“I believe that the stance of the United States towards North Korea will become much tougher.”

Japan Prime Minister, Shinzo Abe, 2/13/17


  • Despite slow start to February, Tax Receipts still up materially to start the year.
  • Financials and Tech still leading S&P Earnings beats.
  • Japan GDP slows below 1% again.


Last week we fielded some calls regarding a large brokerage firm claiming that a drop in API gasoline demand was a recessionary signal.  Our general response was that such conclusions weren’t backed up by a single other meaningful economic signal, particularly tax receipts.  Recent data suggests that tax receipts have only strengthened since then.

According to the U.S. Treasury, tax receipts are up +7.9% Calendar Y/Y through February 9th following a blistering January start.  Note that receipts were up +14.2% at the end of January, but have reversed some of that out in early February, as February is down -9.4% month-to-date Y/Y.  It should be noted that Income and Employment Withholdings Taxes are up +8.1% Calendar Y/Y (+14.0% Y/Y at the end of January … but February has fallen -6.6% MTD Y/Y), Excise & Other Taxes are down -62.7% MTD Y/Y and slowed to +1.5% Calendar Y/Y (+13.1% Y/Y at the end of January) and Corporate Income Taxes are down -44.2% MTD Y/Y but up +17.4% Calendar Y/Y (versus +21.1% Y/Y at the end of January).





As of last Friday, 354 of the S&P 500 Index companies have reported Q4 earnings, of which 242 have beaten earnings (68.36%) and 72 have missed (20.34%), albeit on lowered estimates.  However, this would be the lowest beat level since Q3 2015.  Thus far, the beats have been led by the Financial and Tech sectors, as 48 out of the 59 Financials that reported earnings and 44 of the 53 Tech firms that reported earnings have beaten estimates.




Furthermore, over the past few weeks, Wall Street analysts lowered their Q4 EPS estimates by -$1.23/share to $28.93.  Moreover, they lowered their 2017 EPS estimates by -$0.35/share to $130.76 and they lowered 2018 EPS estimates by -$0.58/share to $147.39.  This implies EPS growth of +21.9% Y/Y and +12.7% Y/Y in 2017 and 2018, respectively.  Our forecast remains well below those lofty forecasts (see table below).




JAPAN Q4 2016 GDP UP +0.2% Q/Q:

According to the Japan Cabinet Office, the GDP in Japan increased +0.24% Q/Q during Q4 2016 (+0.34% Q/Q in Q3 2016).  Also, Q4 GDP increased at an annualized rate of +0.95% (+1.35% annualized rate prior), which is the slowest pace since Q4 2015.  In the quarter, Government Consumption increased +0.39% Q/Q, Private Non-Residential Investment increased +0.94% Q/Q, and Exports increased +2.64% Q/Q.  Also, Imports increased +1.32% Q/Q, which resulted in a ¥1.071 trillion improvement in Net Exports.  However, Private Consumption declined -0.01% Q/Q and Public Inventories declined -¥733.8 billion in the quarter.





U.S. GDP:  Our GDP model points toward stronger growth in 2H 2017 (+3.4% Real GDP) given improvements in workforce population growth and workforce participation.  Our official forecast for 2017 is 3.0%. 




U.S. Inflation:  Recent inflation data in the U.S. has been accelerating.  The Fed’s preferred inflation metric, the Core PCE Deflator continues to approach the Fed’s 2% inflation target (+1.7% in December).  Meanwhile, U.S. CPI has been trending higher, with headline CPI at 2.07% and Core CPI at 2.20%.  As we anniversary the drop in commodities prices, we expect headline inflation to eclipse Core inflation in 2017 and our base assumptions are for 2.5% headline CPI and 2.25% Core CPI by yearend.

U.S. Federal Reserve:  Given our belief that the U.S. economy continues to improve, and inflation will rise, we believe the FOMC will hike rates more than the market currently appreciates in 2017.  We are setting a yearend 2017 Fed Funds target of 1.5% as a result.

U.S. Treasuries:  On the heels of stronger growth in the U.S. and backup in yields throughout Europe, we recommended to short the U.S. 10-year Treasury bond.  Despite low inflation globally, we believe U.S. 10-year yields will approach 3.0% in 2017.  We believe that economic conditions will likely deteriorate above the 3% threshold, based on recent history in the housing sector. 

