption contributes about two-thirds of GDP. So, by restoring confidence, the stimulative policy actions (and the anticipation of them) has been self-reinforcing.
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We had a jobs report this past Friday. The unemployment rate is at 4.1%. We’re adding about 172k jobs a month on average, over the past twelve months. These are great looking numbers (and have been for quite some time). Yet employees, broadly speaking, still haven’t been able to command higher wages. Wage growth continues to be on the soft side.
With little leverage in the job market, consumers tend not to chase prices in goods and services higher — and they tend not to take much risk. This tells you something about the health of the job market (beneath the headline numbers) and about the robustness of the economy. And this lack of wage growth plays into the weak inflation surprise that has perplexed the Fed. And the weak growth that has perplexed all policy makers (post-crisis). That’s why fiscal stimulus is needed!
And this could all change with the impending corporate tax cut. The biggest winners in a corporate tax cut are workers. The Tax Foundation thinks a cut in the corporate tax rate would double the current annual change in wages.
As I’ve said, I think we’re in the cusp of an economic boom period — one that we’ve desperately needed, following a decade of global deleveraging. And today is the first time I’ve heard the talking heads in the financial media discuss this possibility — that we may be entering an economic boom.
Now, we’ve talked quite a bit about the run in the big tech giants through the post-crisis era — driven by a formula of favor from the Obama administration, which included regulatory advantages and outright government funding (in the case of Tesla). And we’ve talked about the risk that this run could be coming to an end, courtesy of tighter regulation.
Uber has already run into bans in key markets. We’ve had the repeal of “net neutrality” which may ultimate lead big platforms like Google, Twitter, Facebook and Uber, to transparency of their practices and accountability for the actions of its users (that would be a game changer). And we now know that Trump is considering that Amazon might be a monopoly and harmful to the economy.
With this in mind, and with fiscal stimulus in store for next year, 2018 may be the year of the bounce back in the industries that have been crushed by the “winner takes all” platform that these internet giants have benefited from over the past decade.
That’s probably not great for the FAANG stocks, but very good for beaten down survivors in retail, energy, media (to name a few).
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As we’ve discussed, in the post-election world (of last year) we’ve had a passing of the baton from a global economy driven by monetary policy, to a global economy driven by structural reform and fiscal stimulus.
With the anticipation of fiscal stimulus, the election represented the end of the QE-era. With that, the top central bankers in the world (Fed, ECB, BOJ, BOE) met today and had a coordinated message to that effect. Just as they coordinated their QE programs to stabilize the world and manufacture recovery, they vowed to coordinate on the exit of QE.
Still, Europe has more work to do before following the Fed’s lead on “normalizing” rates. And Japan will be far behind Europe in ending QE. But that message of coordination should keep global (market) interest rates moving higher.
We’ve talked in recent days about the pockets of selling in global markets. Last week it was junk bonds, then Japanese stocks, then Treasurys and then gold. Today it was commodities, led by oil. Oil was down 2.4% on the day. And the dollar was lower (not higher, as some might expect with commodities moving lower).
Meanwhile, the big U.S. market indices couldn’t be shaken and the Treasury market was very quiet. These intermarket relationships haven’t been normal. And that should raise some eyebrows about elevating risk.
We’ve talked in recent days about the influence that we may be seeing in markets from Saudi Arabia’s move to investigate (potentially seize) up to $800 billion of wealth from high profile officials accused of fleecing the country.
The proxy for global market stability, throughout the past decade (the crisis and post-crisis era), has been U.S. stocks. So as long as U.S. stocks are holding up, people continue to ignore some of these “risk” signs. But give it a 2% down day and suddenly the observables may become observed.
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The Fed decision today was a snoozer, as expected. The market continues to think we get a third rate hike for the year in December (fourth since the election).
Thus far, with three hikes, we’ve had just about the equivalent (just shy of 75 basis points) priced-in to the 10-year Treasury market. Yields popped from about 1.70% on election night (just about a year ago) to a high of 2.64%. We’ve had some swings since, but we sit now at roughly 2.40% (70 basis points higher over the past year).
