” ‘This country wants waking up and setting to rights,’ said the ruffian.” – J.R.R. Tolkien, The Return of the King
As we reach the end of a January not marked by the heavy selling of a year ago, I nevertheless feel more worried now than I did then. To be sure, the stock market sell-off in January 2015 occurred against the backdrop of weak earnings and a weak economy, so it was something to be concerned with, but it wasn’t attributable to anything specifically wrong and even at the time was thought of as possibly a case of portfolio rebalancing in a thin market – i.e., selling stocks to buy bonds. In a market dominated by black-box trading, all moves tend to be exaggerated.
My worries for this year begin with the stall-speed economy and very expensive valuations of the stock market, but are being piqued by the latest speeches coming out of Washington DC. This is a column for investing and not a political forum, and so I will restrict myself to speaking as an investor – but had the uneasy sentiment as I listened on Friday that investors really ought to be running for the exits.
Trading over the last few months has been focused on what tax cuts, deregulation and infrastructure spending might do for the economy, or more precisely, all the wonderful things that are sure to follow. Yet I have not been the only one to observe that tax cuts are still theoretical at this stage, and while I don’t doubt that something will happen in that sphere, a bill doesn’t seem likely to pass until early summer. Most rational estimates of infrastructure spending I have seen put the effects as not beginning until next year and the year after. As for deregulation, I suspect that the beneficial effects are being greatly exaggerated by an emotional overreaction.
In the meantime, while it’s too early to be definitive on the new administration, the rancorous, somewhat chaotic nature of last week’s presidential remarks and statements made me worry as an investor. One may agree or disagree vehemently with administration politics – President Obama, for example, was not especially popular on Wall Street, yet the markets did very well during his tenure – yet it’s generally unwise to invest based on Washington themes. For that matter, any president’s ability to do much about the economy is much smaller than generally supposed.
Presidents are rather more capable of doing harm than good, though even that must be taken with a grain of salt. However, the backdrop of a business cycle that is quite old is already something to worry about. Episodes of political instability in such instances can have more of an impact than at other times, and last week seemed to positively scream instability. That should worry investors. Admittedly we are only one week in and may simply be experiencing a bout of coughing and sputtering as the new engine warms up, but more of last week would not be welcome.
In the meantime, a lot is on the table this week, in the form of quarterly earnings, another Fed meeting and the January jobs report, so the combination might push the new administration off the front pages. If last week is any indication, that could be a very good thing indeed.
The Economic Beat
The report of the week was the first estimate of fourth quarter GDP, coming in at an annualized rate of 1.9% after adjusting for inflation and seasonal effects. 2.2% had been broadly expected. The first estimate for 2016 is now 1.6% real growth (inflation-adjusted), quite a comedown from 2015 (2.6%) and even 2015 (2.4%). Or so it stands for now, as both the final quarter (and thus 2016) are in for two more scheduled revisions, not to mention the eventual benchmark revisions that can affect years and years of growth data. However, the trends do not usually vary much.
Turning to some of the details, nominal growth (before adjusting for inflation) did edge down from the third quarter to the fourth, but not enough to prevent the four-quarter nominal rate from rising back above 3% to 3.5%, a level not bested since the second quarter of 2015 (4.1%). Indeed, the first three quarters of 2016 had all seen four-quarter rates below 3%. A year ago, the four-quarter rate was 3%, but before we celebrate, much of the change is due to nothing more than higher oil prices. The price index rose to 2.1% in Q4-2016 from 1.4% the previous quarter, though remained (so far) at only 1.3% in 2016 vs. 1.1% in 2015. The Fed-preferred PCE index excluding food and energy currently stands at 1.7% for the year.
There are always bumps and creases in each quarterly GDP report, allowing various claims about momentum of one sort or another, but despite the many claimed signs of discerned momentum in 2016, there was never any positive change in trend apart from the rebound in energy prices. 2016 ended with a four-quarter nominal GDP of 3.5%, compared with the trailing three-year average of 3.7%.
There was a spark of good news though – sort of – in durable goods orders for December. Although orders fell 0.4% after a 4.8% November decrease, they were up 0.5% excluding transportation. Based on current estimates, new orders fell 0.3% in 2016 and by the same amount when excluding transportation. Better than 2015.
After nine consecutive months of negative year-on-year comparisons using not seasonally adjusted data, new orders in the business capital spending category finally comped higher in December and were up 1.2% from December 2015. It was virtually the first positive comp of 2016, as February owed its slight increase (0.5%) to an extra leap-year day. On the other hand, it was still a below-average December compared with recent years. Looking back, a similar sudden year-year pop of 1.1% in November 2015 that ended a 13-month streak of negative comps was not followed up with any increased activity in orders until last month. So the jury is still out on this one, and if oil prices flatten out orders may well resume their anemic pattern.
That said, the post-election burst of optimism continues to paint survey data in rosy hues, with the Richmond Fed index rising to +12 (0=neutral) and Kansas City remaining at +9. All of the Fed regional surveys were strongly positive over the last four weeks, yet the Chicago Fed’s activity index, which does not measure sentiment, showed no such change, rising to +0.14 in December only because utility output rose (i.e., the weather). November was revised down to (-0.33) and the three-month average remained negative at (-0.07). The index is oft-revised and remains a coincident indicator rather than a leading one, but as of yet we are not seeing any evidence of a genuine bump in the economy.
The pace of home sales slowed in December, possibly affected by recent increases in the ten-year mortgage rate. The rate for existing homes fell by 2.8% to 5.49 million (seasonally adjusted and annualized), with the year-on-year rate falling to 0.7%, though total sales in 2016 were up 3.8% for the year. The new-home sales rate eased back to 536,000 (536K), seasonally adjusted and annualized, while the preliminary estimate of sales for all of 2016 is 562K, the same as the TTM rate in November. New home sales rose 12.4% in 2016, compared with 13.9% in 2015. The million-plus rates of the beginning of the century seem like a distant memory now.
Weekly jobless claims data rose slightly but remain historically low, while weekly retail sales data point to a weak January. Next week will start off Monday morning with personal income and spending data for December and finish with the big kahuna, the jobs report.
In between we’ll get the Fed meeting statement on Wednesday, which might be a bigger kahuna than jobs, depending on what they say. It’s rash to predict policy changes, but I suspect (along with most everyone else) a continuation of the steady, cautiously incremental approach that the Fed has favored. The members will surely have seen the latest jobs estimate, along with the ADP report that morning, so the tenor of their comments might be a tip-off to Friday.
We’ll also get pending home sales Monday, then regional manufacturing surveys from Dallas and Chicago that will be followed by the national manufacturing purchasing manager survey on Wednesday (ISM), accompanied as usual by the latest construction spending. Thursday will see an update on productivity, while Friday will add on the ISM non-manufacturing survey and factory orders.