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Weekly Market Cheat Sheet, June 26, 2017

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Last Week in Review:

For a second-straight week, we got underwhelming data and a more-hawkish-than-expected Fed. And for a second-straight week, stocks ignored it. Yet as we keep saying, unless this changes it can only be ignored for so long.

Starting with the former, there was only one material economic report last week, and it came Friday via the June Flash Manufacturing PMIs. Underscoring yet again that the regional surveys (which have been strong in June) apparently have no bearing on the actual national manufacturing PMI, the June composite flash PMI missed estimates at 53.0 vs. (E) 53.6. To boot, both the manufacturing PMI (52.1 vs. (E) 52.7) and the service sector PMI (53.0 vs. (E) 53.7) also missed estimates.

So, at least according to this flash PMI, manufacturing and service sector activity decelerated in June. Now, to be fair, all three numbers (the composite, manufacturing and service PMI) remain in positive territory above 50, so it’s not like activity is outright slowing. However, the level of acceleration continued to decrease in June.

Bigger picture, Friday’s numbers certainly aren’t damning for the economy, but again they are not going in the right direction. And with stocks extended (and a lot of good news priced in), and the Fed apparently more hawkish than we thought, the lack of economic acceleration so far in 2017 is going to become a problem if it doesn’t change.

Speaking of the Fed, last Monday Fed Vice Chair Dudley reiterated that he expected economic growth to continue, and was again dismissive of the disappointing inflation numbers. And, he clearly meant to imply that the Fed remains on course to 1) Begin to reduce the balance sheet in 2017 and 2) Hike rates again.

As with the slightly hawkish Fed meeting of two weeks ago, markets largely ignored the comments. But the bottom line is that the Fed is trying to communicate a more hawkish message to the markets, and the markets aren’t listening, yet. That’s something we’re going to be covering more in depth later this week. The chances of a hawkish “shock” from the Fed are rising (they aren’t high yet, but they are rising).

To end on a positive note, however, housing data bounced back nicely last week. Existing Home Sales and the FHFA Housing Price Index both beat estimates, and countered a very soft New Home Sales report.

Bottom line, over the past two weeks the data has continued to underwhelm while the Fed appears to be more hawkish than most thought. So, one of two things will happen if this continues: 1) Bonds will be right, and the economic data will get worse, which obviously isn’t good for stocks, or 2) Bonds will stop ignoring the Fed’s hawkish message and rates will rise. Either way, it will resolve itself with an uptick in volatility for stocks.

This Week’s Preview:

This week is similar to last week in so much as the important economic data points comes Friday, although on an absolute basis we do get more data this week.

The most important report coming this week is Friday’s Personal Income and Outlays Report, because it contains the PCE Price Index (the Fed’s preferred measure of inflation). If that number is soft, you will likely see the 10- year Treasury yield drop to new 2017 lows (likely below 2.10%, and the bond market’s warning on future economic growth will get louder).

The second most important number this week is the official Chinese June Manufacturing PMI, which comes Thursday night. I covered why China is so important last week in the “Credit Impulse Continued” section of Thursday report, but the bottom line is that if this number drops below 50 (which it shouldn’t, but there’s a chance) people will get nervous again about Chinese growth, and that will become a headwind on markets.

Looking elsewhere, Durable Goods will be reported and it will be yet another opportunity for “hard” economic data to show some acceleration and close the gap between strong “soft” sentiment surveys and hard economic data. Bottom line, next week is truly the key week for economic data, but this week’s inflation numbers (in the US and Europe) and Chinese PMIs will move markets, and give us further color into the state of growth and inflation. If the numbers disappoint, I’d expect lower bond yields… and lower stocks.

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Why “Credit Impulse” Matters to You, June 21, 2017

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Credit Impulse Explained: There are many analysts and investors who believe that the entire ’09-’17 stock rally is nothing more than the result of a historic, globally coordinated credit creation event from the world’s major central banks. Put in layman’s terms, every major central bank in the world has done QE at some stage over the past eight years, and pumped the world full on cash. So, all they’ve done is create massive asset inflation in bonds, stocks and real estate.

