Monthly Dollars & Sense Newsletter

Here is the e-version of our popular and informative monthly newsletter, Dollars & Sense. It briefly discusses topics we believe to be important this month.

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Despite foreign policy snafus, the resignation of a key appointee, and ongoing (although subsiding) protests of the new administration, few are quibbling with the story making headlines: the stock market's record high. Bullish investors are elated, bears, not so much. In fact, we've coined a new acronym: FOMOthe fear of missing out, in Millennial-speak[1]to help explain the rush for sidelined money to join the party. Sam Stovall, Chief Investment Strategist at CFRA Research, pointed out that the market's valuation as a percentage of GDP is at its highest point since 1989, when the data series began.[2]

Do any of us recall when Dollars and Sense appeared to hang on every nuance from the Federal Reserve? Barely, it seems. These days, Chair Yellen's testimony makes news for a nanosecond or two, before the bull charges forward. Even the fourth quarter's lack-luster GDP growth and an uptick in the unemployment rate failed to stymie the market. It sputtered a bit, but kept on running, as investors waxed optimistic over the administration's announced tax cuts (albeit with few details), stronger corporate earnings, and a general feeling that the economy may move forward at last.

On January 13, 2017, the Dow Jones Industrial Average (DJIA) closed at 19,886, and the Standard & Poor's 500 (S&P) was at 2,275. Oil was priced at $52.53, and gold was at $1,198. The dollar was at $1.06 versus the euro, and the yield on the 10-Year Treasury Note (10-year) was 2.39%. On February 14, 2017, the DJIA had risen to 20,504, the S&P to 2,337, and oil inched up to $53. Gold climbed to $1,230, the dollar strengthened to $1.05 versus the euro, and the 10-year yielded 2.47%. Both the price of gold and the yield on the 10-year suggest that some investors may be hedging against potential risk.[3]


EMPLOYMENT

ADP announced 246,000 new jobs were added to private sector payrolls in January, versus only 165,000 forecast,[4] (the highest number since January 2016), paving the way for a solid January Employment Situation Report released on February 3. Nonfarm payrolls rose by 227,000, compared to consensus estimates of 170,000, although the unemployment rate increased to 4.8%.[5]


CURRENCY/FEDERAL RESERVE

The dollar was under pressure at the beginning of this reporting period, but managed to trade in a fairly moderate range, in spite of the administration's lamenting, "Our companies compete with them (China) because our currency is too strong, and it's killing us."[6] Although the dollar promptly eased, it strengthened the next day. [7]

This activity was followed by Chair Yellen remarking that it "makes sense" to gradually raise rates, warning that were we to wait too long, we could be in for a "nasty surprise" and possibly suffer a "new recession."[8]

BNP Paribas followed up with its own prognostication that the Fed would hike in the second half of 2017, and possibly see quarterly hikes in 2018.[9] At its February 1 FOMC meeting, the Fed was unanimous in voting not to raise rates, citing the economy's moderate growth path and "soft" business investment, while acknowledging both business and consumer confidence rising since the election.[10] Some analysts assigned just a 15% probability to a rate rise in March.[11]

However, data indicating that inflation is increasing, which we discuss below, may impede Chair Yellen's ability to maneuver. In her February 14 testimony to the Senate Banking Committee, she stated it would be "unwise to wait too long to tighten."[12]


OIL

Oil prices ranged between a low of $52.50 on January 17 and a high of $53.84 on February 3. Despite the Organization of Petroleum Exporting Countries' (OPEC) agreement to limit production and its high compliance rate (ranging between 82% and 85%, depending on whom one believes), US shale production and rig count are up.[13],[14] Higher prices, resulting from reduced OPEC production, provide an incentive for US producers to capitalize on them, causing some nervousness as to whether OPEC actually will adhere to their production cut agreements. The Saudi Oil Minister Khalid al-Falih was quick to tout that the deal was already draining excess supply, to the tune of 1.5 million barrels per day (mbd), and that both OPEC and non-OPEC nations are showing "very good compliance." Rob Haworth, Senior Investment Strategist at US Bank Wealth Management, opined that prices could be vulnerable in the near term.[15]

Prices did fall the next week, as data showed US drillers again increased rig count (the 12th such increase in 13 weeks). That bit of news (either good or depressing, depending on whether one enjoys paying less for heating oil and gasoline or is speculating on higher future prices) accompanied the International Energy Agency's (IEA) forecast of an additional 320,000 bpd in oil output growth for 2017.[16]

Despite news that OPEC's supply cuts appear to be materializing, both US production and inventories are on the rise. The American Petroleum Institute (API) reported a 5.8 million barrel increase in US inventories,[17] and the EIA upped that figure to 6.5 million barrels.[18]

But none of this seemed to move the needle muchoil prices continued to trade within a narrow range, until Reuters reported that growth in China's oil demand was at its lowest pace in three years, coinciding with a drop in US gasoline demand.[19] And on February 8, prices declined for the third day in a row on the back of the API's report that oil stocks rose by 14.2 million barrels in the latest week.

