November

HUTCHENS INVESTMENT MANAGEMENT WEEKLY COMPASS November 28, 2016

on Monday, 28 November 2016. Posted in November, 2016

HUTCHENS INVESTMENT MANAGEMENT WEEKLY COMPASS November 28, 2016

A Boost to Normalization
 
“Change is the law of life and those who look only to the past or present are certain to miss the future.”                      

                                                                                                                                   John F. Kennedy

The stock market has reacted favorably to the election of Donald Trump.  The opinions of Clinton voters and those who did not vote do not matter.  A program of infrastructure renewal, lower taxes, deregulation, and better healthcare has “Trumped” protectionism for now.  Presidential honeymoons do not last long and it will be imperative for definitive plans to quickly replace speculation.  Already most economic forecasts have been revised upward for 2017, and interest rates have risen in anticipation of the Fed meeting in December.  It is the bond market where the bleeding is happening.  As mentioned in our last Compass, it is too early to declare the “Great Rotation” from bonds into stocks, but when the yield of the 10-Year Treasury rises 67% from mid-July, every economist should take notice.  The increase in overall rates since the election has precipitated a shift out of fixed-income Mutual Funds and bond ETFs.  More than $1 billion has flowed out since the election as rates rose 50-basis points for the 10-Year Treasury.  For many investors the full effect will not be apparent until they receive their November or December statements.   
 
Before the election it was a widely held belief that a Clinton victory was assured and investment managers accepted a continuation of the status quo.  A large federal government positing overregulation, higher taxes, and rising healthcare and education costs was deemed a manageable investment climate.  The 2% economy had prevailed since 2010 and the stock and bond markets remained in bull mode.   All of this is changed.  The economy has the opportunity to be better, inflation will return and interest rates will rise as fiscal policy accelerates to normalization.  Rotation in the stock market away from Utilities, REIT’s, and Consumer Staples into Financial and Industrials was immediate on the day after the election.  Some adjustments have been made, the move into drugs has been tempered after realizing that responsibility for rising prices were market forces rather than potential broad-based price regulation.  Industrials are falling victim to a rising dollar, lowering foreign earnings offsetting the positives of the effects of an infrastructure buildout.   This is all occurring in an economic environment that has many of the characteristics of a market bottom as compared to a market top.  Consumers and corporations have deleveraged, US productivity is at a post-War record lows, and unused capacity is plentiful.   
 
The Economy
 
Even prior to the pro-growth mindset the economy was showing consistent improvement in concert with our forecast of longer-term consumer-led economic growth accompanied by low rising interest rates and moderate inflation.   With the election this outlook received a substantial boost, now the magnitude and duration of the bull market has much more potential.   
 
The Consumer:  The consumer and the housing market are poised to continue their growth in 2017.  Household formations are growing about one million annually, a trend that is expected to continue as more Millennials (87 million) settle down to family life.  The major problem for housing has been the inconsistency in sales due to low inventory.  The most recent October 2016 Existing Home Sales from the National Association of Realtors were 5.6 million, up 5.9% above year-ago levels and the highest since February 2007.  The median existing home price is $232,000 a 6.0% increase from October 2015, and the 56th consecutive monthly year-over-year price increase.  Unsold inventory is at an historically low level of 4.3 month supply.  A large number of lower-end single family homes and condos were purchased by investors following the financial crisis.  Many of these were converted to rental units.  At year-end 2015 there were 17.5 million renter occupied single family homes, compared with 10.7 million in 2000.  With rising rents and price appreciation, investors are holding these longer, but eventually most will be sold adding to supply.  Also, more Baby Boomers are aging in place and downsizing at a much later age.  This has created a surge in home improvement spending, but lessens the supply of existing homes.  New Home Sales were 560,000 in October 2016, lower than the estimate of 590,000, but up 17.8% year-over-year, and the best October since 2007.  Supply remains low at 5.3 months.   
 
