2017

HUTCHENS INVESTMENT MANAGEMENT WEEKLY COMPASS August 14, 2017

on Monday, 14 August 2017. Posted in 2017, August

HUTCHENS INVESTMENT MANAGEMENT WEEKLY COMPASS August 14, 2017

A Geopolitical Exercise

Today, August 14th, stocks are rallying as headlines read “Markets rally as North Korean tensions ease.” This should not surprise long-term market followers as most instances of geopolitical fears quickly abate. While there is no timetable for the return to “business as usual,” the uncertainty subsides. This is not to say that the events leading up to the geopolitical uncertainty have disappeared, but rather digested by the market. The real change is in the perception of the geopolitical threat. The reaction of the market to the saber rattling was classic. Momentum-oriented traders reassess their positions and risk is repriced. The pricing exercise results in a multiple compression of P/E’s and shares are liquidated. Non-committal momentum traders sell as prices rarely matter nor do the fundamentals of the underlying companies. None of the technology or biotech stocks sold last week had any economic involvement in the Korean crisis. Bear markets result from economic deterioration, not from geopolitical events. More selling may return as headlinehungry media focuses on impending war and its aftermath, but barring actual confrontation, any selloff will be short lived. Each geopolitical crisis is different depending on market valuation and perceived risk of holding these momentum stocks.

That being said, stocks should continue to rally as geopolitical tensions decline. There will be some shift away from more speculative smaller companies as well as caution with Large Cap technology and biotech companies. We would expect the Industrial and Financial sector to benefit from the reallocation. Retail remains weak but in fact, it is more of a shift away from low tech brick and mortar to Internet convenience. This trend will continue until a profitable balance is reached. Store consolidation will accelerate, along with changes in merchandising; it may take years to reach equilibrium. Consumers, particularly Millennials, will dictate the timing for retail spending in a world of both online and offprice. The FANG stocks have been tainted as Amazon and Alphabet (Google) disappointed on 2Q2017 earnings. Other companies priced to perfection, such as Tesla and Nvidia, cannot afford any mistakes. Excessive optimism reflected in current valuation may be justified for companies with accelerating corporate profits through 2018. Additionally, low interest rates justify higher than historical P/E’s.

Corporate Earnings: Locked and Ready

Earnings of S&P 500 companies rose over 10% in 2Q2017. Revenues were up a surprising 5.1%. According to FactSet, 73% of the companies in the S&P 500 reported EPS above estimates. For sales, 69% of the companies were above forecasts. Both earnings and revenues were above the 5-year average. As shown in the Table below, 10 sectors have reported year-over-year earnings growth in 2017, led by Energy, Information Technology, Utilities and Financials. The Consumer Discretionary sector reported a decline in earnings of 0.3%. Amazon reported EPS of $0.40 for the quarter, down 77.5% from 2Q2016. Excluding Amazon, the EPS for the Discretionary sector would be a positive 1.8%.

8 17 table

The forward 12-month P/E for S&P 500 companies is 17.4X, above the 5-year average 15.4X and the 10-year average 14.0X. Based on consensus earnings estimates the bottom-up 12-month target for the S&P 500 Index at the current P/E is 2,705, which is 10.9% higher than the 8/11/17 close. We anticipate earnings higher than as currently forecast.

Investment Policy

Our investment policy remains optimistic. Despite the recent selloff, our view does not assume a meaningful decline resulting in a market correction of 10% or more. Over the past two months, more than 1/3 of listed companies have had a 10%+ correction, led by Energy, Retail and Technology sectors. Going forward into 2018, the tailwinds will be better-than-expected earnings, low inflation, moderation in rate increases, and strong consumer confidence. We expect the economy to grow at a 2% annual rate for 2017, but data for wages, housing and Internet retail will continue to improve as the consumer remains healthy and willing to spend. At this time it is unlikely given the strength in the economy and the outlook for corporate earnings that the long-term bull market will be interrupted. Realistically the positives from expansionary US policies will take more time than generally expected. Longer term we believe that consumer-led economic growth, accompanied by slow rising real interest rates and moderate inflation, will result in increased earnings and multiple expansion with further upside for select domestic Large-Cap Consumer Discretionary, Technology and Industrial companies. Portfolios should include companies exhibiting accelerating earnings growth, solid fundamentals, expanding P/E ratios, and a sustainable business model.

Authors:
David Minor
Rebecca Goyette

Editor:
William Hutchens

HUTCHENS INVESTMENT MANAGEMENT WEEKLY COMPASS July 31, 2017

on Monday, 31 July 2017. Posted in 2017, July

HUTCHENS INVESTMENT MANAGEMENT WEEKLY COMPASS July 31, 2017

More for Less in a 2% Economy

“Technology makes the world a new place.”

                                    Shoshanan Zuboff

 

The 2% economy chugs along; earnings moved double digits, major averages set new highs, tech with some bumps continues to dominate, and the Wall of Worry gets higher.  The recently released 2Q2017 GDP report shows real growth at 2.6%, and when averaged with 1.2% for 1Q2017, gives 1.9% for 1H2017.  Estimates for the second-half 2017 remain in the 2%-2.5% range.  The inflation rate remains below the desired 2% and interest rates remain lower than had been expected.  The Fed FOMC meeting left interest rates unchanged, but gave indications of a balance sheet unwinds in the not-to-distant future.  Another sharp selloff in the tech-heavy NASDAQ brought the technicians to claim an “Outside Reversal,” signaling an intermediate top with a possible reversion to the 200-Day moving average.   
 
As intelligent investors know, stocks do not go up in a straight line forever.  Although looking at the charts of the major averages since the lows in February 2016, it certainly did over 17 months.  From those 2016 lows until its record highs last week, the S&P is up 37.2%, while the NASDAQ Composite rose 53.5%.  Over the same period, the S&P 500 Information Technology Sector rose a staggering 74%, followed by Financials at 60% and Industrials up 45.3%.  Prior to the early-2016 correction, Healthcare was the undisputed sector leader.  But, since early-2016 it rose a paltry 23%.  Over this time the economy, measured by real GDP, grew at 1.9%.  Earnings and revenues flatlined in 2016 as energy prices fell and then rose modestly and the dollar strengthened.  Throughout this period, Volatility, as measured by the CBOE Volatility Index (VIX), remained in a 10-12 range before falling to a record low 8.8 last week.   
 
The combination of new record highs and a period of low volatility is taken by many as a prescription for a pullback, particularly for sectors in “extreme overbought” territory.  This seems to be the reasoning for the recent sharp sporadic downturns in tech.  The selloff in late-June/early-July for tech reversed and set new record highs.  But once again, last week into today the NASDAQ again is selling off.  One of the reasons cited by investors negative on equities is the lack of buying power in the form of potential inflow.  As evidence, bears mention that cash holdings at Charles Schwab are at a historically low 11.5%, compared with a historical average of 15.6%, concluding that the market is near a peak.  However this conclusion does not address the possibility of rotation out of fixed income into equities, a strong likelihood as rates begin to rise.  According to Morgan Stanley, net exposure to equities of their Prime Broker Content (Hedge Funds) is at 46%, reflecting a lack of commitment.  Additionally, Mutual Funds are 54% equities, below the 59% in 1999 and 56% in 2008.  Moreover, a combined outflow of equity Mutual Funds and stock ETF’s was $29 billion in the past month.   
 
Over the last few years, our Reports have discussed the back-loaded consumer.  The financial condition of households is in the best shape since the 1980’s.  But this consumer has become accustomed to convenience and productivity at a lower price.  This preference shift has created shocks to retailing and many aspects of everyday life.  How many people could go more than a day without a smart phone?  Getting more for less is not only redefining consumer spending, it is pervasive and affects all sectors of
the economy.  This is one reason for our long-term outlook for low inflation in a full-employment environment.     
 
Technology advances are the reasons for excess capacity utilization, particularly in manufacturing.  With levels below 80% there is less pressure to raise wages and build additional plant and equipment.  This is more evident in retailing with a rapid growth of the Internet, it is directly responsible for the closings of malls and big box stores.  These Internet retailers are expanding into urban areas, utilizing less space and catering to the lifestyles of the tech-centric millennials.  Free standing ATMS and Uber and other ride sharing services, have increased convenience and lessened demand for bank branches and car ownership.   
 
What appears to be a secular bear market for commodities limits the potential for inflationary pressures.  Technology affects all commodities, with sophisticated location equipment or highly technical extraction machinery.  This reduces costs and has created over supply for most minerals and industrial materials.  Advances in agriculture have increased output and limited the effects of droughts and floods, but nowhere are the changes more evident than in energy.  Advances in solar have lowered costs to an acceptable level and along with other renewable sources, approach 10% of energy consumption.  Fossil fuels best illustrate the effects of technology.  From a world of rapidly depleting oil and gas reserves, the introducing of fracking and other geological and related technologies has created a global supply glut never imagined only 20 years ago.  Oil and gas fracking continue to provide a disruptive force as supply is available at manageable costs.  Inflation in the energy sector is limited by technology and consumers and corporations benefit from more for less.   
 
As mentioned earlier, 2Q2017 earnings are better than even the more optimistic forecasts.  While traders focus on short term valuation, this earnings season shows the potential for rising corporate earnings going out through 2018.  Despite disappointment with Amazon and Google, Technology is leading the trend in continued earnings growth.  Combined with Financials, these two sectors are about 38% of the S&P 500 and are forecast to lead earnings growth through 2018.  FactSet reports that with 57% of the S&P 500 companies reporting, 73% of both earnings and revenues have beaten the mean estimates.  Overall, 10 of the 11 sectors are above forecasts.  Looking out into 2018, these two leading sectors are expected to grow earnings in double digits, along with Consumer Discretionary, Industrials, Energy and Materials.  Earnings are in the early quarters of elevated growth.  More important than the 2% real growth economy will be the balance among various sectors.

Investment Policy

Our investment policy remains optimistic. We do not discount the possibility of a market sell off as investors become frustrated with slow implementation of stimulative policies. However, any correction should be considered a long-term buying opportunity.  It is unlikely given the growing strength in the economy and the outlook for corporate earnings that the long-term bull market will be interrupted.  Realistically the positives from expansionary fiscal policies will take more time than generally expected. Longer term we believe that consumer-led economic growth, accompanied by slow rising real interest rates and moderate inflation, will result in increased earnings and multiple expansion with further upside for select domestic Large-Cap consumer, financial, industrial and technology companies.  To mitigate the potential of higher-than-expected inflation and multiple compression, portfolios should include value companies exhibiting sustainable earnings growth and dividends.

Authors:
David Minor
Rebecca Goyette

Editor:
William Hutchens

HUTCHENS INVESTMENT MANAGEMENT WEEKLY COMPASS July 17, 2017

on Monday, 17 July 2017. Posted in 2017, July

HUTCHENS INVESTMENT MANAGEMENT WEEKLY COMPASS July 17, 2017

Amazon Skews the World

“If consumers make better choices, the marketplace will change.”

