October

HUTCHENS INVESTMENT MANAGEMENT WEEKLY COMPASS October 31st 2016

on Monday, 31 October 2016. Posted in 2016, October

HUTCHENS INVESTMENT MANAGEMENT WEEKLY COMPASS October, 31st 2016

A Peek into 2017

Where stocks end the year is anyone’s guess, but peeking into 2017 should reignite optimism.   Since July, stocks have been in a narrow range that is getting more narrow as next week’s election approaches.  The campaigns of both candidates have been a race to the bottom.  Given the choice, American voters would rather choose between Mike Pence and Tim Kaine rather than Mr. Trump and Mrs. Clinton.  Perhaps the best outcome is continued gridlock, which seems a certainty if Wall Street’s choice, Mrs. Clinton, does not sweep.  Markets can live with a 2% economy, a Fed policy of slowly raising rates, moderate inflation, and increasing corporate earnings.  Short term things may get ugly as the mood of America is reflected in the election results.
 
Normally presidential elections do not have a long-term impact on the financial markets, and this time will be no different.   Throughout the post-election period politics will be an overly analyzed input to the proverbial “Wall of Worry.”  As mentioned often in our Reports, the US is a 2% real growth economy with no catalysts to break above this sluggish level.  Earnings season is winding down and the market will turn its attention to the Fed and a December interest rate rise.  Recent economic data, on balance, show some upward momentum and Friday’s employment number should be in line with recent reports.  The wages and weekly earnings data from the report may prove the determinant for Fed action.  Inflationary pressures are beginning to surface and the last thing the Fed wants is to be behind the curve.  As mentioned markets, measured by the S&P 500, remain in a tight range (2,193.91 – 2,114.72) since the beginning of the third quarter.  As of last Friday, the S&P 500 was only 1.3% above its June 30, 2016 close.  Although only down 3.1% from its all-time high on August 16, 2016, only 32.7% of the S&P 500 companies are above their 50-Day moving average.   
 
Earnings  
 
Going into the third quarter earnings season FactSet estimated S&P 500 earnings to decline 1.3%.  As of October 28, FactSet reported its blended earnings (reported plus estimated) growth rate for the S&P 500 is +1.6% with 74% of the 294 companies reporting earnings above the mean estimates.  Thomson Reuters also estimated earnings to decline 1.3% prior to the actual reporting.  Data from Thomson Reuters and published in Fundamentalis show S&P earnings beginning 3Q2015 through 2017 when quarterly earnings turned negative year-over-year.

 10 31 table

The Table shows a return to profitability beginning in 3Q2016, along with the diminished negative impact of the Energy sector.  Although not shown on the Table, the estimated level of growth is in part due to weak comparisons but at rates comparable to 2011-2012, years of substantial stock market appreciation. Depending on the level of inflation, with earnings reported in nominal terms, these levels could change meaningfully in either direction.   
 
Economy
 
To successfully reach the current estimated level of earnings growth, the economy must maintain minimal real growth at 2%.  No doubt, there are many unanswered political questions but the economic tailwinds are picking up.  Looking into next year we see positive growth in personal income and relatively low delinquency rates supporting consumer fundamentals.  Stronger than anticipated payroll growth suggests solid consumer spending.  As expected, the tighter labor market has resulted in a slowdown in employment from an average monthly rare of 251,000 in 2014 to 229,000 in 2015 and to 178,000 through September 2016.  Accompanying this tightening labor pool has been a recent increase in average hourly earnings, from 2.4% in August to 2.6% in September.  Personal income rose 0.3% in September after falling 0.2% in August. Consumer spending rose 0.5% in September, after declining 0.1% in August.   
 
Consumer sentiment appears to be influenced by the uncertainty of the upcoming election and the added problems of the “de facto” bankruptcy of Obamacare.  This is reflected in the 5.7% elevated personal savings rate in August.  Home prices rose 5.1% in July, positively affecting household net worth.  The tight supply of homes is expected to continue but price increases are forecast to moderate.  This scenario has been in place for some time as supply has been limited by the lack of new starts of moderately priced homes.  Sales of new single family homes rose to 563,000 in September, a 30% increase over year ago levels, but only 3.1% above a downward revised August 2016.  Home inventory remains at an historically low 4.8 months.  Real consumer spending ex-autos rose 2.7% in September 2016, up from 2.1% in August, and up 2.4% from a year ago September.  Leading the sales were non-store retailers (90% online), up 10.6%, once again coming at the expense of Department Stores which were off another 4.8%.
 
Investment Policy
 
Our investment policy remains optimistic.  Rising volatility related to the outcome of the election and the potential Fed policy may continue in the short term.  This should not interfere with long-term investment strategy.  The recent economic data confirms that we remain in a 2% growth cycle, but with better earnings on the horizon and a healthy and vibrant consumer.  The transition into a more consumeroriented economy is on schedule, 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 October 17th 2016

on Monday, 17 October 2016. Posted in 2016, October

HUTCHENS INVESTMENT MANAGEMENT WEEKLY COMPASS October, 17th 2016

Confusion not Uncertainty
 
“Volatility is noise.  The short-term trader bets on the noise; the long-term investor listens to the signal.”                

