Markets were closed yesterday for MLK Day but they are off to the races again today

Markets continued their strong start to the New Year with another 500+ point advance in the Dow Jones Industrial Average last week breaking through DOW 26k today.  Improving fundamentals for the global economy, and corporations, are buoying investor confidence; weekly inflows into global equity markets hit a six-month high.  Small cap value stocks outpaced large cap growth stocks; the market?s preference for small caps indicates that investors are starting to look for returns outside of popular areas such as the ?FAANG? stocks.  And, sectors that are more sensitive to the economy, including Energyand Industrials, continued to outperform Utilities and other, more conservative areas.  This trend reflects growing confidence in the economy and an associated willingness by many investors to accept additional risk.  Indeed, in only nine trading days, the PHLX Oil Service Sector Index has returned nearly 10% in 2018.  West Texas Intermediate crude oil, the North American benchmark, closed above $64 per barrel for the first time since December 2014; current prices may support deepwater offshore projects, such as those in the Gulf of Mexico, which had been on hold for the past several years.  Meanwhile, both Treasury yields and inflation rose.  The recently announced increase in the minimum wage, and rising transportation costs, will place further upward pressure on prices.  The long-delayed increase in inflation is consistent with broad economic expansion; higher inflation is typically neutral-to-positive for stocks, but negative for bonds.

The earnings season started with JPMorgan Chase and Wells Fargofalling short of estimates due to write-downs related to the lower corporate tax rate.  The longer-term impact of tax reform, though, will be generally positive for the U.S. economy.  Jamie Dimon, CEO of JPMorgan Chase, noted that, ?The enactment of tax reform in Q4 is a significant positive outcome for the country.  U.S. companies will be more competitive globally, which will ultimately benefit all Americans.  The cumulative effect of retained and reinvested capital in the U.S. will help grow the economy, ultimately growing jobs and wages.?  This week, 25 companies in the S&P 500? Index report results; overall, sales are expected to grow 6.7% while earnings are expected to grow 10.5%.  This would mark the third time in last four quarters that the Index will have posted double-digit earnings growth; earnings grew 14.0% in Q1, 10.3% in Q2, and 6.4% in hurricane-impacted Q3.  Companies have started to provide details on the likely impact of tax reform; several, including Wal-Mart and Delta Airlines, have announced wage increases and bonuses.  Likewise, analysts are also beginning to adjust financial models to account for the lower tax rate; some expect earnings for domestically-focused industries, such as retailers and transportation, to benefit as much as 20%.

The strong start to 2018 is a positive sign for the remainder of the year.  The 3.7% month-to-date gain in the Russell 2000? Index of small companies contrasts sharply to the slow starts over the past several years: the Index rose 0.4% in January 2017, and fell -8.9% in January 2016, -3.3% in January 2015, and -2.8% in January 2014.  The last time the markets started off as strongly was in 2013 when the Index gained 6.2% in January; that year, small cap stocks soared 37.0%.  Notably, 2013 was characterized by a shift in investor sentiment that may be similar to today; then, investors? appetite for risk following the European debt crisis provided a catalyst that drove the market?s advance.  Today, tax reform and global economic growth are providing a boost to investor confidence that, at least in the early going, is prompting a rally in small cap stocks.

* Pacific Global Management

Chart reflects price changes, not total return.  Because it does not include dividends or splits, it should not be used to benchmark performance of specific investments.

 

