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Financial Markets Updates

Monday, December 18th 2017

Stocks rose to all-time highs on Friday as expectations rose for passage of tax reform. For the week, the Dow rose 1.3%, S&P 500 gained 0.9% and the Nasdaq increased 1.4%. Telecom was the big gainer, though consumer discretionary, consumer staples and healthcare were all up over 1%. However, utilities, financials, energy and materials ended lower on the week. Oracle missed on Cloud revenues and guidance and Costco posted strong November quarter comps. Activist headlines revolved around Hess and Xerox. As we head toward the holidays the corporate calendar will see lower earnings volume.

Disney announced an agreement to acquire certain assets from Twenty-First Century Fox in a deal valued at approximately $52.4 billion. The transaction includes the rights to the X-Men, Simpsons, and Avatar franchises and will create a formidable media giant with a vast content library. Disney’s move was driven in response to emerging technology-based competitors such as Netflix and Amazon. The new Twenty-First Century Fox will retain live news, national sports networks, and real estate assets.

In Washington, this week’s likely schedule involves a vote by the House on Tuesday, followed by a Senate vote, with the goal of presenting the new tax bill to President Trump on Friday. The signature element of the legislation will reduce the U.S. corporate tax rate from 35% to 21% to better compete with the average corporate tax rates in Asia and Europe of around 20%. Proceeding forward on the Congressional agenda will be infrastructure with a bipartisan spending program to rebuild the nation’s roads, bridges, and buildings which would further accelerate economic growth. 

The Federal Reserve raised benchmark interest rates by a quarter percent last week with an increase in the Fed Funds Rate and Fed officials reiterated their October estimate of three rate hikes in 2018 and two in 2019. This was Janet Yellen’s final meeting as Fed Chair. Heading into 2018, investors seem almost universally optimistic regarding the outlook for the global economy and the stock market. However, many are watching for clouds on the horizon which might include monetary policy changes under a new Fed Chair with the possibility of a more aggressive schedule of interest rate hikes and we cannot forget the lunatic leading North Korea that could lead to a “black swan” event.

Mid-term elections in 2018 may also cause stock market volatility and heightened investor bullishness could contribute to conditions that increase the likelihood of a stock market correction. Semiconductors (SOXX) are a good proxy to follow for signs of the inevitable reversal in the equity markets. The sector powered the stock market higher in 2017 and semiconductors have recently tested a long-standing uptrend as indicated in the following chart. When that uptrend is broken, I will take that as another “caution” sign on this stock market rally. However, the index was able to finish up 1% last week, so the trend continues higher for now. Stay tuned.

On the other hand, the stock market may continue to climb the “Wall of Worry” as the underlying economic fundamentals support continued growth in corporate sales and earnings. A JFK/Reagan tax reform style economic boom will likely provide a boost to the economy that would enable the equity markets to continue to achieve further new highs. Indeed, companies have expressed confidence in the positive impact of tax reform on both hiring and investment. As noted earlier, potential legislation related to infrastructure spending in 2018 could further buoy corporate and investor spirits. Buckle-up and stay tuned!

In overseas markets, major European stock indexes were generally lower last week, although the UK’s FTSE 100 recorded gains. The European Central Bank (ECB) kept its key lending rates and its bond-buying program unchanged at its December meeting, but the ECB raised its growth and inflation forecasts through 2020. Meanwhile, Germany’s Central Bank revised its 2017 growth forecast from 1.9% to 2.6%, and increased the 2018 GDP forecast from 1.7% to 2.5%. In China, industrial production rose 6.1% in November; new construction starts increased 18.8% and retail sales gained 10.2% year-over-year. After raising its bank lending rate for the first time in 10 years in November, the Bank of England (BoE) kept its bank rate unchanged at 0.50% at its December meeting on Thursday. Inflation rose in the United Kingdom at an annual rate of 3.1% in November which was higher than expected and the fastest pace in more than five years.

