Since my last column, the Dow Jones Industrial Average (DJIA) did indeed hit 20,000 and has since gone well beyond. Most of the post-election run-up initially appeared to have occurred in the November 8th to December 20th period when the index went from 18,333 to 19,975, a rise of 1,642 points (7.9%). Over the next 44 days, until February 2, the DJIA was flat, actually losing 116 points. But since then, it has gone on another tear, closing on February 16 at 20,620, a rise of 761 points (3.8%) in just 10 market days.
Foreign Policy, Taxes, and Monetary Policy
Given the already high valuations, what is this new surge based on? Part of it is likely a collective sigh of relief that the Trump foreign policy isn’t going to be isolationism that the markets had interpreted from his campaign rhetoric. The latest market advance actually began when the President promised his tax cuts would soon be outlined. The market also likes the reduced regulatory promises, especially with regard to Dodd-Frank and the banking sector. With the resignation of Daniel Tarullo, a Dodd-Frank advocate, from the Fed’s Board, Trump can now appoint someone with financial regulatory views similar to his own.
Wall Street clearly likes this! The problem is, and continues to be, a market that appears to have gotten way ahead of itself. Yes, Q4 corporate profits were better than expected (+5% vs. +3% expected). But, that’s hardly a reason for a 12%+ market advance!
The Level of Bullishness is Almost Unprecedented
The latest edition of the Investor Intelligence poll shows the Bull camp at a rarified 62.7% with the Bears at a lowly 16.7%. The Bull-Bear differential is 46 points. Historically, a net difference greater than 40 points never lasts very long. In addition, once the index hits the mid-50s, markets don’t generally advance much further. This doesn’t mean that a major correction is imminent or that the market can’t advance further, as there have been periods of several consecutive months as recently as 2015 where this index remained above 50. But, given historical precedent, it is highly probable that now is not a good time to buy equities, and that investors are likely to be better off if they wait for the bullish sentiment to sink into the 30s, or even better, the 20s (where history tells us is always a great buying opportunity).
Rates Rising Despite a Soft Economy
Fed Chair Yellen gave her semi-annual testimony to Congress February 14 and 15 where she sent a signal to the markets that she and the FOMC intend to raise rates again. She said “waiting too long…would be unwise.” Her rhetoric leads me to believe that a March rate hike is very much in play. And, at least some of the increase will show up in the 10-year Treasury yield and thus in mortgage rates (which depress the housing market). Readers of my columns know that my view is that interest rates cannot rise significantly unless the economy is strengthening. So far, no such signs.
• January’s actual retail sales (not seasonally adjusted) were down 22.4% from December’s level. A January fall is typical, but this was the 2nd largest January fall in the past 10 years, and it only looks positive through the magic of the controversial “concurrent” seasonal adjustment process;
• While headline CPI was higher than expected for January, most of it was the rise in gasoline prices. Except for gasoline, inflationary pressures are simply not showing up in the data;
• Wage growth continues to disappoint; still just over 2% (annual rate) and not showing any signs of rising;
• A close look at the Household Employment Survey shows that employment in the all-important 25-54 age cohort actually fell 305,000 in January;
• The Fed’s Senior Officer Loan Survey indicates that banks are seriously tightening credit, an end of cycle phenomenon.
Don’t Count on Infrastructure Spending
For those counting on “infrastructure” spending to spur the economy, the February 11th weekend edition of the Wall Street Journal has an article entitled Speed Limits on Trump’s Infrastructure Drive… (David Harrison) which highlights the difficulty in today’s world of getting infrastructure projects off the ground, unlike times gone by. According to the Journal and to Fed economist John Fernauld, “[t]en years after the Interstate Highway System’s 1956 creation, the government had inaugurated 21,000 Interstate miles. That drove public capital spending to record levels and helped boost the country’s productivity…” But today, “[i]t can take decades to bring such investments to fruition.” Reviews under the National Historic Preservation Act of 1966, the National Environmental Policy Act of 1970, The Endangered Species Act of 1973 and other laws cause years and even decades of delay. The article is replete with examples. Anyone who thinks that Trump’s infrastructure initiatives will have a significant economic impact during his tenure in office ought to read this article.
The markets have significantly enhanced the value of infrastructure companies over the past two months. Tread lightly here!
Conclusion
The hard data continue to point to slow growth while the markets are discounting something much faster and sentiment is in nosebleed territory where it rarely stays very long.
