Market Minutes for the week of February 26th:
“There are three ways to go broke: liquor, ladies and leverage” – Charlie Munger (Berkshire Hathaway)
Breaking: We have the same problem now that we had a month ago, just a different fuse this time. In February we had a hot employment report accompanied by rising wages which triggered a rise in volatility. Now, the “Orange Swan” otherwise known as President Trump has said he will impose a 25% tariff on steel imports and a 10% tariff on aluminum imports, which was a bit of a surprise to the markets and again, triggered a rise in volatility. The owners of the inverse volatility “products” apparently didn’t learn a painful enough lesson the first time as they are once again, caught holding a stick of dynamite that has exploded, and that is leading to forced selling of stocks to cover leveraged losses. Again, I must stress we have a technical event, NOT a fundamental event (see my thoughts on tariffs below). The global economy remains strong. The Fed is still in a “no panic” mode. Corporate profits are really strong. Banks are as well capitalized as they have ever been. This remains an environment to be a buyer of quality U.S. and foreign stocks.
Here is what I am hearing and thinking: 1.) I am not a fan of protectionism and tariffs because these policies interrupt the free market process and produce very little economic change for the better. In other words, the upside to an economy is limited while the downside is greatly exposed if…a global trade war erupts. Perhaps this is why the markets have become concerned (volatile) once again. 2.) The top supplier of steel to the U.S. in 2017 was Canada, followed by Brazil, South Korea, Mexico and Russia. The risk that these countries would retaliate with tariffs of their own on our major exports could ignite a trade war that would dampen competition, increase prices and lead to higher inflation, which in turn would push interest rates higher and lead to a slowing economy. Get the picture? 3.) What impact will these tariffs have on our economy without a trade war? The damage should be contained and more industry specific (higher input costs with marginally better/worse job creation in those industries). 4.) Tariffs on steel have been largely ineffective, going back as far as the Nixon era (Bush W., Clinton, and Reagan tried steel tariffs but they were met with little overall success). Because the U.S. imports 4 times as much steel as it exports, tariffs have been proven to barely move the needle when it comes to slowing imports and generating more jobs in steel industry. 5.) For February, the DJIA fell by -4.3%, the S&P 500 was -3.9% and the NASDAQ was -1.9%. Other markets outside of the U.S. fared worse, all down by -5% to -8% in the month. 6.) From Mike Lewitt at Credit Strategist: “In February, we experienced what it feels like to live in markets dominated by machines copulating with each other without regard to economic fundamentals. I don’t know about you, but this gave me no pleasure.” 7.) Wall Street veteran (of 40 years) Jeff Saut said that the recent correction is one for the history books. “I’ve never seen sentiment swing so fast…Going from euphoria, basically, at the end of January [to] a 12% correction…I think a lot of bullish sentiment has already been rung out of the market,” Saut said. 8.) There was a reduction in the number of Bulls this week from 51.9 to 48.5 according to Investors Intelligence. This is the first time below 50 since last September. Most of the drop ended up in the Correction camp which climbed for a 3rd week to 36.9 from 33.7. 9.) Barron’s Andrew Bary on GE: “The next humiliation for GE as a corporate icon could come if it is dropped from the Dow Jones Industrial Average as a result of its depressed stock price. It is the last remaining original member of the 1896 Dow: Its peers included the U.S. Leather Company and Tennessee Coal, Iron & Railroad.” 10.) Do increasing deficits cause rising interest rates? No, according to Brian Wesbury of First Trust Portfolios: “When tax cuts and regulatory reform lead to stronger economic growth, a pickup in the velocity of money, and rising inflationary pressures, the bond market begins to realize that short-term interest rates need to rise – across the yield curve. Rising interest rates have everything to do with better economic data and nothing to do with QE and deficits.”
The Conference Board said that it’s leading economic indicator index rose 1% in January for the 4th gain in a row and the biggest increase in 3 months. The strong gain was mainly driven by building permits and the financial subcomponents. 8 of the 10 indicators were positive.
The Conference Board also reported that January consumer confidence rose to 130.8, the highest level since 2008.
The ISM Purchasing Manager’s Index for February came in at 60.8, the strongest reading since May of 2004! Gains were seen in Employment, Inventories, Backlogs, and Supplier Deliveries. Comments from purchasing managers: “It seems like the tax break for business is making a difference. Customers are spending more for capital equipment” … “[The] Steel market is doing rather well. Everybody is out of what I need.” … “Employment is one of our biggest challenges. No labor available.’”
