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What’s the Specific Word Trump Said That Sent the S&P 500 Through 2300 Last Week?

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What’s the Specific Word Trump Said That Sent the S&P 500 Through 2300 Last Week?

Last week started off a little down on Monday, then flat on Tuesday and Wednesday. Thursday looked like it was going to be another boring day until President Trump made comments during an airline CEO meeting that he would present a “phenomenal” tax plan in a few weeks. Those comments were followed by a more legitimately positive article from The Hill that said Trump may be willing to cut entitlements to pay for tax cuts. Stocks jumped on the headlines and markets moved to all-time highs.

The momentum continued on Friday as political expectations continue to rise, and stocks rallied small in quiet trade. And with no news to break that momentum, stocks drifted higher into the close and with modest gains on the week.

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A More Hawkish-Than-Anticipated Federal Reserve: February 15, 2017

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An excerpt from the Sevens Report. Sign up for a two-week free trial of the full report at www.7sReport.com.

Yesterday I began profiling a couple of non-political risks to explore when making decisions for your clients and talking with prospects. Here’s the second:

Non-Political Risk 2: A More Hawkish-Than-Anticipated Federal Reserve

Profiling this risk seemed only natural, given Yellen’s Humphrey-Hawkins testimony yesterday, and her marginally hawkish comments served as a good reminder that the market is pretty complacent with regards to expected Fed rate hikes in 2017.

Yellen’s comments to the Fed on Tuesday, February 14th, were slightly hawkish.

Starting with Yellen, she was slightly hawkish in her comments mainly because of her upbeat assessment of the economy combined with her reiteration that waiting too long to hike rates would be “unwise,” and that the Fed will consider further increases at “upcoming meetings.” Finally, Yellen repeated that she expects a “few” rate hikes this year (she cited the median dots were three hikes in 2017).

While none of those comments were new, it was a reiteration that the economy is doing relatively well and that the Fed is focused on removing accommodation, and markets reacted slightly hawkishly as the dollar rose while Treasuries declined/yields rose.

From an equity standpoint, the fact that the Fed has not been hawkish so far in 2017 has helped stocks rally, as the 10-year Treasury yield has backed away from the 2.60% level. Above that we believe higher rates will start to become a headwind on stocks. But, there is clearly a risk that rates rise higher than current expectations, and as such we want to profile that risk.

Probability of 3 rate hikes this year (one more than expected)? > 50%. This is my opinion, and it’s higher than the current consensus, but to me it makes sense. If investors think that better growth is going to support the stock market, then why do they expect that acceleration in growth not to invite more interest rate hikes from the Fed? The answer is because the Fed has been ultra dovish for years, but I believe that is changing due to multiple factors.

First, growth is as good as it’s been in years. Second, dis-inflation/deflation is no longer a threat (we think this is an underappreciated change in the macro-economic dynamic). Even in ’13 and ’14, when growth had periods of acceleration, inflation was still trending downward and the Fed was in full QE mode. Now, inflation is trending upwards. Third, the composition of the Fed will change as Trump can nominate three Fed members this year, and it’s a good bet they will be more on the hawkish side. So, while it’s still Yellen’s Fed, the scales should start to tilt toward the hawks later this year.

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Economic Growth Slows: February 14, 2017

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An excerpt from today’s Sevens Report.

Non-Political Risk #1: Economic Growth Slows.

Stronger economic data remains an unsung hero of this post-election rally, and while Trump gets the headlines, it’s really the economic data that’s enabling this rally as better economic growth is allowing the market to continue to give Trump and the Republicans the benefit of the doubt.

I can go through the litany of reports, but whether it’s PMIs, the Jobs Report, or Business Investment, the data has been accelerating since mid to late 2016, and that’s created the proverbial “rising tide” that’s helped under-write both policy optimism and the rally in stocks.

But, while hope may be growing that there will be less drama from the administration (the reason for Monday’s rally), at the same time there’s growing evidence that actual policy reality will not meet market expectations.

So, in the near term, it’s going to be up to economic data to continue to provide a reason for markets to give Washington the benefit of the doubt, otherwise the sober reality of a market that now trades well over 18X current-year earnings will begin to cause problems.

