“We want to start making our products again. If you look at some of the original great people that ran this country, you will see they felt very strongly about that.”
S. President, Donald Trump, 1/23/17
FAST FACTS ABOUT TODAY’S ECONOMIC DATA:
- For Stock Market to push higher, Trump will have to live up to Tax and Regulation promises.
- Russian Industrial Production turned higher in December.
WHAT’S THE RIGHT TRUMP MULTIPLE? FOR STOCKS TO MOVE HIGHER, PROMISES WILL NEED TO BE KEPT:
We watched and listened to President Donald Trump’s message to CEO’s this morning and we believe they got the message. If these executives close a plant in the United States and move that plant offshore – for any reason – he’s going to tax them when those products return to the United States. We’ve heard this threat/promise over and over again now. It’s more than just campaign rhetoric. He means it.
We feel uneasy about the President’s border tax plan (or better put, the lack of any actual plan besides bluster at this point). The concept of taxing companies for operating in the best interest of shareholders leaves us with great concern. The United States accounts for roughly 22% of the world’s $80 trillion economy. The tax plan/threat being championed by Mr. Trump therefore would require companies to focus more on the 22%, than on the remaining 78%. A global U.S. company with manufacturing facilities worldwide would therefore need to have additional local production within the United States in order to escape the border tax penalty. This sounds inefficient and bloated at best, and at worst tells us that the world will soon face manufacturing overcapacity unlike anything it has ever witnessed.
So what is a global company to do? The obvious answer is to build plants in the United States. But what if that is neither feasible nor cost-effective? In that instance, a global company could decide to forgo sales into the U.S. in order to avert the cost of the tax penalty. In short, U.S. consumers would be left with less goods to purchase and thus would face a shortage of the things they need. Economics 101 taught us that a shortage in goods leads to higher prices. Economics 101 tells us that Donald Trump’s border plan leads to inflation.
As we have stated in our work for quite some time, we believe 2017 is already setting up for higher levels of inflation. We are already seeing signs of rising inflation in China, the U.K., and the United States. As we anniversary low oil prices, we believe inflation will turn higher in the coming months. Inflation is already set to increase, and a border tax will only worsen underlying inflation.
So herein is the problem…Trump’s border tax threat is a negative for companies. It’s a negative for markets. It’s a negative for U.S. consumers, and it’s inflationary at its core. The only way any of this is good for the market is if Mr. Trump lives up to all his other promises, such as this one stated this morning: “We are going to be cutting taxes massively for both the middle class and for companies. And that’s massively. We’re trying to get it down to anywhere from 15 to 20 percent”. Or this one … “We think we can cut regulations by 75 percent…maybe more.”
So what are we to do as market strategists when faced with competing policies that have the potential to either help or hurt the market? The answer may be to simply cut your forward multiple. What are we to do as market strategists when the president may tweet something out against any major company, industry, currency, or Fed policy at any given moment? The answer, again, may be to simply cut your forward multiple. For now, we will give the president the benefit of the doubt and assume a more favorable business environment in the months ahead. But if not, we reserve the right to cut our forward multiple. As we show below, it will take 8.5% EPS growth to offset a small cut in P/E multiple from 17.5 to 16.5. To borrow a carpentry phrase, Trump is best served measuring twice and tweeting once going forward.
RUSSIAN INDUSTRIAL PRODUCTION UP +3.2% Y/Y IN DECEMBER:
According to the Federal Service of State Statistics, Russian Industrial Production increased for the seventh consecutive month, up +7.4% M/M. Output is now up +3.2% Y/Y (versus +2.7% prior), which is the highest level since December 2014. Utilities output increased +10.0% M/M and +5.5% Y/Y, Manufacturing output increased +7.9% M/M and +2.6% Y/Y, and Mining output increased +4.4% M/M and +2.9% Y/Y.
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 are assigning 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. We will consider lowering our multiple further if inflation were to accelerate beyond our expectations, or if President Trump’s pro-business policies don’t live up to expectations. 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 already 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 surged in October. Canada’s monthly GDP has been remarkably steady at 1.0-2.0% Y/Y this year. 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 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.
The say great fences make for great neighbors, but we’re not sure a big wall qualifies in that regard. Today we see that President-Elect Donald Trump is again taking Twitter shots at Mexico, by calling out GM auto imports from Mexico. This political backlash has already led to Ford canceling plans to build a plant in Mexico.
Prior to Trump’s election, Mexican industrial production was already showing signs of weakness. Post-election, the central bank raised rates given the significant decline in the peso. Meanwhile, Mexican equities are exposed to downside risk given their rich valuations. We remain neutral on Mexican equities at this time, but we are watching the subtle decline in consumer confidence and manufacturing data. Note that recent economic data suggests that Mexico’s inflation is beginning to trend higher (producer prices have surged and to a lesser extent CPI is rising too).
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. Meanwhile, Italy is installing yet another technocratic government (Italy seems to approve given both consumer and business confidence turned higher in December), the U.K. will likely enact Article 50 and begin BREXIT, and Ireland will battle with E.U. officials over corporate tax policy. Regardless of recent improvement, 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 next year. 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: Recently, we turned 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. China’s currency continues to deteriorate as China does all it can to crack down on both capital outflows. 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 may be on the rise in China.
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.
MACRO TRADING IDEAS:
GLOBAL CENTRAL BANK SCORECARD:
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WEEK IN REVIEW – BEST & WORST PERFORMERS:
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COMMODITIES MARKET PERFORMANCE:
MAJOR GLOBAL STOCK MARKETS:
MAJOR GLOBAL BOND MARKETS:
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