The Markit U.S. manufacturing and services index for February rose by 2.1 points to 55.9, the best level since May of 2015. Within services, new orders, backlogs and employment were higher and input costs (inflation) were sharply higher. Within manufacturing, new orders, employment and inventories increased month over month as did inflation pressures.
The Institute for Supply Management said that its U.S. PMI Composite Flash estimate for February hit a 27-month high at 55.9. Services at 55.9 vs 53.3 prior. Manufacturing at 55.9 vs 55.5 prior.
The Labor Department said that weekly jobless claims fell to 210,000, the lowest level since 1969. Companies are hesitant to lay off any workers because of the challenges of finding skilled employees.
The Commerce Department stated that the U.S. trade deficit in January rose by 3.0% to $74.4 billion as the U.S. imported more goods than it exported. The number is likely to be a drag on first-quarter GDP.
The Commerce Department also announced that durable goods orders (equipment with a greater than 3-year lifespan), fell by 3.7% in January as businesses trimmed investment. This is the first time since 2016 that core goods orders have fallen for 2-straight months.
Based on the recent economic data, the Atlanta Fed has reduced its 1st quarter GDPNow forecast to +2.6% from +3.2% a week ago.
The Fed said that its Chicago Fed’s index of national economic activity eased in January to a +0.12 from +0.14 in December. October’s reading of +0.91 was the best reading since +0.94 back in December of 2006.
The Bureau of Economic Analysis reported that the headline PCE (Personal Consumption Expenditures) for January rose by 0.4% month over month and 1.7% year over year. Services inflation rose by 2.4%, which was offset by a 2.3% decline in durable goods prices. This is the Fed’s favorite inflation indicator and bottom line: It still shows that inflation isn’t yet a problem but could be going forward, as the private sector wage and salary was up 0.5% m/o/m and 5.0% y/o/y for the 3rd straight month.
The Commerce Department said that new-home sales for January fell by 7.8% vs December to an annualized rate of 593,000. The median selling price in January was $323,000, about 2.4% higher than a year ago at this time.
The National Association of Realtors announced that January existing-home sales fell by 3% to 5.38 million units, the fastest pace of slowdown in more than three years. First time buyers made up 29% of purchases, down from 32% in December. Available inventory declined 9.5% over a year ago and the median price rose by 5.8% from a year ago.
The S&P/Case-Shiller Home Price Index/Composite 20 rose a seasonally adjusted 0.7% in the 4th quarter and was up 6.3% compared to a year before. The usual suspects lead the increase: Las Vegas +11.1%, Los Angeles +7.5%, Denver and San Diego +7.4%, Detroit +7.1% and Dallas +6.9%.
The National Association of Realtors said that pending home sales fell by 4.7% in January, marking the lowest point in nearly 4 years. Rising mortgage rates and relentlessly higher prices are to blame.
The U.S. Energy Information Administration said that in November of last year, U.S. oil production climbed to an all-time high above 10 million barrels per day, beating a 1970 record. The United States is now producing about the same as Saudi Arabia as the two compete for the title of the second-largest oil producer in the world.
Investing.com reports that India has replaced China as the world’s fastest-growing economy. India GDP grew at 7.2% in the 3rd quarter of 2017, while China’s GDP growth was 6.8%. Manufacturing, government spending, and services contributed to the growth.
Birinyi Associates says that corporate buybacks continue to surge after the passage of the tax reform bill and are now at a year-to-date record of $170.8 billion. The biggest announcement so far comes from Cisco Systems at $25 billion followed by Wells Fargo’s $22.6 billion.
According to the Vertical Group, in the 12 months leading up to the 2016 elections, foreigners were net sellers of $339 billion in U.S. Treasury securities. Since then and up until December of 2017, they were net buyers of $20 billion. China and Hong Kong are the biggest buyers and hold 6% of all outstanding Treasury debt. Other buyers increasing their holdings during last year were Saudi Arabia +$47.1 billion, the U.K. +$34.2 billion, Singapore +$28.1 billion, India +$26 billion, Switzerland +$19.3 billion, Russia +$15.6 billion and Korea +$11.2 billion.
Lending Tree says that the Denver, Colorado real estate market is the “most challenging” market in the country (out of 100 cities) for first-time home buyers. The criteria used to determine the ranking include: average down payment needed ($66,806), the share of buyers using an FHA mortgage, the average down payment percentage, the percentage of buyers with a credit score below 680, and the share of homes sold that the median income family can afford.
