PERFORMANCE

US equity markets continued to fall as Trump rallied in the polls. A Clinton victory was priced into the market but Trump is now threatening. Markets view a Trump victory as a major threat to the status quo. There are a lot of questions on what would ultimately happen with trade, taxes and other policies. Clinton is the known quantity and that is what investors like.

The market has fallen for nine days in row, the first such stretch since December of 1980. However, the drop has been relatively contained. The fall is just 3.1%. The SP500 is now 4.8% off its August 15 high. By contrast, in 1980, the nine-day losing streak dropped that market 9.4%. If the market drops on Monday, that would be 10 in a row, that last happened in 1975. The all-time losing streak is 12, dating back to 1966.

Fivethirtyeight.com has the chances of a Clinton win at 65%. Should Trump pull the upset, the conventional wisdom is a market sell-off in the 5-10% range. Investors and most economists are frightened by a potential trade war.  But conventional market wisdom is often wrong and sentiment is negative going into the election.  A Democratic sweep for the House and the Senate, would also probably lead to a sell off. A Clinton victory with the Republicans holding the House and the Senate, or at least the House, seems to be what the market wants and that could set up a relief rally. Another scenario that would be negative would be no clear winner emerging Tuesday night.

We have written about the poor technical condition of the market the last few weeks. The market did break a support level this past week and is now resting on its 200-day average. If it can’t hold there, the next line in the sand is the 203 and then the 198 area. The FBI announced on Sunday that they won’t seek charges against Clinton after reviewing the newly discovered emails, that will likely rally the market.

Treasury rates fell across the curve. The dollar declined and crude was off by almost 9%.

EARNINGS

Earnings have been solid so far this quarter. According to Factset, 71% of SP500 companies have reported earnings above their mean estimate. The blended earnings growth rate for the index is +2.7%, likely marking the end of the five-quarter losing streak.

FED RATE HIKE

The employment reports continue to point toward a December rate hike. Assuming that there is not a big negative reaction to the election, December will likely be the first rate increase in one year. Non-farm payroll employment increased by 161k, and prior months were revised upwards by 44k. The six-month annualized increase in private-sector average hourly earnings came in at 3.1%, showing that wage pressures are building and the Fed will exceed its 2% inflation target. The unemployment rate fell to 4.9%, although that was helped by a decline in the workforce.

GDP

The Atlanta Fed’s GDP Model GDPNow put in their final Q3 estimate at 2.1% growth. The model opened up their Q4 estimate at 2.7% and it was then raised to 3.1% to close the week. Higher forecasts for consumer spending, equipment investing and exports helped raise the estimate. The NY Fed’s Nowcast currently forecasts Q4 growth at 1.6%.

GLOBAL ECONOMY

The October PMI reports show that the economic outlook around the world is improving. Many countries are making new highs and growth trends appear to be broadening. The US was up 1.9 points to 53.4. The Eurozone increase by 0.9 points to 53.5.

VLMAP

Here is an argument on why equity returns will be low over the next few years. Value Line, an equity research firm that covers 1,700 stocks, publishes the median estimate of appreciation over the next three to five years. This is called the Value Line Median Appreciation Potential (VLMAP). It currently stands at 40% which represents an 8.8% annualized return. That number sounds pretty good. But historical research has shown that the VLMAP number tends to be on the optimistic side. The 40% expected appreciation potential is in the lowest decile of readings dating back to the 1960s. In contrast, the expected appreciation was 185% in March of 2009, that turned out to be a good signal to go long. But is the system foolproof? Of course, the answer is no. The readings were also at 40% four years, since then, the market returned 6.4% annualized. As with other valuation models, the level of interest rates is a huge factor that can and has altered historical tendencies.

THE CUBS INDICATOR

And finally, if you are looking for a reason to go long, here is an indicator that comes along every 100 years or so. The last time the Cubs won the World Series prior to this year, in 1908, the DJIA rallied 8% in the following month!

PERFORMANCE

US equity markets fell in the US and around the world fell about 0.9%. Bond markets also fell about 0.6%. Interest rates have been rising and that has pushed bonds down and has been a drag on equities. Interest rate sensitive stocks like REITs fell. The Vanguard REIT ETF (VNQ) fell 3.6%. Regional banks rallied by 2.6% (KRE). Banks are likely to be helped by higher interest rates.