The major Japanese stock market benchmarks turned in mixed results last week. The bellwether Nikkei 225 Stock Average ended the week over 1% lower. However, the Nikkei 225 index has gained 18% year-to-date. On a positive note, the European Union and Japan capped off several years of negotiations and finalized a sweeping trade deal during the week. The Economic Partnership Agreement encompasses 600 million consumers and nearly one-third of the global economy and will eliminate tariffs on more than 95% of products traded between the markets. China’s economy remains strong at the end of 2017, a year in which growth was expected to decelerate after Beijing stepped up efforts to crack down on excessive borrowing and real estate speculation. Global demand for Chinese goods, a buoyant housing market, and public infrastructure spending have led China’s economy to outperform in 2017.

Oil - The International Energy Agency (IEA) says that U.S. shale production will cause non-OPEC oil production to rise by 1.6 million barrels per day next year, up from the 600,000 barrels per day supply in 2017. The IEA stated that "Just as the OPEC oil ministers were sitting down in Vienna, our colleagues at the U.S. Energy Information Administration released data showing that for September U.S. crude oil output increased month-on-month by 290,000 barrels a day to reach 9.48 million barrels a day, the highest monthly average since April 2015 and 928,000  barrels a day above a year ago". Energy company share prices were weak despite international (Brent) oil prices climbing above $65 a barrel, their highest level since June 2015. A late-November agreement between OPEC and non-OPEC member Russia to extend production cuts has pushed up prices, and recent pipeline shutdowns and other disruptions have provided further supply pressure.

Gold gained about $8 a troy ounce to close at $1258 last week on the dovishly interpreted FOMC ( Federal Open Market Committee) release. Gold hit the downside measured move target in the $1230s, and is now retracing higher. Despite the uptick in volatility, gold remains largely trendless at this time. Gold is trading in the middle of the 2017 trading range, leaving the outlook neutral with a mild and contrarian bias to the upside. Gold was offered an extra boost last week from the threat of another missile launch by the lunatic leading North Korea.

"I've got nothing but money ... and I wanna spend it all on you." Solid consumer spending kicked off the holiday shopping season on a bright note. The Commerce Department reported that Retail Sales jumped in November, rising 0.8 percent. This was more than double the 0.3 percent expected. In other good news, October sales were revised higher to 0.5 percent from 0.2 percent. Since November 2016, Retail Sales grew by 5.8 percent. A strong labor market coupled with an improving economy were the catalysts behind the gains. Inflation continues to remain tame. The November Producer and Consumer Price Indexes were both in line with estimates. Core CPI, which excludes volatile food and energy prices, edged lower to 1.7 percent year over year. This reading remains below the Fed's target range of 2 percent and is closely watched by the Fed.

Weak economic news normally causes money to flow out of Stocks and into Bonds, helping Bonds and home loan rates improve. In contrast, strong economic news normally has the opposite result. The chart below shows Mortgage Backed Securities (MBS), which are the type of Bond on which home loan rates are based. When you see these Bond prices moving higher, it means home loan rates are improving. When Bond prices are moving lower, home loan rates are getting worse. To go one step further, a red "candle" means that MBS worsened during the day, while a green "candle" means MBS improved during the day. As you can see in the chart below, bond prices have been volatile in recent days, but home loan rates remain attractive.

Chart: Fannie Mae 3.5% Bond Friday December 15th

Following the broad-based equity market expansion of 2017, will such growth be sustainable in 2018? Although many assets are deemed to be at full value, I remain optimistic that prudent monetary policies, new pro-growth fiscal policies/deregulation, stimulative tax policies in USA and the healthy momentum behind economic conditions will continue to support global earnings growth. However, the sell-side and economists and press reports last week noted the risk of a faster tightening cycle given the better growth backdrop from a potential tax tailwind.

Stock market corrections are part of the process and we also need to be cognizant of a range of disruptive technologies that have far-reaching impacts on existing industries and practices, providing further opportunities for growth and dominance in the “winning” companies. For example, Amazon is a clear winner!  I drove my daughter and son-in-law home this weekend and dropped them off at their apartment building rental in Hoboken and the lobby desk was piled high to the ceiling with rows of Amazon Prime boxes. The legendary investor, Peter Lynch, made a fortune for his investors with these kinds of simple observations. As my mother and wife often tell me, pay attention!  I will be in NYC for the next few days for important meetings, so I will be “paying attention”. LOL and happy holidays to everyone!

Economic Calendar for the Week of December 18th to 22nd

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