The impending Fed increase in interest rates should only have a marginal impact on real Disposable Personal Income.  Consumers balance sheets, unlike in other periods of rising rates, are more countercyclical.  Almost 75% of outstanding household debt is in fixed-rate mortgages with roughly 90% at an average 3.8% rate.  Other fixed-rate instruments (including auto debt) account for an additional 15% of household debt, leaving less than 10% of debt at a variable rate.  The November 2016 University of Michigan’s Index of Consumer Sentiment, sharply increased following the election.  The overall Index rose 6.6 points to 93.8, the largest month-over-month gain in three years.  Notable is the 8.4 point rise in the sub-Index of Consumer Expectations.  This trend was confirmed by Holiday sales over Black Friday through Cyber Monday.  Housing and real Personal Disposable Income should be positively impacted as the low unemployment rate and slower job growth result in rising wages and salaries.   
 
Earnings
 
Forgotten over the past two weeks is the positive for corporate earnings from an expansive fiscal policy.  Initially, infrastructure spending will benefit a select group of companies and should have a multiplier effect on consumer spending.  Tax cuts will take longer to pass, if for no other reason than government moves at government speed.  The unwinding of Obama Executive Orders will have a positive short-term impact on costs for many small companies, banks, and the energy sector.  JP Morgan estimates a $15 increase in 2017 S&P 500 earnings and most other estimates fall in the $10-$12 range.  These estimates would bring the 2017 consensus earnings P/E of 17.0X down to a range of 15.0X-15.5X.  Corporations will have more freedom to control their destiny, that in itself should add to earnings.   
 
Investment Policy
 
Our investment policy remains optimistic.  Transitioning to a new Administration may increase volatility short term, but should not interfere with long-term investment strategy.  A more dominant consumeroriented 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, industrial and technology companies.  Portfolios should move to include value companies exhibiting sustainable earnings growth and dividends.     

Authors:
David Minor
Rebecca Goyette

Editor:
William Hutchens

HUTCHENS INVESTMENT MANAGEMENT WEEKLY COMPASS November 15, 2016

on Tuesday, 15 November 2016. Posted in November, 2016

HUTCHENS INVESTMENT MANAGEMENT WEEKLY COMPASS November 15, 2016

The Scales Tip to Growth

Surprise, Candidate Trump is now President-elect Trump and beating odds of more than 20 to 1, Congress remains with the GOP.  The lopsided victory, after markets had risen over 2% following nine straight days of decline, caught investors flatfooted with allocations in the wrong sectors.  A Clinton victory was assured and no one shifted portfolio allocations that reflected more regulatory pressure from Washington on banks, healthcare and energy.  But in one fell swoop the regulations on banks are reduced, Obamacare repealed or greatly modified, and price controls on drugs limited.  Attaining energy independence becomes a reality.  Immediately after a Trump victory became apparent late last Tuesday, the world of “fast money” began reorienting portfolios and stock futures fell over 800 points.  But the biggest impact was in the bond market, where yields rose sharply and the benchmark 10-Year Treasury closed to equal levels of last December.   
 
Two days following the election many of the perceived negatives of a Trump presidency were reinterpreted as positives.  Tax reform, deregulation, infrastructure renewal, and more competitively priced healthcare were all stimulative before the election and remained stimulative after the election.  One has to wonder why the doubt ever existed?  In reality, a wall across the US southern border may be impractical as is the banning of all Muslims coming into the country.  The economic and security programs are inflationary and come at a time when a Fed move will be welcomed.  By last Friday the benchmark the 10-Year Treasuries at 2.25% had surpassed the forecasted yield (2.14%) for year-end 2017.  Certain stocks, which act as bond proxies became an endangered species, particularly the Utilities and Telecom sectors.  For income-generating companies exhibiting growth in a non-regulated environment, dividends are part of total return and with higher earnings, these companies will grow beyond rising interest rates.   
 
