Perspectives

The Federal Reserve did what almost everyone expected today, raising the target range for the federal funds rate by 25 basis points to 1.00% - 1.25%.

Here are the key takeaways from today's statement from the Fed, its updated forecasts, its plan on reducing the balance sheet, as well as Fed Chief Yellen's press conference.

First, although the market consensus is that the Fed isn't going to raise rates again until 2018, the Fed thinks we still have one more hike in 2017, with the odds of two hikes equal to the odds of none at all.

Second, the Fed has a concrete plan to start reducing the size of its bloated balance sheet, a plan it is likely to start later this year. Once implemented, for the first three months, the Fed will reduce its balance sheet by $10 billion per month ($6 billion in Treasury securities, $4 billion in mortgage-related securities). Then, every three months, the amount of monthly balance sheet reduction will rise by $10 billion (w/ the same 60/40 proportion between Treasury securities and mortgage-related securities). That escalation will continue until the Fed is cutting its balance sheet by $50 billion per month.

Third, compared to three months ago, the Fed is expecting a little more economic growth this year, less unemployment, and less inflation. However, projections for economic growth and inflation remain unchanged beyond this year. The only significant change in the forecast was that the Fed now thinks the jobless rate will average 4.2% in 2018-19 instead of 4.5%. In addition, the Fed thinks the long run average rate for unemployment is 4.6% versus a prior estimate of 4.7%.

Fourth, the Fed is not impressed by the recent softness in inflation and does not think that softness is a reason to change the projected path of monetary policy. Although the Fed acknowledges inflation has receded back below its 2% target and is "monitoring inflation developments closely," it thinks inflation will head back to 2% in the medium term.

Fifth, the Fed is no longer as concerned about the potential negative influence of foreign events, having removed language saying it was closely monitoring "global economic and financial developments."

We still think the most likely path is that the Fed makes no policy changes in July but then uses the September meeting to make its last interest rate hike of the year while also announcing balance sheet reductions will start October 1. This is our interpretation of Yellen saying the balance sheet reductions would start "relatively soon." A less loose monetary policy than the market consensus believes is, in part, why we think long-term Treasury yields will be moving up significantly later this year, with a 3.00% target for the 10-year Treasury Note by the end of the year.

The most disheartening part of the today's Fed releases was that the plan for reducing the balance sheet noted that the Fed stands ready to use quantitative easing again in the future when the economy gets weak. We don't think QE helped the economy and had been hoping the Fed had learned that lesson. Apparently not.

Overall, however, we are pleased the Fed raised rates today and look forward to another rate hike and the beginning of balance sheet reductions later in 2017. Neither of these will hurt the economy and will help prevent future problems that could. Please call or email us with any questions you may have.

Source: Brian Wesbury First Trust

Markets were flat-to-down this week on mixed economic data and ongoing domestic political turmoil. The technology-heavy NASDAQ trailed the broader S&P 500® Index for the second consecutive week; and, small cap stocks underperformed large caps while consumer-oriented and commodity-related sectors also lagged. On Friday, Amazon announced an agreement to acquire Whole Foods; the news triggered sell-offs among traditional grocers such as Kroger, and non-traditional grocers such as Wal-Mart and Target, as investors contemplated the technology company’s expansion into the “brick and mortar” landscape. Investors are also apparently reacting to softening economic data. Retail sales posted their largest monthly decline in over a year while housing starts fell for the third consecutive month. An unexpected decline in the University of Michigan’s consumer sentiment measure for June points to an increasingly cautious consumer. These data suggest the economy is in a temporary lull. The consensus view, based on conversations with management teams across a variety of industries, is that economic conditions remain generally healthy. Industrial activity, in particular, which is widely expected to accelerate in the second half of the year as overseas conditions improve, should help sustain the economy’s positive momentum.

Source: Pacific Global Investment Management Company

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.