Last Week's Headlines

  1. Consumer prices have remained relatively stable through 2017, according to the Consumer Price Index. The price increase was driven primarily by an increase in housing and medical care costs. For the last month of the year, the CPI increased a marginal 0.1%. Over the year, the index rose 2.1%. Core prices, less food and energy, increased 0.3% in December — the largest increase since last January. For 2017, core prices have increased 1.8%.
  2. In yet another sign that price inflationary pressures are stagnant, the Producer Price Index for December fell 0.1% after advancing 0.4% in both October and November. This drop in prices is the first such decline since August 2016. Most of the decline is attributable to a 0.2% decline in the prices for services. Core prices (less food, energy, and trade services) edged up 0.1% in December. For the 12 months ended in December, the PPI rose 2.6% after advancing 1.7% in 2016. Core prices increased 2.3% in 2017, after climbing 1.8% the prior year.
  3. With prices remaining consistent, it isn't surprising that retail sales picked up in December, particularly during the holiday shopping season. Advance estimates of U.S. retail and food services sales for December 2017 increased 0.4% from the previous month, and 5.4% from December 2016. Total sales for 2017 were up 4.2%.
  4. There were 5.9 million job openings on the last business day of November, according to the Job Openings and Labor Turnover report from the Bureau of Labor Statistics. There were 5.5 million hires and 5.2 million separations. The quits rate was 2.2%, while the rate of layoffs and discharges was 1.1%. Job openings increased in retail trade (+88,000), but decreased in other services (-64,000); transportation, warehousing, and utilities (-60,000); and real estate and rental and leasing (-39,000). Over the 12 months ended in November, hires totaled 64.6 million and separations totaled 62.4 million, yielding a net employment gain of 2.1 million.
  5. The federal deficit was $23.2 billion in December. Over the first three months of fiscal 2018, the total deficit sits at $224.9 billion. For December, government receipts were $325.8 billion, while the government spent about $349 billion.
  6. Prices for U.S. imports ticked up 0.1% in December, following an 0.8% rise the previous month. Higher fuel prices more than offset a decline in the price index for nonfuel prices in December. In contrast, U.S. export prices edged down 0.1% in December, after advancing 0.5% in November. Nevertheless, export prices rose 2.6% in 2017 following a 1.3% rise in 2016. The 2017 advance was the largest calendar-year increase since 2011, when the index rose 3.6%.
  7. In the week ended January 6, initial claims for unemployment insurance was 261,000, an increase of 11,000 from the previous week's level. The advance insured unemployment rate dipped to 1.3%. The advance number of those receiving unemployment insurance benefits during the week ended December 30 was 1,867,000, a decrease of 35,000 from the prior week's level, which was revised down by 12,000. This is the lowest level for insured unemployment since December 29, 1973, when it was 1,805,000.

 

Eye on the Week Ahead

The holiday (Martin Luther King Jr. Day) week offers little in terms of economic reports. However, the latest report on new residential construction for December is out this week. Applications for building permits and housing completions were down in November, although housing starts were up. Frigid temperatures and some inclement weather may put a further damper on new home building in December.

 


 

Fortem Financial 2018. All rights reserved. Data Sources: News items are based on reports from multiple commonly available international news sources (i.e. wire services) and are independently verified when necessary with secondary sources such as government agencies, corporate press releases, or trade organizations. Market Data: Based on reported data in WSJ Market Data Center (indexes); U.S. Treasury (Treasury Yields); U.S. Energy Information Administration/Bloomberg.com Market Data (oil spot price, WTI Cushing, OK); www.goldprice.org (spot gold/silver); Oanda/FX Street (currency exchange rates). All information is based on sources deemed reliable, but no warranty or guarantee is made as to its accuracy or completeness. Neither the information nor any opinion expressed herein constitutes a solicitation for the purchase or sale of any securities, and should not be relied on as financial advice. The opinions expressed are solely those of the author, and do not represent those of Fortem Financial, LLC or any of its affiliates. Past performance is no guarantee of future results. All investing involves risk, including the potential loss of principal, and there can be no guarantee that any investing strategy will be successful. Carefully consider investment objectives, risk factors and charges and expenses before investing.

The Dow Jones Industrial Average (DJIA) is a price-weighted index composed of 30 widely traded blue-chip U.S. common stocks. The S&P 500 is a market-cap weighted index composed of the common stocks of 500 leading companies in leading industries of the U.S. economy. The NASDAQ Composite Index is a market-value weighted index of all common stocks listed on the NASDAQ stock exchange. The Russell 2000 is a market-cap weighed index composed of 2,000 U.S. small-cap common stocks. The Global Dow is an equally weighted index of 150 widely traded blue-chip common stocks worldwide. Market indices listed are unmanaged and are not available for direct investment.

Monthly Commentary

2017 was a great year for the markets and the overall economy.  Looking forward to what we may expect in 2018, the data so far seems to suggest there is still room for the economy (and markets) to continue their expansion.  Some of the things we are watching are:

  • Since congress passed the tax bill, 85 (and counting) US companies have announced new bonuses for their employees or that they are increasing their employees’ benefits
  • The New York Fed’s underlying inflation gauge stands at 2.95%, and the unemployment remains at 4.1%
  • The number or workers voluntarily resigning is at a level last seen in the Spring of 2001 (historically, when we see the number of workers who voluntarily resign climbing, it’s been indicative of a good market)
  • We continue to see improvement in Consumer Confidence and in Household Net Worth
  • The Small Business Optimism Index and the ISM Purchasing Managers Index both also continue to climb

All these indicators typically indicate equities will do well. 

