Week In Brief: February 24

February 27, 2017

Friday saw the Dow Jones Industrial Average in the red most of the day. Till a last half-hour buying spree sent shares higher. Closing up 11.44 points. And posting its eleventh consecutive daily record.
The weekly tale of the tape for the S&P 500? Positive again. For the fifth consecutive week. As expectations for tax cuts, infrastructure spending and relaxed regulations continue to buoy stocks.
In fact, the market has entered an Aronofsky-esque dream state. Drifting ever higher. Without so much as a one-percent pullback in over three months. While breadth has been as narrow as Kate Moss's waistline. And concentrated in financial and technology concerns.
Had a premonition last week. When I received a call from a local company president asking if he could purchase individual stocks in his 401(k) account. As I hung up? Déjà vu all over again. There we were. 2000. Or 2007. Near the top.
Not forecasting. Just cautioning risk management.
So what catalyst could assassinate the market's creeper uptrend? How about a sneak attack by the Federal Reserve. One that raises rates at the March policy meeting. Futures markets assign an 18 percent probability of such an occurrence. With June seen as more likely. At more than a two-thirds chance of a single quarter-point hike.
Regardless. Something wicked this way comes.
Just as many of the tea leaves signify growing investor complacency.
When investors become complacent, they engage in certain behaviors.
1. They become overly bullish.
2. They bid settle for meager options premiums which drives down the VIX (fear) index.
3. They allocate all cash into the market, laying low money market fund levels.
4. They trade small/narrow volumes on QQQ index.
All have transpired, of late. And as complacency grows? So grows the risk of a marked market pullback.
Even traders, typically frenetic market devotees, are clearly not much concerned about volatility risk. Nor correction risk. Nor even political risk. Translation? If they cannot become any less worried, then they can only become more worried. And when that occurs, they'll likely be reacting negatively to pernicious, volatility creating headlines. Sending stocks prices lower. Only then will it be too late to remove volatility from portfolios.
Fact is, the S&P 500 has already surpassed Wall Street's consensus forecasts for the year. And we're only in February. Rendering market performance as pleasantly bizarre as has been the weather.
The average Wall Street analyst forecast a 5.5 percent gain on the year. Already, the market has eclipsed that. Having risen 5.7 percent as of last Thursday. Leaving the Dow Jones Industrial Average in uncharted territory: sitting 2000 points above its 200-day moving average for the first time in its 120 year history.
Regardless of which tea leaves you read, they all whisper of toppy equity markets.
And yet, glimmers of hope.
The S&P 500 rose 1.8 percent in January. Has continued up another 4 percent this month. Since 1945, the market has seen positive gains in both months only 27 years. And in 27 of those 27 years? The market has finished the year in the green. Up 24 percent on average.
Further, pockets of the market are simmering.
Cisco and Taiwan Semi, both emblematic of the recent rally, have reached new highs. Yet, both remain relatively cheap given their growth. And still provide fat dividends. We see similar opportunities in Apollo Global, Fortis, and other heavy yield plays whose prices remain reasonably valued.
Another interesting tidbit dug up this week?
Noted technical analyst Tom Mclellan recently highlighted one of his favorite stock market correlations. It involves the correlation between crude oil prices and the Dow Jones Industrial Average. And reveals that crude oil has long served as an effective ten-year leading indicator for stocks. Perfect? Not. But uncanny in its precision.
According to his charts, crude oil trendlines show that the DJIA should continue upward until June 2018, give or take a few months, at which point stocks will incur a serious decline. Do not use Mclellan's work to drive your investing decisions. Rather, tuck this idea away. Be cognizant next year of its implications. And relax in knowing that Mclellan also believes that stocks will recover nicely thereafter.
And these details, Dear Watson, provide evidence as to why this rally may have legs. Singularly? Nothing truly compelling. Taken as a whole, however, one discerns patterns.
There remain a number of large companies in technology, finance and healthcare whose shares have been sluggish this last decade. And institutional investors, forecasting higher economic growth under Trump, can acquire them without compromising hard-earned valuation scruples.
Globally, GaveKal Capital reports that only 44 percent of developed market stocks have outperformed the MSCI World Index these last 200 days. That compares to an average of 57 percent outperformance the last 15 years.