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Credit ImpulseQE is Quantitative easing. It is a “monetary policy in which a central bank creates new electronic money in order to buy government bonds or other financial assets to stimulate the economy (i.e., to increase private-sector spending and return inflation to its target).”

First, the theory goes, it was China’s central bank (the PBOC) and the Fed unleashing the initial wave of QE following the financial crisis in ’08/’09. Both central banks kept their foot on the accelerators over the next several years (remember QE1, QE2, Operation Twist, and then QE Infinity). In 2013, the Bank of Japan joined the Fed, PBOC and Bank of England at the QE party, only they came to really party, and upped the ante by creating a huge QE program.

Then, as the US and Chinese economies showed signs of life (finally) in 2015, the Fed and PBOC paused their QE/credit creation programs. And, whether causally or coincidentally, 2015 turned out to be one of the more volatile years in the markets in the last decade… and US stocks largely traded sideways until early 2016.

But by that point, the ECB had joined the QE party, and the PBOC restarted its credit creation machine following the economic scare of 2H 2015. So, even while the Fed has stopped QE, on a global basis the total amount of QE and credit in the system resumed a steep acceleration, as now the PBOC, BOJ and ECB were doing QE.

Again, coincidentally or causally, stocks broke out in February 2016, and they literally haven’t taken a break in 19 months (excluding two one-night scares with Brexit and the US election).

So, again, while there is no hard proof that this global expansion of credit has powered US (and now global) stocks higher, there certainly is at least a casual relationship if we look at history.

The reason I am pointing this out is simple: There are growing signs that the near-decade-long global credit creation/QE cycle appears to be nearing the end. First, there are the central bank actions. The Fed is hiking rates, and likely taking steps to reduce its balance sheet, draining liquidity from the system.

Second, the ECB appears to be on the verge of tapering its QE program, and while that will still result in a net credit increase for the next year, the pace of credit creation will slow. Finally, and perhaps most importantly, China continues to aggressively reduce credit in its economy, and I’ll again remind everyone the last time they did that, we got the volatility in 2H ’15.

This is where the “Credit Impulse” comes in.

Credit Impulse is a term used by various research firms that measures the “Rate of Change of Change” of global credit creation/QE. Put simply, while the global amount of credit may still be rising, the pace of the increase has not only slowed… it’s turned negative. Similar to taking your foot off the gas while you’re still going forward. It’s just a matter of time until you stop.

Getting more granular, UBS has been out front on this issue, and back in February noted that Credit Impulse turned negative. In a much-anticipated report out last week, the firm said that the decline over the past three-to-four months has accelerated, with Credit Impulse dropping to -0.6% annualized over the past three months.

Now, Credit Impulse is a composite of various measures of credit, including loans, loan demand and other metrics, so this is not a hard-and-fast number. And the fact that it has turned negative doesn’t mean we’re looking at an impending collapse in stocks.

But if we look at the entire picture, negative Credit Impulse; a more-hawkish-than-expected Fed that’s apparently committed to reducing its balance sheet, a Chinese central bank that is apparently committed to reducing credit in that economy, and an ECB that will begin tapering QE in 2018… the fact is we appear to be nearing the end of the post-financial-crisis credit expansion, and with economic growth where it is, I cannot see how that will be positive for stocks longer term.

Bottom line, I’m not turning into ZeroHedge (although they are all over this), but the fact is that I sense a lot of complacence regarding the end of this global credit creation cycle.

People seem to think that because the Fed ended QE and hiked rates, and then nothing “bad” happened, that this means things will be ok. The only problem is they fail to consider that at the exact time the Fed stopped QE, the BOJ, ECB and PBOC all ramped up their QE programs. That means global liquidity continued to expand, and stocks and Treasuries have been the massive beneficiary.

So, there’s what keeps me up at night, i.e., what happens in 12 months if the only central bank still doing QE is the BOJ? Maybe nothing, but I can’t be sure, especially considering current economic growth.

We will continue to watch the tectonic movements in the global economy for signs of stress, because while we enjoy quiet markets and low volatility now, we appear to be on the cusp of an unknown period where the global punch bowl slowly gets removed from the party. And, I’m bound and determined to make sure we don’t get stuck with the proverbial bill. Food for thought.

