April

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