We revisited yesterday, the prospects for some significant wage growth (and therefore inflation), with the fuel of fiscal stimulus feeding into an already tight (but underemployed) labor market.
The Treasury market isn’t pricing that scenario in, at all.
In fact, the yield curve continues to look more like a world that doesn’t fully believe fiscal stimulus is happening (or will happen), and does believe the Fed is more likely damaging the economy through its rate “normalization.”
That’s a bet that continues to underprice the prospects of fiscal stimulus. And, therefore, that’s a bet that continues to be disconnected from the message other key markets are sending. Over the past six months, we’ve talked the case for stocks to go much higher. We’ve talked about the opportunities in European and Japanese stocks (German stocks hitting new record highs and Japanese stocks nearing new 26-year highs today). We’ve talked a lot about the building bull market in commodities. We’ve talked about the positive signals that copper has been sending, as the leading indicator of a global economic turning point. We’ve talked about the outlook for much higher oil prices – oil hit $55 today. (July 30: Explosive Move Coming For Oil And Commodities Stocks).
And oil prices, whether the central banks like to admit it or not, heavily impact inflation, inflation expectations and policy making decisions.
With that, this next chart suggests that market interest rates are about to make a move (higher).
Source: Billionaire’s Portfolio
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Interest rates and stocks are on the move today (higher), following the vote last night in the Senate to pass the budget. This opens the way for an approval on the tax plan.
As stocks continue to print new record highs, so does policy execution for the Trump administration (the latter the cause, the former the effect).
So we’re seeing more and more of the pro-growth plan fall into place. Markets have been telling us this (betting on this) for a while.
Remember, we talked about the prospects that hurricane aid could kickstart the Trump infrastructure plan (proposed at $1 trillion over 10 years). There’smore progress on that front in the past week.
Among the pillars of Trump’s growth plan, this one (infrastructure/government spending) looked to be among the long shots given the politicians can always play the debt card to fight it. But then the hurricanes hit.
After Irma rolled through Florida the estimated damages for both Harvey and Irma were estimated at $200 billion. Then Hurricane Maria decimated Puerto Rico. Estimated damages there are now $95 billion. I’ve thought we’ll ultimately see a 12-figure package out of Congress in response to the hurricanes. The ultimate federal aid on Katrina was $120 billion.
In September Congress approved $15 billion in aid for hurricane victims. They just approved another $35 billion! This quiet government spending piece, that will substantially grow from here, may turn out to be the most powerful in terms of driving wage growth and economic growth.
So tax reform and infrastructure, two big pillars of Trumponomics continue to progress. And on the deregulation front, Trump has already been aggressively peeling back regulations that have crushed some industries, while ramping UP regulatory scrutiny on Silicon Valley, as we discussed yesterday.
Some of the top venture capitalists in Silicon Valley said this week that they expect to see some failures this year of startups once valued north of a billion-dollar. That’s a result of less money flowing that direction, less government favor, and more money flowing back into publicly traded stocks.
With that in mind, let’s take a look at the chart on Amazon to finish the week …
We talked about Amazon’s miss on earnings back on July 27th as the catalyst to take profit on the FAANG trade (the loved tech giants). The top continues to hold in Amazon.
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As we know, one of the pillars of the Trump administration’s growth policies has been deregulation. With that, today the head of the EPA signaled the withdrawal from the Clean Power Plan – an Obama regulation to fight climate change.
What does this mean for coal stocks?
Let’s take a look at the two largest American coal producers, both of which filed bankruptcy last year: Peabody Energy and Arch coal.
These are now two post-bankruptcy stocks!Peabody emerged from bankruptcy earlier this year after shedding about $5 billion in debt. Similar story for Arch coal. They filed early last year and emerged from bankruptcy late last year, eliminating $5 billion in debt in the process. So shareholders were wiped out and debt holders became stock holders in new low debt, cash flow positive companies with deregulation coming down the pike. With that, you would think the stocks would be screaming higher. That hasn’t been the case.