Bottom line, if economic growth slows in the near term, that will cause a pullback in stocks. So, in today’s Sevens Report for subscribers, I go into detail on: 1) How likely is an economic slow down? 2) What are the leading indicators to watch? and, 3) How do we position if it happens?

First, how likely is an economic slow down? > 50%.

A probability that high may surprise people, but I have several reasons for it: First, we’ve seen an acceleration in economic activity, but we still haven’t really achieved the “breakout” pace of consistent 3% GDP growth that tends to feed on itself and further stimulate the economy. For all the excitement, we’re still in a 2%ish GDP regime (GDP Now from the Atlanta Fed has Q1 GDP at 2.7% in Q1). Point being, things down have to slow very much before the economy is right back in neutral.

Second, the consumer has powered this economic acceleration, but the consumer is tired. Credit creation is slowing, and retail sales reports have been lackluster of late. To boot, the job market remains basically at full employment and while wages are rising, they aren’t rising fast enough to power incremental acceleration consumer spending. Unless we see proof consumers are accessing the equity in their homes, I don’t see what will cause consumer spending to grind higher.

The Citi Economic Surprise Index rose steadily through Q4 of 2016 as economic data consistently beat expectations. Going forward, this index is now an important leading indicator for the market, as any material move back down towards zero will create a headwind on stocks.

Third, business investment has accelerated lately and that is good, but the uncertainty over the tax code changes (and trade in general) has the potential to be-come a headwind on business investment. Here’s my point: The tax changes being discussed in Congress could eliminate interest deductibility and change a host of other tax issues. If I’m a business and I’m thinking of getting a big loan to finance expansion, I’m likely going to wait until there’s more clarity on these and trade issues be-fore taking on too much risk.

Finally, leading indicator of growth for the global economy, China, is actively trying to slow its economy. China’s credit-fueled expansion back in February 2016 marked an inflection point in the global economy and things have been better since. But with a year of stimulus be-hind it, currency issues, and once again overheating property and asset markets, Chinese authorities are trying to cool their economy. The effects aren’t immediate or direct on the US economy, but the fact is that a slow-ing Chinese economy will become a headwind on the US at some point (how much of a headwind depends on how well the cooling is managed).

“Leading Indicators” and, “How do we position if it happens?” sections are restricted to subscribers.

Take advantage of the limited time special offer—if you subscribe to the Sevens Report today, and after the first two weeks you are not completely satisfied, we will refund your first quarterly payment, in full, no questions asked.

Copyright 2017, Kinsale Trading LLC. All Rights Reserved. www.sevensreport.com

Economic Cheat Sheet: February 13, 2017

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Last Week:

There was very little incremental economic data last week, and what reports did come met expectations and importantly did nothing to change the perception that economic activity is legitimately accelerating—a perception that continues to support stocks broadly.

From a domestic data viewpoint, there isn’t a lot to talk about. Jobless claims continued to fall and hit another multi-decade low (a 43-year low), and that’s even more impressive when you consider how much the population has grown since then. Internationally, there was mixed data from China as their foreign exchange reserves dropped below the psychologically important $3 trillion level. While that was ignored by markets this week, China continues to bubble as a potential macro surprise in Q1/early Q2. These foreign currency reserves are a story we need to continue to watch.

But, January Trade Balance was much stronger than expected (exports up 7.9% vs. (E) 3.1%), and that data point early Friday helped alleviate some concern. Still, China’s currency reserves are declining, and authorities are actively trying to pull leverage from their economy and cool growth. More often than not, that leads to some sort of macro-economic growth scare—so just a heads up for the coming months.

Bottom line, economic growth remains an important pillar of this rally, and nothing last week changed that set up, which again was why at worst stocks were flat before the political headlines caused the late-week rally.

This Week:

As we’ve said, two of the biggest risks to the rally outside of Washington remain 1) Lackluster data and 2) A more hawkish Fed. Given those risks, the growth and inflation data this week is important.

