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Last Quarter / Year Review:
Q4, 2016 was up slightly less than Q3 at 3.25% v. 3.3%. The second half of the year was much better than the first. Market Strategist Bob Doll of Nuveen summarizes very well: “In many ways, the beginning and ending of 2016 were mirror images. As the year began, financial markets were dominated by fears of recession and deflation, and investors were uneasy over the Federal Reserve’s December 2015 rate hike. This environment produced a sense of malaise that resulted in a 10% drop in equity markets by early February. From that point, dovish global central bank policies, improving liquidity and a stronger labor market boosted economic growth modestly. As corporate earnings began to recover, stock market indices rose through most of the rest of the year, and rallied strongly following the presidential election.
“In addition to changes in equity market performance, we saw several other key inflection points. Amid economic growth concerns, the yield on the 10-year U.S. Treasury bottomed at 1.37% on July 8 and has climbed more than 100 basis points (1%) since then. We believe the July low marked the end of what had been a 35-year bull market for bonds. Fed policy also shifted as the central bank again hiked rates in December and indicated additional increases would follow in 2017. And, of course, the global political environment changed markedly. The Brexit vote, Donald Trump’s election and the Italian constitutional referendum all point to a world that is increasingly rejecting globalization and growing more nationalistic and protectionist.”
Investment & Economic Summary (source – Moody’s Analytics):
Economic data is shifting more positive but not robust and is mixed with both positive and negative results. Overall the data favor Bulls (optimists) over Bears (pessimists). The FED did follow thru with a December interest rate increase and plan 3 more in 2017. Normal interest rates as soon as possible without impacting economic growth is in the best interest of all. Sr. citizens who depend in interest income have been punished long enough. Economic details are:
- The Chicago Fed National Activity Index fell slightly in November. A reading of -0.27 still suggests the U.S. economy expanded at a below-average rate and is easing its foot off the accelerator after a stronger performance in early summer. However, the index’s three-month moving average improved to -0.14, its highest reading since August.
- Consumer confidence climbed again in December, reaching its highest level in more than 15 years, and marking what is beginning to look like a persistent level shift in consumer confidence that began in August. The election result has had a strong and immediate effect on consumer expectations with a large surge in respondents’ optimism for business conditions, employment, and their own household incomes. The increase in expectations was more than enough to overcome the buyback in present conditions.
- On a year-ago basis, the headline CPI was up 1.7%, and the core index rose 2.1%. Since 1995, year-over-year growth in the core CPI has averaged 2.1%. That said, year-over-year growth in the core CPI has been running about 0.5 percentage point ahead of the core personal consumption expenditure deflator that is favored by the FED.
- The U.S. labor market continues its steady march toward full employment. Unemployment is at 4.6%. Payrolls are growing at a slower but still-healthy pace as the pool of workers who are cyclically unemployed or underemployed shrinks. How much of the decline in labor force participation was cyclical remained an open question throughout the recovery, but the recent uptick suggests that at least some of these workers are willing to re-enter the labor force if job opportunities improve and employers are motivated.
- The ISM manufacturing index was better than expected in November, increasing from 51.9 to 53.2. The increase puts the index above its third quarter average of 52.2 and is further evidence that the worst for manufacturing has passed. The ISM nonmanufacturing index came in better than expected in November, rising from 54.8 to 57.2. Through November, the nonmanufacturing index is averaging 56 per month, better than the 54.7 in the third quarter. This suggests that growth in nonmanufacturing has broadened.
- Productivity is unchanged on a year-ago basis in the third quarter. Even year-over-year growth in productivity is volatile. It’s important to look at the longer trend. Productivity growth over the past five years is averaging less than 1%, much below the 2-3% long-term decade’s average. Low productivity limits real wage growth.
- The probability of recession fell 2 percentage points to 11% in November, the lowest this year. There is no immediate threat of a recession, as we normally adopt a recession as our baseline when the probability of recession hits 60%.
Expectations – next quarter: It is wonderful to see expectations move to reality. The quarter to quarter positive earnings improvements since March 2016 moved to the year over year earnings improvements shown in the table nearby. After 7 quarters of negative year-over-year earnings, this is a welcome change and the main impact to second half market improvement. While earnings look to increase going forward, we expect that the P/E of the market will drop a bit. With real policy change to fiscal growth implemented (lower taxes and regulation) investors may expand the P/E perhaps in the second half of 2017. The gridlock between the President and Congress will now shift to gridlock between Senate Democrats and Republicans. State Governments will likely cooperate more than Federal and continue to be laboratories of democracy. We’ll see the impact soon enough.