Additionally, the news abroad is good.  The Chinese Purchasing Managers Index is in expansionary territory, the ECB is beginning to cut back its Quantitative Easing, and the Unemployment Rate in Germany and Japan are at cycle lows, etc.  A synchronous global expansion (like what we are now experiencing) could pave the way to increased economic growth and higher markets. 

On the negative side, we have trouble finding much to hold on to.  However, one thing we are watching is the valuation of US equities.  As we shared last month, the S&P 500 is well above its historical average.  But high valuations do not mean bear markets.  Looking at historical data, we found that between January 1976 and December of 1979, the PE Ratio of the S&P 500 fell 47% and the price return of the S&P 500 was 7.6%.  In addition to the price return, the S&P 500 paid a healthy stream of dividends.  The cumulative dividend yield between January 1976 and December 1979 was another 19.9%, giving a total return of approximately 27.5% (about 6.3% / year).  

While these were not the market’s highest returning years, compared to the 10-year Treasury, currently at 2.48%, it still looks attractive.  Then between February 1994 and Feb 1995 the PE ratio of the S&P 500 Fell 25%, and the total return of the S&P 500 was about 0.9% during that period.  The importance of this observation is that Valuations can come back to more normal levels in two ways:  equities lose value or earnings accelerate.  We have witnessed both in the history of our markets.  

Because many market indicators suggest equities will continue to rise (and because we are not able to identify a lot of negatives), we continue to maintain our relatively underweight position in fixed income and our relatively overweight position in equities.  We will be sensitive to economic data and earnings estimates.  If they begin to weaken or slow down, that may be an early indicator of how the equity markets will get back to more historical valuations.  For the markets to continue their pace, we’ll need to see an acceleration in earnings, and it will likely be accompanied by an acceleration in economic growth. 

If you’d like to have a more detailed, personal portfolio review, please let us know.  Your monthly reports are also now posted to your client portal.  You can get there by going to www.fortemfin.com and clicking on client login button in the upper right of the webpage. 

Economic Data Sourced from Thomson Datastream.

Nearly every Worker will get a Raise in February via Tax Cuts

As the New Year begins, investors are beginning to assess the impact of tax reform on corporate earnings and growth estimates.The IRS will issue guidance in mid-January which will allow for worker paychecks to be adjusted for lower taxes (and higher take-home pay) by February. This is akin to giving nearly every worker in America a raise at the same time. The last time paychecks adjusted for lower taxes in 2003 growth and yields surged. Additionally, nearly 80 companies have publicly announced increasing bonuses, wages, and other employee benefits since the tax cut passed into law.

To date, analysts have held off on updating earnings models pending information as to how corporate executives will apply the new tax policies.  Companies may utilize the benefits of the tax reform to return money to shareholders in the form of dividends and buybacks; hire new workers; purchase new equipment; expand operations; or acquire complementary businesses.  Each of these case-by-case decisions will likely have a positive long-term impact on corporate finances.  And, most individuals will pay less income tax as a result of tax reform.  Some households may opt to save or invest, while others will buy products and services.  These will also factor into projections for corporate earnings and growth.  Fourth quarter earnings conference calls will provide the first official look into expectations regarding tax reform; JPMorgan ChaseWells Fargo, and Delta Air Linesbegin the reporting season next week.  Management comments and outlooks may help shape the market?s early-year trend.

2018 started off on a positive note, with the Dow Jones Industrial Average gaining more than 575 points (+2.3%) in the first week of trading.  All market sectors, except Utilities, rose while Consumer Staples, which includes household products, food, and beverage companies, was essentially flat.  These areas typically attract investors seeking stability and relatively high dividends; their underperformance suggests a shift away from conservative investment strategies.  At the same time, last week?s 4.0% gain in NASDAQ 100 confirms the continued popularity of large cap growth stocks.  Small cap value stocks, though, remain overlooked; the Russell 2000? Value Index returned +1.2%.  We expect the trend to reverse this year.  Retailers provided holiday updates: JC Penney reported a 3.4% increase in sales on strong demand for home and beauty products; Macy?s also increased sales (+1.1%), including double-digit growth in its online platforms; sales at Costco increased +9.1% in December as the warehouse chain continues to gain market share while fending off online competition; and, L Brands reported a 6% sales decline atVictoria?s Secret.  Overall, holiday spending estimates (+4.9%) suggest the largest increase in six years.

* Pacific Global Management

Chart reflects price changes, not total return.  Because it does not include dividends or splits, it should not be used to benchmark performance of specific investments.