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Earnings Season Post Mortem & Valuation Update, May 9, 2017

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The S&P 500 has been largely “stuck” in the 2300-2400 trading range for nearly 10 weeks, despite a big non-confirmation from 10-year yields, modestly slowing economic data and political disappointment. Given that less-than-ideal context, the market has been downright resilient as the S&P 500 only fell to around 2320ish. The main reason for that resilience is earnings and valuation.

While it’s true that stocks are at a valuation “ceiling” right now, and need a new macro catalyst to materially breakout, it’s also true that given the current macro environment the downside risk on a valuation basis for the market is somewhat limited. That’s why we’re seeing such aggressive buying on dips.

Here’s the reason I say that. The Q1 earnings season was better than expected, and it’s resulted in 2018 S&P 500 EPS bumping up $1 from $135-$137 to $136-$138. At the higher end of that range, the S&P 500 is trading at 17.4X next year’s earnings. That’s high historically to be sure, but it’s not crazy given Treasury yield levels and expected macro-economic fundamentals.

However, if the S&P 500 were to drop to 2300 on a macro surprise, then the market would be trading at 16.67X 2018 earnings. In this environment (low yields, stable macro environment), that could easily be considered fairly valued.

Additionally, most analysts pencil in any help from Washington (including even a small corporate tax cut and/or a foreign profit repatriation holiday) adding a minimum of $5 to 2018 S&P 500 EPS. So, if they pass the bare minimum of expectations, it’s likely worth about $5 in earnings, and that puts 2018 earnings at $143.

At 2400, and with $143 expected earnings, the S&P 500 is trading at 16.8X 2018 earnings. Again, that is high historically, but for this market anything sub 17X will elicit buying in equities (whether it should is an open question, but that is the reality).

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Last Week and This Week in Economics, April 24, 2017

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Last Week in Economics – 4.17.17

April economic data started with a bit of a thud as all three April reports missed estimates last week. And while on an absolute level the numbers imply economic activity remains “fine,” the lack of additional progress is contributing to growing doubts about the strength of expected economic reflation (and that’s why bond yields are lower than most expect).

Last week’s headline economic report, flash April Manufacturing PMI, missed expectations at 52.8 vs. (E) 53.9, and declined from the March reading. Likewise, April Empire Manufacturing and Philly Fed also missed expectations and declined from very high readings in March.

Now, to be clear, on an absolute level all three readings show continued economic growth, but again it’s the pace that matters. Stocks have priced in reflation, but the loss of momentum in economic data undermines that thesis, and that’s why stocks have grinded sideways now for six weeks.

Meanwhile, the gap between soft sentiment surveys and hard economic data remained wide. March Industrial Production beat estimates but that was only because of strong utility production given the March blizzard. The manufacturing sub-component declined and badly missed estimates, again providing non-confirmation for the still high (in absolutely terms) manufacturing PMIs.

Bottom line, economic data wasn’t outright “bad” last week, but it didn’t help reinforce the expected reflation trade, and that did at least partially stoke concerns about the pace of growth. Meanwhile, economic data didn’t help close the gap between hard and soft.

This Week in Economics – 4.24.17

The slow drip of economic data continues this week (next week is the big one), although given the precarious nature of the bond market (10-year yields signaling a potential slowdown) all economic data is at least partially important.

With that in mind, the most important number will be Friday’s Employment Cost Index. Inflation is a key component of the reflation trade, and any broader uptick in inflation has to come from increased wages. In Q1, wage data in the government jobs report wasn’t particularly strong. So, if the Employment Cost Index shows no real uptick in wage pressures, that will further undermine the reflation trade.

Other important data next week includes the first look at Q1 GDP (which will be lucky to hit 1%) and Durable Goods. Starting with GDP, it’s not going to be a strong report, but if consumer spending (PCE) is stronger than expected that will be a silver lining. Meanwhile, Durable Goods offers yet another opportunity for hard economic data to meet surging sentiment surveys, and in doing so close the gap between strong soft data and lackluster actual data. Other notable data points this week include Pending Home Sales and Existing Home Sales, both of which will be under more scrutiny following the disappointing Housing Market Index and Housing Starts numbers from last week.