Price / Operating Earnings Trend – neither too hot nor too cold
Nov. 30, 2016 Jeremy Siegel is the Russell E. Palmer Professor of Finance at the Wharton School of the University of Pennsylvania and a senior investment strategy advisor to Wisdom Tree Funds.
“I see no reason, despite the fact we’ve had two sizable bear markets in the past 15 years and a nice run from the March 2009 lows, to stay away from equities. U.S. stocks are only slightly above their longer-term average price-earnings ratio. Europe and emerging markets are below their long-run valuation averages, so they are very attractive. Do not ignore foreign markets, even though you might think the U.S. is going to grow faster, because faster growth is already impounded into the prices of US stocks.
“I find bonds and fixed income to be very dangerous at the current time and much more so since the Trump victory. Although many of us had reservations about Trump for any number of reasons, on the economic front, if he does not veer off into tariffs, quotas, trade wars, or foreign adventures that are not in our interest, the policy which the Republicans advocate is tremendously more capital-friendly than the Democratic positions that many of us were resigned to endure for four or more years.
“The Republicans control all three houses, but they don’t control it by such enormous margins that all their policies are a slam dunk to be passed. In fact, GOP margins have been reduced in both the House and the Senate from the last Congress.
“Nonetheless, the opportunity to enact more-capital friendly regulations and tax policies, particularly for corporations, is very positive for equities going forward.”
Advisor Alert: Frank Holmes, CEO, US Global Investors 10/21/16
The Slowest Recovery Since the Great Depression
“Household income is up, unemployment is down—and yet sales are stagnant. It’s a paradox.
“A paradox, that is, until we examine another economic indicator: labor productivity.
“In simple terms, productivity means labor efficiency—producing more goods and services without working longer hours. And when productivity rises, it increases our standards of living.
“Since the end of World War II, productivity rose pretty steadily. But growth has been near-anemic for close to a decade now and is currently running lower than it’s ever been.
“Consider the following chart. Each bar represents a new business cycle following a recession. Crawling along at 1 percent annually, today’s productivity growth is weaker than the previous 10 cycles. In the September quarter, it actually fell 0.6 percent. The big question is: Why is this happening?
“The answer depends on who or which economist you ask.
“Possible factors that have been tossed around include the aging of the workforce, the strong dollar (which reduces the competitiveness of U.S. companies) and a slowdown in capital spending by businesses since the recession.
“One of the leading theories, presented by economist Robert J. Gordon in his recent book “The Rise and Fall of American Growth,” argues that 19th and 20th-century innovations—air conditioning, indoor plumbing, the microwave, the automobile—were much more impactful on workers’ productivity than modern inventions such as the internet, cloud computing and smartphone apps. (Indeed, we’d probably all agree that these things often waste, instead of enhance, our time and energy.)”
My personal take on this is that given GDP growth is poor, companies don’t want to invest in productivity enhancing capital because return on capital is poor. It’s easier to keep employment tight and if necessary, eliminate positions. GDP growth rate is anemic because of poor fiscal policy (taxes, regulation, hostility towards business by government) which offsets accommodative FED monetary policy. Government as a percent of GDP is at 36% and rising. Private enterprise is the only thing that can grow GDP and Private enterprise is declining as a portion of GDP.
Some are saying that this bull market is long by historical standards which is true. But markets don’t end due to age, they end due to excess of some sort caused by mostly Government errors demanded by politicians of all stripes. The private sector is self correcting due to competition. Simply recall how much better US autos are now because of German and Japanese competition. The earnings table above, if true, will power the market along with more cash coming from bonds and un-invested cash. We are very hopeful for 2017.
Regarding Tempo news, we have hired a Market Analytics firm to help us better monitor market rotation and asset investment choices. While Large Cap Growth has done well in the past, 2016 was a very lean year for that sector as measured by the asset IVW, our poorest performing asset. The Value sector, such as DVY which is also widely owned by us, performed well. This business partner has many tools allowing us to see market rotation quicker and take advantage of those movements. We will be making allocation changes early in this new year.
Happy New Year and Best Wishes!
Brent Romenesko, CFP®