Market Recap

Posted on September 14, 2018 by Gemmer Asset

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Is Growth and Inflation Softening at the Margin?


The equity markets were generally higher this week while bonds lost ground. For the week the S&P added +1.2% and small-caps gained +0.5%. The overseas markets also performed well with the EAFE up +2.0% and emerging +1.0%.


In general, the economic reports have been decent with growth a touch on the soft side and inflation moderating, at least for a month. Big picture wise, third quarter growth estimates are running between say +3.7% (Merrill Lynch) to +4.4% (Atlanta Fed). This would be a strong showing coming on a heals of +4.4% in the second quarter.


But there is softening around the edges. Retail sales missed estimates even though the previous couple months were revised higher.



Housing continues to soften. For example, housing inventories nationwide were flat in July after falling for 37 consecutive months. Take a look at inventory levels for Houston, Las Vegas, Sacramento, and Phoenix below. Total inventories nationwide are in black.



Sacramento inventories are up 22% year-over-year. Vegas is up 20%. While not shown, Bay Area inventories were up +5% year-over-year in August. Clearly the market is coming off the boil in many areas as buyers step back. Higher rates and pricy homes will do that. And my unofficial inventory monitor of the Tahoe/Truckee market is showing a massive amount of homes and condos for sale.



Finally, the latest inflation data showed that the rate of growth slowed in August. Mike’s blog post yesterday addressed this topic.


Shaping Up for a Good Earnings Season


All in all, there are hints of slower growth as the third quarter comes to an end, but not much to worry about. At least as the equity markets are concerned, the softer inflation number was a key positive for the week.


Another key is that there is little short-term to derail the earnings story. S&P 500 earnings should be up close to +30% in the third quarter and close to +20% for 2018 as a whole. As you can see below, Goldman thinks we’ll see 7% growth next year and 5% in 2020.



Analysts in general are more optimistic. They see earnings growth of almost 27% in 2018 and over 12% in 2019. Solid numbers.


But there are nuances to the broad earnings story in light of the on-going trade disruption. At least so far, the White House has imposed 25% tariffs on $250bn worth of Chinese exports, while China has retaliated by taxing $150bn worth of American imports. President Trump has threatened to add another $200bn to the list, essentially adding tariffs to all imported Chinese goods.


Corporate bottom lines are starting to show the impact as supply chains are disrupted. There has been an increasing number of profit warnings from U.S. multinationals on tariffs, and those companies with high amounts of international sales have underperformed significantly the last few months, as you can see below.



It is tough to see this issue getting resolved before the mid-terms.


Yield Curve in the Sweet Spot


The Fed meets in a couple weeks and another quarter-point rate hike should be announced on September 26th. This would take the Fed Funds rate to between 2.00% and 2.25%. Another quarter point hike in December, as is widely expected, would take us to 2.25% to 2.50%. Naturally, the $64 trillion dollar question is what happens to long-term rates. All eyes are going to be on the yield curve in the weeks to comes. Today the spread between the 10-year and 2-year yield is 0.21%, down from 0.52% at the beginning of the year. As Alpine Macro notes:


“It is interesting to note that, both in the 1990s and the 2000s, U.S. equity prices continued to soar along with a flattening yield curve. The top in equities was made only when the curve was inverted (Chart below). It looks as though the equity bull market in the U.S. is following the same track this time around.”



Will equities roll over if the curve goes negative? Or is this time different because the curve is being distorted by quantitative easing? Only time will tell, but we doubt things are dramatically different this cycle.


What Really Matters Over the Long-Term


This week the media was awash with retrospectives on the failure of Lehman Brothers in 2008. Maybe we should say something coherent about the event, but we just can’t bring ourselves to do it. For some strange reason the financial crisis seems both like yesterday and a lifetime ago. What’s equally strange is how little has changed. Banks are still big. Home prices are soaring. The market has had the longest run in history. Jobless rates are at multi-decade lows.


If someone had told us we’d be where we are today ten years ago…???


Along these lines, the Collaborative Fund had a tremendous blog post this week. It started with:


“NEW YORK – In what analysts called “the most important economic metric that exists,” 360,000 people were born yesterday, 78% of whom are expected to survive into late adulthood. Most will grow up to become productive, working members of their societies.


Subtracting the 150,000 global deaths reported during the day, economists said there were a net 210,000 new humans on the planet Tuesday. Amid news that three-quarters of the world now lives in a free or mostly free political state, at least 100,000 new humans entered the world on Tuesday who will be given the opportunity to learn the accumulated lessons and knowledge of the 100 billion people who came before them….Asked what his forecast was for Q3 GDP, Mr. Douglas looked confused. “Did you just hear what I said about all the new people? That’s what’s going to matter over the coming decades.”


In essence it satirizes our all too human inclination to focus on just the here-and-now and forget about the long arch of human advancement.


“The Dow Jones Industrial Average fell 48 points on Tuesday. Greg Jones, an analyst at Merrill Lynch, expected that no one would care about that useless, vapid, fact by tomorrow.”


It is well worth a read link is here.


Have a good weekend.





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