 

Last Week's Headlines

  1. The employment sector finished 2017 in good shape. There were 148,000 new jobs added in December and the unemployment rate, at 4.1%, was unchanged for the third consecutive month. Job gains occurred in health care, construction, and manufacturing. In 2017, payroll employment growth totaled 2.1 million, compared with a gain of 2.2 million in 2016. Over the year, the unemployment rate and the number of unemployed persons were down by 0.6 percentage point and 926,000, respectively. The labor force participation rate, at 62.7%, was unchanged over the month and over the year. The employment-population ratio was unchanged at 60.1% in December but was up by 0.3 percentage point over the year. The average workweek was unchanged at 34.5 hours in December. Average hourly earnings for December rose by $0.09 to $26.63. Over the year, average hourly earnings have risen by $0.65, or 2.5%.
  2. The international trade deficit for goods and services was $50.5 billion in November, up $1.6 billion from October. November exports were $200.2 billion, $4.4 billion more than October exports. November imports were $250.7 billion, $6.0 billion more than October imports. Year-to-date, the goods and services deficit increased $53.4 billion, or 11.6%, from the same period in 2016.
  3. Purchasing managers noted an improving manufacturing sector in December, according to the survey conducted by IHS Markit. The U.S. Manufacturing Purchasing Managers' Index™ registered 55.1 in December, up from 53.9 in November — the highest such reading since March 2015. Greater demand spurred acceleration in new orders, stronger production growth, and cost inflation.
  4. According to the Manufacturing ISM® Report On Business®, supply managers/respondents also reported that economic activity in the manufacturing sector expanded in December. The December PMI® registered 59.7%, up from November's 58.2% reading. New orders, production, supplier deliveries, inventories, and prices increased in December. Only employment decreased last month.
  5. Growth slowed in the services sector in December, according to the Non-Manufacturing ISM® Report On Business®. The Non-Manufacturing Index registered 1.5 percentage points lower than the November reading. Business activity and new orders also decreased last month. On the plus side, business managers reported an uptick in employment and prices. Included in the report are service industries such as retail trade; utilities; arts, entertainment and recreation; health care; accommodation and food services; finance and insurance; and real estate.
  6. In the week ended December 30, initial claims for unemployment insurance was 250,000, an increase of 3,000 from the previous week's level, which was revised up by 2,000. The advance insured unemployment rate remained 1.4%. The advance number of those receiving unemployment insurance benefits during the week ended December 23 was 1,914,000, a decrease of 37,000 from the previous week's level, which was revised up 8,000.

 

Eye on the Week Ahead

Trading is expected to pick up this week following the prior two holiday-shortened weeks. Inflation indicators for December are available this week, led by the Consumer Price Index. Inflation had been stagnant for much of 2017, although consumer demand for goods and services during the holiday season may nudge prices upward — at least for December.

 


 

Fortem Financial 2018. All rights reserved. Data Sources: News items are based on reports from multiple commonly available international news sources (i.e. wire services) and are independently verified when necessary with secondary sources such as government agencies, corporate press releases, or trade organizations. Market Data: Based on reported data in WSJ Market Data Center (indexes); U.S. Treasury (Treasury Yields); U.S. Energy Information Administration/Bloomberg.com Market Data (oil spot price, WTI Cushing, OK); www.goldprice.org (spot gold/silver); Oanda/FX Street (currency exchange rates). All information is based on sources deemed reliable, but no warranty or guarantee is made as to its accuracy or completeness. Neither the information nor any opinion expressed herein constitutes a solicitation for the purchase or sale of any securities, and should not be relied on as financial advice. The opinions expressed are solely those of the author, and do not represent those of Fortem Financial, LLC or any of its affiliates. Past performance is no guarantee of future results. All investing involves risk, including the potential loss of principal, and there can be no guarantee that any investing strategy will be successful. Carefully consider investment objectives, risk factors and charges and expenses before investing.

The Dow Jones Industrial Average (DJIA) is a price-weighted index composed of 30 widely traded blue-chip U.S. common stocks. The S&P 500 is a market-cap weighted index composed of the common stocks of 500 leading companies in leading industries of the U.S. economy. The NASDAQ Composite Index is a market-value weighted index of all common stocks listed on the NASDAQ stock exchange. The Russell 2000 is a market-cap weighed index composed of 2,000 U.S. small-cap common stocks. The Global Dow is an equally weighted index of 150 widely traded blue-chip common stocks worldwide. Market indices listed are unmanaged and are not available for direct investment.

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