It was a “phenomenal” week for risk assets… well at least for the final two days following President Trump’s meeting with airline executives in which he said an announcement would be made within 2-3 weeks that would be “…phenomenal in terms of tax”. Although no details were offered about the plan (will it involve a border-adjustment tax, limits on interest expense deductions, caps on individual exemptions, or abolishing the estate tax (please!)), investors/traders embraced the President’s pro-growth mojo. Indeed, the Big 3 stock indices (S&P 500, Dow Jones Industrial Average, and Nasdaq) all tacked on approximately 1% in gains reaching new records and, in so doing, added $225 billion in total market capitalization for the week (source: Barron’s). International equities drafted on their domestic counterparts, rising by a similar amount, while emerging markets continue to outpace gaining 1.2% on the week and 7.1% year-to-date. Interestingly, in spite of the risk-on sentiment, yields on US Treasuries declined (i.e. bond prices increased), as perhaps the “smart money” is waiting for details on the tax plan to assess its likely impact on the real economy. In the commodity complex, the results were mixed as precious metals gained, while crude prices declined slightly (WTI Crude closed the week down 0.1% at $53.79 per barrel).
For a detailed view of weekly, month-to-date and year-to-date asset class performance please click here.
Great Expectations: Paraphrasing from our most recent quarterly Economic Review and Outlook (available here) the Presidential election has created the greatest divergence between sentiment and economic data we have witnessed in recent memory. In sum, the new administration’s pro-growth campaign promises struck a chord that resonates strongly with consumers, business owners, CEOs and investors. And while the economy is expanding at around 2.5% per annum, the sentiment indicators imply dramatically accelerating growth. The chart below, which compares Consumer Confidence to the Chicago Fed National Activity Index (a forward-looking composite of 85 subcomponents of overall economic activity that provides an indication of what the economy may look like in the coming months), underscores that statement.
Source: Real Investment Advice
Optimistic sentiment is not a bad thing. In fact, this nation was born out of an optimistic view of how a democratic society could enable citizens the rights to life, liberty and the pursuit of happiness. Optimism also propelled the United States to develop into the most innovative country on the planet as entrepreneurs, each pursuing a specific better vision of the future optimistically pursued progressive innovations. Studies have indicated that optimistic people are more successful…. and happier. Optimism, generally speaking, is a powerful state of mind.
Yet, too much optimism or positive sentiment predicated on a series of interconnected events that is each subject to unique variables (such as timing and magnitude) can result in short-term disappointment as hope meets reality. This is as true for entrepreneurs as it is for the markets. In this regard, sentiment indicators such as Consumer Confidence (shown above) and the Small Business Optimism Index shown below seem exaggerated, or in trading parlance they appear “priced-to-perfection”.
This optimism has been mainlined into the financial markets as equities have advanced more than 10% since the election, while there has been little change in corporate earnings (other than the typical beginning-of-year rosy earnings growth forecasts). Equity gains based on hope are vulnerable to pullbacks if investors become disappointed with the timing and/or magnitude of market-friendly policies. In fact, while equities appear attractive relative to bonds from a historical perspective, both asset classes are richly priced compared to almost any other metric. That’s not to say that stocks won’t keep moving higher, but to do so will require improved earnings or even greater optimism. Although both catalysts are possible, long-term investors would prefer the former to backfill the already high levels of optimism.
Weekly Economic Data Summary: It was a light week for economic data releases. On the labor front, the December Job Opening and Labor Turnover (JOLT) survey revealed a stable, yet mature labor market. The number of Job Openings remains elevated at 5.5 million, although that is a decline of 300,000 openings from the peak in April 2016. Moreover, confidence amongst the workforce (i.e. their belief they can find a better job) is strong as indicated by a Quits rate of 2%. For reference, the Quits rate was 2.6% just prior to the recession in 2001 and only 1.3% at the depths of the Financial Crisis. The February Michigan Consumer Confidence Survey came in below expectations at 95.7. Looking deeper in the survey, consumers’ assessment of Current Conditions was relatively unchanged from the prior month at 111.2. However, the forward-looking Consumer Expectations survey declined from 90.3 to 85.7, perhaps due to the perception that the new administration may fall short of achieving their aggressive agenda for the first 200 days.