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Last Week and This Week in Economics, April 17, 2017

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Week of April 17th and April 10th in Economics

Last Week in Economics – 4.10.17

The two important economic numbers came out Friday when markets were closed, so they didn’t receive much attention, although they should have. Both numbers (CPI and Retail Sales) further eroded the reflation trade thesis and will increase worries the economy is losing momentum.

Starting with retail sales, the headline on this number was plain ugly. March retail sales declined 0.2% vs. (E) 0.0%. Almost as importantly, February retail sales were revised down to -0.3% from the previous 0.1%. As longer-term readers know, we generally disregard the headline and instead look at the “control” group retail sales, which is retail sales ex autos, gasoline and building materials. That control group gives us a better read on truly discretionary spending.

Here the numbers are a bit better. Control retail sales rose 0.5% in March vs. (E) 0.3%, but February was revised lower from 0.1% to -0.2%. So, considering revisions, the March number wasn’t a beat.

Bottom line, this number is not good for stocks. Consumer spending was the engine powering the Q3/Q4 2016 economic acceleration, and the sluggishness in consumer spending now is extending beyond what we would consider normal slack following a big acceleration. These are not the kind of numbers we would see if a bigger economic acceleration is looming.

Turning to CPI, it also undermined the “reflation” trade in the near term. Headline CPI dropped -0.3% vs. (E) 0.0% while core CPI declined -0.1% vs. (E) 0.2%. Additionally, the year-over-year core CPI reading dipped from 2.3% in Feb. to 2.0% in March. This soft CPI reading isn’t a damning number, and clearly the trend of inflation is higher. Yet markets need modestly higher inflation and better growth to power stocks higher, and last week’s numbers did not suggest that’s happening.

Bottom line, this week now is very important, as it will go a long way to resolving the now-glaring discrepancy between still sluggish “hard” economic data and surging “soft” economic sentiment surveys.

Finally, to make this a bit more real, Friday’s numbers resulted in the GDP Now for Q1 dropping to just 0.5%. That type of economic growth simply cannot support stocks at these levels, and as such we should expect Friday’s data to further pressure bond yields and the dollar, which will increase stock headwinds.

This Week in Economics – 4.17.17

This week is important for markets because we will get a much more definitive answer to the question of whether the pace of economic growth is losing momentum. How that question is answered will go a long way to determining whether the S&P 500 takes out the March low of 2322, or if stocks can bounce.

To that point, the most important economic releases this week all contain March data, and the most important report will be the flash manufacturing PMIs out Friday, followed (in importance) by Empire Manufacturing (today) and Philly Fed (Thursday). The reason those numbers are so important is because it’s April data, so they will give us the most current view of the pace of economic activity in the US. If they further imply there is a loss of momentum, that will further undermine the reflation trade and hit stocks. Conversely, markets need strong data this week to help reinvigorate the reflation trade thesis.

Looking beyond those March data points, the next most important report this week is March Industrial Production. This number is important because a wide gulf still exists between “soft” sentiment -based data, and “hard” economic numbers. Industrial production is the next opportunity for some of that “hard” economic data to move higher and begin to close that gap.

Bottom line, we’re coming to a head on the debate over soft vs. hard economic data, and whether the recent economic acceleration can last. While there aren’t a lot of numbers this week, what data we do get is important to resolving that debate… and that will move markets.

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Geopolitical Update: Bearish Catalyst or Excuse?, April 12, 2017

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Syria Political MapGeopolitical risk has reared its head over the past week, but while the potential military showdowns in Syria or North Korea are the focus of the media headlines, in reality these events aren’t so much direct risks on stocks as they are a reminder of just how priced to perfection the stock market is right now.

Getting more specific, it’s not that anything really got worse yesterday in Syria or North Korea (and if anything,Tillerson heading to Russia may help calm tensions). But rising geopolitical tensions are simply piling on right now along with growth and policy anxiety.

That said, there is always the possibility of more military action in Syria and/or North Korea, so I want to cover each situation briefly and review which sectors and assets are winners and losers during periods of heightened geopolitical stress (should we see one).