According to RealPage, multi-family construction is at a 40-year high, although most of the construction is at the “luxury” level. Apartment completions in 150 of the largest U.S. cities soared to 395,775 units in 2017, which is 46% higher than production in 2016. Upscale and luxury buildings made up for 75% to 80% of the new supply in the current cycle.
According to the Brian Eason of the Denver Post, “PERA [Public Employees Retirement Association] is barreling toward its second watershed moment in a decade. PERA has only 58.1% of the money it owes in future retirement checks. Its funding gap has ballooned to $32.2 billion by one accounting measure – and $50.8 billion by another. But unlike in 2010, when PERA’s looming insolvency was triggered in part by the global financial crisis, the latest fiscal crunch was arguably self-inflicted, brought on by wishful thinking and a consistent pattern of putting hard choices pushed off into the future.”
According to a survey by Delta Dental, the average payout from the “Tooth Fairy” fell by 11.0% in 2017, from $4.66 per tooth to $4.13. The survey, conducted in December, polled 1,007 parents of 6 to 12-year-olds. Kids in the Western states faired the best at $4.85 per tooth while kids in the Midwest faired the worst at $3.44 per pearly white.
Too many football games and too many players using them as a political platform. According to Goldman Sachs, NFL TV viewership for the 2017 season declined for the second consecutive year, by 8% year over year, bringing the total 2-year decline to 17%. The showing is actually worse than the 15% decline in non-sports broadcast programming.
According to The Wall Street Journal, Wells Fargo is again under the scrutiny of the Justice Department. The bank’s wealth management division, Wells Fargo Advisors, has been flagged with problems related to product and service sales practices. Sources say that sales were made: “with an eye toward earning more compensation than finding the best fit for the customer.”
Yum Brands announced that their Pizza Hut brand will become the new official pizza sponsor of the NFL. Pizza Hut replaces Papa John’s after it severed ties with the league to focus on deals with specific players and teams. HhH
KFC, another Yum Brands company, said in addition to a chicken shortage at its 900 U.K and Ireland franchises, they now have (heaven forbid) a gravy shortage. KFC said that it switched its delivery contract from Bidvest Logistics to DHL on February 14 and there are ongoing “distribution challenges” that still need to be sorted out.
According to ComScore, Disney’s (Marvel) “Black Panther” earned an estimated $25.2 million in last Thursday’s previews at U.S. theatres, setting a new record for a February release and was now tracking for a massive $192 million opening over the President’s Day weekend. The movie was also the biggest revenue producer globally that weekend, taking in an estimated $361 million. In its first full week, the film has grossed more than $500 globally.
Priceline Group has changed its name to Booking Holdings. The company has grown from one website to six brands with operations around the world.
Music streaming service Spotify has filed to go public. Shares have traded as high as $132.50 on the private markets according to the company, which would give it a valuation over $23 billion. The company lost $1.5 billion in 2017.
On February 14th, Amazon past Microsoft to become the third-largest U.S. company by market capitalization. Amazon is now worth $702.46 billion compared to Microsoft’s capitalization of $699.2 billion.
Axios has said that Amazon will acquire doorbell start-up “Ring” for an undisclosed amount. Ring reportedly has a valuation of around $1 billion. Back in 2013, Ring CEO Jamie Siminoff went on ABC’s “Shark Tank” to pitch his company then named “Doorbot.” All of the investors but Kevin O’Leary passed, and he made what Siminoff considered to be an unacceptable offer and Doorbot didn’t make a deal. As they say, the rest is history.
Apple announced that it is launching medical clinics to its employees to deliver the “world’s best health care experience”. Called “AC Wellness,” the clinics will be staffed with a primary doctor, exercise coaches, care navigators and an on-site phlebotomist to administer lab tests. The clinic will initially serve Apple employees in Santa Clara, County.
According to Bloomberg, Apple will release 3 new iPhones this fall. The lineup will include the largest iPhone ever with a nearly 6.5-inch screen, a lower cost iPhone, and a budget-friendly option that’s still packed with features.
Starting in June, McDonald’s has announced that it will drop cheeseburgers from its Happy Meal offerings. They will be available upon request, but for now it’s only a hamburger and 4-piece and 6-piece chicken McNuggets. French fries will be scaled down to “kid-sized” and the chocolate milk will be reformulated to lower the sugar content.