                                                    Mike Huckabee

 

After a brief selloff stocks resumed their upward move with most of the broader averages setting record highs last week.  The NASDAQ remained 0.4% below its June 9th record after falling 4.2% in late June/early July.  This compares with a 2% downdraft for the S&P 500.  The Tech sector (XLK) closed 1.3% lower than its record high, also set on June 9th.  The turnaround in tech stocks was led by the LargeCap favorites, FANG + APPL + MSFT, all of which had fallen double-digits.  The selloff resulted in a reawakening of the permabears and the Fed watchers, while most bullish market-strategists focus on a shift away from Tech into Financials.  This is a normal rotation away from higher-priced growth stocks to value.  Large bank earnings thus far justify this strategy as the S&P 500 Bank sector (KBE) has rallied.  The after earnings Conference Calls have not confirmed the long-term earnings optimism as regulation, low inflation, and a flattening of the yield curve remain.  The KBE is up 5% over the past three months and 37.4% above year-ago levels.  It outdistances the XLK, which has risen “only” 26.4% year-over-year.  It is important to note that from a trader’s prospective, many of the leading tech stocks have not broken above their former highs, and therefore remain in a trading range.
 
In our opinion there is little likelihood of a bear market related to an impending recession.  The current bull market is in its ninth year and officially one of the longest in history.  For many investors the duration of the bull market and the accompanying P/E’s substantially above historic norms, leave them to constantly reevaluate risk.  With the negative media attention, investors remain anxious in spite of rising prices.  Fear that stocks are overpriced results in an instinctive reaction to sell in order to avoid the upcoming swift selloff in the beginning of the bear market.  Remember bear markets result from economic distortions or euphoria as experienced during the Internet bubble in 1999.  Although some economic imbalances in housing and energy exist today, they are manageable.   
 
Last week Amazon held Prime Day, the annual event was for 30 hours and sales were 60% above yearago levels.  According to data from the Consumer Intelligence Research Partners, 45% of Amazon’s 40+ million customers in the US have Prime.  Amazon collects $99 annually for a membership that yields an average of $1,500 in annual sales, compared to only $625 for non-members.  In an attempt to offset potential loss and market share, other retailers including Wal-Mart and Best Buy, competed with Prime Day.  Unlike Amazon, these “brick and mortar” retailers sell from their own inventory.  But Amazon, in addition to acquiring and selling merchandise on its own, offers a service called “Fulfillment by Amazon” that handles third-party sellers.  Amazon’s success is well-recognized, but our research leads us to believe it is not fully reflected in the retail data published by the Census Bureau in its monthly Retail Sales Report and utilized as an input for Personal Consumption Expenditures (PCE) and GDP.
 
Unfortunately for data consistency, Amazon only reports net sales however, data from the 1Q2017 earnings release shows retail third party sales were up 34% for year-ended 1Q2017.  According to a study
done by Taxjar, in 3Q2013 third party sellers “were generating more than $17 billion of Amazon’s $32 billion gross merchandise value.”  Our own unsophisticated survey conducted on Prime Day showed that the third party fulfillment merchandise was 54% of all sales.  This percentage varies greatly within the various retail categories.  Amazon tends to sell more of the $200 and over items with only 30% being sold by outside suppliers.  Since Amazon does not report Gross Merchandise Sales in its financials, where then does the Census Bureau get their numbers?  Even if Amazon reports sales, it would be for Amazon itself and not the tens of thousands of third party suppliers (fulfillment is another income category).  As the number one or two retailer for most categories (books, clothing, electronics and furniture), if unrecorded the absence of these sales are significant.   
 
According to Morgan Stanley, Amazon accounted for 38.5% of the growth in 1Q2017 retail sales.  Data reported by the Census Bureau are from a probability sample of 4,700 employer firms selected from the Monthly Retail Trade Survey, all the monthly data are benchmarked to a larger annual survey for the previous year.  Aside from sampling error, non-sampling error can occur for “insufficient coverage for retail business.”  The Census Bureau claims the Retail Sales Report includes sales from pure-play ecommerce and retailers, but third party suppliers could easily fall between the definitional cracks.  It has been our contention that these sales may be uncollected and therefore absent from consumer purchases.  Healthy consumer balance sheets, full employment, low gas prices, and the level of consumer sentiment do not justify PCE for GDP at an historically low 2.0%-2.5%.  As consumers continue to get more for their money, the 2% real GDP growth does not justify 10% increase in quarterly earnings.  We will carefully monitor for an increase in the July Retail Sales Report to see if Prime Day significantly moves the needle.  
 
A vibrant consumer seems to be lost in the data which does not reflect the rapidly changing demographic and the seismic shift in retail.  As we have stated, the Gross Output is a better indication of economic activity rather than final sales (Compass 09-15-14.)  Corporate earnings are more reflective of Gross Output as it takes into account all goods and services used in the production process, including intermediate production rather than final consumption.  In this measurement PCE is only about 38%.

Investment Policy

Our investment policy remains optimistic. We do not discount the possibility of a market sell off as investors become frustrated with slow implementation of stimulative policies. However, any correction should be considered a long-term buying opportunity.  It is unlikely given the growing strength in the economy and the outlook for corporate earnings that the long-term bull market will be interrupted.  Realistically the positives from expansionary fiscal policies will take more time than generally expected. Longer term we believe that consumer-led economic growth, accompanied by slow rising real interest rates and moderate inflation, will result in increased earnings and multiple expansion with further upside for select domestic Large-Cap consumer, financial, industrial and technology companies.  To mitigate the potential of higher-than-expected inflation and multiple compression, portfolios should include value companies exhibiting sustainable earnings growth and dividends.

Authors:
David Minor
Rebecca Goyette

Editor:
William Hutchens

HUTCHENS INVESTMENT MANAGEMENT WEEKLY COMPASS June 26, 2017

on Monday, 26 June 2017. Posted in 2017, June

HUTCHENS INVESTMENT MANAGEMENT WEEKLY COMPASS June 26, 2017

Everything in Moderation

“Moderation is the secret of survival.”

                       Manly Hall

 

Stocks continue to set new all-time highs.  All major averages (Dow Industrials, S&P 500, NASDAQ Composite and the Russell 2000) recently made new highs, accompanied by highs in breadth.  Since the beginning of the year the NASDAQ is up 16.4%, reflecting the 19.8% increase in the S&P 500 GICS Technology sector over the same period.  The S&P 500 rose for the seventh straight month in a row in May and has recorded 24 record closes for 2017.  Despite the move to new highs, the recent rate increase at the Fed’s June 14th FOMC meeting and unveiling of their plan for unwinding its balance sheet has diverted attention back to Fed policy and the recent flattening of the yield curve.  The flattening yield curve is often interpreted as a leading indicator of an economic slowdown and eventual recession.  This past week the yield of the 10-Year and 3-Month Treasuries approached their one-year low.  However, according to the Bespoke Investment Group, this is not a forecast for falling stock prices.  They stated that “Instances since 1990 in which the yield curve of the 10-Year and 3-Month Treasury is at 52 week lows the return for stocks was surprisingly good.  The S&P 500 averaged 2.24%, 5.33%, and 9.33% over the next one, three and six months, respectively.”   
 
The bearish view anticipates a flattening of the yield curve to be a precursor of inversion.  The rate increases by the Fed are too slow in an economy experiencing excesses; this is far from the situation today.  The low rate of inflation has misled bears to misinterpret the current moderate flattening.  In this environment we expect that Fed policy will remain data dependent to adequately negotiate the current slow growth situation.   
 
The Moderate Economy
 
The US economy remains at 2% real growth.  There are many different factors limiting the upside, some of these are regulatory and demographic, but in large measure it is the technological advances in the marketplace allowing consumers to purchase more for less.  It has taken nearly 10 years to restore a sense of balance in the economy.  Both banking and housing were, and still are, affected by government banking regulations.  The rise of the largest demographic, 85 million Millennials, is becoming fullfledged participants in the economy and the impact of innovation on everything consumer.   
 
Banking – The enactment of many restrictive regulations during the Great Recession to limit the farreaching “destructive power” of large banks, curtailing risk but at the expense of slow economic growth by the government assuming the role of the private banking system in the recovery.  The current review of Dodd-Frank may lessen some of the more onerous regulations, but a full repeal seems unlikely.  The most recent “Stress Test,” which all banks passed, opened the door of opportunity for banks to seek approval
from the Fed to raise dividends and to initiate new or increase stock repurchases.  This may in part, explain some of the recent flow of funds into the banking sector.   
 
Housing – remains the largest asset for most consumers, but securing the “American Dream” is much harder today than prior to the 2000-2009 fiscal crisis.  The housing market is far from stable.  Needless to say, things are slowly improving as the supply/demand imbalances continue to impede steady growth.  Among these problems are:
 
A.  Regulations.  Mortgage qualifications are much harder on potential homeowners, this has severely impacted first-time buyers.  Building regulations have added up to 25% of the builder’s costs, and to some extent created a shortage in the supply of labor.  This lack of skilled labor has affected primarily small contractors who are unable to continue building houses and have left the market.  This is, in part, the result of the expansion of government disability rolls immediately following the collapse of the housing industry in 2008.  Federal checks in hand, many tradesmen found additional sources of income that enabled them to remain on government assistance.  With the industry in depression for years there were no new workers trained.  Today, a short supply of skilled construction workers are driving builder’s costs higher, not all of which is passed on to home purchasers.   
 
B. The Cost of Homeownership.  With the median prices for new and existing homes at record levels, the percentage of homeownership is at historic lows.  The median price for a new home in May 2017 is $345,800, and for existing homes $254,600, respectively up 16.9% and 5.8% over May 2016. Inventory for new homes is 5.3 months and 4.2 months for existing homes.  The level for existing homes is exceptionally low and has resulted in bidding wars reminiscent of the 2005-2006 housing boom.  Renters are avoiding purchasing homes because of the high prices and according to the National Association of Realtors, only 52% of potential homebuyers feel it is a good time to buy now, this is down from 62% a year ago.  Instead of buyer demand creating supply, the high home prices have created disequilibrium.  Lower priced or starter homes are in short supply as builders target first-time homebuyers rarely pricing homes below $200,000.  Investors take advantage with cash offers to buy lower-priced homes for single-family renters.  An inadequate supply of affordable housing is the problem and although housing data will remain positive, the upward trend will be erratic.
 