The stock chart of the SPY (SP500 ETF) is showing a descending triangle. Some technical analysts consider that a bearish pattern that shows distribution of stocks. We are slightly overdue for a pullback at this point (see our Webinar from last week, link below), and given all the political uncertainty, there is a reasonable (not definite) chance for a selloff. You can also make the opposite case that if the market can hold support in the 212 area it can break out of the triangle to the upside.

TREASURY RATES

The treasury curve continues to get steeper. The 10 and 30-year were up by 12 and 14 basis points for the week, while the 2-year increased by only 2 basis points. For the entire month, the 2-year increased by 9 basis points and the 10-year by 26 basis points.

EARNINGS

According to Factset, 58% of SP500 companies have now reported earnings. 74% have beaten the mean estimate and 58% have beaten the mean sales estimate. So far, the blended earnings growth rate is 1.6%, it that trend continues, the 5-quarter losing streak for earnings (consecutive quarters of declining year over year earnings) will end.

GDP

The initial estimate for Q3 GDP by the Bureau of Economic Statistics came in at a surprisingly strong 2.90%. That beat the Q2 number (1.4%) by more than double. Meanwhile, GDPNow is estimating Q3 growth at 2.1%. The Nowcast remained unchanged at 2.2% for Q3 and 1.4% for Q4. The economy continues in slow growth mode.

LINK TO OUR QUARTERLY WEBINAR:

A Vanguard video showing the impact of the Presidential election on the market. The answer…not much.

Here is a series of Ben Graham articles he wrote in 1932 for Forbes Magazine:

1. Inflated Treasuries and Deflated Stockholders (PDF)
2. Should Rich Corporations Return Stockholders’ Cash? (PDF)
3. Should Rich and Losing Corporations be Liquidated? (PDF)

PERFORMANCE

Equity and fixed income markets were down on the week. US markets fell by about 1% and international markets by about 1.50%. Bonds declined by 0.19%, as the longer end of the curve got steeper.

Earnings season got off to a poor start on disappointing earnings by Alcoa. SP500 earnings have declined for five quarters in a row, and the expectation is for a small decline for Q3. However, normally earnings come in a little bit above expectations, so there is hope that the earnings slide might end.

A rising dollar (+1.38% for the week) also has not helped. That would cut into US exports and lower earnings from overseas, impacting US large-caps. The British pound fell by 2.17% as Brexit becomes closer to reality. A lot of the increase in the dollar was due to the fall of the Pound.

The political environment certainly has not done anything to help improve long term confidence in the US economy, unless one considers that Trump’s chances to win seem to have fallen. Not that the alternative is much better.

Technically, the market is starting to roll over from positive to negative. The chart below shows the price action of the US total stock market as measured by the VTI ETF. Prices are shown in white. The colored lines measure a linear regression for different lengths of time. When the regression line is moving higher, the trend is up for the given period. Likewise, when the regression line is moving down, so is the trend. For periods of 5-days (red), 21-days (yellow) and 63-days (green) the trend is down. For the two longer periods, 126-days (purple) and 252-days (blue), the trend is still up. This does not necessarily mean that the prices will continue down, but it is a different way to see that the market has lost its short-term positive momentum.

ECONOMY/GDP

The Atlanta Fed’s GDP forecast for Q3 growth continued to fall. It has pretty much been one-way down since the original forecast in late July (see below). The estimate is now at 1.90%, which is down from 2.10% last week. The decline was impacted by a lower estimate of personal consumption expenditures.

The NY Fed’s Nowcast estimate for Q3 increased to 2.3% from 2.2% last week. The Q4 estimate increased to 1.6% from 1.3%. Higher than expected retail sales helped push the estimates higher.

Our politicians would have you believe that immigration is bad for the economy. Philly Fed President Patrick Harker sets the record straight in this speech.

PERFORMANCE

Both US and international equity markets were down about 0.70% for the week. The market is starting to think about a possible December rate increase. The yields on the 5 and 10-year note shot higher by 12 and 13 basis points. That caused interest rate sensitive assets like REITs and utilities to sell off. REITs were down about 5.3% and utilities dropped 3.8%. On the flip side, banks, which would benefit from higher rates, increased by about 2.5%.

The SPY (SP500 ETF) has now been trading in a tight range between 212 and 219.5 since July 7. The range has gotten even tighter over the last few weeks and could break out one way or the other any day now.

