Covenant Weekly Market Synopsis as of December 30, 2016

January 2, 2017

Like most years, 2017 is starting with an optimistic tone…. and why not?  Uncertainty regarding the presidential election has been replaced with anticipation of a more business-friendly administration characterized by lower taxes and less regulation.  In response, the S&P 500 rocketed 7.9% post-election to finish the year the year up 12.0% (including dividends).  Small capitalization stocks (as measured by the Russell 2000 Index) had an even better finish, rallying 17.3% to end the year up 21.3%.

Will that optimism prove to be prophetic, or will it follow the same fate as the billions of New Year’s Resolutions that sound so good in theory, but are so difficult in practice and later abandoned as the year wears on?  We will begin to learn more later this month when Trump is inaugurated, kicking-off the critical “First 100 Days” in office.  At that point a theoretical Trump Presidency will become a practicing one, Tweets and all.

In comparison to US stocks, developed market indices outside of the US did not fare as well in 2016, continuing a multi-year trend of underperformance. When priced in US dollars, the EAFE Index (Europe, Australasia and Far East stocks) rose only 1.1%, while the Nikkei Index (Japanese stocks) increased by 5.9%, dragging on the performance of diversified equity portfolios.

For a detailed view of weekly, month-to-date and year-to-date asset class performance please click here.


Irrespective of the market’s recent performance and the general hope that Trump will make the country (and by extension, the economy) great again, we remain focused on the data. And the data regarding the health of the consumer is starting to show early warning signs of a potential slowdown in consumption, as reported by Foleynomics. Since consumption makes up roughly 70% of Gross Domestic Product, trouble in consumer land would spell trouble for the rest of the economy as well. Indeed, absent the consumer, GDP growth over the past year would have been close to negative as the vast majority of other economic sectors have been stagnant or contracting. This is not a call that the economy is in imminent danger, but consider the following four trends related to consumption:

1. After peaking at 5.7% in mid-2015, real year-over-year personal income growth is slowing into the 1% – 2% range. This is consistent with a mature labor market and limited wage gains.  Slowing income growth eventually leads to lower consumption levels, absent a reduced savings rate or increased borrowing, neither of which can continue indefinitely.


Sources: Bureau of Labor Statistics, Foleynomics and Covenant Investment Research.  Note there is a big distortion in the 2012 – 2013 data in this and the following two slides due to Obamacare Tax hikes and income timing strategies. Ignore that period please.


2. Personal Consumption Expenditures (PCE) have outpaced Disposable Personal Income (DPI) since August. As the chart shows, this is not a sustainable condition in the long-run.  Either wages must increase or consumption will decline as consumers do not have unlimited savings or credit resources to finance spending in excess of earnings.


Sources: Bureau of Economic Analysis, Foleynomics and Covenant Investment Research


3. Speaking of savings, the Personal Savings Rate (as a percent of Disposable Personal Income) has been declining since Q1 2016.  Just as a higher savings rate can serve as a “store of value” for future consumption, depleted savings levels will detract from future consumption.


Sources: Bureau of Economic Analysis, Foleynomics and Covenant Investment Research


4. Consumer credit growth is outpacing income growth when consumer debt levels are at an all-time high. Indeed, credit growth has outpaced disposable personal income for 53 months, which is just shy of the record 59 months set in the late 90’s into the early 2000’s.


Sources: Bureau of Economic Analysis, Foleynomics and Covenant Investment Research.


If consumption is plateauing, or has already peaked, it will be tough sledding ahead for the new administration. Likewise, investors are now confronted with the challenge of assessing the likelihood of Trump’s campaign promises being implemented, the timing for doing so, and their ultimate impact on the many structural issues affecting the US economy (an aging demographic, high debt levels, etc.).   It’s just about “go time” for Team Trump and with modest economic growth of 2-3% domestically combined with a weak global economy, there is little margin for error in fiscal and monetary policies.  It promises to be an interesting year and equity markets are likely to experience a lot more volatility than in the recent honeymoon period since Trump was elected as these various forces play out.

Be well,