Covenant Weekly Market Synopsis for January 26, 2018

January 29, 2018

Although Friday’s early estimate of annualized real (inflation-adjusted) Q4 2017 GDP growth was below expectations (2.6% actual vs. 3.0% consensus), it was, nonetheless, a strong report. Final sales (domestic and sales to international consumers) were up 4.3%, and Personal consumption rose 3.8%, the strongest reading in 18 months. The main drags on GDP in the fourth quarter were the higher number of imports (which detract from growth in the GDP calculation) and a lack of inventory investment, as highlighted in the chart below. The weaker US Dollar (leading to higher exports) should help alleviate the former and as producers invest in inventory to meet surging demand, inventory investment should increase as well in Q1.

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Source: FTN Financial

We will be distributing our semi-annual Economic Review and Outlook in a couple of weeks, which will include a detailed examination of the current state of the economy and explore the likely impact of the recently implemented tax reform. Spoiler alert: good news in the short term, but exacerbating longer-term problems in the form of entitlements and national debt levels. Kind of like Wimpy and his famous promise “I’ll gladly pay you Tuesday for a hamburger today.” In the meantime, economic growth has accelerated over the last year and that is not a bad thing.

True North – The indefatigable equity market is the gift that keeps on giving. The S&P is off to its best start (+7.55%) to a calendar year since 1987 and the strongest on a risk-adjusted basis since 1967 (thanks to continued low volatility). At 398 days (and counting), the S&P set a new record last week for the longest stretch without a 5% pullback. The previous records were in 1996 (394 days) and 1965 (386 days). In the 12 months following those historical stretches the S&P rose 42% and declined by 1%, respectively. The moral of the story is that no matter how vociferously some talking head on TV tells you where the market will be 12 months from now, he/she doesn’t really know. The decibel-level with which someone expresses their opinion about the market is not an indication of their prognostic skillset, though they would like you to believe so. For example, Goldman Sachs forecasts the S&P 500 will end the year at 2,850 (only 0.4% higher from here), while others see the market rising 20% or more. From an investment perspective, the best course of action, proven time and again, is to stick to your asset allocation through rebalancing….adding to less-loved (i.e. relatively cheaper) assets and trimming exposure to expensive assets. Your asset allocation is your financial compass showing where true north lies. In unfamiliar territory (and markets are always as unfamiliar as they are uncertain), that compass is the best tool to keep you on the path to achieving your financial goals.

NAFTA – President Trump’s America First slogan is beginning to make its way into tangible trade policy actions. Last week the administration announced new import tariffs on solar panels and washing machines while continuing to negotiate new terms for NAFTA. Investors reacted quickly to the tariffs as publicly traded stocks of solar companies that manufacture solar panels abroad declined, while those that manufacture in the good ol’ US of A rose (America First!). With regards to NAFTA, which is causing greater concern, the outcome remains uncertain. Negotiators from Mexico, Canada and the U.S. met for the sixth of seven scheduled rounds of NAFTA talks. President Trump is talking tough, following his proven negotiating style of staking out an extreme position to establish an advantaged starting point for compromise. Indeed, it would not be surprising for his administration to announce an intent to withdraw from NAFTA. Not only would the action be consistent with The Art of the Deal, but the President is already negotiating from a position of strength. First, trade between the U.S. and Canada would likely be unaffected by a NAFTA withdrawal because of a prior free trade agreement between the countries. Second, most estimates conclude that exports to Mexico comprise only 1% of U.S. GDP and sales to all of Latin America make up just 3% of S&P 500 sales (source: Goldman Sachs). In isolation, the NAFTA renegotiation is tailor made for the master dealmaker to extract extraordinarily positive terms for the U.S. However, the President needs to be careful that he does not go too far and touch off a broader trade conflict that extends beyond NAFTA. The global economy has become more efficient and consumers have enjoyed lower prices for goods and services as a result of global commerce, which requires some give and take among all participants. Protectionist policies that are too strong will throw sand in the gears of the global economy (for example South Korea reinstated levies on US imports in response to President Trumps announced tariffs), slowing the economic machine and reducing efficiencies decades in the making… a suboptimal outcome for everyone.

Monkey Business – This fable will likely upset Bitcoin bulls. Yet, I’m not a Bitcoin basher (full disclosure, I speculated on a small amount in early 2017 that I still own), I just think this is a humorous take on cryptocurrencies that, like most fables, contains an important principle….caveat emptor.

A lot of monkeys lived near a village.  One day a merchant came to the village to buy these monkeys!   He announced that he will buy the monkeys @ $100 each.   The villagers thought that this man is mad.  They thought how can somebody buy stray monkeys at $100 each?  Still, some people caught some monkeys and gave it to this merchant and he gave $100 for each monkey.

This news spread like wildfire and people caught monkeys and sold it to the merchant.  After a few days, the merchant announced that he will buy monkeys @ $200 each.  The lazy villagers also ran around to catch the remaining monkeys!  They sold the remaining monkeys @ $200 each.  Then the merchant announced that he will buy monkeys @ $500 each!   The villagers start to lose sleep! …

They caught six or seven monkeys, which was all that was left and got $500 each.  The villagers were waiting anxiously for the next announcement.  Then the merchant announced that he is going home for a week.  And when he returns, he will buy monkeys @ $1,000 each!

He asked his employee to take care of the monkeys he bought.  The employee was taking care of all the monkeys in a cage.  The merchant went home.

The villagers were very sad as there were no more monkeys left for them to sell it at $1,000 each.  Then the employee told them that he will sell some monkeys @ $700 each secretly.  This news spreads like fire.  Since the merchant buys monkey @ $1,000 each, there is a $300 profit for each monkey.  The next day, villagers made a queue near the monkey cage.

The employee sold all the monkeys at $700 each.  The rich bought monkeys in big lots. The poor borrowed money from money lenders and also bought monkeys!  The villagers took care of their monkeys & waited for the merchant to return.

But nobody came! …. Then they ran to the employee……But he has already left too.  The villagers then realized that they have bought the useless stray monkeys @ $700 each and were unable to sell them! 

The Bitcoin will be the next monkey business. It will make a lot of people bankrupt and a few people filthy rich in this monkey business.

Be well,

Jp.