Economy
 
No doubt the Trump proposals, even without details, are stimulative for the economy which is exactly what the markets are telling us.  Most political achievements of incoming new Presidents are moderated compared to campaign promises because of the reality of compromise required to secure Congressional approval.   Therefore, it is premature to discuss the extent of potential growth or the negatives of a more restrictive trade policy.  However on balance, the US economy should grow in 2017 beyond the post-financial crisis average of 2%.  Our optimism for US equities has been based on a vibrant and financially secure consumer.  Just prior to the Trump victory, Morgan Stanley reported on November 7, 2016 that “The latest employment data suggest that wage growth is heating up in middle and high wage industries….sustained it could a long way in supporting a stronger trend in aggregate wage growth.”  Average hourly earnings rose 0.4% month-over-month and 2.8% year-over-year in October, the fastest annual growth since June 2008.   
 
The most recent retail sales data for October 2016, published by the US Census Bureau, confirms a strengthening consumer sector.  US real retail sales rose 0.8% last month and up a revised 1.0% in September from 0.6%.  These month-over-month increases are the largest two-month rise since early-2004.  Year-overyear October sales were up 4.3%, led by non-store retailers (predominately online purchases) which increased 12.9% from the 2015 level.  On the back of these data 4Q2016 GDP forecast will most likely be revised upward with many moving above the 3% level.   
 
The Role of the Federal Reserve
 
The Fed bookies are touting an 80% chance of a 25 basis point increase at the December FOMC Meeting.  Should markets continue to rise until the meeting FedSpeak will center around a quarter point being “too little too late.”   However, this increase will be well-received by markets fearful of rapid inflation.  Higher rates have had an immediate strengthening of the dollar as the euro at 1.13 prior to the vote fell sharply and is now at 1.07.  The Mexican peso fell about 10% immediately following a Trump victory and President Enrique Pena Nieto has already expressed a willingness to work with President Trump on revisiting NAFTA.  Perhaps most affected are the non-commodity exporting emerging market countries.  Stocks of these countries (EEM) are down close to 8% as the dollar has risen.  A continued strengthening will prey on those developing countries with a heavy sovereign debt burden denominated in US dollars.   The Fed will have to get in front of any acceleration and carefully monitor the magnitude of the infrastructure spending and budget negotiations to take place in the spring of 2017.  Complicating the situation will be a Trump Administration critical of the current FOMC members, especially Chairman Yellen.   
 
Earnings
 
According to FactSet, with 91% of the S&P 500 reported, 71% beat consensus estimates.  Overall earnings rose 6.5% ending five quarters of declining year-over-year earnings.  On the top line only 55% beat estimates with aggregate sales up 0.5%.  For 2017, total S&P 500 earnings are estimated to grow 11.4% with only Energy (331.8%) and Materials (15.1%) outperforming the total Index.  Recent events may have something to say about the sector breakdowns.  We have and remain optimistic on corporate earnings going forward through 2017.  However, the extent of inflation and the accompanying higher rates creates a dilemma.  Earnings growth (nominal dollars) drive stock prices higher but rising interest rates compress P/E ratios, but sustainable growth should lessen the impact of moderate rate increases.    
 
Go or No Go Rotation
 
As the stock market rotates between various sectors in anticipation of a new Administration’s economic agenda, it will be the other rotation, from fixed-income into other assets including equities, which will garner investor attention.  Mutual funds have had 70 consecutive weeks and 128 out of 133 weekly equity fund outflows.  For calendar years 2014, 2015 and thus far in 2016 (11/4) equity fund outflows total $387 billion.  Bond mutual fund inflows over the same period totaled $173 billion.  Money in bond mutual funds has accumulated for much of the bull market for fixed-income which began in 1981 and accelerated over the past decade.  We will continue to follow these data which may well-prove the indicator of the “Great Rotation.”
 
 Investment Policy
 
Our investment policy remains optimistic.  Transitioning to a new Administration may increase volatility short term, but should not interfere with long-term investment strategy.  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, industrial and technology companies.  Portfolios should move to include value companies exhibiting sustainable earnings growth and dividends.   

Authors:
David Minor
Rebecca Goyette

Editor:
William Hutchens