Market Response – Are we in a tantrum or a moment of terror? The market has reacted violently with volatility. The cause and effect can be seen clearly by the spike in 10 year bond yields. The market has reacted to fear of inflation with a vengeance. Although there is a note of caution from the central banks, their economic forecasts seems to remain in place. So, is this a sell off for a few days, a correction somewhere around 10%, or bear market pull back around 20% or more? With the synchronized global growth, Asia showing tremendous growth as a counterweight to the US and Europe, it feels more like a correction then the beginning of the bear. Volatility feels like a shock of pain, but realize this type of volatility was normal prior to 2008. We have become complacent and perhaps a bit spoiled with relatively calm markets for 10 years. Is this, as Warren Buffett describes, the “blood in the water”, opportunity to buy? Or an ominous sign of recession? We think this is more tantrum than terror.
The Markets –U.S. equities began the year on a very strong note. For January the S&P 500 opened the year at 2673, hitting a mid-month high of 2872 on January 26th. However the index finished the year on a pull-back settling at 2823 on January 31.
Washington – We received our Christmas present from the current administration in the form of a new tax bill. WCM will be writing more about this in the near future.
The Economy – Almost from the moment the tax bill passed, the soothsayers raised 2018 top line revenue estimates for the S&P 500 by some 14%. These same folks have also raised their expectations of bottom line earnings accordingly. One could conclude then, that they believe the S&P 500 Index will continue to climb at about a 14% pace this year. We aren’t so convinced and as always, we reserve the right to be smarter later.
Perhaps, what is most important to the sustainability of our current bull market is the market’s perception of the new Fed. Since the 2008 recession, the Fed has been a dove in that their primary focus has been employment. With the new Fed Chairman, Jerome Powell, not even warm in is seat yet, the bond market seems to be predicting a rise in inflation and the markets do not like it. The ten year US Treasury note yield has gone from 2.44% at Christmas to 2.86% today, a change of 17%. That seems to be signaling the Fed may have to raise rates faster and higher than previously thought just to head off inflation. What could cause this inflation? To begin with, higher oil prices will lead to higher prices at the pump. Those higher prices will lead to higher cost to deliver goods, which will lead to higher prices for those goods. It doesn’t take a rocket scientist to spot the cycle. Another bit of ammo for the inflation hawks is wage inflation. Since unemployment is at its lowest in many years, one could reason that the competition for qualified help is greater, which creates a bit of a seller’s market. The folks selling their services; truck drivers, dock workers, factory workers, etc. can sense that there is less competition for jobs, thus they can demand a higher wage. Again, it doesn’t take a rocket scientist, or economist, to see that upward pressure on wages can lead to higher cost of goods. The counter to that argument, and rightfully so, has been that technology has been driving efficiency and thus driving down costs of goods. If technology wins the battle, we see little inflation. If costs such as fuel and labor increase, then we see inflation. A bit of inflation, somewhere between 2% – 3% is considered normal and good. While higher, or hyperinflation, can certainly cause a recession. We believe that how this inflation story plays out will determine if we see the next leg up in the S&P or the end of the bull market. Stay tuned.
Headlines – As we begin the New Year it seems like more of the same political back & forth. House Intelligence Chairman Devin Nunes, R-California released a memo alleging the FBI abused its surveillance tools. The bottom line is that the memo is intended to call into question bias within the agency’s top ranks. This memo has released a fire storm of responses from the FBI, Congress, and the White House. The nation’s top intelligence and law enforcement agencies; the FBI and CIA are supposed to conduct their work without political bias or prejudices. This memo calls into question those very ideas. Due to the sensitive nature of intelligence activity we may never know all the facts. What we do recognize is that we haven’t seen this level of infighting among the various agencies and departments since Watergate.
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