Drearily, exists a fairly strong though negative correlation between the percentage of stocks outperforming and the direction of the index. The index moves higher, yet fewer stocks outperform. The 44 percent reading has been hit only twice in 15 years: 2000 and 2012. So as global correlations have fallen to multi-year lows around the world, the current environment isn't a boondoggle for active funds. As the pool of outperforming stocks shrinks further.
How about the continued improvement in the nation's economy?
The Philly Fed, jumped to its highest reading since 1984. And biggest one-month increase since June 2009. January housing starts and permits beat expectations. Building permits rose 4.6 percent to a one-year high. Up 8.2 percent year over year.
Initial jobless claims remained impressive, coming in at 239,000 an improvement on last week and better than the 245,000 estimate. It was the sixth week out of the past seven coming in below 250,000.
Headline consumer inflation jumped 0.6 percent in January. Double expectations. And the largest leap since 2013. Year over year, consumer prices have risen 2.5 percent. Adding to the Fed's arguments that interest rates must be raised faster than scheduled lest inflation overwhelm us.
Most compellingly, JPMorgan's annual Business Leaders Outlook for mid-sized companies reports that 80 percent are optimistic about their businesses and the economy. That's the highest in the survey's history. And twice the optimism of last year's 39 percent.
That's real progress.
Summating? Growth trends appear to be percolating. Could real GDP growth be afoot? Were that the case, and assuming inflation remains in check, then equity multiples could expand. And serve as another tide to lift all equity boats.
Switching tracks, let's consider a potentially interesting scenario that flies in the face of today's headlines. One that finds the U.S. confronting a contrarian opportunity. And portends a global power shift that could occur in the petro markets.
Mexico has been a whipping boy of late. A falling peso. Corruption. Drug cartels. Trump's wall. NAFTA's ending. Immigration problems. American manufacturers being lured back to the U.S. These last six months? Very little has gone right for our southern neighbors. But what if, after two months of badgering Mexico, the Trump administration were to complete a deal. One that provides Mexico with its largest, most steady oil client. While providing the U.S. with cheap labor and access to lots of oil. Oil that lay outside of the Middle East's volatile sphere.
This renders the U.S. virtually independent of Iraqi and Saudi oil. Mexico gets an economic reprieve, and a big PR victory. And while the U.S. may need continue to protect Saudi Arabia from its encroaching Shiite problem, it would be less immersed in the daily machinations of the world's most volatile hotbed.
In so doing, Russia may gain additional influence over global energy pricing. But in return, the U.S. may be able to enlist Russia's help in combating global Islamic extremism. So gaining the equity partner long missing in that vigorous effort. And simultaneously cooling the long-simmering tensions between the two. Even going so far as to offset the relationship between Russia and its middle eastern client, Iran.
That's close to four birds with one geopolitical stone. Not a bad efficiency rate. And just the outcome that nobody currently expects. Making something akin to such a shift all the more likely.
President Trump continues to drive opponents crazy. Leaving his administration to face a never-before-seen oppositional bulwark. One that's established itself against much of what he hopes to accomplish. Hollywood. Open-border organizations. Much of the traditional media. Most of Washington. And a coterie of anti-___________ protest groups funded by billionaires like George Soros. Nor will these oppositional forces dissipate anytime soon.
If Trump cannot gain traction in the policy areas that won the election - tax reform, deregulation, immigration reform, national security and economic enhancement - then his will be a four-year term. If he can push forward on these initiatives. And the American electorate observes as a non-career politician accomplishes much of what it has desired these last two decades? Then Trump will likely gain a second term. And further change the complexion of American politics. The primary reason he was elected in the first place.
Like those outspoken GOP critics who have since made pilgrimages to The White House (Ohio Governor John Kasich last Friday), his opponents would be well served to remember the old adage: You come at the king, you best not miss.
Trump has become the bête noire for any number of societal facets that have a vested interest in today's status quo. The front lines of this war will manifest throughout the country. There will be winners and losers. We will cover it closely, as well as the attendant investment consequences, on your behalf.
Stay tuned.

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