U.S. Equities and Earnings:  As discussed above, S&P 500 operating earnings will rise materially in 2017 (the street believes earnings will grow approximately +20% in 2017).  We have a yearend S&P 500 target of 2400.  Note that we have lowered our multiple slightly to 17.5x forward earnings (from 18.0x) given the rising rate environment, but if the White House continues its confrontational approach to trade negotiation, or if tax reform measures are delayed, we expect to lower that forward multiple further.   We continue to favor the Financials and Healthcare sectors, as well as the Homebuilding sub-sector, and are offsetting that against underweight views in Consumer Staples and Utilities, which are overvalued by historical measures, particularly in light of more Fed rate hikes in 2017.

Argentina:  In short, the economic data out of Argentina has been “less bad”.   Industrial Production was less negative at -2.3% Y/Y in December, which is an improvement from -8.0% Y/Y in October.  However, Consumer Confidence hasn’t budgeted much over the past three months.  All that being said, “less bad” isn’t exactly “good” and we believe the United States’ stronger dollar and tighter trade policies are a major negative for emerging market economies, particularly economies like Argentina, where GDP is still negative.

Brazil:  Recent data in Brazil has been mixed.  Although inflation has turned meaningfully lower, and consumer confidence has improved, retail sales remain negative.  Meanwhile, business confidence hasn’t improved and PMI manufacturing data worsened in January.  Given that Brazilian markets have rallied substantially since President Rousseff’s removal, we feel Brazil’s current economic condition is mostly priced in and believe downside risk is rising for Brazilian equities.


Despite a housing bubble that appears to be deflating in some areas, building permits and home prices improved in Q4.  Canada’s monthly GDP has been remarkably steady at 1.0-2.0% Y/Y.  Unemployment has been stable around 7.0% since 2015.  CPI has hovered between 1.1% and 1.5% since May, and Manufacturing PMI’s remain modestly expansionary.  So far, the only signs of weakness in Canada appears to be with the Consumer, as retail sales have slowed from +7.3% Y/Y in January 2016 to just +3.0% Y/Y in November; however Consumer Confidence has been stable As the U.S. economy experiences liftoff, we will be watching Canada for signs that it too may follow suit.  As oil prices rise, we are becoming less concerned about Canada’s exposure to oil prices and certainly a recovery in the energy patch would delay fallout from inflated housing prices.  At this time, we remain neutral on Canada.


Inflation is picking up, Confidence is declining, Manufacturing is slowing, and Trump and Mexican President Nieto are firing off shots at each other.  What’s not to like about this situation??  We’re neutral on Mexico because it’s impossible to assess what’s coming next here.  From an economic perspective, the trend appears to be continued weakness, although recent improvements in USDMXN are worth monitoring.


Saudi Arabia:  If we had to place a wager on the direction of oil prices, we’d argue that the fix is in for higher oil prices until Saudi punts its Aramco IPO onto the market.   It seems to us the U.S. energy production is starting to rise again, but likely not fast enough to offset OPEC’s supposed oil production cuts.  Once Aramco is no longer their problem, we suspect that dynamic will change and supply will be plentiful again.

As Saudi’s economic situation, despite being a G-20 country, they provide little timely data.  Real GDP declined -1.3% Q/Q in Q3 and slowed to just a 0.9% Y/Y rate.  Inflation is slowing, but non-oil exports remain negative.

South Africa:  Initial January data show improvements in PMI, Business Confidence and Vehicle Sales following weak Q4 data, inflation is in a rising trend.  Given South Africa’s commodity-driven exports, a stronger U.S. dollar could continue to hamper export growth.


United KingdomThe U.K. economy seems to be on decent footing post-BREXIT, which is now acknowledged by the Bank of England.  With the odds rising for another rate hike, we remain bullish on the GBP versus the Euro. 

European Union: 2017 will be a year of political uncertainty as Europe’s biggest economies: Germany, the Netherlands, and France undergo federal elections.  Any further unrest or terrorism in Europe will undoubtedly push the European populace more towards protectionist positions, favoring anti-establishment (and anti-EU) candidates.  Although economic data has improved in Europe, the political landscape is currently filled with too many possible pitfalls.  We’ll remain short the Euro as a result.