 Oil Prices – once again lower prices of crude oil are being touted as an indicator of slower economic growth.  But unlike housing, the problem is oversupply.  OPEC plus non-members led by Russia agreed in May to extend production cuts to reduce global supply by 2% through March 2018.  Since then, overall production has increased as crude has fallen into a bear market.  Today, WTI closed at $43.47 a barrel, down 20.2% from its peak of $54.45 a barrel on February 23, 2017.   US crude rig count peaked at 1,609 in October 2014 and hit a low of 316 in May 2016, the lowest level since the 1940’s.  As of June 23, 2017 the rig count is back to 758.  Breakeven levels continue to fall with about 40% of the decline coming from lower costs from equipment providers.  Technological innovations in fracking have improved decline rates, meaning wells are lasting longer, producing more and fewer wells are needed to increase current output.  Wells are producing below $40 a barrel with some as low as $20 breakeven.  Competition is Saudi Arabia which produces at $23 a barrel.  Aside from lower cost, the improved regulatory environment will add to US production and transport, opening up export opportunities.  Consumers are the major beneficiary, as gasoline demand has risen while maintaining lower prices.  Unfortunately, the Energy sector (XLE) is down 14.7% so far this year.

Investment Policy

Our investment policy remains optimistic. We do not discount the possibility of a market sell off as investors become frustrated with slow implementation of stimulative policies. However, any correction should be considered a long-term buying opportunity.  It is unlikely given the growing strength in the economy and the outlook for corporate earnings that the long-term bull market will be interrupted.  Realistically the positives from expansionary fiscal policies will take more time than generally expected. Longer term we believe that consumer-led economic growth, accompanied by slow rising real interest rates and moderate inflation, will result in increased earnings and multiple expansion with further upside for select domestic Large-Cap consumer, financial, industrial and technology companies.  To mitigate the potential of higher-than-expected inflation and multiple compression, portfolios should include value companies exhibiting sustainable earnings growth and dividends.

Authors:
David Minor
Rebecca Goyette

Editor:
William Hutchens

HUTCHENS INVESTMENT MANAGEMENT WEEKLY COMPASS June 13, 2017

on Tuesday, 13 June 2017. Posted in 2017, June

HUTCHENS INVESTMENT MANAGEMENT WEEKLY COMPASS June 13, 2017

Chicken Little; Short Seller

“The sky is falling.”

                       Chicken Little

 

The selloff that began in technology stocks on Friday and continued through Monday has elicited a broad range of opinions from market strategists.  Those negative on the market seized on the idea that it is a drawdown of the FANG+AAPL+MSFT that is long overdue.  The real bears are not stopping at technology, they believe this trend will broaden beyond to other sectors and expose the “weakening economy and the slowing earnings growth.”  Permabears are already stepping forward to claim the title “I told you so.”  Seems to lack as much credibility after 10 years as Chicken Little did claiming the “sky is falling.”  The conditions initiating the Tech selloff began after noted “activist short-seller” Andrew Left issued a report on chip maker Nividia (NVDA), concluding overvaluation as the primary reason that the chip stocks would go down.  He shorts the stock prior to the report released through his firm Citron Research.  No doubt by conventional fundamentals, NVDA carries a lofty P/E (41.1X), along with a 238% price appreciation over the past year and 50% over the past three months.  Whether the argument on value is valid has little to do with the trade.  Left already alerted other short sellers after taking his position.  For those who missed his call, he had an exclusive interview on CNBC’s “Half-Time Report” on Friday.  By the close, NVDA was down 10%.     
 
This was not Left’s first report on NVDA overvaluation.  In December 2016 he predicted the stock to fall at $90, but it rose to a high of $165. Persistence, capital, and in Left’s, case broad media exposure, are the tools of his trade.  The fact he has made some credible calls on questionable company practices does not always spill over into valuation calls.  But timing is everything.  The Citron report follows Citi, Merrill Lynch and UBS, raising target prices up to the $180’s over the past few days as their previous targets were surpassed.  As mentioned on these pages many times, 85% of hedge fund money is with 5% of the managers.  With about 8,000 hedge funds, that leaves 7,600 managers competing for 15% of the remainder.  Many of these funds are trading firms, including algorithmic and flash traders.  These funds trading long and short and accentuate the movement in both directions.  Performance under these circumstances requires quick moves, getting in early and out before a turnaround.  Smart money has already been made in NVDA.  With all the hype of the recent FANG+2 stocks, it is not surprising for short-sellers to apply the subjective term of overvaluation to tech stocks that have run up nearly 50% over the past year.  There have been rumblings of similarities to the 2000 tech bubble for some time.
 
With regard to the FANG+2 stocks it has come to pass that without overweighting these favorite LargeCap growth stocks, it is virtually impossible to outperform the S&P 500.  While this is true to some degree, but generalization does not take into account that the 50 largest winners in the S&P 500 were up 8.35% year-to-date through April, while the 50 worst performers were off 6.57% over the same period.  It is also interesting that for year-to-date through last Friday, the Equal Weight S&P 500 rose 8.62%, while the Cap Weight S&P 500 was up 8.25%.  Whether the large tech valuations are ahead of fundamentals is a subjective judgement and not a primary consideration for momentum traders.  Academics believe that
an efficient market for stocks exists however, people like Andrew Left have shown value is in the eyes of the beholder or short-sellers.  Others note that the S&P 500 has not had a 5% selloff since July 2016 - - the longest time period since 1996.   
 
The immediate response to the Tech selloff among the many professionals was a reorientation of portfolios away from Tech and into Financials.  This is not readily apparent although there is rationale to such a rotation.  Since the beginning of the year through last Friday, the S&P 500 GICS Financial sector was up 4.1%, while Tech rose 18.6%.  The Fed is expected to raise interest rates 25 basis points this week and, the Comprehensive Capital Analysis and Review is being released by the Federal Reserve on June 28 and many expect the report to show the benefits of lessened regulation; giving economic rationale to rotation.  Also, money managers and individuals hold outsized profits in Large-Cap tech stocks (S&P 500 GICS Technology Sector is up 32.0% year-over-year), an incentive to taking long-term capital gains at current levels.
 
Whatever the reasons for the selloff in the Tech Sector, the companies that have gained 40% or more since the beginning of the year are correcting.  But it will not be long before 2Q2017 S&P earnings are reported.  According to FactSet, current estimates are for a rise of 6.6% for earnings and 4.9% for revenues.  Nine sectors are estimated to show earnings growth, led by Energy (+404.3%), Technology (+9.3%) and Financials (+7.2).  All sectors except Telecom are expected to have revenue increases.   The current Tech selloff should not broaden to other sectors and it is more likely that any rotation will increase purchases in economic sensitive companies rather than out of equities.  The companies experiencing the rapid price depreciation are for the most part, innovative/well-managed and profitable with a growth outlook.  Readjustments of equity prices and sector rotation are common characteristics of bull markets working in conjunction with the business cycle.   
 
By Tuesday, most of the affected Tech stocks have stabilized and reversed course.  There is no guarantee that the selloff is exhausted.  There is a growing recognition that many of these Large-Cap Tech stocks are long-term winners.  The sharp declines on Friday and Monday morning are characteristic of algorithmic trading.  After three days, NVDA is at $150, down from its closing high on June 8th of $160, a day prior to the Citron report.  

Investment Policy

Our investment policy remains optimistic. We do not discount the possibility of a market sell off as investors become frustrated with slow implementation of stimulative policies. However, any correction should be considered a long-term buying opportunity.  It is unlikely given the growing strength in the economy and the outlook for corporate earnings that the long-term bull market will be interrupted.  Realistically the positives from expansionary fiscal policies will take more time than generally expected. Longer term we believe that consumer-led economic growth, accompanied by slow rising real interest rates and moderate inflation, will result in increased earnings and multiple expansion with further upside for select domestic Large-Cap consumer, financial, industrial and technology companies.  To mitigate the potential of higher-than-expected inflation and multiple compression, portfolios should include value companies exhibiting sustainable earnings growth and dividends.

Authors:
David Minor
Rebecca Goyette

Editor:
William Hutchens

HUTCHENS INVESTMENT MANAGEMENT WEEKLY COMPASS May 30, 2017

on Tuesday, 30 May 2017. Posted in 2017, May

HUTCHENS INVESTMENT MANAGEMENT WEEKLY COMPASS May 30, 2017

Down the Road to Normalization

“The pessimist complains about the wind; the optimist expects it to change; the realist adjusts the sails.”  

                                                                                                                      William Arthur Wood

 

Through last Friday the S&P 500 was up 7.9% year-to-date, meanwhile the mid-cap S&P 400 and smallcap S&P 600 rose 4.0% and declined 0.5%, respectively.  Unlike the S&P 500, which set a new record high last week, these other indices reached their highs earlier in the year.  Narrowing breadth reflects these returns for the S&P 400 and 600 indices.  The gains in the S&P 500 are the result of the top 15 stocks generating over half of the increase this year.  As earnings growth estimates continue to rise and investors believe the gains are achievable, expect a broadening in the markets.   
 
The narrow breadth is mirrored in lower volume and low market volatility.  High volatility is most often indicative of a declining market but, the Volatility Index has remained at historic lows since mid-April.  The only exception was the brief sell off in mid-May.  Technicians talk of this low volatility as a sign of complacency and as a precursor to a correction.  However, others have cited the increased use of index ETFs as a contributor to the current low volatility.  According to the Investment Company Institute, over the past ten years about $1.4 trillion flowed into domestic equity index funds.  Over the same period, $1 trillion flowed out of active managed mutual funds.  Today the top 50 ETF’s (2% of total) control twothirds of ETF assets, while the top 100 control 84% of the assets.   
 
The US markets are benefiting from a pro-business sentiment. To date, the 2% economy remains as underlying strength improves.  So far, buying into geopolitical fear, even if it comes about, has proven to be wrong.  The recent rally which brought broader averages to new highs is about positive change, synchronous global growth, solid 1Q2017 earnings, and low interest rates.  There is a change in attitude as individual investors are beginning to shift away from fixed income.  Funds are being invested overseas in ETFs for Europe and Emerging Markets.   
 
The Misrepresented Consumer
 
Over the past two years, our Reports have discussed at length, a “backloaded consumer” as the lynchpin to sustainable economic growth.  Consumers are now in the best financial health since the Great Recession.  But, interpretation of a report on consumer debt questions that outlook.   
The New York Federal Reserve Bank recently released its “Quarterly Report on Household Debt and Credit” for 1Q2017.  Aggregate household debt increased by $149 billion in 1Q2017 to a record $12.73 trillion, above the previous peak of $12.68 trillion in 3Q2008.  Economists, market analysts, and the media jumped on the headlines and implied the debt cycle is once again in full swing.  In reality, the raw data overwhelmingly show the strength of the consumer balance sheet, rather than focusing on the increase in liabilities.  For example, not reported is the fact the debt reaching a new peak is about 103% of disposable income, down from record 133% in 4Q2007.  This is the lowest level of the debt-to-income
since 2002.  More importantly, the level of debt is more manageable as the quality of the average borrower has risen to a 700 credit score, a level not seen since 2005.   
 