Syria: All about Russia. The Syrian situation is important from a geopolitical standpoint, because it indirectly pits the US against Russia. For context, Syria is in the middle of a horrific six-year civil war. The Syrian government and rebels have fought to a standstill for the last several years, thanks to Russia’s arming of the Syrian government and (likely) the US’ arming of the Syrian rebels. Given those proxies, sensationalists out there tout the possibility of the US and Russia getting involved in a military conflict due to their opposed positions.

That is the big fear; however, it is very, very unlikely that will happen. Syria simply isn’t that important to either nation, and apart from the human tragedy (which is quickly approaching Biblical standards for those poor people) that situation is much more bluster than battle.

North Korea: All About China. While Syria gets the headlines, North Korea is considered the much bigger actual geopolitical risk. The reason is partly because its leader, Kim Jong-un, is viewed as mentally unstable, and because the country has low-grade nuclear weapons.

This week, the situation has escalated after President Trump sent a US naval carrier group to patrol the waters off the Korean peninsula, a not-so-subtle reminder that the US is watching. But what likely prevents this standoff from becoming something more serious is China.

China basically funds North Korea’s economy, and it has long been believed that the only way to get North Korea to comply with international demands is through China.

From a geopolitical standpoint, it is very unlikely North Korea would launch a preemptive strike against the US, Japan or anyone else for fear of losing Chinese economic support. So again, while there are dangers, the likelihood of actual military conflict is low.

What It Means for Stocks

As we learned in 2016 with Brexit and Trump, just because something is viewed as being low probability doesn’t mean it won’t happen! With that in mind, there will be specific sector winners and losers if we see further elevated geopolitical tensions.

Sector Winners of Increased Tensions. Withheld for subscribers. Unlock with a free trial of the Sevens Report.

Sector Losers of Increased Geopolitical Risks. Withheld for subscribers. Unlock with a free trial of the Sevens Report.

Going forward, we don’t think geopolitics will be a major influence over stocks (and don’t think yesterday’s sell-off was caused by geopolitics). But as we said Monday, even a small uptick in geopolitical risks with valuations stretched and markets this optimistic could exacerbate any earnings, economic or policy-related pullbacks in stocks.

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Time to Buy Emerging Markets? March 29, 2017

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The Case for Emerging Markets, an excerpt from today’s Sevens Report. Everything you need to know about the market in your inbox by 7am, in 7 minutes or less.

Time to invest in emerging markets, tom essayeAs expectations for a pro-growth policy based reflation trade (i.e. the Trump trade) fade here in the US, one potential beneficiary is emerging markets. The sector has underperformed since the election due to a combination of

1) Dollar strength,

2) Rising US bond yields, and

3) Fear of trade wars.

But, if we see an extended pause in the dollar and bond yield rally, and continued poor execution on pro-growth policies, then emerging markets offer value in an otherwise expensive market.

Now, I’m not saying I’m a long-term bull on emerging markets, nor does this analysis mean I’m not a long-term bull on the dollar or bond yields… I think both go higher long term.

However, the fact is this market has already priced in a an acceleration of growth in the US. If that doesn’t materialize, we could see a sideways chop in the dollar and bond yields, and emerging markets will likely outperform near term (i.e. the next few months).

The investment thesis behind EM is comprised of three pillars: Valuation, inverse correlation to the US-based reflation trade, and positive exposure to global growth.

Pillar 1: Attractive Relative Valuation. Emerging markets are much cheaper than most developed markets, as several research pieces we’ve read have emerging markets trading 12X forward P/E, compared to 17X and 15X for the US and Europe, respectively. So, there is value there, especially after the under-performance following the election.

Pillar 2: Hedge Against a Reflation Trade Unwind. If we see the reflation trade continue to unwind (which started in earnest last Tuesday) then emerging markets will benefit. Case in point, since the election, our preferred emerging market ETF (withheld for subscribers) has returned 5.9%. But, almost all of those gains have come over the past few weeks thanks to the Fed’s dovish hike, and the healthcare failure.

If reflation trade enthusiasm wanes in the US, emerging markets will continue to benefit thanks to the weaker dollar and lower yields. To put it simply, emerging market returns are highly inversely correlated to the dollar. If we see the dollar continue to grind sideways or continue to fall, emerging markets should outperform.

