Six More Weeks…

The financial markets had their version of Groundhog day this week as the market was looking for a signal to keep pushing stocks higher or retreat to lower prices. We opened the week with an unexpected gap down in stocks which created what is called an “island reversal” which denotes weakness in an uptrend and a potential top. Apparently, the financial groundhog did not see his shadow on Thursday as we got a very good employment report on Friday morning where a rally ensued for the stock market (more in the chart section).

We need to see a good open early next week to get back on good footing for a continued rally. In the last week we have gone from bullish to bearish to neutral. The NASDAQ did put in an intra-day high on Friday so the rally may be intact for the time being or six weeks, anyway.

Economic & Central Banking Snippets

  • A strong employment report on Friday showed strong job growth (+227,000) with a rise in the unemployment rate (4.8% v. 4.7%). There was also a large gain in labor force participation (62.86% v. 62.67%, with the labor force +584,000. One of the best reports we have seen in years.
  • Industrial production growth in Japan eased in December, but not by as much as economists had forecast. The preliminary reading from the Ministry of Economy, Trade and Industry showed output grew 0.5% down from a 1.5% in November (the strongest level in five months). November’s level was the highest since March 2014, so Japan’s industry is looking to be in reasonable shape at the moment.
  • Home-price appreciation across 20 major US metropolitan areas unexpectedly picked up steam in November. The S&P/Case-Shiller 20-city index climbed in November by 5.3%.
  • Economic growth for the eurozone rose 1.7% last year. The region’s jobless rate also fell to 9.6%, the lowest figure since May 2009, while inflation of 1.8% is now near the ECB’s target of 2%.
  • The Federal Reserve indicated this week that it remains on course for further increases in short-term interest rates as inflation heads higher. The Fed left the federal funds target unchanged following a quarter-point increase at the previous meeting in December.
  • The Bank of England (BOE) has upgraded its short-term forecasts for UK economic growth for the second time in three months. The BOE now thinks GDP growth will hit 2% from an earlier estimate of 1.4%. The BOE now holds £6.1B of corporate bonds as its bond buying program continues to run ahead of its expected pace. The central bank started buying corporate bonds as part of a plan to cushion the economy from any post-Brexit weakness. The BOE said it would buy £10B of bonds over an 18 month period but surpassed the halfway point after just 5 months.
  • Construction spending fell 0.2% in December. However, homebuilding posted a strong 1.0% gain in December following recent upside in singlefamily housing starts.
  • The ISM reading confirmed broad gains in the regional Fed surveys. The composite ISM index rose 1.5 points in January to 56.0 (high since November 2014). As recently as August, the ISM was in contractionary territory at 49.4.
  • Personal income rose a less than expected 0.3% in December, and spending gained an in-line 0.5%, lowering the personal savings rate to a 21-month low of 5.4% from 5.6%.

The Trump T(i)rade

  • This week, President Trump signed executive orders curbing immigration (overturned this weekend), facilitating energy pipelines, granting states and businesses greater flexibility under the Affordable Care Act (ACA), renegotiating NAFTA, and withdrawing from the ratification process of the Trans Pacific Partnership (TPP), among other things.
  • More bilateral trade agreements could be in the horizon in place of the TPP as Japan’s Prime Minister Shinzo Abe visits the White House in the coming weeks.
  • The Kremlin issued a press release after the phone call between Russian President Vladimir Putin and U.S. President Donald Trump. There was no mention of sanctions repeal, but it underscored the importance of economic ties. The two sides agreed to establish cooperation on the conflict in Ukraine, counterterrorism, North Korea and the Iranian nuclear program. They agreed to begin preparations for an in-person meeting.
  • Personal and Business Tax Reform: The GOP will pass individual tax reform in Q1/Q2 of 2018, ahead of the midterm elections using reconciliation (only 50 Senate votes needed). Its likely that seven brackets become three along with the creation of a new lower rate for small business pass-through income. Corporate tax reform has a shot at Q4 2017 and will likely be married to an infrastructure bill. Both the 1981 and 2001 individual tax cuts were phased in over five years so you can expect a stimulus out towards the 2018 and 2020 elections. On corporate tax reform, look for capex (capital investment) to be allowed as an immediate write off, rather than depreciate over time which should incentivize business investment. Net interest expenses may no longer be deductible, as an incentive away from corporate leverage and financial engineering. (Bear Traps Report)
  • Trump will be able to act on trade issues faster than other policy matters. The War Powers act of 1973 gave the executive branch wide latitude for tariff implementation. (Bear Traps Report)
  • The White House has launched a review of North Korean policy, reflecting the growing nuclear threat from Pyongyang that Barack Obama told Donald Trump would represent his most pressing national security challenge.
  • President Donald Trump intends to roll back much of the 2010 Dodd-Frank financial regulations through an executive order today and work toward rescinding the Department of Labor’s fiduciary rule.

