"Never make predictions, especially about the future."
-- Baseball legend Casey Stengel.
That said, here we go.
The Year Ahead
The financial markets have had quite a run over the last two months. Yeah, no kidding. We've run into some holiday week turbulence. Again... pension fund rebalances. We did see some of this rough terrain coming. The question now is how to navigate moving forward, and not because the calendar turns, but because we are probably at a fairly significant pivot point as far as the U.S. economy, and our ability to succeed within that space, are concerned.
We all know what has worked since election night. We all see where Consumer Confidence is in relation to where it was. There is hope, and it is founded on doing something different. Anything different.
After showing some signs of improving for most of the second half of 2016, many macro-economic data-points such as wages, participation, inflation, retail sales, industrial production, durable goods orders, and housing starts all either contracted or missed expectations rather badly in November. Yet, confidence remains high. Why?
Going forward, I don't think any one thing will broadly boost the economy and be as easy to implement as will be lowering corporate taxes and subsequently personal income taxes. Who would argue against? Maybe someone who has no desire to compete, and is not interested in re-election, but that would be about it.
This is important, gang. The forward looking PE ratio for the S&P 500 is a smidge above 17x earnings right now. There are estimates out there that predict that every one percentage point drop in the corporate tax rate (currently 35%) could produce somewhere from $1.25 to $1.40 per share of increased earnings for the index, moving into 2017.
Right now, most of the estimates for 2017 at the current tax rate that I have seen are for (S&P 500) earnings to land between $127 and $132. The president-elect's initial proposal is for a reduction in that corporate tax rate all the way to 15%. The final result will probably be somewhere in the middle. Just do some simple math.
There are several other items that will impact the success of the economy, and eventually the success of the marketplace as well. Deregulation, repatriation, public spending and healthcare reform are all necessary cogs if this economy is to reach its potential. The trouble is that, to varying degrees, these all bring a requirement for a certain level of political finesse and can sacrifice long term sustainability for short-term gains.
The Stock Market
I believe that there will probably be some pent-up profit taking in early January after the year-end rebalances, and then some initial inflows hit the marketplace. There will be both stomach-churning selloffs and screaming rallies over the next six months. Volatility will become normal while the new administration finds its footing. You, the investor, will be nervous, more so than you have been in a long while. A certain level of discomfort is good, and is what makes traders defend themselves.
Policy shifts take time. Then, those shifts take even longer to show results. There will have to be some visible progress on several levels for the markets to keep believing as the year wears on. Then there's the Fed. Monetary policy could get in the way of broad gains if tightening is implemented too aggressively, impacting not just the cost of borrowing but currency valuations as well.
Given the past inability of the FOMC to tweak policy appropriately, it is not crazy to have some serious concern here. I would prefer for the FOMC to wait at this point to actually see evidence of growth and inflation before pushing on, now that the economy seems to be weakening into year's end. I do think that this growth, and inflation will indeed come if not snuffed out by awkward monetary policy.
My favorite industries moving forward include the banks and consumer finance, both from the financial sector. I also like the transports in general, specifically the railroads, as well as defense and aerospace. Those areas reside within the industrials. My target for the S&P 500 is 2465 for the coming year. This target assumes a corporate tax rate in the mid 20%s, and a DXY that stays below 105.
I am probably assuming far more than I should (see Casey Stengel's quote above). I would also not be extremely surprised to see the 2100 area tested, should the market get impatient with progress in seeing some results.
This is obviously just to give you an idea of what I'm thinking. You should discuss your financial decisions with a professional, a family member, your favorite clergyman... anybody. Just remember, you are in control of your decisions.
Many folks that I talk to went to high levels of cash just prior to the election. Some of them are still there and have not reacted, or have reacted in reduced scale to the market moves that we have seen. For me, a cash allocation of 20% should be plenty. We are regular people here, and we have to be prepared to handle a flooded basement, or a leaky roof. In fact, although cash is a position, folks should figure out how much they are comfortable with having in reserve, and then decide how to divvy up their investment portfolio. Many of my friends, some of them sophisticated, are still even now way above 20%.