Pillar 3: Positive Exposure to Global Growth. Finally, emerging markets should benefit from a rising global economic tide. US rate hikes aside, the rest of the world’s central banks remain very “easy,” and generally speaking global growth is on an upswing… and that should continue to benefit emerging markets. There are, however, risks to the trade. First, if we get border adjustments in a corporate tax cut package, that’s negative EM because it effectively puts a tax on all emerging market exports (i.e. raw materials), which will reduce demand. Second, if the Fed becomes more hawkish near term, then the dollar and bond yields will rise, and EM will lag. Third, if China sees another growth scare that will hurt EM. Finally, if the Trump administration begins to levy import taxes or engages in aggressive trade policies, that will obviously be EM negative. Of these risks, we view the most probable as the Fed getting more hawkish. But, near term that just isn’t very likely. So, the risks to this strategy are real, but we don’t view them as imminent.

Finally, I’m not saying emerging markets are a long-term strategy, but I do think EM is something that can outperform over the coming months, especially if we see a lack of progress on tax cuts. As such, EM offers reasonable upside in a market where not much is cheap, and we think the potential reward is worth the risk.

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How Many Rate Hikes in 2017? Last Week and This Week: March 5, 2017

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The Economics excerpt from today’s Sevens Report, which focuses on the most important financial news and takeaways for investors, financial advisors, and CPA’s, last week and this week.

Even uber-dove Lael Brainard supported potentially hiking in March.

Last Week:

The major takeaway from the economic data and Fed speak last week is that because of continued strong data and hawkish Fed speak, a March rate hike now is expected by the markets. Probability (according to Fed Fund futures) of a rate hike on March 15 rose from just over 20% two weeks ago, to over 70% at the end of this week… and that was a legitimate surprise for markets.

The reason that change didn’t cause a pullback in stocks is simple. Economic data last week showed continued acceleration in growth and inflation, and as such that helped cushion the blow from the increased rate hike expectations.

To that point, there were three big numbers from last week and they all beat estimates. February ISM Manufacturing PMI rose to 57.7 vs. (E) 56.4, February ISM Non Manufacturing PMI rose to 57.6 vs. (E) 56.5. And, the core PCE Price Index (the Fed’s preferred measure of inflation) rose 0.3% in February, the biggest monthly increase since January 2016. While the core PCE Price Index rose 1.7% yoy, same as January, the headline PCE Price Index rose 1.9% yoy, just below the Fed’s 2% target and the highest level since February 2013!

Not every economic data point was strong last week (Pending Home Sales missed estimates as did Core Durable Goods. And, headline revised Q1 GDP was a touch light at 1.9% vs. (E) 2.1%). Still, the good data handily outweighed the bad data.

Bigger picture, it’s hard to understate how important continued good economic data has been for markets in 2017. Strong data has helped buy Washington more time on corporate tax cuts, and now it’s helping to cushion the blow from a potentially more hawkish Fed. Strong economic data continues to be the unsung hero of the 2017 stock rally, and it needs to continue given the increasingly bleak policy outlook, and potentially a more hawkish Fed. Frankly, watching and correctly interpreting economic data hasn’t been this important in years.

Looking at Fed speak from last week, it was almost universally hawkish. Clearly the Fed is trying to pave the road for a March rate hike. Fed officials Williams, Dudley and Powell all signaled that a rate hike could come in March, and even uber-dove Lael Brainard supported potentially hiking in March.
Then, as if there was any doubt left by the end of last week, on Friday Fed Chair Yellen basically said that if the jobs report is in line, the Fed is hiking rates (her exact words were more general, and a bit more eloquent, but that was her point).

Bottom line, the Fed appears to be sticking to its promise of three rate hikes in 2017, with the first likely coming in 10 days.

This Week:

Are Janet Yellen and the other members of the Fed supporting more rate hikes in 2017?

Jobs reports are always important economic releases but due to the potential for a March rate hike, this jobs report is even more important than normal because it will decide whether we get a hike next Wednesday.

As usual, it’s jobs week, so that means we will get the ADP report on Wednesday, weekly jobless claims on Thursday (which continue to hit levels last seen since the 1970s), and the official jobs report Friday.

