Market Update

Posted on October 27, 2017 by Gemmer Asset

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Despite a strong rally on Friday global equities closed flat for the week. The S&P picked up +0.2% while the Russell 2000 was off -0.1%. Only the NASDAQ stands out with a +1.1% weekly gain after some major names blew past earnings estimates on Thursday. The international markets were soft for a second week in a row, due in large part to a strong dollar. Japan bucked the trend with a +2.6% gain after a favorable national election outcome (more below).


Bond yields closed modestly higher, with the 10-year advancing 5bps on the week. Intermediate-term government bonds lost -0.2% while long-term bonds dipped -0.6%.


Earnings Season and the Death of Retail


We are in the middle of third quarter earnings season, and so far things are progressing well. For example, on Thursday Amazon, Google, and Microsoft all beat earnings estimates and their stocks spiked higher. About half of U.S. corporations have reported results thus far, and 79% have beat estimates, the best in 3 years. Interestingly, not only are companies beating estimates, they are increasing future estimates. As you can see below, 58% of firms have raised future growth estimates, the best since at least 2012.




Back to Amazon for a minute. The stock was up +13.2% on Friday and vaulted CEO Jeff Bezos into the number one richest man in the world spot. Friday’s math is a little mindboggling. Bezos owns almost 80 million shares of Amazon. The stock gained $128.52/share on Friday. This works out to a net worth gain of a cool $10.268 billion. Just on Friday.


At the other end of the spectrum is JC Penney. Its stock plunged -14.8% on Friday to just $3.12/share after a lousy earnings report. The chart below shows the total return (including dividends) for JC Penney from 1980 to today. It’s up a cumulative 52.8%.





That works out to just 1.1% per year!!! And that assumes you didn’t have to pay tax on the dividends. Retail is turning into a wasteland, at least as far as the stock market is concerned.


Investment Is Finally Picking Up


There were a few interesting economic reports this week


New-Home Sales


New-home sales unexpectedly surged last month. Sales rose 18.9%, the biggest monthly jump in 25 years, and the fastest annual rate in nearly 10 years. Certainly, there was a rebound from Hurricane Harvey, but this was still a solid report. Inventory levels fell to 5 months in September from 6 months in August. While not as low as existing homes, inventory levels are still well controlled (chart below).




Durable Goods Orders


This measure blew past estimates. Orders increased 2.2% in September, significantly better than the 0.7% expected. The most interesting bit of this report showed that business investment advanced 1.3% for the third month in a row. These orders have climbed 7.8% in the past year, the fastest pace since early 2012.




Much has been made of poor business investment the last few years as one of the reasons for lackluster GDP growth. Investment this year has taken most everyone by surprise, in a good way.


Third Quarter GDP Growth


On Friday, the first estimate of GDP growth in the third quarter came out. It beat expectations. Growth came in at 3%, better than the 2.5% estimate, and essentially matching second quarter growth, as you can see below.




The big swing factor was the investment component of growth, although consumption growth remained robust despite the hurricanes. Equipment investment increased at an 8.6% annualized rate while investment in non-residential structures was up 5.2% year-over-year.


The inflation component in the report was also well behaved. Core personal expenditures rose 1.3%, in line with estimates.


Election in Japan Drives Equities


Japanese stocks jumped to a new 20-year high this week after Prime Minister Shinzo Abe was re-elected. The market has been a tear the last few weeks, as you can see below.




After Sunday’s election, Abe’s Liberal Democratic Party and its coalition partner retained a two-thirds majority. This result puts Abe on course to become the longest-serving Japanese prime minister in Japan’s history. This latest vote sets the stage for two things in the months to come:


1) More reflation. Abe is expected to continue pushing for more stimulus to drive the economy forward and inflation higher. The leadership at the Bank of Japan isn’t likely to change meaning the BoJ continues to pursue its dovish policy of pegging the 10-year bond at 0%.


2) Second, this also sets the stage for constitutional reform. Abe has talked for some time about changing or clarifying Article 9. Taken literally this bans a Japanese military, but has been interpreted in recent history as limiting Japan to just a defensive force. He’s likely to push for more flexibility. In theory Abe’s coalition government’s 2/3’s majority in both houses of parliament means it can push through pretty much any legislation it wants. A recent survey found that 80% of politicians in the newly elected lower house support a constitutional rewrite. However, any changes to the constitution require majority approval from the public in a referendum. At the moment, at least polls are mixed.


Could Democrats Cross Party Lines?


There was more progress on the budget/tax front this week. The House voted 216 to 212 on Thursday to approve the Senate’s budget resolution. The move paves the way, procedurally, for Republicans to fast track their overhaul of the U.S. tax code. Twenty Republican voted against the measure, 11 of whom are from high tax states. They oppose the elimination of the state and local tax deduction that is likely to be in any tax bill. No democrats voted in favor. We should get more detail next week when House Republicans release and their draft bill on tax reform.


Despite some resistance in the House, the Senate will be the major hurdle before passage. Republicans can only lose two votes in the Senate. On this score, it was a more than a little surprising that Bob Corker told CNBC on Thursday that he is ‘all in’ on the tax plan despite his high-profile dispute with the President. His key comment was as follows:


“Look, I’m all in in closing $4 trillion of loopholes. And I’m all in for locking arms and having the intestinal fortitude to do it. … If we do it right, and we do the corporate things we’re talking about, I’ll believe we’ll get the dynamic score that is necessary to close that trillion dollars that I was talking about on the front end.”


What he is saying that he feels he can still portray himself as a budget hawk by assuming the economy will grow enough to pay for the tax cuts.


A couple of points jump out from this week’s activity:


1) To the extent some Republican’s oppose eliminating the state and local tax deduction, there is a reasonable chance the tax cuts get even larger. After all, they can make the math work simply by assuming more rapid growth over the next few years. Problem solved!!


2) We shouldn’t write off the possibility of some Democrats from red states voting for the upcoming tax bill. BCA produced the table below that is illuminating. It shows that there are a number of Democratic senators in red states that won their 2012 seat by a narrow margin. They may feel pressured to vote for any tax plan to help their re-election plans next fall. Further, analysts only half-jokingly say that Joe Manchin is actually more of a Republican than Democrat.




We will have more next week on the guts of the new tax plan. We should also find out who the next Fed chairman will be.


Have a good weekend.



Charles Email Sig



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