Market Week

Thoughts on Amazon & Whole Foods

Amazon announced on Friday it would buy Whole Foods Market for $13.7 billion, which has caused massive selloff on shares of brick mortar retailers big and small. As owners of a group of the traditional retailers such as Wal-Mart, Target, CVS, and Walgreens, we actually believe Amazon’s move is a vindication of our long hold view that physical presence is essential to traditional retailers winning the retail war and they should rationalize their physical assets to their best advantage. Below are some additional thoughts:

1. As owners of brick mortar stores, we have assumed in our valuation models that margins will remain at low levels in the foreseeable future for those companies. It is not obvious to us an Amazon/Whole Foods combination will put sizable, incremental pressure on those margins, given it will take years for Amazon to scale up its grocery business and traditional retailers are actively investing and rationalizing their asset base.
2. Amazon paid a fair price for Whole Foods, and the premium could be justified if Amazon helps Whole Foods become more competitive in pricing, more efficient in logistics, and bring in more traffic to the stores.
3. Amazon is dead serious about grocery and it does need physical presence to be successful or more successful. Fresh, perishable produce creates mighty challenges for delivery, which makes fast growth and profitability hard to come by at the same time. Amazon probably needs to own grocery stores to learn about the grocery business and potentially decrease delivery cost. Acquiring Whole Foods is a relatively low risk Amazon is taking to learn to operate physical stores and omnichannel business.
4. Buying Whole Foods helps give Amazon quick distribution network in upper scale neighborhoods, which has been Amazon’s primary focus for grocery business, and likely the more profitable segment in the grocery business. Whole Foods’ ~400 store presence, however, is no comparison to Walmart, Target, CVS, Walgreen’s thousands of stores’ network in the US. It is not obvious to us that buying Whole Foods will give Amazon immediate advantage competing against those massively populated brick-mortar stores.

Market Week: 6/19/17

The Federal Reserve, as expected, raised interest rates by 25 basis points this week; yet, the yield on the benchmark 10-year U.S. Treasury Note fell by 6 basis points to close near its low for the year. The decline in market interest rates reflects lowered expectation for future Fed rate hikes; indeed, following the Fed’s meeting, the odds of a September rate hike declined from 29% to 18%. Fed Chair Janet Yellen noted in her prepared comments that a strong labor market and increased business spending supported a tighter monetary policy. At the same time, she acknowledged that “inflation has declined recently” and the Committee “is monitoring inflation developments closely.” Ms. Yellen also anticipates that the Fed’s process of “balance sheet normalization” (that is, winding down bond holdings accumulated following the financial crisis), will begin sometime this year. Overall, the Fed’s assessment of the economy remains positive, and yet the reduced outlook for future rate hikes suggests that investors anticipate only a modest pace of economic growth. Still, most economists concur that a recession is unlikely; and, the aforementioned acceleration of industrial activity should enable the economy to exceed currently muted expectations.

Source: Pacific Global Investment Management Company

We will watch the evolution of the retail space very closely and keep you posted.