A shift in borrowing patterns, particularly with tighter regulation for home mortgages (68% of total debt), has reduced the level of risk significantly.  Using credit scores as a barometer of borrower ability to pay, the quality of loans has increased dramatically.  This is true across a broad range of consumer debt, with the exception of student loans.  At the height of the housing depression, in 1Q2010, 8.9% of mortgage loans were delinquent over 90 days.  Today that number is 1.7%.  For credit cards the same pattern exists, delinquent loans of more than 90 days were over 13% in 2010-2012, but has since dropped to 7.5%.  Both home equity and the “other” category, which account for 7.7% of the total loans, show the same pattern.   
 
Auto loans (10% of the total) are somewhat troubling.  However, the problem is being attended.   Auto loan delinquencies are only at 3.8% of the $456 billion of the auto total.  The length of the loan is more troubling because during the 2012-2015 period the overall credit quality of borrowers was low.  Recently, credit quality has improved, raising the 720+ credit score for borrowers up to the 60-65% for new loans compared with the lower quality borrowers (below 720) which dropped below 40% after accounting for  60% or more over the past few years.  Given the loan mix until 2016, it seems reasonable to assume many of the 6-7 year loans will fall into delinquency and repossession.  This does not take into account the likelihood that many cars may not last the duration of the loan.  If there is good news, it is that the current $17.2 billion delinquent is only 0.135% of total household debt.   
 
Student loans are a well-known problem that is priced into the debt equation.  Totaling about 10% of all household debt it is difficult to foresee a favorable outcome.  With a delinquency rate of 11%, over 50% of these loans are for students who attended “for profit” colleges and have not graduated.  Without a degree it will be almost impossible to collect these funds.  This should not have a direct effect on the average consumer.   
 
In conclusion, the record level of debt has been misrepresented as a burden for the consumer and a negative for the economy.  Further examination shows a more robust consumer on the verge of increased income and better opportunities as full employment approaches.  The rise in home prices and the stock market have been major contributors to the lowered ratio of household debt to net worth from a financial crisis high of 25.4% to 15.8%.

Investment Policy

Our investment policy remains optimistic. We do not discount the possibility of a market sell off as investors become frustrated with slow implementation of stimulative policies. However, any correction should be considered a long-term buying opportunity.  It is unlikely given the growing strength in the economy and the outlook for corporate earnings that the long-term bull market will be interrupted.  Realistically the positives from expansionary fiscal policies will take more time than generally expected. Longer term we believe that consumer-led economic growth, accompanied by slow rising real interest rates and moderate inflation, will result in increased earnings and multiple expansion with further upside for select domestic Large-Cap consumer, financial, industrial and technology companies.  To mitigate the potential of higher-than-expected inflation and multiple compression, portfolios should include value companies exhibiting sustainable earnings growth and dividends.

Authors:
David Minor
Rebecca Goyette

Editor:
William Hutchens

HUTCHENS INVESTMENT MANAGEMENT WEEKLY COMPASS May 8, 2017

on Monday, 08 May 2017. Posted in 2017, May

HUTCHENS INVESTMENT MANAGEMENT WEEKLY COMPASS May 8, 2017

Earnings Trump Swamp

The major problems of attempting to input politics as a significant variable in determining investment strategy is “politics by definition is irrational.”  Excepting external events such as war or financial crises, markets quickly adjust to changing political conditions.  It is best to ignore the short-term political dysfunction and take a longer term view from the direction of the economy.  This is particularly important today as political chaos reigns in the media, but more importantly, the underlying economy continues to improve.
 
As of last Friday the S&P 500 was up 7.2% year-to-date, and just about at its record close on March 1, 2017.  The major difference is that the net new highs as a percentage of the S&P 500 is only 10.6% compared with 26.3% at the record high.   Although the S&P 500 breadth shows near-record levels, the net new highs are more concentrated in Technology and Consumer Discretionary, and more specifically the FANG stocks plus Apple and Microsoft.  These six stocks comprise 13% of the S&P 500 weighting and are all near or above 2017 highs.   Money managers, over the past two years, have had a difficult time beating the S&P 500 without being overweight these companies.   Also, the recent selloff in energy stocks has lowered the percentage of net new highs.   
 
Corporate Earnings
 
With the contentious Healthcare bill sent over to the Senate, tax reform moves center stage.  Healthcare has no significant financial impact and tax reform will be pushed well into the second half of 2017 or even 2018.  First quarter 2017 earnings have surpassed most estimates in breadth and quality.  FactSet’s Earnings Insight shows that as of March 5th, with 83% of the S&P 500 reporting, 75% have beat the mean EPS estimate and 66% have exceeded on revenues.  Overall, 1Q2017 S&P 500 earnings are up about 15% over 1Q2016.  For 2Q2017 estimates are forecast to rise about 8.0% and revenues 5.0%.  The most recent Forward 4-Quarter Growth rate is 9.8%, higher than all recent estimates creating a floor for S&P 500 prices moving forward.  (These estimates do not assume any tax relief whose primary beneficiaries are Energy, Technology and Healthcare the most.)  
 
InfoTech is the leading S&P 500 GICS Sector with a 16.5% price increase year-to-date through May 5th.  According to Thompson Reuters, with 85% of market cap of InfoTech reporting, 96% were at/above estimates.  Overall earnings were 6.3% above estimates.  For Consumer Discretionary, the sector average is up 10.8% year-to-date and with 64% of market cap reporting, actual earnings are 11.3% above 1Q2017 estimates.  A GICS sub-industry, Retail Internet leads a troubled Retail sector with actual earnings up 22.4%.  Energy shows a different picture.  Earnings are at/above estimates by 24% in 1Q2017 but prices for the Energy sector is off 10.7%.  This reflects the price decline in WTI which began in early-March and fell from $54 a barrel to below $44 a barrel last week.   
 
For market bears this recent decline in the price of oil is an indicator of slowing global growth.  However, there is reason to believe the WTI may no longer have any major role as an economic indicator.  Oil prices are now more reflective of technological advances, resulting in greater efficiencies and lower prices.  US Shale is the swing producer, offsetting OPEC reductions.  US Production forecasts have been rising since last year.  In April 2016, production was 8 million barrels per day and has risen to a current level of 9.2 million for April 2017.  Fracking is profitable for most US drillers over $50 barrel.   Production is expected to rise as break-even levels continue even lower.  Lower oil prices will be positive for lower input costs and for consumers, gasoline prices.  We continue to believe oil will track in a $45$50 a barrel range for the foreseeable future, even following the expected OPEC extension of production limits in June.  Also, the high yield market does not reflect any concern similar to 2015-2016.  

Investment Policy

Our investment policy remains optimistic. We do not discount the possibility of a market sell off as investors become frustrated with slow implementation of stimulative policies. However, any correction should be considered a long-term buying opportunity.  It is unlikely given the growing strength in the economy and the outlook for corporate earnings that the long-term bull market will be interrupted.  Realistically the positives from expansionary fiscal policies will take more time than generally expected. Longer term we believe that consumer-led economic growth, accompanied by slow rising real interest rates and moderate inflation, will result in increased earnings and multiple expansion with further upside for select domestic Large-Cap consumer, financial, industrial and technology companies.  To mitigate the potential of higher-than-expected inflation and multiple compression, portfolios should include value companies exhibiting sustainable earnings growth and dividends.

Authors:
David Minor
Rebecca Goyette

Editor:
William Hutchens

HUTCHENS INVESTMENT MANAGEMENT WEEKLY COMPASS April 24, 2017

on Tuesday, 25 April 2017. Posted in 2017, April

HUTCHENS INVESTMENT MANAGEMENT WEEKLY COMPASS April 24, 2017

Sell in May and Go Away

As May approaches there will be more and more discussion of this Wall Street adage.  Based on a British maxim (Sell in May and go away, and come back on St. Leger’s Day), this referred to the seasonal custom of wealthy Londoner’s leaving the heat of the city and going to the country and returning for the St. Leger’s Stakes, the third leg of the British Triple Crown in mid-September.  Ironically, when applied to the stock market, the results show the historical seasonality of returns.  Going back over a 65 year period from 1950 through 2015 the May-October period for the S&P 500 averages a loss of 1.7% with only 36 years positive, while the November-April period has returned 9.2% with 57 years of gains.  What is more astonishing are the 65 year gains (loss) on an initial $10,000; the May-October investment returned a    -$6,709 and the November-April period showed a gain of $2,496,640.00.   Why then do managers not follow this phenomenon?  Selling and buying stock is not a part-time business.  Although there are data to show that the markets over time follow a pattern, seasonality is not reason enough to sell stock.  The determinants of stock market valuation do not include seasonality no matter how many people head for the beach.  For Example, seasonality is questionable in October, which has four of five worst days in the S&P 500 since 1950, has three of the best five days.
 
Stocks, as measured by the S&P 500 Index, remain in a tight trading range which began after new highs on March 3rd.  As of last Friday, the Index was only 2.1% off its highs.  Examining the performance of the major S&P 500 sectors shows that Technology is clearly outperforming all other sectors, while relative performance favored Industrials and Consumer Discretionary.  The shift back to more economic sensitive sectors is significant as many managers have cited weakness in the economy for 1Q2016 to continue into 2Q2016.  Real GDP growth will be released this coming Friday and is forecast to be below 2.0%, with the Atlanta Fed’s GDPNow at 0.6% and most others in the 1.0%-1.5% range.  Whatever the number for 1Q it appears the economy is locked in at 2.0% for 2017, unless a retroactive tax cut passes before year-end.  Earnings, though still early in the reporting season, are coming in above expectations.  But it is too early to know how much optimism is already reflected in stock prices.  As we have said since the election, the Trump Agenda, if followed, would stimulate economic growth.  To date, nothing has changed except limited progress in the form of reduced regulation with no movement in fiscal policy.  Thus far, the swamp remains full.   
 
A Perfect Storm
 
Politics – Other than a Supreme Court appointment, the Congress, including both sides of the aisle, seem hell-bent on screwing things up.  Democrats are expected to vote against anything coming from the new Administration, but it is the Republican side that fails to realize the closing window of opportunity.  GOP Congressmen, sensing risk being tied to an unpopular president may undercut any controversial legislation as the midterm elections approach.  These are the same inept Republicans who voted eight times to repeal Obamacare and 40 additional times to get the Law changed, but not actually repeal it.  After all of this legislative BS, the GOP House members had no plan to replace the Law.  With only significance for a small universe of related healthcare stocks, the repeal of Obamacare is threatening the implementation of fiscal policy, which has been absent since the financial crisis.  Talk about a full swamp, this is quicksand.  