I am going to leave gold at 5%, which is where it was the last time that I tweaked the model. There is a chance that I go to 7.5% at $1065, but I'll make that decision if and when it gets there. The yellow stuff would have to go a long way (perhaps $1300) for me to up the allocation based on momentum.
Just after the election, I cut the bond allocation from 17.5% to 15%. I think I'm going to take that down another peg, perhaps to 12.5%, which is very low for me historically. Having a higher than the street percentage of my holdings in fixed income has bailed me out a few times.
That said, I am mildly uncomfortable being below 14% in this space, but this time does feel different. If I need to correct this sometime in the first quarter, I would think that it would be in a northerly direction. I would spread this fairly evenly across the Treasury, municipal and corporate space. You will need an advisor for that.
As for high Treasury yields impacting equity allocations, I think I'll worry when the yield for the 10-year approaches 3.25%; still a long way off, and actually quite handle-able if the growth and inflation are there.
I've already told you what I like in this space. What I am not sure of is the energy space, as WTI crude seems to be trading closer to the high end of its potential than it is to the lower end. I am also uncomfortable with health care right now. I know, a lot of experts like health care moving forward, but it remains a political football.
There is no doubt that the Affordable Care Act is unaffordable, and has crushed the middle class. Yet, there has been no good idea for a suitable replacement. I am likely to take equities up from their current 55% to 60%. Aside from the industries mentioned above, I also think that I want exposure in the tech space, industrial metals and construction and engineering.
08:30 - Initial Jobless Claims (Weekly):Expecting 268,000, Last Week 275,000. The four- week moving average for this weekly has nudged its way up to just less than 264,000. That's higher than it has been in a good while, but not really cause for concern in a broad sense. The marketplace will not likely react strongly to this release.
08:30 - Goods Trade Deficit (November):Expecting $-61.5 billion, October $-62 billion. This component of the Trade Balance (which you'll see next Friday) is sort of the 800-pound gorilla in the room. For October, this item printed at $-62 billion, and was revised lower to $-63.4 billion in that combined print, which includes services. The U.S. service sector typically runs at a surplus that only partially offsets the deficit seen in goods, which is why the focus remains on this report.
08:30 - Wholesale Inventories (November -p):Expecting 0.1%, October -0.4% m/m. Just so you understand what you are looking at here, wholesale inventories are a component of the headline item known as business inventories. We'll see that number when this component is joined with retail and manufacturing inventories on Friday, Jan. 13. Today's print will be the preliminary wholesale number, which itself will be revised on Tuesday Jan. 10. We have not seen a truly healthy month of inventory building in this space since May.
10:30 - Natural Gas Inventories (Weekly):Expecting -185 billion, Last Week -209 billion cubic feet. This will most likely be the sixth consecutive weekly draw on natural gas supplies, and those draws just keep getting larger and larger. Natural Gas pricing has been trending higher since early November when this change in direction started, and will likely react to another sizable draw here today.
11:00 - Oil Inventories (Weekly):Expecting -900,000, Last Week +2.3 million barrels.
11:00 - Gasoline Stocks (Weekly):Expecting +500,000, Last Week -1.3 million barrels. Crude prices softened overnight as the American Petroleum Institution numbers once again differed greatly from professional consensus view coming into this report. The API data show a headline inventory build for WTI Crude of 4.2 million barrels and a draw for Gasoline of -2.8 million barrels. It does seem like almost anything goes in this space of late, and I think the marketplace may place more importance on the U.S. rig count this week, with crude trading in the low to mid $50s, than on actual supplies.
Sarge's Cash Levels
SPX: 2273, 2267, 2259, 2250, 2242, 2235
RUT: 1383, 1376, 1366, 1358, 1349, 1339
There are no quarterly earnings releases scheduled for today that have caught my attention.
At the time of publication, Stephen Guilfoyle had no positions in the stocks mentioned.