Chart Time!

I mentioned an island reversal in the intro, click HERE if you want to learn more about this technical pattern.

S&P 500 (SPY)
S&P 500 (SPY)
Dow Jones (DIA)
Dow Jones (DIA)
Russell 2000 - Small Caps (IWM ETF)
Russell 2000 – Small Caps (IWM ETF)
10 Year Treasury Yields - TNX
10 Year Treasury Yields – TNX

Market Snippets

  • The Department of Education (DOE) recently released a memo admitting that repayment rates on student loans have been grossly exaggerated. Data from 99.8% of schools across the country has been manipulated to cover up growing problems with the $1.3 trillion in outstanding student loans. New calculations show that more than half of all borrowers from 1,000 different institutions have defaulted on or not paid back a single dollar of their loans over the last seven years. This comes in stark contrast to previous claims and should call into question any statistics provided by government agencies. The American people haven’t fully grasped the long-term implications of loaning a trillion dollars to young people who have no credit or assets. Increases in tuition seen over the past two decades have become a point of controversy and angst for those who don’t fully understand the contributing factors. Between 1995 and 2015, the average cost of a public, four-year university skyrocketed by well over 200%. Although federal student aid programs are often championed as a necessity, they have been instrumental in making higher education unaffordable. The opportunity to pay for college by working a part-time job evaporated as soon as huge sums of money were handed out to anyone with a pulse. Since students no longer pay their tuition upfront, colleges are able to raise prices in perpetuity, knowing the government will step in and make credit easier and easier to obtain. As an added bonus, outstanding student loans account for 45% of the government’s financial assets. (WSJ)
  • Boeing was awarded a $2.1B contract with the Pentagon for refueling and transport aircraft. Boeing will provide the Air Force with 15 KC-46 tankers.
  • The Wall Street Journal reported, Apple executives have been meeting with India government officials in relation to tax and tariff exemptions, including a 15-year tax holiday on imports of components and equipment. Its expected that a new factory will be built there in the near future.
  • Apple plans to double the size of its services business within the next four years, turning revenues from the App Store, iCloud and its Music and video services into a nearly $50B annually by 2021.
  • Volkswagen has agreed to pay at least $1.26B to settle claims related to 75,000 3.0-litre engine diesel cars equipped with illegal emissions-test cheating software in the US.
  • Apple returned to revenue growth and said it would accelerate in the coming months, as sales of its smartphone rebounded around the world. But its outlook fell short of Wall Street’s estimates amid continuing sales declines in China and foreign currency exchange headwinds. (FT)
  • Trading volumes of US corporate debt hit a record level on Tuesday as more than $38B worth of investment grade, high yield and convertible bonds swapped hands. Banks and companies that hold investment grade credit ratings sold $177.9B of debt in January.
  • Facebook is creating an app for television set-top boxes, including Apple TV, giving it a home for video content – as well as a new vehicle for video advertising. Facebook is also in discussions with media companies to license long-form, TV-quality programming, WSJ reports.
  • Illinois’ credit rating was downgraded one notch to BBB by Fitch on Wednesday, leaving the state two rungs above junk territory. Analysts attributed the cut to the state spending “far in excess of available revenues” and its failure to enact a full budget. (FT)
  • Snap (formerly Snapchat) has made public its filing for an initial public offering, which is expected to be one of the biggest tech IPOs in recent years. The company expects to raise $3B with a valuation of $20 – $25B and is looking to float its shares in March.
  • Chocolate industry executives have begun the year with a collective sigh of relief. The blow from the bankruptcy of a key cocoa industry player, Transmar Commodity Group, at the end of 2016 has been cushioned by excess inventory and other suppliers stepping in and making sure a key ingredient for chocolate is available for confectionery makers. The company is a top 10 supplier of cocoa beans and processed products for clients such as Hershey, Mars and Nestlé.
  • Amazon plans to schedule more than 200 flight departures and landings per day at a $1.5B cargo hub it’s building near Cincinnati, in a sign of the online retailer’s soaring shipping ambitions. Amazon has disclosed leasing 40 Boeing 767 and is also building operations at smaller airports across the country.