 The latest version of the Healthcare Bill reverses all the tax increases and cuts Medicaid substantially by setting up a separate fund for high-risk individuals.  Responsibility for the Fund would shift over to the States, thereby lowering the Federal Government costs which would offset the revenue shortfall for tax cuts.  Today, Speaker Ryan let it be known that there is no rush to vote on Healthcare.  This flies in the face of the President’s intention of passage within the artificially-hyped 100-day window.   Also today, a new NBC/WSJ poll shows 45% of respondents believe Trump is off to a poor start.  This accompanies a 40% approval rating, the lowest of any President in 50 years.  These low levels indicate growing frustration in the domestic agenda.  The snail’s pace of Congress is anticipated, but the new Administration shares the blame.  To date, 85% of key executive governmental appointments are unfilled. Of 554 requiring confirmation, 473 have no nominee and only 24 have been nominated, of which 22 confirmed.  The majority of these positions are still held by Obama appointees.  This is particularly troubling as Congress interacts with these appointees and also of concern is the sentiment of the Trump White House that there is no rush as they can ably do it alone.   
 
To avoid the missteps of Healthcare, the process for the Tax Bill will be more deliberate, allowing hearings and bipartisan overtures.  Democratic support is unlikely as agreement over tax cuts for the middle class relative to favoring the wealthy will short circuit any bilateral agreement between the party’s leaderships.  The recent Supreme Court nomination showed that the possibility of any meaningful crossover of the vulnerable ten Democratic senators is highly unlikely.  It will be a long slog with growing frustrations even if the repeal of Obamacare comes quickly.  For now, attention will be on the budget and the possibility of a government shutdown.  This should prove a short-term distraction and not an interruption with little or no effect on stock prices.   
 
The Economy – For the next couple of weeks after the release of the GDP data, the 2% economy will be characterized with low growth by persistent media comments of a slowdown continuing into the secondhalf of the year.   Permabears, uninformed bears, and the financial media will join together to herald the upcoming recession and the end of the nine-year bull market.  Not so, the economy is growing, interest rates and inflation remain low.  The global economy is improving, the IMF just raised its growth estimates across the board, and the China transition is succeeding as recent growth at 6.9% was above the estimate of 6.5%.  Oil has stabilized and trades in a $45-$55 a barrel range and French elections, scheduled for June, will have less impact on the US than Brexit.   
 
Growth, not contraction, in 2Q2017 as consumer spending, housing, and Capex improve.  Consumers, despite a slowdown in auto purchases, will be buoyed by a strong balance sheet evidenced by an historically low debt ratio.  Housing is backloaded with low inventory and home prices and rents are rising.  New Housing Starts were down in February from January, but rose 9.2% over last year and can be expected to rise in 2017 as millennials settle down.  We expect Single Family Starts to accelerate as the year progresses.   
 
There is much discussion on Retail Sales data from the Commerce Department, particularly the negative month-to-month declines in February and March 2017.  Almost all of the lower sales are in clothing stores and department stores.  Consumers have not stopped buying clothes, but have shifted away from instore purchases.  Credit Suisse estimates that over 7,000 brick-and-mortar stores closed in 2015 and 2016 combined.  For 2017, their estimate is 8,600 closings.  Whether voluntary or involuntary buyers will gravitate to online purchases.  Gasoline station sales are dictated by oil prices.  Buying the same amount of gasoline at a lower price is a negative for retail sales but an increase in consumer purchasing power.  On a year-over-year basis, Total Retail Sales rose 4% for 1Q2017.  Business fixed investment, an important step to increased productivity, is showing signs of improvement.   Elimination of non
productive regulations, particularly for small companies, has aided technological upgrades.  For larger companies, expanding Capex needs tax certainty.

Investment Policy
 
Our investment policy remains optimistic. We do not discount the possibility of a market sell off as investors become frustrated with slow implementation of stimulative policies. However, any correction should be considered a long-term buying opportunity.  It is unlikely given the growing strength in the economy and the outlook for corporate earnings that the long-term bull market will be interrupted.  Realistically the positives from expansionary fiscal policies will take more time than generally expected. Longer term we believe that consumer-led economic growth, accompanied by slow rising real interest rates and moderate inflation, will result in increased earnings and multiple expansion with further upside for select domestic Large-Cap consumer, financial, industrial and technology companies.  To mitigate the potential of higher-than-expected inflation and multiple compression, portfolios should include value companies exhibiting sustainable earnings growth and dividends.

Authors:
David Minor
Rebecca Goyette

Editor:
William Hutchens

HUTCHENS INVESTMENT MANAGEMENT WEEKLY COMPASS April 3rd, 2017

on Monday, 03 April 2017. Posted in 2017, April

HUTCHENS INVESTMENT MANAGEMENT WEEKLY COMPASS April 3rd, 2017

The Consumer:  A Case of Mistaken Identit

“Kites rise higher against the wind - not with it.”                                                                                                                                                                                                            Winston Churchill
 
 
Stocks rose during 1Q2017 for the sixth consecutive quarter.  The broader market, as measured by the S&P 500 Index, rose 5.5%, while the tech-heavy NASDAQ Composite rose 9.8%.  The S&P 500 rise marks the third best 1Q over the past 10 years.  But it is well-below the gains of 2012 (12.0%) and 2013 (9.9%).  Both of these years finished above 1Q levels; 13.4% in 2012 and 29.6% in 2013.  This current bull market has the S&P 500 up 254% from the March 2009 bottom, compared to the record 530% in 1987-2000.  The NASDAQ Composite is up almost 365%.  While these historic data give no indication of future market performance, it is interesting to note that the 2% economy is in its 34th month and is the second longest on record.   Many economic indicators resemble early stages of recovery; among these are inflation and interest rates.  Bear markets occur as excesses dominate the economy.  Today, there are no signs of a boom, leading us to conclude there is no bust on the horizon.   
 
Short-term there appears to be no new fiscal policy initiatives, but after a recession of the magnitude brought on by the financial crisis, history has shown that it takes at least a decade to restore the economy to a sustainable “normal” growth.  Now in the ninth year post-crisis, the economic data and business and consumer confidence are signaling “all clear.”  Most recently, Morgan Stanley reported that its March “Capex Plans Index” reached another postrecession high. The current five-month increase is the strongest in over seven years.  This increase parallels improvement in capital goods shipments resulting in solid growth in 1Q17 real capex.  Today, The Institute for Supply Manufacturing Index reported that its ISM Index hit 57.2, above the expected 57, marking the 94th consecutive monthly expansion for the manufacturing sector.  Of the 18 industries surveyed, 17 reported growth.  Also today, according to Markit, Global PMI in March was 53.0, a 69-month high.   
 
Despite the high levels of consumer confidence reported in the Michigan Survey and by the Conference Board, the sustainability of consumer spending is being questioned.  To adequately assess the consumer, the changing retail environment and the increases in productivity must be fully recognized.

A. Consumer dollar spending may not increase at reported levels of previous retail cycles because of a shifting away from traditional retail sales.  Online sales are in the early stages of future domination.  It is a fact that consumers get more for their buck and this trend will continue as competition from innovative retailers drives prices lower for Internet sales of traditional retailers.  The company-branded credit card offers cash incentives toward future purchases and has been long-utilized successfully by LL Bean and Costco, has made its way to Amazon Prime customers.  These new cards introduced in January offer various financing options, have no annual fee, and rebate 5% back as a statement credit.  Already, 23% of Amazon customers have an Amazon private label card, but according to a Morgan Stanley survey 13% of consumers without an Amazon card are “very likely to sign up for a new card.”  Of these potential card holders, 82% answered they would shop more at Amazon and 61% expect to shop less at other retailers.  Walmart Money Card offers 3% for online purchases, but only to a maximum of $75.00 annually.   
 
B. In our June 27, 2016 Compass, the competition between Amazon and Walmart was discussed, but as these retail leaders battle each other, the consumer wins and most all other retailers and suppliers suffer.  For years Amazon has offered product purchases directly from manufacturers and third party distributors.  Amazon does fulfillment and acts as distributor, cutting costs by eliminating third party wholesalers.  A portion of these savings are passed on to consumers.  Other companies such as Wayfair and Overstock.com specialize in furniture and home goods.  This trend will accelerate as Amazon GO moves into urban areas with groceries and perishable items putting pressure on supermarkets and local grocers.  To accomplish these goals Amazon and Walmart are pressuring producers to lower costs by dealing direct.  Combined
with free shipping, consumers can buy more but spend less.  Ultimately consumers will ratchet up purchases, spending on additional products.  Losers are the companies that cannot afford to meet the demands of Amazon and Walmart.   
 
C. The shifting retail paradigm makes it difficult to track retail sales.  As consumers benefit from lower prices from innovation, the old tried and true method of government monthly surveys becomes less relevant.  While big box stores and department store data collection are consistent, when online distributors offer fulfillment from thousands of companies a monthly survey likely does not include the sales of many large and small retailers, but only show up as fulfillment income for Amazon or Wayfair, etc.  This loss of sales is virtually impossible to estimate as the sellers fall below the radar for government surveys.  Additionally, these retailers are in and out of selling groups.

The consumer is spending, but not in the conventional way.  Two very diverse demographic categories, Baby Boomers and Millennials, are creating this distortion.  Millennials are not the consumers of prior generations.  Convenience brought this digital generation to an urban lifestyle where live, work, and recreate are foremost.  Also, travel as opposed to autos, suburban living, and marriage and family are of less importance as life is transacted online.  With the second largest demographic, Baby Boomers, reaching retirement age, spending is winding down and for many continued work is necessary to supplement pensions and Social Security and save money for unforeseen medical expenses.  There is nothing wrong with consumer spending but rather it is a shift in values, combined with the ability to get more product for less money that is misleading analysts.  Tracking the spending is more difficult and may not be sufficiently covered by current government statistics.    
 
As mentioned, Consumer Confidence is at its highest level since 2004 and Household Debt Services is at its lowest level since 1980.  Unemployment at 4.7% is at levels not seen since 2007.  Gas prices remain historically low and should continue to reflect the increase in supply of oil.  Personal Savings are at 5.5%, above the 4% pre-crisis rate.  With wage pressure beginning to accelerate the middle class may soon reestablish itself.  A tax cut would be a welcome stimulus.  A back loaded consumer may not create a Tulip Bulb Mania, but will extend the business cycle well-beyond expectations.
 
Investment Policy
 
Our investment policy remains optimistic. We do not discount the possibility of a market sell off as investors become frustrated with slow implementation of stimulative policies. However, any correction should be considered a long-term buying opportunity.  It is unlikely given the growing strength in the economy and the outlook for corporate earnings that the long-term bull market will be interrupted.  Realistically the positives from expansionary fiscal policies will take more time than generally expected. Longer term we believe that consumer-led economic growth, accompanied by slow rising real interest rates and moderate inflation, will result in increased earnings and multiple expansion with further upside for select domestic Large-Cap consumer, financial, industrial and technology companies.  To mitigate the potential of higher-than-expected inflation and multiple compression, portfolios should include value companies exhibiting sustainable earnings growth and dividends.

Authors:
David Minor
Rebecca Goyette

Editor:
William Hutchens

HUTCHENS INVESTMENT MANAGEMENT WEEKLY COMPASS March 20th, 2017

on Monday, 20 March 2017. Posted in 2017, March

HUTCHENS INVESTMENT MANAGEMENT WEEKLY COMPASS March 20th, 2017

Markets Look to Economy and Earnings.

