By David Nelson, CFA
Just 9 trading days into the year 2018 is one of the best starts I’ve seen in my career. I’m sure everyone is getting out their Trader’s Almanac but for now let’s just agree it’s been good. Of course, the next question is how long will the good times roll?
2017 was obviously a good year but at least from my vantage point the real acceleration started in September as Tax Reform made its way back into the news cycle. Most of the 4th quarter was driven by headlines out of Washington but when it became clear the tax overhaul was about to become law, investors started pricing in a potential $150 of S&P (SPY) earnings or 15% year on year growth.
The strong start is welcome news but this goes way beyond corporate taxes being slashed to 21%. You don’t give a wage hike just because there’s a short term pickup in your business. It’s very difficult to unwind or roll back wage increases so the only logical conclusion is management is confident the growth is sustainable looking out 3, 4 even 5 years.
In a recent story, Yahoo’s Melody Hahm reported at least 80 companies have announced wage hikes, bonuses or both since the tax bill was signed. Walmart (WMT), AT&T (T), Wells Fargo (WFC) and Capital One (COF) are just a few announcing and already Republicans and Democrats are trying to spin this to their advantage. As you might expect the GOP and the administration believe it to be hard evidence their plan is working while on the other side of the aisle House Minority leader Nancy Pelosi calls it “Crumbs.”
Money doesn’t care whether your mascot is an Elephant or a Donkey but right now stocks like this backdrop especially with the NFIB – Small Business Optimism Index sitting very close to highs.
Sentiment is strong with some national polls indicating 66% of the nation view the economy as good or excellent. It has enormous implications for the political dynamic as we head into an election cycle.
Trump trade
More important than the market rise is the tenor of the performance and its overall implications for the real economy. The so called Trump trade is in full swing with cyclicals outperforming defensives as Energy (XLE), Industrials (XLI), Healthcare (XLV), Materials (XLB) and Financials (XLF) lead the way. The only sector with any defensive qualities outperforming is healthcare.
The usual suspects underperforming in a risk on market Utilities (XLU), Consumer Stables (XLP) and Real Estate (XLRE) are down (-4.6%), (-0.4%) and (-5.3%) respectively year to date.
With crude sitting close to $65 it’s not a surprise energy stocks would react favorably but it does beg the question how long will this dynamic play out. For OPEC little has changed in that they need every dollar to fund their social programs and at some point they may increase supply taking advantage of the improved pricing. The best news for energy has been geosynchronous global growth forcing a rise demand.
As for financials, the rollback of regulatory overreach along with rising rates is just what the doctor ordered.
For bond investors the news hasn’t been good with treasuries (TLT) and tips (TIP) both underwater. Junk (HYG) which I regard as an equity substitute is hanging in there but with spreads as low as they are is it worth the risk?
As I pointed out last week, I still believe China and the potential for trade disruption the biggest risk equity investors face as we march through 2018. China has become more emboldened and is increasingly aggressive, unafraid to use its political and economic muscle enhanced by an increased military presence around the world.
At risk of repeating myself; “it’s what we can’t see or forecast that usually ends the party.” Add the fact that the S&P 500 (SPX) is more than 10% above its 200 day moving average, the concern is understandable. However, abandoning ship just because we see some clouds on the horizon is safe but likely not the smart move.
We play the cards in our hand. Let it ride!
*At the time of this article some funds managed by the author were long SPY, TLT, TIP, XLE, XLI & XLU