ECONOMY

The Atlanta Fed’s GDPNow forecast for Q3 growth fell to 2.1%, down from 2.4% last week. The fall was due to lower inventory investment and slower government spending growth. The NY Fed’s NowCast for Q3 remain unchanged at 2.2%. The Q4 estimate increased by 0.1% to 1.3% due to strong ISM reports and international trade data.

The Institute for Supply Management’s (ISM) Non-Manufacturing report for September was extremely strong. The reading came in at 57.1 versus 51.4 for August. Above 50 is considered expansionary. It was the largest one month increase in the history of the survey. Combined with the manufacturing survey, and adjusting for the respective weights in the economy, the ISM increased to 56.5 compared to 51.2, also the largest increase on record.

Employers added 156k job in September. The number of jobs added was slightly below the consensus, but it is still a solid number. Until the economy picks up steam and corporate earnings begin to rebound, private sector job growth is likely to remain more subdued than it has been over the last couple of years. The unemployment rate ticked up by 0.1% to 5.0% but that was due to an increase in the number of people now looking for work.

Measures of weekly earnings and hourly earnings both improved year over year.

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PERFORMANCE

Markets were mostly flat. US equity markets were up about 0.15% for the week. International markets were down very slightly (-0.06%), bonds up 0.17% and the US dollar was down 0.05%. Crude was the big winner, +6.84%, on news that OPEC and reached an agreement to limit production.

Deutsche Bank frightened the market for most of the week. The US Justice Department made it known in mid-September that it would seek a $14b penalty for mortgage problems prior to the great recession. That number was big enough to get investors thinking about the survival chances for Deutsche. Inevitably, that led to the beginnings of a run on the bank, as some hedge funds pulled money from the bank (its also possible some of these funds were short the stock at the same time). The shares tumbled and brought the market down with it. But on Friday, news was out that the penalty number would be much lower. Shares rallied 14% on the day, and led the market higher.

GDP

The Atlanta Fed’s GDPNow model took another big hit on their forecast for Q3 growth. The estimate fell by 0.4% to 2.4%. The model had fallen by 1/2% the week prior. The decline was caused by a lower estimate for consumer spending growth and by a lower contribution from inventory investment. The NY Fed’s Nowcast fell by 0.1% to 2.2% for Q3. Q4 remained steady at 1.2%. The Nowcast was negatively impacted by personal consumption expenditures and sales of single family homes, but was helped by durable goods orders and wholesale inventory data.

PERFORMANCE

The Fed did not lift rates this week and that moved the markets higher. The US equity markets were up 1.40% and international markets were up 2.90%. The US dollar declined 0.72% and oil rallied by 4.28%. The Fed made it clear that the pace of interest rate increases would be very deliberate and carefully considered. That helped bonds, which rallied by 0.38%. However, the Fed is probably leaning towards a December increase. Assuming nothing crazy with the economy between now and then, we believe a slow and measured pace of interest rate increases would be beneficial for the economy in order to put it back into a historical balance.

ECONOMY

The Atlanta Fed’s GDPNow declined to 2.90% from 3.0% due to a drop on the forecast for third-quarter real consumer spending growth ticked down by 0.10%.The NY Fed’s Nowcast forecasts took a big hit. Both Q3 and Q4 declined by 1/2% to 2.30% and 1.20%, respectively. The largest negative contributions came from manufacturing, retail sales, and housing and construction data.

Initial claims for unemployment fell by 8k to 252k. It was one of the lowest numbers since 1973 and indicates a tightening labor market.

EARNINGS RECESSION CONTINUES

According to FactSet, earnings will decline for the sixth straight quarter, the longest streak since 2008. The losing streak was expected to end this quarter but that likely won’t happen. Analysts now expect earnings to finally improve in Q4.

FISCAL STIMULAS WORLDWIDE

There seems to be a worldwide movement beginning to utilize fiscal stimulus to get economies moving. Canadian Prime Minister Justin Trudeau has a $46b 10-year infrastructure plan. Japan has a $45b plan. There is similar talk elsewhere around the world and both Clinton and Trump favor new fiscal stimulus. The consequences are unknown, but someone will have to pay or finance this spending. In the US, higher inflation and a lower dollar might result, but the plan could put an end the earnings recession cited above.