“Life is really simple, but we insist on making it complicated.”                                                                                                                                                                                                              Confucius
 
 
Markets continue to move up despite a slowdown of momentum for the Trump Agenda.  The economy is on a pace to grow above the 2% level in 2H2017.  A chorus of permabears; David Rosenberg, Marc Faber, David Stockman and most recently joined again by Nouriel Roubini, are all in sync that markets are “doomed.”  Reasons may vary but the conclusion is unanimous.  Most often-heard for a correction is the extended length of the current bull market.  Presently, the 2009-2017 bull market is the second longest in history and third in appreciation.  Since the election the S&P 500 has gained 14.1% while the NASDAQ has risen 17.2%, both indices are near all-time highs.   Since the bottom on March 9, 2009, the S&P 500 has gained 257% but has remained one of the least respected bull markets in history.  Contrary to what many pundits predict at every selloff, stocks do not collapse from age.  In fact, the recent move in equities since the election is more reminiscent of 2013, when stocks measured by the S&P 500, gained over 30%.  Without any help from fiscal stimulus, full year 2017 earnings are forecast to increase 10%, but these estimates continue to be revised higher, unlike during the past three years.  For 2013, earnings grew an actual 6%, followed by 8% in 2014.  Both 2012 and 2016 had corrections early in the year.  In 2012 it was the European Sovereign Debt crisis and for 2016 it was oil, China and the US dollar.
 
The problems which led to the selloffs over the past few years have lessened or disappeared.  Europe remains in reflation mode and Brexit, although set to reappear March 29, is confined to the UK and the EU, fallout to US interests is minimal.  Oil, which in early 2016 approached $26 a barrel, has since doubled and hovers around a manageable $50 a barrel.  Even with cheating on output quotas, there is little chance of a retest of the lows of February 2016.  For years China was widely believed to be incapable of transitioning to a consumer economy.  Aside from avoiding the expected financial shock, it is now on a path to managing the debt cycle and longer-term the emergence of a high income economy.  The US dollar stabilized in 2016 and remains high, but below the peak levels of 2015.  The US Dollar Index (DX) is 8.8% above the May 20, 2016 cyclical low.   
 
There is little doubt that the election tipped the scales to growth.  The current Administration’s ability to rapidly enact its fiscal stimulus has been stalled by politics.  Firstly, Repeal and Replace ObamaCare was a bad choice as the initial policy initiative.  There is no economic value to TrumpCare, only fulfillment of years of GOP rhetoric on a better plan which thus far is unsubstantiated.  A replacement is 2-3 years away and will be contentious and headline grabbing at every turn.  Secondly, the cost estimates of replacement going forward from the Congressional Budget Office (CBO) will negatively affect tax reform.  With a sizeable conservative contingent, i.e. the Freedom Caucus, the passage of any budget busters is unlikely.  Demands for a “revenue neutral” tax bill will be center stage with higher health costs limiting the savings to individuals and corporations.  For the time being, it will be the rollback of Obama initiated regulations that will stimulate additional growth.   
 
Wall Street has not reacted to the first Trump Budget, knowing full-well it will not be passed as presented.  Congress holds the purse strings and for elected officials the proposed budget is extreme.  Defense will not get an additional $50 billion, nor will the cuts be as deep.  Where infrastructure spending winds up is anyone’s guess.  Throughout all these negotiations, there will be a unified Democratic opposition, whose primary purpose is disruption and delay.  For now the economy and earnings will have to carry the stock market.  Consumer and business sentiment currently remain optimistic and the prospect of additional reduced financial regulation is on the horizon.  Already, banks are broadening their loans and the removal of environmental restrictions have moved stalled energy projects forward.  Eventually it will be Tax Reform and the Repatriation of overseas funds that extend and broaden the current bull market.  
 
Investment Policy
 
Our investment policy remains optimistic. We do not discount the possibility of a market sell off as investors become frustrated with slow implementation of stimulative policies. However, any correction should be considered a long-term buying opportunity.  It is unlikely given the growing strength in the economy and the outlook for corporate earnings that the long-term bull market will be interrupted.  Realistically the positives from expansionary fiscal policies will take more time than generally expected. Longer term we believe that consumer-led economic growth, accompanied by slow rising real interest rates and moderate inflation, will result in increased earnings and multiple expansion with further upside for select domestic Large-Cap consumer, financial, industrial and technology companies.  To mitigate the potential of higher-than-expected inflation and multiple compression, portfolios should include value companies exhibiting sustainable earnings growth and dividends.

Authors:
David Minor
Rebecca Goyette

Editor:
William Hutchens

HUTCHENS INVESTMENT MANAGEMENT WEEKLY COMPASS March 6th, 2017

on Sunday, 05 March 2017. Posted in 2017, March

HUTCHENS INVESTMENT MANAGEMENT WEEKLY COMPASS March 6th, 2017

Will the Washington Circus disrupt the Bull Market?

“I remain just one thing, and one thing only, and that is a clown. It places me on a far higher plain than any politician.”                                                                                                                                Charlie Chapman
 
 
The most recent assertions by President Trump of wire taps in Trump Tower have unnerved even his staunchest supporters.  Whether it is true is unclear as the President has offered no evidence to support his claims, only a Tweet.  After outlining his agenda in a well-delivered State of the Union Address earlier in the week, the President put his own credibility on the line again on Saturday. For investors, these accusations should not matter, but rather it is the cumulative effect of these unsupported messages that bring his ability to manage within the Government into question.  Upcoming legislation will need all the GOP support for passage without distraction.  This week is the unveiling of a draft of “Repeal and Replace ObamaCare,” again something of no financial significance to the markets, that was until Trump trumped himself.  What should be a non-event for financial markets could be interpreted as a negative by some investors.   
 
Markets set all-time highs last week as the enthusiasm generated in Tuesday’s speech spilled over into stocks on Wednesday.  Through last Friday, the S&P 500 had risen 11.3% since the election and the NASDAQ Composite is up over 13%.  The rise reflects stability in the economy as housing, corporate earnings, and signs of capital investment lifted stocks and a healthy consumer began spending.  This pattern continues today.  However, the election of Donald Trump, fraught with controversy, but with a stimulative platform engendered confidence at the same time the economy was stabilizing.  Underlying strength in the economy continues but consumers are spending less than the historical pattern in prior recoveries.  Online is replacing brick and mortar, as the 85 million Millennials are changing housing and leisure preferences.  We have discussed in our past Reports how the demographic shifts would lengthen the housing cycle as families are started later and Baby Boomers remain employed beyond normal retirement.  It remains a 2% economy, although lessened regulation, tax reform, and proposed fiscal stimulus have the potential to increase growth beyond that level for the first time in eight years.   
 
Not since the financial crisis has Washington had such a major role in setting US economic policy.  Fortunately, the economy is at the stage of recovery to benefit from a fiscal stimulative agenda with the Fed standing ready to increase rates as inflation rises and growth accelerates.  How much and how soon depends on how fast policy initiatives become law.  After a new healthcare law, tax reform will move into the Congress.  Although Secretary Mnuchin expects enactment in 2017, the implementation of a revenueneutral tax plan may not bring 3% sustained real GDP growth.  This is particularly true if the controversial “Border Adjustment Tax” (BAT) is initiated.   A BAT, despite its revenue producing potential, has unintended consequences.  Among these are:   
 
 A long list of beneficiaries (net exporters and companies leveraging IP overseas), and an equally long list of companies at risk (industries with high import content).   
 
 Growth may increase but Personal Consumption could be slowed by higher costs and the potential of trade retaliation (external benefits at the expense of domestic spending.)
 
 Higher inflation could necessitate higher Fed Fund rates, thereby cutting economic growth and eventually ending the bull market.   
 
Today, markets are looking for the BAT as an offset to rapidly rising deficits.  For investors, the bond market is a leading indicator of its effectiveness.  Using the 10-year Treasury as a proxy for economic growth, we would look to interest rates to rise to about 4% without a stock market adjustment.  However, bears will point to an impeding recession before the 4% rate is reached, which could result in a midcourse correction.  For now, we are nowhere near that level for a definable correction (10% or more).   
 
Earnings Update
 
According to FactSet, with 98% of the S&P 500 market cap reported, 4Q2016 earnings and revenues rose an identical 4.9%.  In 1Q2017 analysts are projecting earnings growth at 9.0% and revenue growth of 7.3%.  For 1Q2017 eight of the eleven major S&P 500 sectors are estimated profitable and all but one (Telecom Services) are forecast to have positive revenue growth.   Earnings are dramatically improving as we approach 1Q2017 reporting season, and along with a healthy consumer provide the foundation for economic growth and in turn, stock market appreciation.  For now, the Circus in Washington is not a game changer for investors, but with the hostile atmosphere between all players, potential disruptions to the Trump Administration’s growth agenda, particularly tax reform, is likely.   Also, the President seems quite capable of self-inflicted chaos.  In such an environment, mid-course selloffs are inevitable (less than 10%).  Stock selection under these changing domestic and trade conditions speak to a more flexible investor.  Our investment policy will address these issues as the agenda moves forward.  
 
Investment Policy
 
Our investment policy remains optimistic. We do not discount the possibility of a market sell off as investors become frustrated with slow implementation of stimulative policies. However, any correction should be considered a long-term buying opportunity.  It is unlikely given the growing strength in the economy and the outlook for corporate earnings that the long-term bull market will be interrupted.  Realistically the positives from expansionary fiscal policies will take more time than generally expected. Longer term we believe that consumer-led economic growth, accompanied by slow rising real interest rates and moderate inflation, will result in increased earnings and multiple expansion with further upside for select domestic Large-Cap consumer, financial, industrial and technology companies.  To mitigate the potential of higher-than-expected inflation and multiple compression, portfolios should include value companies exhibiting sustainable earnings growth and dividends.

Authors:
David Minor
Rebecca Goyette

Editor:
William Hutchens

HUTCHENS INVESTMENT MANAGEMENT WEEKLY COMPASS February 13, 2017

on Monday, 13 February 2017. Posted in 2017, February

HUTCHENS INVESTMENT MANAGEMENT WEEKLY COMPASS February 13, 2017

Must Investors Adapt to a Trump Presidency?

“As long as a stock is acting right, and the market is right, do not be in a hurry to take a profit.”
                                                                                                                                Jesse L Livermore

There is no doubt that the “hit the ground running” President has created uncertainty in the political world.  But the economic data are positive on balance, and the seasonal January/February weakness of the past two years has been averted.  Last week’s announcement of the introduction of a tax reform package within the next few weeks is favorably reflected in stock prices.  Through Friday, the 1-year return for the broader averages is +24.2% for the S&P 500 and +32.9% for the NASDAQ Composite.  These returns are compared with the near-lows of a year ago February.  Since the election, the so-called Trump Rally has lifted the S&P 500 and the NASDAQ 8.4% and 10.4%, respectively.  Small and mid-cap stocks, represented in the Russell 2000 Index have risen 16.2% over this post-election period.   
 