Goldman Sachs predicts the oil glut may have a short lifespan, as OPEC is at 85% compliance in reducing production, which should balance with US producers' increased output.[20] OPEC avers it is at 92% compliance with its targets for January, with the IEA stating that if these levels were maintained, a decline of 600,000 bpd could result.[21] Meanwhile, oil prices declined in the wake of the US shale forecast for March rising by 80,000 bpd over February. [22]

The bottom line: It may be hard to muster sympathy for traders being overly concerned with today's $53 per barrel price, compared to the $41 per barrel price in February 2016, a gain of more than 29% in a year. Especially consumers, who now may be paying more for heating oil and gasoline.


GOLD

Gold traded between a low of $1,191 on January 26 to a high of $1,236 on February 6, rising on concerns over Brexit, which may portend turbulence, and declining on Fed Chair Yellen's expectations of rates to rise "a few times a year."[23], [24] In January, gold posted its best rally since June 2016, in sync with a weakening dollar.[25] After falling on February 1, it bounced back after the dollar declined when the US National Security Advisor took Iran to task for conducting missile tests, accompanied by the Iranians protesting they did not violate the nuclear agreement.[26]

Gold also benefited from a retreating dollar. Being priced in dollars, gold moves in the opposite direction of the US currency. When the dollar declines, assets that pay interest are less attractive, giving gold (which pays none) a bump.[27]


ECONOMY

Economic data released this period had positive and negative points. Beginning with business-related items, the Empire Manufacturing Survey for February soared a whopping 18.7%, nearly three times its prior figure.[28]

The Leading Economic Indicators (LEI) for December (the most-recent figure reported) ticked up by .5%,[29] on the back of an upward revision for November, its fourth consecutive increase. Investors typically view this release as indicative of the economy's anticipated trend, so it may mode well for ongoing growth.

The Institute for Supply Managers Index (ISMI) was 56.0, versus consensus expectations of 55.0, its highest point in more than two years.[30] Analysts point to the correlation between this index and economic growth, which indicates a 4% annualized GDP going forward.

Also on the positive side, factory orders rose by 1.3%, and the Institute for Supply Managers Services Index (ISM), reflecting nonmanufacturing economic activity, was 56.5, although the previous period was revised down to 56.6 from 57.2.[31]

The Producer Price Index (PPI) was up by .6%, versus expectations of .3%. Most of the gain was in final demand prices, although analysts noted that the year-over- year reading was 1.2%, down from 1.6% reflected for the year ended December 2016.[32]

But fourth-quarter GDP, at 1.9%, was a disappointment, particularly after the strong third-quarter figure of 3.5%. Investors may draw solace from the fact that GDP is indicative of past economic performance, and prospects looking forward could be brighter, based on the outlook for a tax cut, infrastructure spending, and less regulation.[33]

The Chicago Purchasing Managers Index (PMI), at 50.3, versus expectations for 55.0, was another economic drawback, compounded by the previous period's being revised downward as was the -2% decline in Construction Spending, compared to a forecast of a .2% increase.[34] Industrial production and capacity utilization also flagged from last period: industrial production fell -0.3%, and capacity utilization was 75.3%, versus 75.6% in December.[35]

On the consumer side of the ledger, most data were strong. The Consumer Price Index (CPI) was up by 0.6%,[36] and housing starts rose by 11.3%.[37] (Analysts had anticipated fourth-quarter GDP would be positively affected by the residential construction component in this readingan expectation that was tempered by exports suffering a decline of -1.7%.)

The Personal Consumption Expenditures (PCE) index rose by 1.6% on a year-over-year basis, and both personal income and personal spending increased, .3% and .5%, respectively.[38] Analysts pointed out that the disparity between income and spending may indicate consumers are drawing on savings, either from necessity or because they are optimistic about their future income prospects.

