“I would suspect that if you’re an American citizen traveling back and forth to Libya, you’re likely to be subjected to further questioning when you come into the airport.”
White House Chief of Staff, Reince Priebus, 1/30/17
FAST FACTS ABOUT TODAY’S ECONOMIC DATA:
- The honeymoon is over. Markets will need to see actual tax reform to move higher.
- S. Personal Income and Spending up in December.
- Pending Home Sales improved in December.
- Dallas Fed Manufacturing Index at highest level since 2010-thanks to $50 oil.
THE HONEYMOON IS OVER:
We have reached the point where the promise of a Trump Administration (lower taxes, lower regulation, healthcare reform, etc.) now must meet the reality of a Trump Administration (protests, trade disputes, immigration reform / walls, etc.). We think the honeymoon is now over and the market is likely too complacent about the prospects for economic/tax reform at this time, particularly in light of what we are witnessing in terms of trade disputes, poorly communicated immigration reform, and ‘paying for the wall’. We think the market may just have plowed right into the wall … a wall of confusion.
We don’t have the classified intelligence to determine whether or not the new immigration policy was the right call. One thing we do know is that when executives from many major Fortune 500 companies are criticizing an immigration plan, when Mexicans are threatening to boycott American products, when allies are questioning our policies and standing in the world, and when the mayor of London wants Trump’s state visit to the United Kingdom cancelled, we have a problem that will affect investor sentiment. It will be difficult for the market to go higher when American leadership is called into question. With that in mind, for the market to go higher from here, actual tax and regulatory reform plans need to be on the table for all to evaluate. The hope trade has officially ended and so has the honeymoon.
U.S. PERSONAL INCOME UP +0.3% M/M IN DECEMBER:
The Bureau of Economic Analysis reported that Personal Income increased marginally in December, up +$50.2 billion to a record $16.29 trillion (SAAR) in December. This is an increase of +0.31% M/M and +3.51% Y/Y (+3.54% Y/Y prior), which is the 10th consecutive monthly gain (37 out of 38 months). Disposable Personal Income (Income less Taxes) increased +$43.7 billion (+0.31% M/M and +3.70% Y/Y). Note that Personal Income taxes increased +0.33% M/M and +2.16% Y/Y to $2.01 trillion (versus +1.89% Y/Y prior).
WAGES REBOUNDED IN DECEMBER:
In December, Wages and salaries rebounded +0.4% M/M, as private wages increased +0.4% M/M (still +3.7% Y/Y) and government wages increased for the 41st consecutive month, up +0.2% M/M and +2.8% Y/Y. Furthermore, there were increases in Rental Income (+1.0% M/M), Supplements to Wages & Salaries (+0.3% M/M), and Interest & Dividend Income (+0.04% M/M); however, Proprietors’ Income slipped -0.01% M/M.
U.S. PERSONAL SPENDING UP +0.5% M/M IN DECEMBER:
Personal Spending (PCE) increased +$63.1 billion to $13.03 trillion. Thus, spending increased +0.49% M/M and +4.249% Y/Y (versus +4.23% Y/Y previously). Since Disposable Income lagged PCE in dollar terms in December, Personal Savings fell -$22.8 billion and the “Savings Rate” fell to 5.38% (from 5.56%).
NOBODY IS “SAVING” ANYTHING (AND WHY SHOULD THEY WHEN SAVINGS YIELDS NOTHING?):
As we’ve shown in prior notes, the “savings rate” is a plugged number and actually isn’t savings at all. It is defined as Income minus Spending minus Taxes. But “Income” isn’t exactly income, as it includes government transfer payments such as Medicare, Medicaid, Unemployment Benefits, and Social Security. When you factor in that individuals are receiving more in government benefits than they are paying into those programs, it becomes clear that savings isn’t actually savings; rather the government is running up the debt on our behalf. This debt is essentially an off-balance sheet item. When we add it back, we find that the true “savings rate” is actually -4.51% (far off from the +5.38% reported number)!
CORE PCE DEFLATOR SLOWED IN DECEMBER:
The Bureau of Economic Analysis also reported that the Fed’s preferred inflation metric (Core PCE Deflator) increased +0.11% M/M and +1.70% Y/Y in December (+1.66% Y/Y prior). Meanwhile, the headline PCE deflator increased +0.16% M/M and +1.62% Y/Y (versus +1.38% Y/Y previously). In fact, this is the highest level since September 2014!
PENDING HOME SALES UP +1.6% M/M IN DECEMBER:
According to the National Association of Realtors, the Pending Home Sales Index increased +1.6% M/M to 109.0 in December. However, on an unadjusted basis, Pending Home Sales are now down -2.01% Y/Y versus +1.43% Y/Y prior. In the month, there were increases in the West (+5.0% M/M) and the South (+2.4% M/M); however, there were declines in the Midwest (-0.8% M/M) and the Northeast (-1.6% M/M).