Here’s a look at the charts…
So we now have Peabody Energy, the leading coal producer in America with a $3 billion market cap. And Arch Coal, number two, has just a $1.7 billion market cap.
Are these cheap stocks?
Let’s take a look at who owns them…
The biggest shareholder in Peabody is billionaire Paul Singer’s hedge fund, Elliott Management. They own half a billion dollar’s worth of the stock and it’s a top ten position. As for ARCH – the top shareholder is the $5 billion hedge fund Monarch Alternative Capital. ARCH makes up 20% of their highly concentrated long equity portfolio (their biggest single stock position). If you’re going to dip your toe in the water on a post-bankruptcy stock, there are few better places to look for guidance than Paul Singer – a former attorney, turned one of the most influential and successful investors in the world.
The media is giving more attention today to the potential change in power at the Fed. We talked about this on Monday. Remember, the President said last week that he expected an announcement to be made in the next two or three weeks on the future Fed Chair.
Along with any advancement on the fiscal stimulus front, the appointment of the next Fed Chair will be the most important news for markets and economy this year (though Yellen isn’t officially done until January of 2018).
Back in March I made the case for Trump ousting Yellen and hiring the Fed newbie, Neel Kashkari. Admittedly, I didn’t think Yellen would last this long. While Bernanke (the former Fed Chair) can be credited for averting a global apocalypse and keeping the patient alive, for as long as it took to bridge the gap to a real recovery. Under Yellen’s leadership, the Fed has been doing it’s best to kill the patient, at precisely the time the real recovery could be taking shape, with the assistance of fiscal stimulus finally in the works.
If the Fed continues on its path, borrowing costs (or, as importantly, the perception of where they may go) may strangle the economy before fiscal stimulus gets out of the gate. This is why I’ve said Kashkari should be the President’s best friend at the Fed. He’s the lone dissenter on the rate hiking path, and he’s been vocal about leaving monetary policy alone until the inflation data warrants a move.
Kashkari released an essay on Monday where he blames the Fed for creating its own low inflation surprise by tightening money and forecasting a tighter path for monetary policy, therefore creating a contractionary effect on the economy as consumers/businesses anticipated the negative effects of higher rates on the economy.
Guess who made this same case? Bernanke. He did so in a blog post last year, around this time. It was just as the world was spiraling into negative rates. He said the Fed shot itself in the foot by publishing an overly optimistic trajectory and timeline for normalizing rates. And that the communication alone resulted in an effective tightening.
This is why the ten year yield (still at just 2.34% after four rate hikes) is pricing in something that looks a lot more like recession than a hot economy.
With the above in mind, there has been a roster of candidates for Fed Chair floated today, which did not include Neel Kashkari. That was until word began to circulate that Jeff Gundlach, manager of the world’s biggest bond fund, said yesterday that he thinks Kashkari will get the nod, because he’s the most easy money guy. Still, it was refuted in the media that he was even a candidate.
As I said on Friday, people continue to look for what could bust the economy from here, and are missing out on what looks like the early stages of a boom.
We constantly hear about how the fundamentals don’t support the move in stocks. Yet, we’ve looked at plenty of fundamental reasons to believe that view (the gloom view) just doesn’t match the facts.
Remember, the two primary sources that carry the megahorn to feed the public’s appetite for market information both live in economic depression, relative to the pre-crisis days. That’s 1) traditional media, and 2) Wall Street.
As we know, the traditional media business, has been made more and more obsolete. And both the media, and Wall Street, continue to suffer from what I call “bubble bias.” Not the bubble of excess, but the bubble surrounding them that prevents them from understanding the real world and the real economy.
As I’ve said before, the Wall Street bubble for a very long time was a fat and happy one. But the for the past ten years, they came to the realization that Wall Street cash cow wasn’t going to return to the glory days. And their buddies weren’t getting their jobs back. And they’ve had market and economic crash goggles on ever since. Every data point they look at, every news item they see, every chart they study, seems to be viewed through the lens of “crash goggles.” Their bubble has been and continues to be dark.
