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Strategic Insights

Volume 6, Edition 44 | November 27 - December 1, 2017

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Off to the Races

Doug_Walters Doug Walters | Articles

Read Time: 6:30 min

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Stocks got enough of a boost from tax reform progress and Fed reassurances to ward off concerns about the political implications of a guilty plea from former national security advisor Michael Flynn. Meanwhile, holiday shopping got off to a buoyant start.

Market Review

Contributed by Doug Walters

Stocks rallied again this week on continued progress on tax reform in the Senate and comforting words from the Fed. But the week was not without drama, with volatility spiking on Friday with the news that former national security advisor, Michael Flynn, plead guilty to lying to the F.B.I.

Comprising Compromises

The S&P 500 added another 1.8% this week, as the Senate made progress toward putting forward their version of tax reform. Passage (which appears imminent as we type) will increase the chances of signing a tax bill, with a lower corporate tax rate, into law before the year-end. Stocks are very sensitive to this bill and have been waxing and waning (although mostly waxing) every step of the way.

Paint it Beige

The Fed released its Beige Book of economic activity this week. The two main takeaways from the book and subsequent comments from Chairwoman Yellen and incoming Chairman Powell were: 1) a slight improvement in the economic outlook, and 2) inflation pressures are building. The market also took comfort from Powell’s congressional hearing where he reiterated his commitment to the slow and steady rate hikes that the market likes. A December rate increase looks inevitable.

Nothing but the Truth

The market was hit with a jolt of volatility Friday as headlines came out of the Michael Flynn plea hearing. Trump’s former national security advisor plead guilty to a fairly low-level crime, lying to the F.B.I., in exchange for his cooperation in the Muller Russia investigation. The stock market, which initially fell over 1.5% before clawing most of that back, was trying to ascertain if this latest development would have any impact on the administration’s corporate-friendly agenda (lower taxes, lower regulation, etc.) The answer appears to be “No.”

Indices & Price ReturnsWeek (%)Year (%)
S&P 500 1.518.0
S&P 400 (Mid Cap)1.914.1
Russell 2000 (Small Cap)1.213.3
MSCI EAFE (Developed International)-0.919.0
MSCI Emerging Markets-3.329.4
S&P GSCI (Commodities)-0.47.9
Gold-0.610.9
MSCI U.S. REIT Index-0.42.0
Barclays Int Govt Credit-0.30.2
Barclays US TIPS-0.50.4

Economic Commentary

Contributed by Doug Walters

Shopaholics

We have survived another Black Friday, Small Business Saturday and Cyber Monday, with consumers hitting the stores in record numbers. Cyber Monday tends to garner a lot of attention amongst investors given the impact online shopping is having on brick and mortar stores. According to the National Retail Federation (NRF), online sales rose to a record $6.59 billion on Cyber Monday, which is about $1 billion higher than last year. November 27th, 2017 now has the distinction as the greatest online shopping day in U.S. history. But reports of the death of the brick and mortar retailer may be greatly exaggerated.

If your house is like mine, there is an increasingly steady flow of Amazon boxes replacing what used to require a trip to the mall. Yet, in the third quarter of 2017, just 9.1% of retail sales were transacted online. That percentage is growing, but not at breakneck speeds. In recent years the percentage of sales online is increasing by about 0.2% per quarter, so less than 1% a year.

9.1%

Cyber Me Not

E-commerce may be thriving, but it still only accounted for 9.1% of U.S. retail sales in Q3 2017. Source: U.S. Census Bureau (Q3 2017)

While most retail sales still occur offline, the growth of online has clearly had an impact on many traditional retailers, particularly department stores. Stocks like Macy’s (M) have seen their share prices more than halved in the past two years. However, perhaps even in department stores, it is too soon to write them off. Macy’s recently announced that it is increasing its seasonal workforce by 7,000, with their chief store operator stating, “Macy’s has had a great start to this holiday season with high customer volume across our business. Due to the strong traffic in our stores, we are adding associates in our stores across the country to ensure that customers continue to receive the high level of service they have come to expect from us.”

At Strategic, we remain cautious on traditional retail and only invest in those bricks and mortar retailers where we see a moat protecting the store from the inevitable rise of online shopping.

