"If every lover was treated like they matter, every day, Valentine's day wouldn't be so special." -- Mokokoma Mokhonoana
The Animal Spirit
We have gone over and over the president's economic agenda like a constantly banging drum. Yet, the beat goes on. In November, investors placed bets that both overall growth, and consumer level inflation, would strengthen as the year progressed thanks to tax relief, some deregulation, and the repatriation of foreign held money (That would permit fiscal stimulus). Yesterday, we also took a look at stronger earnings performance as another support for this rally in equities. There is one other factor that we really haven't discussed all that much in this space. That's the whole "animal spirit" idea that's been thrown around in the financial media.
Is this "spirit" a real thing? Ever rush to the station on your way to work, only to see the doors close, and the train leave as you race toward the platform? Next train is in 45 minutes. Now, you have to call the boss. You will look like a complete buffoon, unless you race the train to the next station. That's the animal spirit. Not that the trend visible before us is not valid -- I think it is. I also do think that that we are seeing some reckless buying, trades based more on trying to catch someone else's momentum than on fundamentals or technicals. Total market cap for the S&P 500 poked above $20 trillion yesterday for the first time. As long as those "phenomenal" tax cuts remain rumor, they are a positive force, an accelerant for the marketplace. Once the tax plan is news, and the warts such as a border or value added tax are quantifiable, there will be a spate of profit taking. Maybe not a correction. I am not that bold, but I know what I will do.
The Chair of the Federal Reserve Bank will testify today before the Senate Banking Committee. The dollar index DXY strengthened yesterday in front of this event, but has softened somewhat in the overnight trading session. Watching dollar strength throughout the testimony will likely be as interesting as actually listening to the proceedings. As always happens at these events, committee members will pepper the Chair with questions on the health of the U.S. economy and its sustainability. They will also likely venture into the prospects of stimulation coming from the fiscal side, as that is what the Fed has been calling for, at least until it became a possibility.
The focus of this event (and tomorrow's) will obviously be monetary policy. Everyone present, and everyone listening around the globe will want to hear something on the timing of the next increase for the fed funds rate. That, my friends, is something that Dr. Yellen will not answer directly; she simply cannot. The CME webpage currently projects the probability of an increase at the March meeting at 13%, while posting the chances of a June hike at 65%. The Fed Chair cannot offer timing on the next interest rate hike, because quite frankly, the new administration's economic agenda has not yet been executed, and its success is therefore still in the realm of theory. She will, however confirm intent, and use the word gradual.
What I would like to see come out of this week's testimonies would be some kind of defined plan to manage the Fed's balance sheet. A better time may not exist to start nibbling away at this 800-pound gorilla, while it remains among the least discussed, most camouflaged policy items under her influence.
The Little Guy
The Russell 2000 hit a new record yesterday for the first time since Dec. 9, which in this environment would make the small cap index look quite pedestrian. At last, this index seems to be catching up to the broader large-cap indices that seem to be breaking records at least a couple of times a week since the election. There are reasons to believe in these stocks, but there is also reason to be cautious. I have told you in the past to hide out in this space in times of dollar strength as the majority of these firms are strictly domestic in nature. That much is still true, but there is more. We all know that the U.S. corporate tax rate currently stands at 35%, among the highest such rates on the planet.
Well, Credit Suisse has released a study that was mentioned in the Wall Street Journal claiming that while firms comprising the S&P 500 average a net effective corporate tax rate of 26%, those firms residing in the Russell 2000 pay a net effective rate of 32%. This means that the Russell 2000 stands to benefit far greater from tax reform than do the other major indices. On top of that, and I believe that this is down the road, sizable portions of any increased spending on infrastructure will likely be localized in nature, meaning that smaller firms will be competitive in any bidding. If only we could trust the dollar. In this era of a new president who seems to pretty obviously favor a weaker dollar policy, I am not sure we can. No matter what Janet Yellen says, what she does is what matters. Well, that's a story for a different day.
06:00 -- NFIB Small Business Optimism Index (January):Expected 104.9, Actual 105.9. Small business optimism has been a driver for employment in specific, and for an increased confidence in forward looking economic expectations nationally. According to the NFIB, small businesses in aggregate are more optimistic now than at any point since 2004. Oddly, according to the same survey, only 18% of small businesses have plans to increase employment, while 31% currently confess current job openings; 48% of small businesses say that they expect the overall economy to improve, which is down slightly from December.
08:30 - PPI (January):Expecting 0.3%, December 0.3% m/m.
08:30 - Core PPI (January):Expecting 0.2%, December 0.2% m/m. Regularly more volatile than inflation at the consumer level, headline producer prices have been increasing rapidly over a four-month period on a year-over-year basis. As for the month-over-month variety, a third consecutive sizable increase is expected. This item impacts the marketplace far less than will tomorrow's CPI data.
08:50 - Fed Speaker: Richmond Fed Pres. Jeffrey Lacker is scheduled to speak on economic forecasting from Newark, Delaware. Lacker has openly worried about inflation of late, and has been openly hawkish. Richmond will not have a voting seat at the FOMC again until next year. Both the media and the audience will be permitted to ask questions at today's event.
08:55 - Redbook (Weekly):Last Week 0.7% y/y. This weekly measure of retail health finally moved in a northerly direction on a year-over-year basis for the first time in 2017. With the retail portion of "earnings season" lined up to start next week, this sudden move in the right direction could not have come at a better time. The trick now is to hold on to that half percent mark.
10:00 - Fed Speaker:Federal Reserve Chair Janet Yellen will testify before the Senate Banking Committee on monetary policy. This is clearly your economic news event of the day, and trumps even tomorrow's event in front of the House Financial Services Committee as this event comes first. The Fed Chair will give very little away intentionally. It's when the questioning starts coming in from Senators with very little professional understanding of the space that things may get interesting. Odds are that yields, and Fed Funds futures move on this semi-annual event.
12:00 - Fed Speaker:Atlanta Fed Pres. Dennis Lockhart is set to speak from Huntsville, Alabama. Not only does Atlanta not vote this year, but Lockhart is retiring in two weeks. Therefore, there is very limited potential for this speech to move the marketplace.
13:00 - Fed Speaker:Dallas Fed Pres. Robert Kaplan will speak from Houston, Texas. Kaplan, who is a voting member of the FOMC this year, has been quoted as being in favor of gradually increasing borrowing costs. More outspoken on other topics, Kaplan has mentioned potential tax cuts and regulatory reviews as being healthy, but has backed off where increased fiscal spending might add to national debt. There will be Q&A session with both the audience, and the media at the conclusion of this event.
Sarge's Trading Levels
These are my levels to watch today for where I think that the S&P 500, and the Russell 2000 might either pause or turn.
SPX: 2356, 2344, 2336, 2327, 2319, 2311
RUT: 1405, 1398, 1392, 1387, 1378, 1371
(This version of the article corrects a previous version, which listed the incorrect earnings schedule for Tuesday)
Tuesday's Earnings Highlights (Consensus EPS Expectations)
At the time of publication, Stephen Guilfoyle was long HUN, although positions may change at any time.