“Giant steps are what you take
Walking on the moon
I hope my legs don’t break
Walking on the moon
We could walk forever
Walking on the moon
We could live together
Walking on the moon”
We go back to 1979 for one of the greatest hits by Sting and The Police. I was reminded of this song while I watched President Trump take a victory lap during his first State of the Union address. Certainly, the stock market has been breathing rarefied air since his administration began. Although he cannot take full credit for equity performance (stocks were doing fine during the Obama Presidency and the economy was improving), some of his economic policies have added fuel to the fire. The combination of deregulation, tax reform, and plain old animal spirits has been a potent aphrodisiac for the market.
January has continued this seemingly inexorable upward trend. As reported on CNBC, the Dow Jones Industrials and S & P 500 had their best month since March 2016, and the NASDAQ had its best positive move since October 2015. Momentum has been from lower left to upper right, and the Yellow Brick Road seemingly still leads to the Emerald City. Let’s look under the proverbial hood a bit to see why this trend has marched forward and whether it’s likely to be sustained.
We’ve been harping on the same themes for quite some time. Quarterly earnings this cycle have been solid. We mentioned in our last missive that corporate tax reform is estimated to add between 8.5 and 11.5% to the party, thus allowing for a further expansion in price-to-earnings multiples. Interest rates remain historically low. Investors are optimistic, and there’s still plenty of retail cash sitting on the sidelines. The “FOMO” (Fear Of Missing Out) mantra underlies the playing field. The wealth effect of higher equity accounts has led to increased consumer confidence. What’s not to like?
Well, I’m finally seeing some canaries in the coal mine. Tuesday’s decline of over 360 points on the Dow was the first 1% decline in 112 days. The length of that stretch tied a record from several decades ago. It came on the heels of a Monday that displayed a sharp reversal from Friday’s upward leg. The Volatility Index, or VIX, reached a level on Tuesday not seen since last August, signifying short-term anxiety that has been largely absent. Many pundits are nervous about the yield on the ten year Treasury creeping up. It’s now over 2.7%, and with the Federal Reserve poised to raise rates three or four times in 2018, that trend should stay intact. This is important since the safety of a government-backed yield can return to a competitive level with stock dividends. Value stocks could be negatively impacted, but I feel that the yield needs to exceed 3% for the flight to bonds to get legs.
Other flies in the ointment include a slight increase in inflation. Crude prices have been in stealth mode, rising from the mid 40’s to the mid 60’s per barrel. This hasn’t been reflected too much in gasoline prices yet, but we’re in a fallow period for auto travel. Other commodities have performed in a bullish manner, with gold having a particularly solid month. Remember that the psychology behind gold is one of a “safe haven”, and maybe this is a harbinger for the future. Although few pundits are discussing this point, I’m worried about Treasury Secretary Mnuchin imploring Congress to raise the debt ceiling. Tax reform has been pegged to add 1.5-2 trillion dollars to the deficit, and it appears as though President Trump’s infrastructure plan could have debt ceiling impacts as well. It’s eerily reminding me of the second Bush Presidency’s “compassionate conservatism”, which turned out to be neither in the end. In expressing adulation or simply caving legislatively to President Trump, Congressional fiscal hawks have been silent.
We’ve said many a time that equities are long overdue for a correction. A 5% downward move would be both healthy and normal for a market in a secular bull cycle. We’ve come a long way in a relatively short period. A pause that refreshes should be in order. That being said, I still feel good about equities, even at these lofty levels. Macroeconomic conditions, both in America and around the world, continue to improve. Tax reform and infrastructure, while deficit unfriendly, should have a positive effect on corporate earnings. Let’s also not forget all of the cash that’s going to be repatriated from overseas by multi-national corporations. Whether these dollars are used for share re-purchasing, increased dividends, capital expenditures, mergers/acquisitions or added jobs, the story for these companies seems to be getting better.
All in all, we hope to continue walking on the moon. We may have a roadblock or two along the way, and we’ll be watching portfolios for those signs. In the meantime, enjoy the January good beginning.
Now, a word about our new arrangement. The transition with W3 is going smoothly thus far, and we are confident that it will continue to do so. I can assure you that there will be no change in level of service. We’re already seeing synergies that will be accretive for everyone. It’s an exciting time… perhaps an end of the Schiffman Grow era in name, but a new beginning as W3. It’s great to be partnering with a like-minded firm.
Thanks as always for your continued trust and support. I look forward to talking with you soon.
The opinions expressed in this letter are those of William Schiffman and should not be construed as specific investment advice. All information is believed to be from reliable sources; however, no representation is made to its completeness or accuracy. All economic and performance information is historical and not indicative of future results. Diversification cannot assure a profit or guarantee against a loss. Indices are unmanaged and do not incur fees, one cannot directly invest in an index.