Janet Yellen (AP Photo/Jacquelyn Martin)

However, the most important event of the week will be Fed Chair Yellen’s semi-annual Humphrey-Hawkins testimony to Congress, on Tuesday (the Senate) and Wednesday (the House). While she isn’t going to telegraph when the Fed will raise rates, her comments are still important considering the market remains complacent with regards to a Fed rate hike. There is no expectation of a March or May hike, and we continue to think the market is a little too complacent with regards to the potential for a May hike (we admit March seems remote).

Staying on the theme of Fed expectations, the next most important number this week is the January CPI report out Tuesday. The Fed does not believe inflation is accelerating meaningfully (due to the data), but if inflation does pick up pace that will be hawkish and will send yields higher—and most likely stocks lower.

Looking at growth data, Wednesday and Thursday are the key days to watch as we get January Retail Sales (Wed), Empire Manufacturing (Wed), January Industrial Production (Wed) and Feb. Philly Fed (Thursday). Of those four reports, the retail sales number is the most important, because consumer spending has been the engine of growth for the US economy, and it needs to maintain a decent pace because while business investment has picked up, it won’t offset a continued moderation in consumer spending.

The Empire and Philly Fed Indices are the next most important numbers next week, as they will give us the first look at February activity. Since better growth is a key support to this rally, they need to show continued strength. Neither number needs to accelerate meaningfully, but we can’t see much of a retracement, either. Bottom line, strong economic data and benign inflation data (Goldilocks numbers) have been an important support for this market as Washington reverts to the mean (gets more dysfunctional), and that needs to continue if stocks can hold recent gains in the face of confusing political headlines.

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Takeaway from Hawkish Fed Minutes

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The bottom line of the minutes from The Fed’s March meeting was that there is little probability of the Fed doing any additional stimulus unless the economic data weakens.

In particular, this is the sentence that got markets moving: “A couple of members indicated that the initiation of additional stimulus could become necessary if the economy lost momentum or if inflation seemed likely to remain below two percent.”

The important part of that statement is “could become necessary” which signals that the committee does not view any additional QE as necessary at the moment.

Effect

The minutes had a big effect on markets. Stocks were already lower heading into the release, but fell sharply post release (Dow down over 100 points) as the realization hit traders that, for now, additional accommodation is off the table.

The U.S. dollar, Euro, Gold and Treasuries were also big movers off the release, as Gold and the Euro fell hard, while the U.S. Dollar and Treasury yields moved sharply higher.

Takeaway

I had said in Monday’s issue, and throughout last week, that I thought the market had misinterpreted Bernanke’s testimony from last Monday and that is wasn’t signaling additional QE. That turned out to be correct.

For a market that has become addicted to quantitative easing and accommodation from the Fed, this news is obviously disappointing in the short term.

But, we need to see the forest for the trees here. The Fed doesn’t see the need to do additional QE because the economy appears to be getting stronger and it isn’t needed.

That is a good thing for stocks if we look beyond the very short term. It is also a good thing for commodities, even through it doesn’t look like it right now. The reason is because The Fed is not going to raise rates any time soon, and we can expect the inflationary implications of The Fed’s previous actions to begin to filter through the economy, and continue the re-inflation that has already begun.

This is a time to use short term weakness to establish a position in equities and commodities. I’m not saying to do it today, as we probably have some more selling to be done—but I will view any decline in the commodities markets based on the disappointment of less stimulus as a buying opportunity. Get your shopping list ready.

 

Bernanke Comments Don’t Signal QE3

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The market took this speech as dovish, and expectations for QE3 rose slightly. I, however, don’t particularly find the comments “dovish.” Anyone who knows to watch the average work week component in the monthly jobs data knows that we’re not seeing additional hiring because of expanding economic conditions.

Bernanke, in my opinion, just said out loud what many already know. The labor market is getting better, but it isn’t healed, and it is still very fragile.

For a while we’ve known that Bernanke and the Fed are data dependent, and if the data gets worse, they’ll be more accommodative.

We knew this coming into the speech: If the economic data gets worse, the Fed will be quick to move with more accommodative policy. If the data gets better, the Fed will be much slower to raise rates. That was the reality we all knew before the speech, and I believe that is the reality after the speech.