Investors, rather than shifting strategy to adapt to Trump machinations, should keep a close eye on the slow-but-steady improving economy and the better outlook from corporate earnings.  The almost daily meetings with business leaders will have more economic significance than the green card fiasco, or even the temporary travel ban.  Despite the rapid succession of Executive Orders, in reality Washington moves slowly. Improvement beyond the 2% real GDP growth will happen, but not overnight.  A move to 2.5% for 2017 would be a welcome improvement.  Meanwhile, the bears are citing the bond market for telling of an economic slowdown as rates settle back from recent cyclical highs.  The benchmark 10-year Treasury yield flirted with 2.60% in early-December, but fell back to 2.34% last week.  (Over the past few sessions, the yield has climbed above 2.44%.)  Stocks on the other hand, remain in rally mode.
 
It has been our contention that the economy was improving prior to the election and that an expansionary fiscal policy would lengthen the duration of the business cycle, with only marginal initial improvement in the level of growth.  Productivity gains could change this outlook.  Rather than adapt investment policy to a Trump Presidency, investors should stay the course, concentrating on economic improvement and those companies which will benefit from a healthy consumer, technological efficiencies, and improving corporate earnings.  Noneconomic policies are just that and, while interesting news, rarely affect the bottom line.    
 
The Evolving Consumer
 
The financially healthy consumer is settling into a pattern of sustained spending.  Housing is showing more stable growth but at levels low by historical standards.  As we have discussed in prior reports, the problems of the housing depression are near resolution.  Going forward the main driver of housing growth will come from Millennials, the largest generation ever with 85 million participants, whose appetite for housing is more in concert with an encompassing lifestyle with work, leisure and home are interrelated.  Unlike previous generations, a short commute, walk to restaurants, and an urban housing environment rather than suburban living, are on their radar.  Baby Boomers for the most part, are retiring later and are opting for sameness rather than total retirement.   These shifts will be gradual, adding stability to housing growth over a longer cycle.

 Consumer spending has experienced the paradigm shift away from brick and mortar, moving to online purchases.  Comparison shopping was never so easy.  Large retailers are burdened by high-cost stores which serve as places to view products before purchasing online at a cheaper price.  Today, walking into a store many find inventory low or nonexistent, sales are lost to online retailers, like Amazon, when the item is price compared.  Alternative use for the enclosed and strip malls will evolve as innovative owners find ways of incorporating the urban living concept, favored by Millennials, into their stagnant real estate.  Today combinations of housing, leisure and work are already being developed.   
 
Accompanying this lifestyle will be the implementation of convenience of a cheaper overall price.  Autos, while still a necessary mode of transportation, could drop to only one per family.  In urban settings, Uber, Lyft, or other forms of transport for short drives will be used.  Savings on cars and commuting expenses could be shifted to leisure and recreation, including travel.  Already the shift away from landlines has affected the business models of the larger telecom companies.  Verizon just announced a reinstating of unlimited data plans.  Companies are now being forced to accede to consumer preferences rather than “business as usual.”   
 
Corporate Earnings  
 
Earnings are the lynchpin to rising stock prices.  Over the past two years, corporate earnings growth has limited equity performance.  The Energy sector is the blame for overall negative quarterly comparisons.   In reality, earnings have remained stagnant because of lack of productivity, strengthening US dollar, a cautious consumer, and onerous government regulations.   As employment rose, wages did not.  Only recently have we seen a pickup.   
 
The good news is that earnings have turned the corner.  For full-year 2017, Thomson Reuters estimates S&P 500 earnings to increase 8% over 2016.  Should the corporate tax level be passed during the year as expected (this seems likely and will be retroactive), a decline from the current 35% rate to 25% is estimated to add 8%-9% to the bottom line.  The current proposals are for 15% (Trump) and 20% (Ryan), but given fiscal constraints, a 25% seems reasonable.  Also, a tax break in the repatriation of foreign earnings held overseas is likely.  This could add an additional 3%-4% to profits.  These changes would come as the economy is moving above 2% real GDP and inflation is slowly rising above the 2% minimum level.  Many market analysts will be surprised when there are productivity gains along with margin and multiple expansion.  
 
Wall Street will reward those companies benefitting from economic momentum as earnings are rising.  Growth, rather than cyclical companies will be the major beneficiaries. Many companies which were disrupters will be disrupted.  This is happening to FedEx, as it happened to Yahoo.  Companies like Amazon (cloud computing) and Facebook (mobile) are examples of companies disrupting their own business.  Apple and Microsoft seem to be moving in that direction.  Companies combining innovative technologies with consumer preferences will succeed.  In fact, a substantial number of the 185 Unicorns (private companies value at $1 billion or more) with accumulative value of $664 billion are consumer oriented.  As the market continues to improve we would expect many of these companies to go public.  Successful IPO’s often give a boost to overall stock prices.   
 
Investment Policy
 
Our investment policy remains optimistic. We do not discount the possibility of a market sell off as investors become frustrated with slow implementation of stimulative policies. However, any correction should be considered a long-term buying opportunity.  It is unlikely given the growing strength in the economy and the outlook for corporate earnings that the long-term bull market will be interrupted.  Realistically the positives from expansionary fiscal policies will take more time than generally expected. Longer term we believe that consumer-led economic growth, accompanied by slow rising real interest rates and moderate inflation, will result in increased earnings and multiple expansion with further upside for select domestic Large-Cap consumer, financial, industrial and technology companies.  To mitigate the potential of higher-than-expected inflation and multiple compression, portfolios should include value companies exhibiting sustainable earnings growth and dividends.

 

Authors:
David Minor
Rebecca Goyette

Editor:
William Hutchens

HUTCHENS INVESTMENT MANAGEMENT WEEKLY COMPASS January 30, 2017

on Tuesday, 31 January 2017. Posted in 2017, January

HUTCHENS INVESTMENT MANAGEMENT WEEKLY COMPASS January 30, 2017

Draining the Swamp Reveals Alligators

“One of the key problems today is that politics is such a disgrace, good people don’t go into government.” 
                                                                                                                                Donald Trump (2000)

Since year-end through last Friday the broader markets, as measured by the S&P 500 (+2.50%), and the NASDAQ Composite (+5.16%), continued to add to the outsized gains since the election.  Unlike the 2016 increases which were led by Energy (+27%), Financials (+22%) and Technology (+20%), the leading sectors thus far in 2017 are; Basic Materials (+6.4%), Technology (+5.9%) and Consumer iscretionary (+4.6%).  The stock performance for Materials reflects the increase in commodity prices while Technology is in response to better estimated earnings for 2017 and improving economic fundamentals.  Somewhat misleading is the rise in Consumer Discretionary which includes Amazon.  With only 34% of the S&P 500 reporting earnings, 65 had actual EPS above the mean estimate with actual earnings rising 2.7%.  Technology and Materials earnings at 88% and 70% are above the S&P 500 totals while Consumer Discretionary at 63% is slightly behind.  
 
Stocks remain in an upward trajectory with expectations of a continued improving economic environment during 2017. Traders are negative for the short term citing low volatility, high multiples and the uncertainty of Trump policy initiatives.  Such is the Executive Order for a temporary ban on entry into the US of immigrants from seven predominantly Muslim countries as a reason for selling.  Issued on Friday, all hell broke out over the weekend and stocks were down sharply at the open on Monday.  But then again this is typical Trump confusing politics and does not flow over into the real world of economy and investment.  There is a short-term reaction, without any meaningful market significance.  
 
There are many positives that will affect the economy and the securities markets over the next few months.  In addition, markets have risen beyond the better economy prior to the election. Listed below are all the issues currently under discussion requiring Executive Orders or Congressional approval:

  • Repeal and replace ObamaCare,
  • Major tax reform,
  • Repeal of regulations,
  • Immigration reform (including enforcing of current laws),
  • Renegotiate existing Trade Agreements,
  • Restoration of pipeline projects,
  • Infrastructure restoration,
  • Build a wall across the US southern border, and
  • A Border Tax
This is an incomplete list of programs already started or under discussion.  From an economic prospective, tax and regulatory reform and trade policy are of leading importance for investors, while immigration and healthcare top the list for social reform.  The role of these above policies will have results negatively impacted by unintended consequences.  For example, tax cuts and infrastructure spending will add to an already high $10 trillion deficit.  Any fiscal policy without a revenue offset will result in higher inflation, rising interest rates, and ultimately a business cycle downturn.  Border taxes will raise costs to consumers increasing inflation.  Economists favoring this tax claim that the increase in import prices would be offset by a rising dollar offsetting the tax.  How smoothly legislation moves through Congress will impact investor sentiment.  There is reason to expect negative reactions from the Trump Administration if legislation is stalled or rejected.  There will be little or no Democratic support on most issues, so managing a contentious Republican Congress will require more time than the new Administration is likely to deem necessary.  
 
Markets have moved up well-beyond and more rapidly than anyone expected since the election.  Much of this movement is borne out in recently released economic data.  With the exception of preliminary 4Q2016 real GDP, the year is off to a solid start.  Earnings for 4Q2016 are beating estimates, but by no means “knocking the cover off the ball.”  It is still “wait ‘til next year,” except it is “now next year.”  According to Fundamentalis, data ignored by most main stream media show the trend in year-over-year earnings growth rising. 

  
1 30 17 table
 
These earnings began to rise prior to the election.  According to numerous sources, including Citi and Goldman Sachs, implementation of announced stimulative policies by the Trump Administration could add 10%-12% to the above latest 2017 estimates.  
 
Investment Policy
 
Our investment policy remains optimistic. We do not discount the possibility of a market sell off as investors see limited visibility for economic improvement from new policies.  However, any correction should be considered a long-term buying opportunity.  It is unlikely given the growing strength in the economy and the outlook for corporate earnings that the long-term bull market will be interrupted.  Realistically the positives from expansionary fiscal policies will take more time than generally expected. Longer term we believe that consumer-led economic growth, accompanied by slow rising real interest rates and moderate inflation, will result in increased earnings and multiple expansion with further upside for select domestic Large-Cap consumer, financial, industrial and technology companies.  To mitigate the potential of higher-than-expected inflation and multiple compression, portfolios should include value companies exhibiting sustainable earnings growth and dividends.

