As I always want to give perspective on markets and the economy, I have to say this as we all debate the impact of Fed policy and whether the hopes for Trumponics are moving stocks higher or not. Let’s use the broad index of the Value Line Geometric equal weighted index of about 1700 stocks (see chart). On December 18th 2013, the day the Fed initiated the tapering of QE3, that index closed at 476. On the day of the US election nearly 3 yrs later on November 8th 2016 it closed at 467. So after flat lining for 3 yrs, the 11% rally from election day we can easily argue was on the hopes for tax and regulatory reform which I’m still confident we will get this year in some form but won’t feel until next year. Some tell me instead they believe it was the earnings rebound in Q1 post election but the market never sold off on the 6 quarter earnings recession. Either way, this index yesterday closed at the same level it finished the day on December 8th, 2016. Thus, outside of the you know who stocks, the broad, equal weighted market has essentially done nothing for the past 6 months but churn which is what it did for 3 yrs before the election. On earnings, all I heard during the 6 quarter recession was to take out energy. I didn’t hear that in Q1 when energy earnings contributed about half of the rebound. Well, if oil stays at near $40, depending on who hedged and who didn’t, take a cut to earnings for the next few quarters.
VALUE LINE GEOMETRIC INDEX OF ABOUT 1700 STOCKS
From day 1 of this year I’ve argued that 2017 will be characterized by the tug of war between the tailwind of a lower corporate tax rate and regulatory relief vs the headwind that is a tightening and/or less easy nature of global monetary policy. All the monetary acronym’s of QE, ZIRP, NIRP, whatever, blew air in the bubble and while air is still going in, the air pressure is subsiding. If one doesn’t think that matters for stocks, then just think about what drove the huge multiple expansion we’ve seen, especially beginning in 2013. As for Trumponomics, we can simply say that the back of the envelope increase to earnings per share will be around 10% if we get a 20% corporate tax rate (all else equal which it never is) and we’ve essentially seen that rally since the election. We also had an initial reflation trade on the hopes that economic growth would accelerate in 2017 but it’s done nothing except muddle along at a 1.5-2% growth rate that we’ve seen and therefore that trade at least in commodities has flamed out and the yield curve spread keeps shrinking as we’ve all seen.
As for that yield curve as we finish the last 3 days of the week with some data after a quiet start, the 2s/10s spread sits at 80 bps, just 5 bps from the lowest level since early November 2007. If you don’t think the flattening doesn’t matter yet, just go back and remember the state of the world in November 2007.
I gave my opinion at the beginning of 2016 that emerging stock markets would outperform US stocks in the coming 5 yrs because of the very wide valuation spread between the two and I’m sticking to that belief. On the MSCI decision to add Chinese A shares, I say it’s about time for the 2nd largest economy in the world.
With the 30 yr mortgage rate holding steady for a 3rd week at 4.13%, mortgage applications to buy a home fell 1% w/o/w but are still up 9.2% y/o/y pointing to a pretty good Spring transaction season. That said, evidence has grown in at least the confidence surveys that at least on the pricing front, we might have reached an inflection point in terms of what buyers want to pay and the expectations of sellers. Also, the market desperately needs more lower priced supply. With refi’s, they rose 2.1% w/o/w but are still down by 30% y/o/y.
A day after Mark Carney said it’s not time to hike rates yet and almost a week after 3 BoE members said it’s time, the BoE chief economist Andy Haldane said “Provided the data are still on track, I do think that beginning the process of withdrawing some of the incremental stimulus provided last August would be prudent moving in the 2nd half of the year.” Remember, soon after Brexit, the BoE cut rates by 25 bps to .25% and added more QE with both Gilts and the modest nationalization of their corporate bond market. He also said that “the risks of tightening ‘too early’ have shrunk as growth and, to lesser extent, inflation have shown greater resilience than expected.” In immediate response, the 2 yr Gilt yield rose 4 bps and is back to a 3 month high. The pound is also higher. So to repeat, 2017 will be marked by some likely policy removal, however ‘gradual’, from the Fed, ECB, BoE, BoJ, PBOC, and BoC.