Top Watch?

The news cycle is squarely focused on the proposed tax bill and the stock markets are looking for a catalyst to continue their march higher. As I warned earlier this year, a failure to have meaningful legislative changes in 2017 would be taken as a disappointment and could result in a reversal of the “Trump Bump”. Under the current proposal, it looks like we will get something more like tax cuts than hard-core reform (that would take too long). The largest beneficiary of domestic policies is the small cap stock index, the Russell 2000, which has pulled back 2.8% from its high in early October. Foreshadowing?

As I mentioned last week, volatility is inching its way back into stocks if you are watching the intra-day price movements. There continues to be unusually large price swings around earnings and the broader indices are pushing higher on fewer and fewer underlying stocks. There is evidence that the financials, homebuilders and industrial sectors are showing signs of a peak. Something good needs to happen as equities look pretty tired right now.

Why would we consider the markets topping now? The stocks market is a forward looking mechanism – most studies would tell you about six months. That means price action today reflects expectations of profits and the health of the economy over the next two quarters. Therefore, tops in the stock market always happen when things are “fine”. However, there are warning signs as I point out in the Economic & Central Banking Snippets section. In other words, stock markets peak before there are signs of an economic slowdown. To wit, in the 16 recessions since 1923, the peak in the Dow Industrials preceded the peak of the U.S. business cycle by an average of 3.75 months. In 1929, the peak came concurrent with the high in stocks while the longest lags occurred with the market peaks of 1968 and 2000 of 12 and 13 months, respectively (EWI).


Fun Fact of the Week

This chart shows the fuel mix for power generation across select countries:


Economic & Central Banking Snippets

  • The IMF is urging Japan to maintain its massive monetary stimulus in support of its struggling consumer prices. With inflation far from its ambitious 2% target, the BOJ has said it is nowhere near dialing back its huge asset purchases even as its U.S. and European counterparts eye an exit from crisis-era policies. (FT)
  • On that note, let’s not forget the projection of central bank activity into 2018. By the end of 2018, central bank purchases are projected to wind down in tandem across the globe. The Fed will be first to tap the brakes on its liquidity train as they are beginning this process now. How will equities price in the withdrawal of this liquidity for 2018? Now that we are on this path, it will be telling if the central banks back-peddle on their own projections in the coming months. That would be a big negative in my mind as that would telegraph global economies are being held together through debt expansion enabled by low interest rates and central bank quantitative easing (asset purchases). The jig would then be up.


  • As I mentioned in the opening statement, the financials (banks) are showing signs of peaking. Conventional wisdom says higher interest rates are good for banks as it helps their margins but only if it is coupled with loan growth. Think of small and medium sized businesses looking to invest and expand their operations by borrowing. The chart below shows the rate of loan growth as compared to the previous year. As you can see, loan growth topped out around 2015 and now we are approaching the centerline of 0%. The shaded areas in the chart represent recessions. As loan growth approaches the zero line, there is always a recession somewhere in the vicinity. Will new tax polices, trade deals and reduced regulations spur growth activity in C&I loans? The trajectory does not look good so something needs to happen soon.


  • Let’s not forget the foreign banks, already crossing the centerline.


  • One last chart of retail employees. Again, notice how there is a recession every time we hit the centerline since WWII. Retail has always been the canary in the coal mine for me and the chart below shows why. Keep in mind that Amazon isn’t the only reason behind brick & mortar store closures.


Chart Time

S&P 500 (SPY)




Russell 2000 – Small Caps (IWM ETF)


10 Year Treasury Yields – TNX


Market Snippets

  • This chart shows Moody’s upgrades and downgrades in the energy sector. If we see crude oil prices test the 2015 lows, that could put considerable stress on the smaller players in the energy sector as many carry below investment grade ratings. A sustained move below $30 would likely see defaults follow in short order.


  • Speaking of below investment grade bonds, the two largest junk bond ETFs, are at their lowest levels in seven months as declines and fresh outflows inject volatility into the asset class. The downward movement has been intensified by lackluster quarterly results by some of the largest high-yield bond issuers, which are often among the biggest holdings of the popular ETFs. (Seeking Alpha)
  • The worsening glut of private jets attests to another deflationary precondition. According to Bloomberg, “corporate jet makers are flooding the market, spurring deep discounts for new aircraft and fueling a three year slide in prices for used planes.” Honeywell International just surveyed 1,500 corporate flight departments, finding that their plans to buy planes hit a 17-year low.
  • The first truly autonomous cars — vehicles that cruise the public streets with no one sitting behind the wheel to take over in case of emergency — have finally arrived. Waymo, which began life as Google’s self-driving car project, disclosed on Tuesday that it had let its driverless cars loose in parts of Phoenix, Arizona, with nobody in the front seats. (FT)
  • The U.S. National Aeronautical and Space Administration (NASA) has entered into a formal services contract with Uber to develop software for “flying taxi” routes, Reuters reported Nov. 8. The joint project with NASA is the first contract of its kind related to low-altitude airspace, as opposed to outer space. Uber will join other industry partners to work with NASA in developing driverless air-traffic management systems. Uber will be involved with Phase 4 of the NASA project, conducting service testing in high-density urban areas, starting in March 2019.

  • Walt Disney Co announced Thursday its commitment to create yet another “Star Wars” trilogy. The company will keep director Rian Johnson, the creative mind behind “The Last Jedi,” on the project as both writer and director.
  • Robots have replaced many U.S. manufacturing workers, but new mechanical exoskeletons (think Ripley in Aliens) are being tested by Ford which may help factory workers function like bionic people. Two of the automaker’s U.S. factories are trying out upper-body devices developed by Ekso Bionics, which are designed to increase productivity and reduce the physical damage of repetitive tasks over many years.


International Snippets

  • The bolivar weakened further in the black market. One has to bring “bags” of the Venezuelan currency to buy one US dollar.


  • In a purge that sent shockwaves through the Middle East over the weekend, dozens of ministers, royals, officials and senior military officers were dismissed or arrested as part of a new anti-corruption campaign. It was another huge stride towards absolute power by Mohammed bin Salman, the young crown prince and de facto ruler of Saudi Arabia.
  • Meanwhile, Turkey’s inflation keeps climbing, with the core CPI at dangerously high levels. The central bank is powerless to do anything about this because President Erdogan wants rates cut, not raised.

Paul McCarthy

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