Despite several reasons to be unnerved about the overall market, the week began with what we would call a “sigh of relief rally” as the weekend’s hurricane turned out to be not quite the Armageddon that was feared. Monday’s breakout to new all-time highs for the S&P 500, (for the first time in 23 trading days) makes this now the second longest and second strongest bull market on record, while the economy continues to muddle through. As of Friday’s close, we will have gone 3,112 calendar days since the last 20% decline — the longest on record was 4,494 calendar days, ending in the March 2000 dotcom bubble bursting.
Looking under the headlines, some things aren’t right
As we discussed on this week’s Cocktail Investing Podcast, the recent rally in Euro junk bonds pushed yields for them below U.S. Treasury rates… eh? While the average for real yields on 10-year sovereign bonds in the U.S., U.K., and Germany sits near record lows, equity markets are reaching new all-time highs — naturally. This week’s AAII sentiment survey showed a surge in optimism as the percentage of bullish investors rose from 29.3% to 41.3% — the largest one week increase since the end of April and the highest level we’ve seen since January — talk about climbing a wall of worry. As we shared earlier this week, these rapid sentiment swings by individual investors tend to be viewed as a contra-indicator by institutional investors.
Those bulls are making it happen with this market
Even though market breadth has been rather concerning in recent weeks, as of Thursday’s close, we’ve gone from less than 42% of stocks in the S&P 500 above their 50-day moving average in mid-August, to 64%. The S&P 500 advance/decline line has also been making new highs, which is a positive indicator. We’ve also seen the number of NYSE stocks making new lows decline, so while this market remains richly priced with a bond market warning that growth prospects are weak, some of the market fundamentals have been improving.
Disappointments for the week
At the top of our list for disappointments was the rather lame event held by Apple (AAPL) at which it introduced several new upgrades for its Apple Watch, Apple TV and iPhone offerings. Yes, we love our Apple products, but in our view these efforts largely shored up its position in the slowing smartphone market. On a positive note for several of our Disruptive Technology investment theme positions on the Tematica Investing Select List, Apple confirmed its inclusion of organic light emitting diode displays in its iPhone X.
Enthusiasm for the new smartphone model was tempered by the high price tag ($US1,000) and a later than expected ship date in early November. We will see how willing consumers are to adopt the iPhone X later this year, but from our perspective we see Apple shares as being stock range bound until the company is able to deliver a new product or service that will put it back on the growth path. Fro now, we’ll continue to favour key suppliers that are seeing the benefits of technologies being placed inside the iPhone and Apple Watch.
On the economic front, not much was inspiring
While the NFIB’s small business optimism index posted a small increase that beat expectations, Taxes and Labour Quality continue to be the biggest problem for business owners. Fifty-nine per cent of businesses reported hiring or trying to hire, (down 1 point), but 52%, (88% of those hiring or trying to hire) reported few or no qualified applicants for the positions they were trying to fill.
Later in the week the JOLTS report from the Bureau of Labour Statistics confirmed this problem, as Job Openings hit a new high with the ratio of Job Openings to Hires also hitting a new high. The gap between Openings and Hires illustrates the difficulty businesses are facing in finding qualified applicants — that’s a headwind to the economy. We also don’t like seeing that the biggest area of increase in the JOLTS report was in “leisure & hospitality,” which has the lowest wages and lowest overall compensation. Looking at our Ageing of the Population investing theme, we continue to be concerned by the wide gap between the number of healthcare job openings and new healthcare hires. We see this becoming an even greater pain point as more baby boomers turn 70 in the coming years.
Before Harvey, construction workers across the U.S. were already in tight supply and material costs were rising. With the profound level of destruction, Houston is likely to face such a severe crunch that it could affect the national economy by pushing up material costs and driving down the U.S. unemployment rate for construction workers even further. For context of just how tight this portion of the labour market is today, there were 225,000 unfilled construction jobs in June, near the recent high of 238,000 recorded in July 2016, according to a National Association of Home Builders analysis of Labour Department data.