                                                                                                        Peter L. Bernstein

After setting a new all-time high on August 15, 2016, the S&P 500 is down 3.0% from that record-closing level.  The S&P 500 has remained in a narrow trading range since July.  More recently the tech and energy heavy NASDAQ made new highs.  Over the past three months, the market has weathered the Fed indecisiveness, signs of economic weakness in August, a strengthening US dollar, a forecast of a sixth quarter of lower earnings, and last week a return of Brexit and weak Chinese import and export data.  Throughout this period, the emerging markets, buoyed by rising commodity prices, gained strength and measured by various ETF’s, outperformed the equities and fixed income of major developed countries.   
 
Despite low volatility, US market internals reflect a shift in sector preference.  While not a definable rotation from growth to value or value to growth, but a shift to more economic sensitive sectors from defensive/income (dividends) stocks.  Market leaders in the first half of 2016 were Utilities (+21.1%) and Telecom (+22.6%) while Technology (-1.0%) and Financials (-4.7%) were the losers.  Since June 30, the former leaders have shown persistent weakness (Utilities -9.1% and Telecom -10.2%) as Technology (+11.6%) and Financials (+4.5%) rallied.  Although early in earnings season, the large banks reporting have beaten on both revenue and earnings.  Technology earnings will come the next few weeks.    
 
The economic data have been erratic and most estimates are for 2%-2.5% real GDP growth in 3Q2016, down from 3%-3.5% earlier in the quarter.  Population, and more importantly labor market growth rates in the US are among the highest of the developed countries.  A favorite of Fedwatchers, the JOLTS Survey, showed a near-record job postings, along with weekly employment claims at 246,000, levels not seen since 1972, points up the underlying strength of the job market. The weak link is productivity, but with a 2% economy and overcapacity there is reluctance to increase plant and equipment spending beyond technology.  Consumer spending and housing remain strong.  Auto Sales have plateaued despite dealer incentives.  Millennials are the driving force for home sales, but with a low inventory of starter homes and somewhat different preferences than prior generations selection is limited.  Mortgage terms remain restrictive, but longer term, earnings increases will close the affordability gap.  The Energy sector, which has been in recession for over two years, is showing signs of stability.  The rig count bottomed at 480 in early-March 2016 and as of last week had increased to 539 operable rigs.  This is a far cry from the record 1,920 units operated in December 2014.  Even with crude over $50 a barrel, it will take time to bring the sector to profitability and even longer to initiate new capital investments.   
 
The Healthcare sector will be the focus of government regulation no matter who wins the election.  As it stands today, Obamacare will implode without dramatic changes.  Costs are out of control and exchanges are failing as young healthy people shun the system and only the sick sign up.  Cost controls and rationing will be viable options as retirees increase and strain the already technically bankrupt Medicare system.  Longer term look for the trend of lower discretionary spending as dollars are shifted to healthcare.   
 
Once again, the Chinese economy is being discussed as a potential negative for the US economy and in turn, US equities.  The most recent negatives on Trade ignore some encouraging data on the transition to a consumer-oriented economy. We have discussed this subject at length over the past two years in our Reports and have concluded no game-changing events are forthcoming from China.  The same can be said of Brexit.  The US dollar remains in a very narrow range against all major currencies accepting the British pound.  Listening to the bears, one would think that the dollar is about to rise in line with the increases in 2014-2015, this is not the case.  Favorable earnings comparisons will begin for US international corporations in 4Q2016 as the sharp upward thrust of the dollar is lapped.   
 
Specifically the clock on Brexit does not even begin until Article 50 of the EU Treaty is triggered.  As it stands, the earliest that this will occur is May 2017.  Pending are two legal challenges questioning the legitimacy of the democratic ballot.  Both suits claim the ultimate decision to leave the EU resides with Parliament.  At the very least, the Brexit divorce will not be final for more than 2 1/2 years.  The immediate consequence of the vote has been the depreciation of the British pounds against most of the major currencies.  It was not dollar strength that resulted in a 17% decline against the dollar since the June vote.  Ironically, over the same period the FTSE Index of listed companies traded on the London Exchange has risen about 17.5%.  This indicates that many British companies not only do the majority of their business internationally, but that the lower price for exports will favorably affect these companies’ earnings.  Domestically, the lower value of goods and services may cause problems, as inflation rises and growth slows, making recession is a distinct possibility.  However, Britain accounts for only about 5% of global GDP and the problems should remain in Britain without any fear of contagion.       
 
Investment Policy
 
Our investment policy remains optimistic.  Volatility related to a confluence of recurring international misinterpretations and potential Fed policy may continue in the short term.  This should not interfere with long-term investment strategy.  The recent weakness in economic data confirms that we remain in a 2% growth cycle, but with better earnings on the horizon and a healthy and vibrant consumer.  The transition into a more consumer-oriented economy is on schedule, 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