European Central Banks:  The ECB is doing exactly what we thought they would do by favoring asset purchases over negative rates, although the ECB has now suggested that they will taper those purchases.  Additionally, TLTRO II is helping Europe to refi its debts and therefore blow the asset bubble ever bigger.  We will watch to see if ECB tapering expectations has any meaningful impact on zero (or near-zero) interest rates throughout the continent.

Eastern Europe: We continue to believe risks remain for Eastern Europe given high Debt/GDP levels, most notably Cyprus (+25% to 110%), Croatia (+7% to 62%), and Slovenia (+14% to 63%).


Australia: Despite the fact that the RBA cut rates twice since April, Australian economic data has yet to achieve liftoff.  In fact, retail sales have slowed for three consecutive months (see above), Consumer Confidence is flattening out, building permits declined materially in Q4, and PMI data weakened in January, while inventories increased.  Although Australia recently experienced an improvement in trade with China, we believe the improvement will be short-lived.  With the ASX200 index up about 12% Y/Y, we believe downside risk is elevated.  We remain neutral on Australia at this time.

China:   We remain negative on China, despite recent strength in trade data. Trump’s anti-trade rhetoric may only exacerbate China’s economic problems, which include industrial overcapacity, housing overinvestment, rising inflation, and concerns about bad loans.  With China fighting capital outflows, cracking down on independence movements in Hong Kong, and continuing to censor social media ahead of the National Communist Party Congress later this year, we believe political uncertainly could accelerate if the economic situation were to deteriorate.   

India:  As part of our broader strategy shift away from emerging markets, we closed out our long India call in late 2016.  It’s hard to make an assessment of India’s economic situation given distortions from the recent demonetization.  Recent data suggests business conditions deteriorated in Q4 and early Q1.

Indonesia:  Indonesia’s GDP and Private Consumption Expenditures have been stable at 5% Y/Y, and inflation has been stable at roughly a 3.5% Y/Y for nearly a year.  As a result, it is reasonable to assume that the central bank’s dovish policy stance may revert to a more neutral stance in 2017.  Consumer Confidence and domestic auto sales turned higher in Q4 and Manufacturing PMI moved back above 50 in January.

Japan:  Data from Japan in Q4 showed positive improvements in Japan’s CPI, PPI, and manufacturing.  However, early data from Q1 shows no further improvement.  We continue to monitor Japan for further signs of economic improvement, but the picture remains mixed.  For now, we will remain negative on the Yen given the BOJ’s ‘buy everything’ until inflation hits 2% policy (which may not happen this decade).

Russia: Russian equities remain the cheapest in the industrialized world and we recently initiated a long bias.  Russia believes that a Trump presidency may ease tensions in the Middle East, and certainly Trump’s rhetoric continues to support that belief.  Economically speaking, Russian inflation has slowed, GDP is about to return to positive territory, and the Bank of Russia has returned to cutting rates, which could further economic improvements.  We continue to believe that the Russian Ruble will rise, particularly versus the Euro, but we remain concerned about the impact of low oil prices on the Russian economy.

Turkey:  Inflation is rising in Turkey (+9.2% Y/Y in January), both business and consumer confidence continue to leak lower, and given political instability, Turkey hasn’t reported GDP since Q2.  Meanwhile, unemployment (last reported in October) has turned meaningfully higher and Turkey’s 10-year bond yield is 160 bps higher than it was in April.  Overall, Turkey’s economic situation appears to be in meaningful deterioration.




































This publication is for Institutional Investor use only and not for distribution to the general public. The comments herein are based on the author’s opinion at a particular point in time and January change at any time without notice. Merion Capital Group does not guarantee the accuracy or completeness of the information contained herein. Merion Capital Group is a FINRA-registered broker-dealer. Merion Capital Group shares in the commissions for trades that are executed through Tourmaline Partners, LLC, a FINRA-registered broker-dealer. This report is distributed for informational purposes only and should not be construed as investment advice or a recommendation to sell or buy any security or other investment, or undertake any investment strategy. It does not constitute a general or personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual investors. Past performance is not a guarantee of future performance. All investments involve risk, including the loss of all of the original capital invested.


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