DALLAS FED MANUFACTURING INDEX AT HIGHEST LEVEL SINCE 2010:
Today, the Dallas Federal Reserve reported that the Current General Business Activity Index increased +4.4 points to +22.1 in the month of January. In fact, this is the highest level since April 2010 and this is the fourth consecutive month of growth in the region. Certainly the rebound in oil prices have helped the region over the past few months. In the month, there were improvements in 12 of 16 current categories, most notably New Orders (+5.6 points to 15.7), Shipments (+10.0 points to +15.8), Capital Expenditures (+9.6 points to +16.3), Number of Employees (+9.5 points to +6.1), and Average Workweek (+6.0 points to +9.1). Moreover, manufacturers had a slightly more positive business outlook, as the Forecast increased +1.2 points to +43.7.
JAPAN RETAIL SALES DOWN -1.7% M/M IN DECEMBER:
According to the Ministry of Economy, Trade and Industry, Japan’s Retail Sales declined -1.72% M/M on a seasonally-adjusted basis in December. Furthermore, Retail Sales slowed to +0.57% Y/Y (versus +1.69% Y/Y prior). In the month, Large-Scale Retailers declined -1.19% Y/Y (-0.07% Y/Y prior), Total Commercial Sales declined -1.55% Y/Y (-0.40% Y/Y prior), and Wholesalers declined -2.54% Y/Y (-1.33% Y/Y prior).
U.S. GDP: Our GDP model points toward stronger growth in 2H 2017 (+3.5% 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 GDP Price Deflator stood at 1.26% in Q3, while the PCE deflator stood at 1.37% in November (Core PCE was 1.65%). 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 rise to 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: With earnings on the rise for 2017 (the street believes earnings will grow almost +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 remains negative Y/Y at -4.1% in November, but that’s an improvement from -8.0%. Construction Activity is also less bad at -9.4% Y/Y in November, versus -19.2% Y/Y previously. 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 started to turn lower, retail sales and consumer confidence have yet to turn higher. Meanwhile, business confidence has declined for two months, unemployment seems to be rising again, and PMI data indicate contraction in November. 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. Also, Consumer confidence has fallen from 59.5 in July to 56.2 in January. 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, Industrial New Orders are slowing, the Peso is getting hammered, 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, however.
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: Real GDP was slow at +0.7% Y/Y in both Q2 and Q3, but inflation has turned higher again in Q4. Meanwhile, vehicles sales, retail sales, and industrial production are negative on a Y/Y basis. Given South Africa’s commodity-driven exports, a stronger U.S. dollar could continue to hamper export growth.
United Kingdom: The U.K. economy seems to be on decent footing post-BREXIT, which is now acknowledged by the Bank of England (they don’t know if they will either cut rates or raise rates at this point). 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. Further unrest and 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%).
ASIA / PACIFIC:
Australia: The RBA cut rates twice since April and we may now be witnessing some subtle improvements in the Australian economy. Retail sales have improved, business confidence has been stable, and PMI’s improved slightly in November, although Consumer Confidence slipped in December. We remain concerned about Australia’s exposure to China, despite recent China stabilization. We remain neutral on Australia at this time.
China: We remain negative on China. 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.
Indonesia: Indonesia’s GDP and Private Consumption Expenditures have been stable at 5% Y/Y, and now inflation is stabilizing at roughly a 3.1% Y/Y core CPI rate. 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; however, Manufacturing PMI still remains below “50”.
Japan: Recent data out of Japan continue to show positive improvements in Japan’s CPI and manufacturing in Q4, on the back of Q3 GDP growth of +0.5% Q/Q (+2.2% Y/Y). However, household spending turned further negative in November (-1.5% Y/Y vs. -0.4% previously), housing starts slowed and small business confidence remains below “50” at 48.8. 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 some of Trump’s cabinet picks are expected to be Russia friendly. The Bank of Russia returned to a rate cut stance recently, 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: It’s hard to make an assessment on Turkey’s economic condition given the current political instability. Turkey hasn’t reported its Q3 GDP, however, economic data suggests Turkey has slowed meaningfully from its +3.1% Q2 GDP (and +4.7% Q1 GDP rate). Since Q2, Inflation has turned higher, Unemployment has risen, Industrial Production has turned negative, and Business and Consumer Confidence have weakened. Meanwhile, Turkey’s 10-year bond yield has risen by roughly 250 bps since the start of Q2. Overall, Turkey’s economic situation appears to be in meaningful deterioration.
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