International Snippets

  • Iranian supertankers are sailing to Europe for the first time since sanctions were eased last year as one of the world’s biggest crude shippers moves to step up deliveries.
  • Turkey and the United Kingdom will form a joint working group to formulate a post-Brexit trade deal. The two countries announced a goal of increasing annual trade from $15.6B to $20B.
  • Greece faces an “explosive” surge in its public debt levels within decades that will mean it will owe almost three times the country’s annual economic output according to the International Monetary Fund. The assessment underscores the difficulty of the IMF to fund a bailout.
  • Andrea Enria, chairman of the European Banking Authority, said in a speech on Monday that the scale of the region’s bad debt problem had become “urgent and actionable”, with lenders burdened by more than €1T of toxic loans. He proposes that the EU should create a taxpayer-backed fund to buy bad loans from struggling lenders.
  • Deutsche Bank agreed to pay $425mm to US authorities to resolve investigations into alleged mirror trades that “laundered $10B out of Russia”, in a move that would reduce one of the biggest remaining legal uncertainties hanging over the bank.
  • Iran has conducted its first ballistic missile test in another apparent violation of a United Nations resolution. The Khorramshahr medium-range ballistic missile flew 600 miles before exploding in a failed test of a re-entry vehicle. The launch possibly defies U.N. Security Council Resolution 2231, which calls upon Iran to not undertake any activity related to ballistic missiles capable of delivering nuclear weapons.
  • Theresa May on Wednesday night won a historic House of Commons mandate to start Britain’s divorce from the EU. Mrs May is on course to start the two-year Brexit process next month after MPs voted by 498 to 114 for a bill that gives her the power to invoke the EU treaty’s Article 50 exit clause.
  • A Japanese amusement park has taken a leap of faith by creating a restaurant with more robots than human workers. They are part of a government-funded project to examine which kitchen and food processes should be automated and which are left to humans as Japan bets on robotic innovation to revive the country’s struggling services industry in time for the 2020 Olympics. (FT)
  • Sony has once again missed its target. The Japanese electronics and entertainment group cut its annual profit guidance for the second time in three months, weighed by a $1B write-down on its film business. Sony had warned earlier this week that it would book $996mm write-down on its movie business, blaming a faster-than-expected decline in the DVD and Blu-ray market. The company said the majority of the goodwill impairment charge arose from the acquisition of Columbia Pictures Entertainment in 1989.
  • Banco Popular posted a €3.5B annual loss that is almost equal to its entire market capitalization of €4.1B.
  • Turkey’s annual inflation rate climbed by far more than expected in January as the country’s central bank battles with a tumbling lira and the worst pace of economic growth since the financial crisis. Annual inflation hit 9.2% last month from December’s 8.53%.

Paul McCarthy

Mr. McCarthy is the President and founder of Kisco Capital.