Also, when we hear all of the messaging, we have to remember that many of the “veterans” on the trading and the news desks have no career or real-world experience prior to the great recession. Those in the low to mid 30s onlyknow the horrors of the financial crisis and the global central bank sponsored economic world that we continue to live in today. What is viewed as a black swan event for the average person, is viewed as a high probability event for them. And why shouldn’t it? They’ve seen the near collapse of the global economy and all of the calamity that has followed. Everything else looks quite possible!
Still, as I’ve said, if you awoke today from a decade-long slumber, and I told you that unemployment was under 5%, inflation was ultra-low, gas was $2.60, mortgage rates were under 4%, you could finance a new car for 2% and the stock market was at record highs, you would probably say, 1) that makes sense (for stocks), and 2) things must be going really well! Add to that, what we discussed on Friday: household net worth is at record highs, credit growth is at record highs and credit worthiness is at record highs.
We had nearly all of the same conditions a year ago. And I wrote precisely the same thing in one of my August Pro Perspective pieces. Stocks are up 17% since.
And now we can add to this mix: We have fiscal stimulus, which I think (for the reasons we’ve discussed over past weeks) is coming closer to fruition.
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After a week away, I return to markets that look very similar to where we left off 10 days ago. Stocks lower. Yields lower. The dollar lower. But commodities higher!
Now, this takes into account, another week of political volatility in Washington. It takes into account another week of uncertainty surrounding North Korea.
What’s important here, is distinguishing between a price correction and a real thematic change. If we’re not making new record highs in stocks every day, and stocks actually retrace 5% or so, does that represent the derailing of the slow but steady economic recovery and, as important, the dismissal of potential policy fuel that could finally lift us out of the post-crisis stall speed growth regime?
The narrative in the media would have you believe the answer is yes.
But the reality is, the economic recovery is stable and continuing. The policy stimulus has been a tough road, but continues to offer positive influence on the economy. And there are strong technical reasons to believe we’re seeing the early stages of a price driven correction in stocks.
Remember, we looked at the big technical reversal signal (the “outside day”) back on August 8th. That was the technical signal, and it was about as good a signal as it gets. The Dow had been plowing to new highs for eleven consecutive days — culminating in another new record high before. And the last good ‘outside day’ in the S&P 500 was into the rally that stalled December 2, 2015 and it resulted in a 14% correction.
Here’s another look at that chart, plus the first significant trend line that we discussed in my last note, August 11th.
I thought this line would give way, which it has today, and that we would see a real retracement, which should be a gift to buy stocks. If you’re not a highly leveraged hedge fund, a 5%-10% retracement in broader stocks is a gift to buy. Remember, the slope of the S&P 500 index over time is UP.
Prior to the reversal signal in stocks, we had already addressed the influence of the FAANG stocks. And I suggested the miss in Amazon earnings was a good enough excuse to cue the profit taking in what had been a very lucrative trade in the institutional investment community. Amazon is now down 12% from the highs of just 18 days ago.
What should give you confidence that the economic outlook isn’t souring? Commodities!
The base metals, as we’ve discussed in recent weeks, continue to move higher and continue to look like early stages of a bull market cycle — which would support the idea that the global economic recovery is not only on track, but maybe better than the consensus market view (which seems to be still unconvinced that better times are ahead).
The leader of the commodities run is copper. We looked at this chart in my last note (Aug 11). I said, “this big six-year trend line in copper (below) will be one to watch closely. If it breaks, it should lead the commodities trend higher.”
Here’s an updated chart of Copper. This trend line was broken today.
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As we’ve discussed, in the post-election world (of last year) we’ve had a passing of the baton from a global economy driven by monetary policy, to a global economy driven by structural reform and fiscal stimulus.
The Fed decision today was a snoozer, as expected. The market continues to think we get a third rate hike for the year in December (fourth since the election).
Interest rates and stocks are on the move today (higher), following the vote last night in the Senate to pass the budget. This opens the way for an approval on the tax plan.
As we know, one of the pillars of the Trump administration’s growth policies has been deregulation. With that, today the head of the EPA signaled the withdrawal from the Clean Power Plan – an Obama regulation to fight climate change.
