Investing on a Budget
Doug Walters
Stocks ignored the political budgetary wrangling this week which dominated the airways and found a reason to reach new highs.
Market Review
Contributed by Doug Walters
The specter of a government shutdown loomed all week. While this cast a shadow on Washington, it did little to dampen the spirits of equities which continued to shine within investors’ portfolios.
Grinding to a Halt
As we write, Congress is scrambling to avoid a government shutdown. Perhaps most interesting (at least to us) in this latest Washington saga is the ambivalence of the stock markets which continued to push forward this week. While a shutdown sounds catastrophic, there are few material macroeconomic implications. The most direct impact is on those that find their jobs furloughed. As we note in our weekly spotlight, government shutdowns are not that uncommon. A much more menacing scenario, which is often confused with budget negotiations, is a debt ceiling standoff. The government has never failed to raise the debt ceiling when push comes to shove.
Seasonality
Earnings season continues with most banks now having reported. Changes to the tax law have muddied the reporting waters, with some banks announcing large one-time charges. While we will get increasing clarity on taxes throughout the earnings season and in the Q1 results, it will be another year before the full implications are realized. Companies are not hoarding all of their tax gains. There are daily announcements about wage increases and special bonuses, and we are likely to see some companies lower prices. The question is how much of this is short-term pandering to Washington, and how much will permanently flow to a company’s bottom line in the years ahead.
Strategy Update
Contributed by Max Berkovich ,
STRATEGIC ASSET ALLOCATION
Going on Record
The first week of corporate earnings had a positive effect on equity markets. Stocks set new highs, while U.S. Treasury yields have been rising. The U.S. 10-Year Treasury extended its decline, pushing yields above 2.63% (yields go up as bond prices go down), a critical technical level not breached since last March.
Stocks continue to move higher as:
- Both Europe and Asia are showing signs of growth. Stronger global growth is good for business.
- The lower corporate tax rate boosts earnings and could result in wage growth with eventual higher consumer spending.
- Negative bond returns give investors reason to give up on safety to chase rising equities.
- FoMo, fear of missing out on stock market gains.
Our thoughts:
- While we embrace stronger profits from corporations as a reason to stay in equities, we are selective and regularly rebalancing, as not all companies benefit equally.
- Within fixed income, rising rates presents an opportunity to buy short-term bonds as they are now offering notably higher yields than a year ago.
STRATEGIC GROWTH
Healthy Livin’
The Energy and Materials sectors were laggards on the week, while Health Care was on top thanks to an earnings report from…
- UnitedHealth Group (UNH) reported another consensus topping quarter. The health services and insurance giant’s revenue was up 10% from last year, and EPS jumped 25%. One notable item from the quarter was an 18.7% revenue jump in services, though the service revenue is only 8% of the total. The company also guided 2018 revenue to be around $180 Billion.
STRATEGIC EQUITY INCOME
MercKey News
Consumer Staples was the leading sector this week, while Energy took a break as crude oil prices stalled at the $64 level. Even Schlumberger’s (SLB) earnings report, which cited a 59% boost in North America revenue, was not enough to keep the party going. Several banks also reported earnings this past week and all were inline or topped expectations, with all except Bank of New York Mellon (BK) receiving a warm welcome from the market. Rising expenses tripped the custodian bank. In other strategy news…
- Merck & Co. (MRK) reported that a phase 3 trial of KEYNOTE-189 produced positive results for lung cancer treatment. The study combined Merck’s KEYTRUDA with another agent from a competitor pharmaceutical company. Later in the week they also announced that KEYTRUDA had a positive effect on mid-stage liver cancer patients.
| Indices & Price Returns | Week (%) | Year (%) |
|---|---|---|
| S&P 500 | 0.9 | 5.1 |
| S&P 400 (Mid Cap) | 0.7 | 4.1 |
| Russell 2000 (Small Cap) | 0.4 | 4.0 |
| MSCI EAFE (Developed International) | 0.7 | 4.4 |
| MSCI Emerging Markets | 1.6 | 6.0 |
| S&P GSCI (Commodities) | 0.0 | 2.4 |
| Gold | -0.4 | 2.2 |
| MSCI U.S. REIT Index | 0.1 | -5.1 |
| Barclays Int Govt Credit | -0.3 | -0.7 |
| Barclays US TIPS | -0.2 | -0.8 |
The Week Ahead
HERD Mentality Driving Stocks Higher
Home sales and building permits are expected to remain steady for the month of December when reported next week.
- Existing home sales remain near a 5-year high at the monthly rate of around 5,800,000 units.
Earnings season picks up steam. Companies in focus include Procter & Gamble (PG) and Johnson & Johnson (JNJ), which will provide an early indication of the health of the consumer and international markets.
Rate decision from Bank of Japan (BOJ) on Tuesday and European Central Bank (ECB) on Thursday will be watched closely.
- The BOJ is unlikely to raise rates just yet, but the discussion about normalization and their balance sheet will be key.
- The ECB’s rates are also unlikely to rise, but the bond-buying program’s size is more important. With the economy expanding can the monetary policy be tightened now?
Durable Goods Orders and Gross Domestic Product are the primary domestic economic indicators of note next week.
- Durable Goods Orders measures current industrial activity and the economic conditions of U.S. manufacturing sector.
- The first read for 4th quarter GDP will give new data on the strength of the economy. The consensus is 3%, but with the Atlanta Fed’s GDPNow forecast of 3.3% expansion and the New York Fed’s Nowcast calling for a number close to 4%, upside surprise looks possible.
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