Winter 2018 Quarterly Commentary

Will improving company fundamentals be constrained by an extended market? Will a stronger economy overheat and result in higher inflation? Will stock benefits of lower long-term rates be offset by Fed rate hikes? Consequently, is the Fed on the verge of a major policy error? You see, for every ‘put’ there is a ‘take’. Hence, our prudent cautiousness. A case could be made for a much higher stock market but we believe an unemotional, balanced risk approach is best right now. Happy New Year!

Economic Positives

Is a melt-up economy ahead? The Institute for Supply Management’s Non-Manufacturing (Services) Index recently advanced for the 96th consecutive month. The Manufacturing Index also remained red hot as the New Orders component advanced 15% year-over-year to 69.4 – a multi-year high.

Deregulation On Steroids A primary focus of the current administration is to reduce the regulatory burden on business. ‘Red tape’ is being eliminated at an historic pace. In fact, the number of pages in the Federal Register has declined from 97,000 to almost 62,000! This bodes very well for business investment.

The Optimism Barometer remains pro-growth: Low rates, available credit, deregulation and lower expected corporate taxes have all contributed to much-improved sentiment. A Small Business Optimism Index recently advanced near 12-year highs and Consumer Confidence is on pace for 2000 levels!

Economic Negatives

Are we near full employment? The U.S. unemployment rate remained unchanged for the third consecutive month at 4.1%. December payroll gains of +148,000 were solid, but not stellar. Is this as good as it gets? Are wage pressures and inflation around the corner?

The wealth gap has widened: An unfortunate unintended consequence of the strong stock market is that the gap between the ‘haves’ and ‘have-nots’ in our country has widened. Because wealth is not evenly-dispersed, our legislators need to remember the ‘have-nots’ in their legislative decisions.

The US dollar dilemma: We believe it’s best to have a strong & stable currency. A weaker US dollar helped manufacturing last year. But, with a stronger economy and higher interest rates most likely on the horizon, we wonder at what point does an appreciating US dollar become a headwind to growth?

Market Negatives

The yield curve has a fairly impressive track record of predicting recessions. Wall Street is increasingly worried that the difference between the 2-year US Treasury and 10-year US Treasury has narrowed to 0.50% (or 50 basis points). Is the Fed raising rates a policy mistake?

Will higher rates and extended valuations depress buybacks? We are often asked by clients, ‘Why is it that money has poured out of equities and the market is still up?’ The main reason is corporate share buybacks. We worry that the capacity to buy back shares diminishes in a rising interest rate environment.

Are T.I.N.A.’s days numbered? With rates still at low levels, stocks are favored over bonds and TINA investors (There Is No Alternative / to stocks) still have the upper hand. However, rates have gradually crept upward and the 2-year US Treasury currently yields > S&P 500 dividend yield. TINA should be worried.

Market Positives

Show me the money! A lesser-known benefit of the recently-passed tax cut package is the repatriation of foreign cash at a much lower rate. We believe this could be a catalyst for a stronger M&A environment as well as additional share repurchases and dividend increases by many multinational companies.

Equities are still under-owned: One of our favorite charts to share with clients shows that, since the financial crisis, more than $2.3 trillion has been poured into bonds over stocks. We consider this ‘dry powder’ favoring equities in the coming years as this gap should narrow in a slowly rising interest rate environment.

The quest for yield favors large caps: We believe we’re in the midst of a multi-year trend favoring large cap, dividend-paying stocks over intermediate to long-term bonds. The recent corporate tax cuts strengthen their already pristine balance sheets and improve their dividend-paying ability. Baby Boomers rejoice!

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