The New York Times reports that Dick’s Sporting Goods will end the sales of all assault-style rifles and high-capacity magazines. After the high school shooting in Florida, Dick’s CEO Edward Stack said: “We don’t want to be a part of this any longer.”
Walmart said it will raise the minimum age for gun purchases to 21 and will remove all items resembling assault-style rifles from its website.
Spectrum Brands has announced a deal to merge with HRG Group in a deal valued at $10 billion. Spectrum Brands is a consumer products company with brands that include Black & Decker, George Forman and Rayovac.
CNBC reports that AmerisourceBergen and Walgreens have ended acquisition talks with no agreement.
According to the Seattle Puget Sound Business Journal, Starbucks is removing roughly 200 products from its store shelves. Themed coffee mugs, thermoses, and coffee-brewing equipment such as French presses will be going away.
Disney has announced a €2 billion multi-year expansion plan for Disneyland Paris. The new development is scheduled to include a remodeling of the Walt Disney Studios Park, adding 3 new areas based on Marvel, Frozen and Star Wars.
NBC News has reported that Boeing and the Trump administration have reached a deal to build 2 new Air Force One planes. The original estimate for the jets was over $5 billion, the final deal is now expected to total $3.9 billion.
Uniti Group reports 4th quarter earnings of $0.64 per share on revenue of $246.3 million, an increase of 19.0% year over year.
Cracker Barrel reports fiscal 2nd quarter earnings of $2.73 per share on revenue of $787.77 million, an increase of 2.0% year over year.
DineEquity reports 4th quarter earnings of $0.74 per share on revenue of $148.78 million, a decrease of 3.5% year over year.
PepsiCo reports 4th quarter earnings of $1.31 per share on revenue of $19.53 billion, an increase of 0.1% year over year.
Coca-Cola reports 4th quarter earnings of $0.39 per share on revenue of $7.5 billion, a decrease of 20.0% year over year.
Deere & Co. said that worldwide net sales increased by 23% year over year to $6.91 billion. Segment Sales: Agriculture and Turf +18% and construction and Forestry +57%.
Genuine Parts reports 4th quarter earnings of $1.19 per share on revenue of $4.21 billion, an increase of 11.4% year over year.
Walmart reports 4th quarter earnings of $1.33 per share on revenue of $136.3 billion, an increase of 4.1% year over year.
Roku reports 4th quarter earnings of $0.06 per share on revenue of $188.3 million, an increase of 27.8% year over year.
Energy Transfer Partners reports 4th quarter earnings of $0.57 per share on revenue of $8.61 billion, an increase of 31.9% year over year.
Macy’s reports 4th quarter earnings of $2.82 per share on revenue of $8.6 billion, an increase of 1.8% year over year.
Priceline reports 4th quarter earnings of $16.86 per share on revenue of $2.8 billion, an increase of 19.1% year over year.
Salesforce.com reports 4th quarter earnings of $0.35 per share on revenue of $2.85 billion, an increase of 24.5% year over year.
Lowe’s reports 4th quarter earnings of $0.74 per share on revenue of $15.49 billion, a decrease of 1.8% year over year.
Nordstrom reports 4th quarter earnings of $1.20 per share on revenue of $4.7 billion, an increase of 8.8% year over year.
Next week: Earnings from: Target, Urban Outfitters, Dick’s Sporting Goods, Costco, Dollar Tree and Kroger. Economic reports: ADP Private Payrolls for February, U.S. Non-Farm Payrolls for February, ISM Non-Manufacturing Index for February and Manufacturing New Orders for February.
WTI crude oil: $61.07 per barrel. 10-year U.S. Treasury note: 2.81%. Gold: $1,311 per ounce.
Sources: CNBC, Barron’s, Real Money Pro, MarketWatch, Seeking Alpha, The Calafia Beach Pundit, Estimize.com, 361 Capital, Bloomberg and Reuters.
Disclosure: This publication shall not constitute an offer to sell or the solicitation of any offer to buy or sell any securities of the companies mentioned. This publication is solely a compilation of recent news releases from the sources cited above.
Ken Beach, President and Managing Partner of Cascade Investment Group, member FINRA & SIPC. Cascade Investment Group is not a tax or legal advisor. You should always consult with your tax advisor or attorney before taking any actions that may have tax consequences.