Wednesday’s Producer Price Index (PPI) report was mixed versus expectations. The year-over-year overall change was up 2.4%, but that’s due to big bump in Energy (Houston anyone) which was offset a bit by 1.3% decline in foods. Excluding those and trade saw the index up 1.9% year-over-year, nearing the Fed’s target 2.0%. For context PPI at the end of last year was 1.8, peaked in May at 2.1% and is now down to 1.9%.
Thursday we got August’s Consumer Price Index (CPI) report which saw core CPI up 1.9%, above expectations for a 1.8% increase as the extreme weakness we saw from March to May starting to wear off. Energy was by far the biggest driver of price increases with the largest year-over-year declines occurring in apparel, airline fares, and as we’ve discussed quite a bit, used cars. New cars are currently experiencing the worst deflation since the Great Recession.
Shelter inflation has started to tick up with the 3 months annualized growth in rent or shelter now stronger than the year-over-year trend. We suspect rents are unlikely to be able to continue rising at a near 4% annual rate if wage growth remains around 2.5%. The combined CPI and PPI reports didn’t help the wave of global bond selling and fuelled the spike in U.S. short-term rates as the probability of a third rate hike in 2017 jumped up over 50% on Thursday, putting us firmly into “coin toss” territory.
Friday morning saw a disappointing Retail Sales report, falling 0.2% in August versus the 0.1% expected increase. Excluding autos, retail sales rose 0.2% versus expectations for a gain of 0.5%. Auto sales experienced the biggest drop since January, likely related to effects of Hurricane Harvey, which hit Texas in the last week of August. We expect that auto sales will see a material boost thanks to all those flood damaged vehicles, which should help dealerships that have been struggling with high inventory levels. Thursday’s CPI gain compressed the growth in real wages such that real average hourly earnings year over year declined to sit at a meager 0.56%.
We’ll point out that if inflation really was starting to kick in, the U.S. would have rallied yesterday rather than slipping 0.4% and bond yields would have jumped rather than remaining a disinterested flat for the day. Tough for us to buy into inflation and growth story when Utilities are up 12.5% year-to-date, outperforming consumer cyclicals by 2% and industrials by 3%.
On the political front of things not everything was peachy
North Korea fired another missile over Japan, with this launch travelling roughly 2,300 miles versus the prior overflight of Hokkaido on August 29th, which travelled 1,700 miles. Guam, which Kim Jong Un has threatened to envelope in fire, is 2,100 from the missile launch site – not good. Japan is none too pleased. Something here is going to have to give, but the stock market appears to be rather bored with the North Korean nuclear saber rattling — go figure. Friday morning witnessed yet another terrorist bombing, this time in a West London Tube station. Although 23 people were injured, thankfully no lives were lost and this one looked like a pretty amateur attempt — small blessings. Again, the market mostly just yawned — go figure.
Bottom line for the week
September, having a track record of being hellish on one’s digestive tract, so far has been relatively calm, despite Mother Nature and that nut in North Korea testing our intestinal fortitude. While equity valuations at historically high levels in the face of an economic picture that continues to be rather ho-hum are reasonably worrisome, market dynamics aren’t giving us much in the way of imminent warning signals. Trump’s deal with the Democrats managed to kick the debt-ceiling can past the November elections, but the bickering and contradictory inconsistent messages make the already herculean task of tax reform all that more unlikely, at least before the end of the year. Overall this was a week that could have been a Pepto-Bismol guzzler, but instead was oddly calm.
As we get ready to bid you a fond weekend, we do have one bit of dour news. Earlier today it was reported Tropical Storm Jose is expected to re-strengthen to a hurricane and produce high surfs and life-threatening rip current conditions along the U.S. East Coast as it moves up the Atlantic. As if that wasn’t enough, yet another tropical depression has formed far out over the Atlantic and is expected to become a tropical storm. And we thought it was March that was supposed be the month that was “in like a lion, out like a lamb.” Then again, given the data we’re seen and the hurricane related revisions, we’re starting to see there’s reason enough to think October won’t start off as soft and warm as a lamb.