Fun Fact:

The term “Cyber Monday” was first used in 2005 by NRF employees, who noticed that online sales spiked the Monday after Thanksgiving as consumers returned to work and were able to take advantage of higher internet speeds to make their purchases.

Week Ahead

Contributed by Max Berkovich

Tax Plan Progress Will be the NET Over the Market

Non-Farm Payroll report, commonly known as the Jobs report, will be released on Friday by the Labor Department.

  • The Early consensus is for 185K new jobs in November, which would be light compared to October’s hot 261,000 number.
  • The unemployment rate is expected to tick up due to more people looking for work and average hours worked is expected to be unchanged at 34.4 Hours.
  • Probably, the most watched data from the report will be average hourly earnings. Earnings were unchanged in October, but the consensus is looking for an uptick of 0.2% month-over-month.

Europe will release a trove of economic data, including 3rd Quarter GDP which is expected to show the Eurozone economy expanding by 2.5%. But the German political issue, Brexit talks and several European Union forums and meetings will take center stage.

  • The European Union Finance ministers will meet as “Eurogroup” on Monday. This meeting will focus on a more complete banking union in the Eurozone and fiscal governance for member nations.

Tax bill progress will be watched. Once the Senate bill is approved (which may have occurred by the time of this publication) the House can vote on it as well, but…

  • If the House of Representatives does not pass the Senate bill, a joint committee of House and Senate members will take up the next step.
  • A joint committee will not be allowed to remove from the bill anything upon which both bills agree. They also cannot add anything that is not in either of the bills.

Strategy Updates

Contributed by Max Berkovich

STRATEGIC ASSET ALLOCATION

Flip Flop

The most eye-catching feature, so far, of the 2017 market trend is the performance diversion between Large Capitalization Growth and Value. Most of this year we witnessed growth outpacing value significantly, with the iShares Russell 1000 Value ETF (IWD) up 8.8% versus the iShares Russell 1000 Growth ETF (IWF) up 27.8% as of last Friday. But this week value was up 2.7% versus growth 0.4%.

  • Strategic’s Quality and Value mandate has kept us out of some of the high-flying Growth names, so needless to say we applaud the flip in market attention to the value side.

Advanced Notice

As the U.S. Senate plays politics in drafting a tax plan, the municipal bond market is responding to each development. Most importantly is the provision that eliminates advanced refunding of municipal debt.

  • Advanced refunding is a process where municipalities would take advantage of lower interest rates by borrowing at those lower rates and invest proceeds in government bonds to earn income until they can call or redeem older bonds.
  • According to Morgan Stanley, so far this year, 40% of new municipal bonds were refunded and it was roughly 50% in 2015 and 2016.
  • Fearing that no advanced refunding would be available in the future, municipalities are jumping early to get this done and thus increasing the supply of new tax-exempt bonds hitting the market. This is dragging municipal bond prices down just as interest rates are moving higher and tax loss harvesting seems to be available in high coupon municipal bonds.
  • We are exploring opportunities to find value in the tax-exempt bond market.

STRATEGIC GROWTH

Almost Missed the Beat

Consumer Staples and Industrials are co-leaders on the week, with the latter driven by a transportation stock in the strategy.  Technology missed its beat this week and finished as the laggard thanks to a tough week from semiconductor stocks. In other strategy news…

  • Ulta Beauty, Inc. (ULTA) reported earnings that narrowly topped consensus, but 10.3% sales growth, with similar guidance and margin pressure, were received unfavorably as good but not good enough.
  • On the other hand, Costco Wholesale Corp. (COST) reported that monthly sales for November grew by 13.2% year-over-year, beating consensus that was looking for 7%.

STRATEGIC EQUITY INCOME

Insuring Future Success

Telecom was the big leader, but Consumer Discretionary and Financials also had a notably good week. Technology was the laggard. In other news…

  • CVS Health Corp. (CVS) is very close to acquiring health insurer Aetna (AET) for $200-205 per share. The roughly $66 Billion transaction is reported to be mostly cash.  This was first reported on in the A Scary Good Run edition of insights.

About Strategic

Founded in 1979, Strategic is a leading investment and wealth management firm managing and advising on client assets over $1 billion.

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