Last Week's Headlines

1. Despite declining inflation that continues to run below the Fed's 2.0% target rate, the Federal Open Market Committee raised the range for the federal funds rate 0.25% to 1.00%-1.25%. The Committee based its decision on the expectation that the labor market will continue to strengthen, and the fact that economic activity has been rising moderately so far this year. The Committee further noted that the unemployment rate has declined, household spending has picked up in recent months, and business fixed investment has continued to expand. The Fed indicated that "inflation on a 12-month basis is expected to remain somewhat below 2% in the near term but to stabilize around the Committee's 2% objective over the medium term." In addition, the Fed proposed to slowly cull its long-term asset holdings, consisting primarily of Treasuries and mortgage securities by letting them mature without reinvestment. This action will also likely push up long-term interest rates.
2. In a sign of receding inflationary pressure, consumer prices fell 0.1% in May, according to the latest report from the Bureau of Labor Statistics. A 2.7% decrease in the energy index contributed to the monthly decrease in the CPI. Over the last 12 months, the CPI has risen 1.9%, a smaller increase than the 2.2% gain over the 12 months ended in April. The index for all items less food and energy rose 0.1% in May, as it did in April. The index for all items less food and energy rose 1.7% over the 12 months ended in May. Comparatively, the index for all items less food and energy increased 1.9% over the 12 months ended in April.
3. On the heels of May's drop in the Consumer Price Index, retail sales (a measure of what consumers are spending at retailers) decreased 0.3% in May from the previous month. This is the largest monthly decrease since January 2016. Sales at department stores fell 1.0%, auto sales declined 0.2%, sales at gasoline stations declined 2.4%, and restaurant sales dipped 0.1%. Since last May, retail sales are up 3.8%, which is below the 4.6% increase in retail sales over the 12 months ended in April. Nonstore (online) retail sales increased 0.8% for the month, and are up 10.2% since May 2016.
4. Producer prices showed no movement in May compared to the prior month, according to the Producer Price Index. For the year, overall producer prices are up 2.4%, while prices less food and energy have increased 2.1%. Production costs may have decreased with energy prices falling 3.0% in May, allowing producers to realize higher margins (profits) without actually increasing prices for goods and services.
5. Eight months into the government's fiscal year, the budget deficit sits at $432.9 billion, which is 6.8% higher than the deficit for the same period last fiscal year. While government receipts are up 1.4% from a year ago, spending is 2.3% higher. For the 2017 fiscal year, the government has spent $390 billion on defense, $623 billion on Social Security, and $368 billion on Medicare.
6. Prices for imports and exports fell in May, according to the latest report from the Bureau of Labor Statistics. Import prices declined 0.3% in May after increasing 0.2% in April. Lower fuel prices drove the decrease last month. The price index for U.S. imports rose 2.1% for the 12 months ended in May. Export prices declined 0.7% in May following a 0.2% advance in April. The price index for U.S. exports rose 1.4% for the year ended in May.
7. Industrial production was unchanged in May following a noteworthy 1.1% increase in April. Total industrial production in May was 2.2% above its year-earlier level. A negative in the report is in the manufacturing sector, which fell 0.4% in May. This drop was offset by a 1.6% gain in mining and a 0.4% bump in utilities. Capacity utilization for the industrial sector edged down 0.1 percentage point in May to 76.6%, a rate that is 3.3 percentage points below its long-run average.
8. The housing sector has been slowing of late, and May's housing starts report adds to that trend. Housing starts in May were 5.5% below the revised April estimate and are 2.4% below the May 2016 rate. Building permits were 4.9% off their April rate and are now 0.8% below the rate for May 2016. Housing completions are up 5.6% for the month and 14.6% above the May 2016 rate. Accelerating housing completions coupled with receding starts and permits will likely lead to shrinking inventory and possibly rising prices.
9. In the week ended June 10, the advance figure for seasonally adjusted initial claims for unemployment insurance was 237,000, a decrease of 8,000 from the previous week's unrevised level. The advance seasonally adjusted insured unemployment rate remained at 1.4% for the ninth consecutive week. For the week ended June 3, there were 1,935,000 insured unemployed, an increase of 6,000 from the previous week's level, which was revised up 12,000.

Eye on the Week Ahead

This week focuses on the latest information from the housing sector. Both new home sales and sales of existing homes have fallen recently, so it will be interesting to see if sales picked up the pace in May.

Fortem Financial 2016. 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.

Stocks were mostly unchanged last week as political developments, both at home and abroad, preoccupied investors’ attention. Former FBI Director James Comey’s testimony to the Senate Intelligence Committee provided a back story of the events surrounding his dismissal in May. However, investors seemed to collectively shrug at the latest White House drama. In the U.K., Prime Minister Theresa May’s Conservative party unexpectedly lost its parliamentary majority; for the Tories to remain in power, they will need to negotiate a deal with a junior party. Some analysts are hopeful that the defeat at the polls will soften the government’s position in negotiating the terms of Brexit with the European Union. In both the Comey affair and the British elections, the market’s muted reaction indicates that, for now, investors are not overly concerned about these latest developments.

Source: Pacific Global Investment Management Company

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.