I’ll do my normal “Goldilocks” jobs preview later this week, but the bottom line is that as long as this jobs re-port remains firm, the Fed will hike rates next week.

Outside of the jobs report, it’s actually a pretty quiet week, economically speaking.

In the US, the only other notable report is Productivity (out Wednesday). Low worker productivity has been a major downward influence on inflation, but it’s shown signs of ticking higher lately. A continuation of that trend will be slightly hawkish. Finally, looking internationally, China will be in focus as we get Trade Balance (Tuesday) and CPI/PPI Wednesday.

Data from China has been consistently decent (including last week’s February manufacturing and composite PMIs), so it’ll be a big surprise if the data suddenly turns south, but China remains a macro area to watch as any hints of a slowdown will make waves for global markets.

Bottom line, this week really is all about the jobs report. If it’s close to in line, the Fed will hike next Wednesday. And, if it’s hotter than expected, get ready for talk about more than three hikes this year (and that idea is a risk to stocks).

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The Political Outlook for Stimulus is Darkening, February 28, 2017

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This is an excerpt from today’s Sevens Report. The Sevens Report is the daily market cheat sheet our subscribers use to keep up on markets, seize opportunities, avoid risks and get more assets. Sign up for a free 2 week trial.

It’s obviously impossible to say “when” this will matter to stocks, but I want to make very clear to everyone that the political outlook for stimulus is darkening, and the chance of any pro-growth measures hitting the markets in 2017 are falling, quickly… and sooner or later that will be a problem for this market.

To that point, yesterday there were three separate areas where the outlook for fiscal stimulus darkened. First, while Treasury Secretary Mnuchin did a good job in both his major interviews (WSJ and CNBC) he didn’t add anything incremental regarding corporate tax cuts, and was downright vague on the idea of border adjustments, which is the key to corporate tax cuts.

Yes, he did say he expects a broad corporate tax reform bill by the August recess, but that’s just repeating what Speaker Ryan has said (i.e., nothing new). Bottom line, the outlook for corporate tax cuts in 2017 (and maybe at all) continues to get worse.

Paul Ryan

Speaker Paul Ryan has said he expects a broad corporate tax reform bill by the August recess. The outlook for corporate tax cuts in 2017 continues to get worse.

There were some additional headlines regarding this issue late yesterday afternoon when President Trump told Reuters he supported “some form of border tax.” Markets initially took this as a positive (implying he was supportive of border adjustments) but that’s premature because what he meant was unclear as his subsequent comments more implied he supported tariffs in some form (not the full scale border adjustments needed to pass corporate tax reform).

Beyond Trump’s comments, the major hurdle for border adjustments and corporate tax reform remains in the Senate. There is little support for that idea in the Senate currently, and until that chances, corporate tax reform is unlikely.

Second, Axios reported that Trump is punting infrastructure spending to 2018. That was treated as a notable headline yesterday, but we and others have been saying for weeks now that infrastructure spending never was on the table for 2017. So, while this isn’t an incremental negative for the market, it was a headline that we wanted to cover.

Third, as we’ve covered, the way things are looking right now Republicans must get the repeal/replace of Obamacare done before they can tackle corporate tax reform. Well, Politico reported that Republican Alaska Senator Murkowski won’t vote for any repeal/replace that reduces the Medicaid expansion. With just a 53/47 majority in the Senate, the chances of just getting 50 votes on a repeal/replace continue to dwindle, and by all reports Republicans remain fractured on how to handle the repeal/replace.

Now, I’m not pointing this out for political reason (you know I’m politically agnostic in this Report). The reason I am pointing it out is simple: No Obamacare repeal/replace, then no corporate tax cuts in 2017, and that’s a problem for stocks (how much of a problem will depend on economic growth, inflation and interest rates, but it’s still a problem).

Bottom line, I don’t want to sound like the boy who cried wolf, but I just want to point out consistently and clearly that the gap between market policy expectations and policy reality is widening—and again, that’s a risk that should not be ignored.

This is a volatile, politically sensitive investment landscape—you need the Sevens Report to stay ahead of the changes, and to calm worried clients.

“Is the Stock Market Too Expensive?” February 23, 2017

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“Is the Stock Market Too Expensive?” 

