Great Expectations
Doug Walters
Stocks are up for the fourth week in a row, and all-time-highs are a regular headline. But there is a rising disconnect between the profits companies earned and their rising share prices. This is a good time for disciplined active management.
Market Review
Contributed by Doug Walters
The S&P 500 was up this week again, making it a four-week winning streak for U.S. Equities. Investors continue to focus on the business-friendly policies of the new administration (tax reform, cutting red tape, infrastructure spending and even health care reform). They have largely ignored the day-to-day drama unfolding in and around the White House.
Playing catch up
We see a one-sided race unfolding between corporate profits and their valuation. Stocks are rising at a pace that exceeds growth in profitability. Investors are assuming that with new reforms, profits will catch up, or at least make this race close. We have some concerns.
- While there is a lot of talk, it is not clear that Congress and the White House are on the same page when it comes to some of the bigger potential reforms. These reforms will take time and may not be as lucrative to corporate profits as investors currently assume.
- In addition, the only thing predictable about the current President is his unpredictability. With stock valuations elevated, there is little room for the market to absorb any negative shocks coming from Washington.
At times like these, disciplined active investment is even more important. Staying calm and systematically assessing the potential risks and rewards of the market is our focus at Strategic.
| Indices & Price Returns | Week (%) | Year (%) |
|---|---|---|
| S&P 500 | 1.5 | 5.0 |
| S&P 400 (Mid Cap) | 0.8 | 4.5 |
| Russell 2000 (Small Cap) | 0.8 | 3.1 |
| MSCI EAFE (Developed International) | 1.0 | 4.5 |
| MSCI Emerging Markets | 1.7 | 9.7 |
| S&P GSCI (Commodities) | -1.0 | 1.4 |
| Gold | 0.1 | 7.4 |
| MSCI U.S. REIT Index | -0.1 | 1.3 |
| Barclays Int Govt Credit | 0.0 | 0.2 |
| Barclays US TIPS | 0.0 | 0.9 |
Economic Commentary
Shopaholics
President Trump met with retail CEOs this week and highlighted their importance in the economy as it relates to American jobs. As we discussed last week (see A Big League Plan), retailers are concerned about the potential implication of a border tax, which may be included in tax reform.
The CEOs followed the meeting by highlighting that their industry provides 42 million jobs. As American consumers regain confidence in a recovering economy, they are spending more on retail. The US Census Bureau released a very positive report this week with retail spending handily beating expectations.
Retail spending was steady and up in most categories with January sales 5.6% higher than a year earlier. Sales at restaurants and bars were up 1.4% from the month prior which was the strongest gain in 11 months for the industry. The one weak spot in the report was auto sales. The auto industry is showing signs that it is at a cycle peak as January sales were down 1.4% from the month prior. U.S. car and light truck sales reached a record in 2016 but sales have since slowed despite lower car prices.
American consumers are spending more on retail overall but are shifting from traditional stores to online shopping. Department store sales fell 3.2% from a year earlier, while sales in non-store retailers including those online, increased 12% in the same time period.
Week Ahead
Day off
The Presidents’ Day holiday falls on Monday, February 20th with equity and bond markets closed for the day. Here are some fun facts about this holiday:
- It was established in 1885 to honor President George Washington’s birthday. This year would be his 282nd birthday.
- There were four presidents born in February including George Washington, Abraham Lincoln, William Harrison and Ronald Reagan.
Smooth sailing
Economic news will focus on the Fed’s meeting minutes and new home sales, while commodity traders will watch crude oil and gasoline inventory updates.
- Analysts expect 575,000 new homes to be sold in January vs. prior month sales of 536,000.
- Oil previously rallied on a better than expected decline in gasoline inventory, but some question if it is one-off event.
Wally World
Wal-Mart Stores, Inc. will report earnings on Tuesday. Though this report is not as exciting as a Presidents’ week trip to an amusement park, it could offer a roller coaster ride of its own.
- As the biggest retailer in America, investors will be very anxious to squeeze the company for information on how they plan to deal with a border-tax.
- Any commentary on the company’s e-commerce strategy could also be of interest, especially after the $3.3 billion Jet.com acquisition last August.
Strategy Updates
Contributed by Max Berkovich ,
Strategic Asset Allocation
Balancing act
Another winning week for large capitalization stocks, as they continue their steady upward momentum. For almost a year, analysts have been arguing over equity valuations. While stocks might be at their highs, corporate tax-cuts and regulatory relief, might make some industries and companies look attractive.
- Corporate tax rates steadily declined from 39% to 35% since 2008, but a move down to 20% is a lot more significant.
- 82% of S&P 500 companies have reported their fourth quarter earnings, which grew 4.6% on average. Consensus estimates are for 2017 earnings to grow nearly 10%.
Despite the above catalysts, equities valuations remain a concern. The traditional alternative to equities, bonds are no bargain either with the 10-year Treasury offering a yield of 2.42% right now and rates expected to go up. We are taking opportunities to trim exposure to equities in favor of cash.
Strategic Growth
Stirring the soup
The Health Care sector had a notable week and a Friday earnings surprise for one holding helped solidify a top finish for the sector. Consumer Staples was the biggest laggard partly due to…
- Organic food and personal product maker Hain Celestial Group (HAIN) announced that the ongoing accounting investigation has now reached a level where the Securities and Exchange Commission has issued a subpoena in the matter. While regulator involvement spooked investors, a few days later the company announced it acquired British soup maker Yorkshire Provender Ltd. The acquisition is supposed to be accretive to earnings in 2018.
Strategic Equity Income
Routing and switching
The Energy sector was a laggard, with crude taking a bit of a tick down for the week. While the leading sector was Technology thanks to an earnings report from…
- Cisco Systems Inc. (CSCO) reported a mostly in-line quarter and guidance that matched consensus. The company also increase its quarterly dividend by 11.5% to $0.29 per share. The key takeaway was that the company continues to see declines in legacy switching and routing. But its own switching from a hardware to a service and security company could eventually be routed to revenue growth once the transition is complete. The company also stands to benefit from a corporate tax cut and a repatriation tax cut. According to a Citigroup analyst, the current tax cut proposal could lead to a 16-20% earnings per share boost.
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