Consumer credit expanded $14.2 Billion, and although it was down substantially from November, it may still point to potential for stronger economic activity.[39] Retail sales rose by 0.4%, following an upward revision to 1.0% from 0.6% reported for December.[40]

Existing home sales declined by -2.8%, reflecting 3.6 months of supply, and may be a function of tight supply, higher mortgage rates, and rising prices.[41] New home sales also fell by 10.4%, again due to rising mortgage rates and higher prices.[42] Sales of homes under $299,999 were most affected.

Consumer confidence fell to 111.8 from a downwardly revised 113.3 in December (which was a 15-year high).[43] Consumer sentiment also dropped, falling to 95.7 from 98.5 in January. Notably, the expectations component reflects a political divide in how potential growth is perceived. Analysts pointed out that negative expectations tend to temper spending more than positive ones propel it, so caution may be the watchword.[44]


STOCK MARKET

The DJIA ranged from a low of 19,732 on January 19 to a high of 20,504 on February 14. Several reasons were cited: upbeat earnings from Boeing,[45] the go-ahead for the Keystone Pipeline, restricting immigration, and a new acronym, FOMOfear of missing outon a rising market.[46] Although not all earnings were positive, and setting aside politics, the earnings outlook may be the strongest underpinning. With more than half of the S&P 500 companies reporting, fourth-quarter earnings are expected to rise 7.5% for 2016 over fourth quarter 2015.[47] And the expectations for the fourth-quarter's growth rate rose 4.6% versus 3.1% in December 16.[48]

Some analysts characterize the market's surge as the "Trump put"a domestic agenda that includes spending and tax cuts (although no details have been forthcoming)which may be a counterweight to foreign policy concerns.[49] Whatever the reason, few can argue that the market has steamed higher in February, after the immigration fiasco, capped by the record close as we go to press. The cautious among us will note, however, that valuations are stretched, even as global growth improves, despite geopolitical tensions and ongoing social unrest.[50],[51]


BONDS

The 10-year yield ranged between 2.32% on January 17 and 2.52% on January 25, ending the period at 2.47%. Typically, yields rise when the stock market surges, as investors must be rewarded with an incentive to forego frothy market returns.


INTERNATIONAL

In Britain, Prime Minister Theresa May seeks an "honest break" from the European Union (EU), and despite carving out control over its own borders and immigration policies, wants to maintain a close trading relationship with the Eurozone.[52],[53] She stated: "We will continue to be reliable partners, willing allies and close friends." It may not be smooth sailing, as the UK Supreme Court insists the government must seek Parliament's vote on triggering Article 50, the mechanism to begin Brexit.[54] Although the government hopes to have a vote by the end of March, the opposition is clamoring for more time.[55]

Italy's banking situation is raising concerns among German officials that the EU's credibility may be questioned vis-à-vis banks that are considered too big to fail.[56] The issue seems that the $9.5 Billion bailout will help individual investors who suffered losses, rather than steering them to the courts for recompense. Wolfgang Schaeuble, Germany's Finance Minister, urged the European Commission (EC) to enforce the rules established by the EU in 2014.

George Friedman, who writes on geopolitics for Mauldin Economics, spoke on the issue, opining that no one is interested in helping Italy any more than they wanted to help Greece two years ago. He opines that the EU's authority has weakened, along with its ability to levy sanctions.

The EC reported GDP growth of .4% for fourth quarter 2016, down slightly from an earlier .5% estimate. The modest decline is attributed to a downwardly revised German growth figure, coupled with a -1.6% drop in industrial output in December, the largest drop in more than four years. The EC also cited uncertainty regarding US fiscal and monetary policies, Brexit, and the upcoming French and German elections for its lowered 1.6% growth forecast for 2017 (from 1.7% in 2016). Britain may experience the greatest decline, 1.5% in 2017 versus 2.0% in 2016, due to Brexit uncertainty.[57]


SUMMARY

Stable US employment and manageable oil prices are offset by strengthening gold prices and higher bond yields, indicating that investors may be hedging their bets. An economy that appears to be moving forward may be propelling investor confidence, which can be seen in the stock market's record highs. Sam Stovall compares the relationship between S&P 500's dividend yield (1.9%) to the 10-year (2.47%), noting that since 1953, when the 10-year was less than one percentage point higher than the S&P's dividend yield, stocks rose an average 11%.[58] Although history doesn't repeat itself, we are reminded, it often rhymes, a quote often attributed to Mark Twain.[59]

- February 2017 Dollars & Sense Data Sources

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