That’s a question I’m getting asked a lot lately by subscribers and colleagues.

With stocks at record highs, there is a lot of worry that the market is unsustainably expensive. But, that’s simply not the case.

Yesterday, in the full edition of The Sevens Report, we broke it down.

  • Provided a three-part analysis of what makes the market 1) Expensive, 2) Fairly Valued (with some room for upside) and 3) Cheap
  • Named each catalyst that would decide that valuation level
  • Listed specific sector and style ETFs that we believe can outperform in this valuation environment.

Excerpt from that research below:

Valuation Update: How Overvalued Are Stocks?

It’s no secret that stocks are richly valued, but while those high valuations make me generally uncomfortable (I’m a value investor at heart) I do feel the need to push back a bit on the idea that valuations, alone, are a reason to lighten up on equity exposure.

Yes, in some scenarios the stock market is simply “too expensive.” Still, there are other, more plausible scenarios where I can show the market as reasonably valued or even cheap. Here are a few of those scenarios.

The Market is Too Expensive If: You’re Looking at Current Year Earnings. Looking at current year earnings, the S&P 500 is historically very expensive. With consensus $128 2017 S&P 500 EPS, the S&P 500 is trading at a whopping 18.44X current year earnings. Anything above 18X has proven (longer term) historically unsustainable.

The Market Is Not Too Expensive (Yet) If: You Look At Next Year’s (2018) Earnings (And This is Without Any Tax Cuts). Consensus 2018 (so next year) EPS are around $135, which does not include any benefit from a corporate tax cut. At $135, the S&P 500 is trading at 17.4X next year’s earnings. Yes, that is expensive (the 20-year average is 17.2X per FactSet) but it’s not unsustainable, not in an environment with historically low interest rates and an apparent macro-economic acceleration.

In fact, if the macro set up doesn’t change (and we don’t get any definitively bad news from Washington), I could see investors pushing that multiple to 18X, or 2,430 in the S&P 500 (about 3% higher from here).

Above that, I think the market would get somewhat prohibitively expensive, but that would depend on what’s happening with the economy, inflation and rates.

The Market Is Cheap If: Real, Material Corporate Tax Cuts Get Implemented. If we do get material corporate tax cuts in 2017, most analysts think that would add at least $10/share to S&P 500 EPS, bringing the 2018 number from $135 to $145.

At $145 EPS, the S&P 500 would be trading at just 16.3X next year’s earnings, which in this environment could easily be considered reasonable if not outright cheap.

“Is the stock market too expensive?”

Six Value ETFs That Can (and Have) Outperformed

From a practical standpoint, the fact that the stock market is on the expensive side historically does reinforce my preference for value-oriented ETFs. Since late 2016, we’ve focused our tactical strategies on sectors we considered a “value” and they have handily outperformed the S&P 500:

  • In September of 2016, we strongly advocated getting long banks due to 1) Compelling valuation and 2) The start of the uptrend in bond yields. Since that call on September 26, our preferred bank ETF has risen 41%!
  • In late 2016, while many analysts were chasing cyclical sectors in the wake of the election, we instead advocated buying value in super-cap internet stocks. Our preferred internet ETF has risen 9.8% in 2017, handily outperforming the S&P 500.
  • At the start of 2017, we cited the maligned healthcare sector as our preferred contrarian play for 2017, based on the idea that overly negative political fears had created a value opportunity. Our two preferred healthcare ETFs have risen 7.3% and 7.5% so far in 2017, and we think that trend of outperformance will continue. 
  • More broadly, we have identified two “Value” style ETFs that we believe will outperform the markets in this current macro-environment, and these two broad ETFs remain our preferred vehicle to be generically “long” the market.

The Sevens Report doesn’t just help you cut through the noise and focus on what’s truly driving markets – we also provide tactical idea generation and technical analysis to help our subscribers outperform. You can sign up for your free trial today: www.7sReport.com.

“This is a huge value add. If I can avoid even a modest portion of significant market pullbacks, and be well-invested during bull markets based on your Dow Theory calls, my clients will be extremely happy with me. I already look like a genius to them!” – Financial Advisor with a National Brokerage Firm, New York, NY.