Authors:
David Minor
Rebecca Goyette

Editor:
William Hutchens

HUTCHENS INVESTMENT MANAGEMENT WEEKLY COMPASS January 17, 2017

on Tuesday, 17 January 2017. Posted in 2017, January

HUTCHENS INVESTMENT MANAGEMENT WEEKLY COMPASS January 17, 2017

Economic Growth Trumps Frustration
 
The election shock resulted in a boost for stock prices as potential economic benefits of Trump’s economic agenda were objectively analyzed.  Through last Friday, stocks, measured by the S&P 500, rose 6.3% since the election, while the NASDAQ is up 7.3% and the broader-based Russell 2000 had a 14.2% increase.  Interest rates measured by the 10-year Treasury rose from 1.80% prior to the election to reach 2.60% in December, but fell back to 2.35% as of the close on Friday.  The Volatility Index (VIX), often defined as an indicator of fear, was 11.23% as of close last week, not far from the 5-year low of 10.28% in early-July 2014.  Many of the market strategists who had forecast a major sell off if the Democrats lost the election have returned with a decidedly negative outlook.  Bearish technicals are beginning to emerge and will gain credibility on any market weakness.  Brexit has reappeared as Europe’s latest problem as Italy’s banks rotate into the background.   
 
Over the past year our Reports have focused on the longer-term trends in the economy.  Primary has been a gradual improvement in the overall economic well-being of the consumer.  This has spurred auto sales to historic levels and served as underpinning for the uptrend in the housing market.  Unfortunately the corporate side of the ledger has been plagued by low productivity and a higher dollar.  Oversupply of oil and other industrial raw materials resulted in recession levels for revenues and profits for their respective sectors.  Despite continued negative forecasts, the economy kept its 2% real growth and stocks corrected by trading in a long-term narrow range.  Our optimism is based on the belief that the mislabeled “Trump Rally” largely is a response to economic gains.  Overall real growth has improved, employment remains strong, Fed policy is on track, inflation and wages are rising, and a vibrant consumer is spending.  The prospects of enhanced growth from aggressive fiscal policies are welcome, but the consumer is the lynchpin to sustainable economic growth and in turn, a rising stock market.   
 
A Healthy Consumer
 
A short-sighted market ignores the potential that the current economic foundation holds for growth.  While waiting on Washington, better demographics and technology continue to drive the economy.  For the consumer, spending is a combination of ability and willingness.  Ability is determined by change in disposable personal income and willingness is chiefly affected by confidence.  Today consumer spending on necessities as a percent of disposable income is at levels not seen since the early-1980’s.  Any boost from tax cuts will go directly into spendable income.  Consumer Confidence, measured by both the Conference Board and the University of Michigan, is near record levels for Expectation Indices, while not directly correlated to spending, the improving financial state of consumers gives weight to spending expectations.   
 
Another gauge of a healthy consumer is credit quality.  At tops of the business cycle, consumer spending is restricted by debt and increasing delinquencies.  The ratio of household debt to disposable income was at 1.35 in 2008, today it has fallen nearly 30 percentage points and is now at levels not seen since 2002.   The debt service coverage ratio (percentage of before tax earnings spent on paying off loans, including
auto, student and revolving credit) is about 10%, a record low going back to 1980 when the series began.  Although there are early indications of increases in auto delinquencies to sub-prime consumers (below 660 credit rating), overall credit delinquencies (90-day plus) are down from 9% in 2010 to below 4% in 2016.  Mortgages represent about 75% of household debt with 90% at a record low 3.8% average fixed rate.  Even with a rising interest rate with less than 10% of consumer loans exposed to rate increases, consumers are protected from higher payments.   
 
Data from the Census Bureau shows that for the first time 2007 real median income for middle-income households increased 5.2% in 2015, the latest data available.  Housing formations have been increasing at a 1 million units annual rate over the past two years and this rate is expected to continue.  These data are part of the tailwind in housing that we have discussed in previous reports.  With home inventories low, rental rates rising, and erratic new home starts, the housing market should benefit from rising wages and negative equity (10%).  Additionally, foreclosures are moving out of the 7-year restriction creating an additional source of potential demand which will continue over the next several years.  In summary, the financial health of consumers continues to improve and even given the frustrations of Congress, tax reform and deregulation will augment consumer spending.
 
Investment Policy
 
Washington moves slowly and with repeal and replace of ObamaCare as the stated first order of business, problems will arise with a replacement plan and accompanying timeline.  Repeal is easy, replacement will be difficult and frustration, especially by the Administration, will be magnified in the media.  Offsetting the long procedural delays for a new healthcare bill could come from reversing Obama’s executive orders.   From an investor perspective, the choice of tax reform is far more beneficial than assuming ownership of contentious TrumpCare.  However, tax reform too will require legislation and Trump already has issue with the House revenue offset, “Border Adjustment” (Compass 1/03/17).  The question facing markets will the delays create frustration turning to impatience and result in a sell off in equities.     
 
Our investment policy remains optimistic. We do not discount the possibility of a market sell off as investors see limited visibility for economic improvement from new policies.  However, any correction should be considered a long-term buying opportunity.  It is unlikely given the growing strength in the economy and the outlook for corporate earnings that the long-term bull market will be interrupted.    Realistically the positives from expansionary fiscal policies will take more time than generally expected.   Longer term we believe that consumer-led economic growth, accompanied by slow rising real interest rates and moderate inflation, will result in increased earnings and multiple expansion with further upside for select domestic Large-Cap consumer, financial, industrial and technology companies.  To mitigate the potential of higher-than-expected inflation and multiple compression, portfolio’s should include value companies exhibiting sustainable earnings growth and dividends.

Authors:
David Minor
Rebecca Goyette

Editor:
William Hutchens

HUTCHENS INVESTMENT MANAGEMENT WEEKLY COMPASS January 3, 2017

on Tuesday, 03 January 2017. Posted in 2017, January

HUTCHENS INVESTMENT MANAGEMENT WEEKLY COMPASS January 3, 2017

Trudging Through the Swamp
 “Concealment makes the soul a swamp.  Confession is how you drain it.”        
                                                                                                    Charles M. Blow

There is no doubt that 2016 finished on much better footing than it started.  January was the worst start of any year on record.   By early February when the market hit bottom, oil had fallen into the mid-20’s and rumors abounded of a repeat of the 2008 banking crisis.  The bull market was over and the permabears chorused “As January goes, so does the rest of 2016.”  Markets remained range-bound into mid-year but the economy showed signs of improvement.  By July stocks were well-above their early 2016 lows as oil prices increased, earnings showed signs of turning positive and China’s growth stabilized.   
 
In August, Brexit was a non-event, and markets rallied.  The earnings recession did not pre-stage an economic recession and by 3Q2016 earnings had recovered and economic data were turning consistently more positive.  Going into the election the S&P was up 4.5%, NASDAQ +4.9% and the broader-based Russell 2000 +5.2%.  These gains reflected the improvement in the economy and optimism on corporate sales and earnings.  The possibility of a Trump victory was not even an afterthought as most forecasters saw no real change in a Clinton White House.  All this changed dramatically in the early hours of November 9th.  Almost immediately the naysayers found growth in a Trump presidency.  Markets reacted and by year-end the S&P 500 closed up 9.5% and the Russell 2000 was up 19.5%.  The leading sectors reflected economic optimism as Energy (+27%), Financials (+22%) and Technology (+20%) provided leadership in the market.   
 
Many market observers believe the recent Trump rally will die under its own weight early this year.  In fact, Morgan Stanley advises clients to “buy the election and sell the inauguration.”  Upon reflection, there is no doubt that the potential of lower taxes, reduced regulation and fiscal stimulus, if enacted, will be a boost to economic growth.  But these policies are not without risk, much of which is political - - the market has not had much experience in navigating the swamp.   
 
US Dollar – The dollar index (DX) has risen 3.6% this year and is up over 7% in the past three months.  The rising dollar has negatively affected US corporations’ earnings over the past few years.  With the Fed raising rates and much of the rest of the Developed World holding to low interest rates, the US dollar has an upward bias.  However, there is an upside to dollar strength as foreigners seek out appreciating assets, US common stock can offer a double bang for the invested buck.  Stocks are denominated in dollars and an appreciating dollar compounds in a rising stock market.  Under such circumstances, the benefits from holding dollar-denominated stocks could outweigh the risk of lower earnings.   
 
There is a House Republican proposal to “border adjust” the corporate income tax.  This blueprint proposes converting the corporate income tax into a destination-based cash flow system by not taxing revenues from exports and disallowing deductions for the cost of imports, effectively an export subsidy combined with an import tariff of equal size.  If this policy is trade neutral the dollar would appreciate.  At a 20% tax rate the US dollar could appreciate 10-15% on a trade-weighted basis.  The potential for disruption has resulted in corporate pushback but the dollar may appreciate as more of this plan is revealed.   
 
Congress – There is no guarantee that Congress will approve all or most of the Trump Administration proposals.  Even Republicans can’t unite.  This is particularly true on tax reform, where Congressional Republicans are for lower rates but split on how to get there.  Some want revenue neutral and for others cost is not an object.  Given priority will be “repeal and replace” Obamacare with Trumpcare.  The problems are obvious, but there is no plan for replacement and whatever it is, Trump and the Republicans will own it.  Already Senator Schumer has targeted Trump’s cabinet for extended confirmation hearings by requesting two days of hearings for eight of the nominees.  On the other hand, there are 25 Democratic Senators and two Independents who caucus with Democrats, up for reelection in 2018.  Of these, ten represent states Trump won.  They are vulnerable, making them more amenable to support many of the new Administration’s populist initiatives.  This could provide a path to passage.  President-elect Trump has shown he is impulsive, rude, impatient, and easily frustrated.  None of these qualities make a good politician.  During the first 100 days the country will find out what to expect for the next four years.    Reality Check
 
In our last Compass we discussed the fact that the Trump rally did not begin in a vacuum, but in an increasingly healthy economic environment that supported many of the growth plans.  Since that Report the economy has shown additional strength in manufacturing and construction, including housing.  The December ISM Manufacturing Index, reported by the Institute for Supply Management, rose to 56.2 from 54.7 in November.  The consensus forecast was for a slight decline to 53.6.  The gain reflects a 4.3 point increase in the Production Index and a 7.2 point jump in New Orders.  The US Department of Commerce said US Construction Spending rose 0.9% in November to a seasonally adjusted annual rate of $1.2 trillion, the highest level since April 2006.  Also, Homebuilder Sentiment published by the National Association of Home Builders, rose to an 11 year high as current conditions and expectations both reached levels not seen since July 2005.   
 
Investment Policy
 
Our investment policy remains optimistic. Realistically the positives from expansionary policies will take more time than generally expected.  A more dominant consumer-oriented economy is evolving, but not fully reflected in corporate aggregate earnings.  Longer term we believe that consumer-led economic growth, accompanied by slow rising real interest rates and moderate inflation, will result in increased earnings and multiple expansion with further upside for select domestic Large-Cap consumer, financial, industrial and technology companies.  To mitigate the potential of higher-than-expected inflation and multiple compression, portfolios should include value companies exhibiting sustainable earnings growth and dividends.     

 

Authors:
David Minor
Rebecca Goyette

Editor:
William Hutchens