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Are markets too exuberant?

Equity markets hit new highs during the Thanksgiving shortened week. Markets often move in anticipation of changes in policy. This post election market, however, appears to have instantaneously adjusted to what it perceives will be policy outcomes. Such outcomes, however, are by no means guaranteed; some outcomes may take several quarters, others years, if at all. This has been quite a stretch for markets where next month is considered “long-term.” There will be many distractions before the results of policy changes are seen, and markets easily forget why they bid prices up.

Let’s first assess where the economy stands at November’s end:

  • The Q3 GDP growth rate of 2.9 percent was a surprise to the upside; but 1.4 of those percentage points was due to inventory accumulation and a quite surprising shrinkage of the trade deficit. Black Friday retail sales should help us determine if the economy is strengthening or not.
  • The dollar has rapidly strengthened in the postelection period to a 14-year high, which reduces exports by implicitly raising prices in terms of trading partner currencies. Those exports are often manufactured items and this could cause manufacturing to contract.
  • The October retail sales report was quite bullish rising 0.8 percent (0.6 percent expected). Nevertheless, the corroborating evidence remains weak. The Liscio Report of state sales tax collections tells a different story. Only 22 percent of states exceeded their sales tax collection targets in October, down from 35 percent in September, and only 35 percent of states reported sales tax growth, down from 65 percent the prior month.
  • The housing data was mixed, with starts and permits positive (starts up 25 percent in October) and existing home sales at a cycle high. But new home sales disappointed, falling 1.9 percent in October. New home sales are contracts signed in October, whereas existing home sales are escrow closings, usually from contracts signed 60 to 90 days earlier (July-August). New home sales represent a better picture of the current housing market. The fall in new home sales was likely influenced by the rise in mortgage rates. Postelection, mortgage rates have spiked. Such a rate rise bodes ill for housing going forward.
  • Initial claims for unemployment in the week of Nov. 12 were 235,000 — the lowest number since October 1973. Employers continue to report extreme difficulty in finding qualified employees; so they are hesitant to let go of existing, trained personnel. Shouldn’t we be concerned about how the economy is going to grow faster when labor resources are so scarce?
That’s where we are now; here is what I see in my crystal ball:
  • Long before any policy changes from the Trump administration can have an impact on the U.S. or world economies, there will be many other issues that could give the markets heartburn and push interest rates lower, including the items listed below which make the EU look unstable:
    • The constitutional vote in Italy: If anti-globalism holds, PM Renzi will lose, and concerns over Italian bank capital could easily re-emerge.
    • The French presidential elections: These are next spring, with Marine Le Pen having a real shot at winning. The policies of her National Front party include rejecting the Euro as France’s currency; protectionism, and closed borders.
    • The German general elections next summer: Voters may reject Angela Merkel due to her immigration policies.
  • The rise in interest rates postelection and the almost certain increase in the Federal Funds rate in December represent significant monetary tightening in a market that has produced little in the way of growth this year. Generally speaking, tightening monetary conditions and rising equity markets rarely go hand in hand, especially in a slow growth world.
  • The Bank of Japan and the European Central Bank are still in easy money mode, so the upcoming Fed rate hike will further strengthen the dollar and negatively impact U.S. manufacturing at a time when U.S. Industrial Production has been flat to down for more than a year and capacity utilization remains at recession levels.
  • Despite market expectations of rising inflation in the upcoming Trump administration (infrastructure spending, tax cuts and the assumed record setting deficits):
    • A Republican Congress is not likely to approve deficits significantly higher than they gave Obama.
    • Infrastructure takes years to plan and longer if land has to be acquired. No doubt, infrastructure spending is needed. It’s just that it isn’t coming tomorrow, and the market will long have forgotten its exuberance over infrastructure by the time such spending and any accompanying inflation arrive;
    • A slow growth world is inherently deflationary. The Fed has missed its 2 percent inflation target on the low side for more than four years. It makes little sense for markets to be pricing in inflation just because the President-elect has infrastructure on his radar.


The economy certainly appears a bit stronger, but underlying data have yet to confirm this. Higher interest rates and a stronger dollar are negatives in the near term. Markets, too, have priced in policies that have yet to be enacted, much less have produced results. Bond yields appear to be way ahead of themselves. Long before we see the effects of new economic policies, there are going to be a lot of other diversions that could easily upset Mr. Market, with the European issues taking center stage in Italy on Dec. 4.


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