Market Week

The market’s relative quiet also reflected the lack of economic data. Even so, following these political events, small caps, led by stocks in the Energy and Financials sectors, outperformed; the technology-heavy NASDAQ, which has already closed at record highs 38 times this year, lagged. The selloff in Technology stocks was particularly noteworthy as the sector has significantly outperformed all others in the S&P 500® Index this year. Several reports this week suggest that Technology stocks have become overvalued and, consequently, susceptible to a correction. In contrast, Financials and Energy have lagged year-to-date. The sustainability of this rotation is not yet clear; nevertheless, the market’s sudden change of direction serves as a reminder of the impact of changes in investor sentiment.

This week’s Federal Reserve meeting is not expected to provide much drama; the current forecast sees a nearly 100% probability of a 25 basis point hike in the Fed Funds rate. Still, investors will focus on Fed Chair Janet Yellen’s commentary regarding the state of the economy, as well as the outlook for further rate hikes and monetary policy decisions. Economic data since the last Fed meeting in May have been somewhat mixed. First quarter GDP was revised higher; unemployment has fallen to new post-recession lows; wages and inflation are on the rise; manufacturing activity is increasing; and consumer confidence remains strong. Job creations, retail sales, the housing market, and services sector growth have been lower than expected. The mixed data suggest that the Fed will be circumspect in its interest rate expectations. Indeed, for the remainder of 2017, analysts currently anticipate just one more rate hike, possibly not until the final meeting in December.

The recent outperformance of Technology stocks may be an example of herd mentality; that is, investors drive stocks higher until an event triggers a sudden reversal. Many high-performing companies in other sectors remain undervalued as investors focused on NASDAQ stocks. As we near the end of June, the focus will shift to second quarter earnings; these updates could highlight other sectors and overlooked stocks.

*Source: Pacific Global Investment Management Company

Last Week's Headlines

1. Activity has slowed in the non-manufacturing sector in May, according to the Institute for Supply Management. The Non-Manufacturing Index registered 56.9%, which is 0.6 percentage point lower than the April reading of 57.5%. The non-manufacturing sector, which includes such industries as real estate, accommodations, food, arts and entertainment, and health care, grew for the 89th consecutive month (a reading of 50% or higher indicates growth), but at a slower pace than the prior month.
2. According to the Non-Manufacturing ISM® Report On Business®, new orders, business activity, and prices all showed a slower rate of growth compared to April. Only employment grew at a faster pace.According to the Job Openings and Labor Turnover (JOLTS) report, there were 6.0 million job openings in April. Job openings increased in a number of industries, with the largest increase occurring in accommodation and food services (+118,000). Job openings decreased in durable goods manufacturing (-30,000). The number of job openings increased in the Midwest and Northeast regions. The number of job hires decreased by 253,000 to 5.1 million. Hires decreased in health care and social assistance (-68,000) and real estate and rental and leasing (-23,000). The number of hires decreased in the West region. Total separations (turnover) edged down 225,000 to 5.0 million in April. Total separations increased in state and local government education (+17,000) but decreased in retail trade (-100,000). Over the 12 months ended in April, hires totaled 62.9 million and separations totaled 60.7 million, yielding a net employment gain of 2.2 million.
3. Following last week's election, the UK's ruling Conservative Party lost its parliamentary majority. How this development will impact the Brexit remains to be seen, but indications are that negotiations will push ahead even though the political strength of Prime Minister May has been weakened.
4. In the week ended June 3, the advance figure for seasonally adjusted initial claims for unemployment insurance was 245,000, a decrease of 10,000 from the previous week's revised level. The advance seasonally adjusted insured unemployment rate remained at 1.4% for the eighth consecutive week. For the week ended May 27, there were 1,917,000 receiving unemployment benefits, a decrease of 2,000 from the previous week's level, which was revised up 4,000.

Eye on the Week Ahead

The big news this week surrounds the FOMC meeting and whether interest rates will be increased. The Committee held off on an interest rate hike in May and appeared primed to jack up rates in June. However, major economic indicators, such as consumer prices, consumer spending, the GDP, and the employment sector, have not been especially strong, leading to speculation that at least some members of the Committee may be inclined to hold rates as is until steadier economic progress is evident.

Fortem Financial 2016. 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.