For a PDF version of the below commentary please click here Weekly Letter 11-20-2017

Commentary quick take:

 

  • Major developments:
    • Mixed results for US markets
    • House passed tax reform
    • Senate fighting over tax reform begins

 

  • US:
    • House passed tax reform bill; now onto Senate
    • Senator Ron Johnson comes out against tax bill
    • Government shutdown looming
    • Q3 earnings season ending
      • 95 percent complete
      • Current growth rate is 6.2 percent

 

  • Global:
    • Germany Coalition talks fell apart
    • Brexit going nowhere fast
    • Singles day 2017
    • President Mugabe is trying to hold on

 

  • Hybrid investments strategy update:
    • No changes to hybrid models
    • Wal-Mart earnings

 

  • This week for the markets:
    • Slow week for the markets
    • Tax reform discussions continuing

 

  • Interesting Fact: Singles Day is a relatively new “holiday”

 

 

Major theme of the markets last week: Tax reform yet again last week!

US tax reform continues to be the primary focal point for financial markets in the US and around the world. Last week, the House of Representatives passed its version of tax reform in a bill that received no Democratic support and saw several Republicans side with the Democrats in voting against the measure. The bill was largely what was discussed two weeks ago in the weekly market commentary. There remain major differences between what is being discussed in the Senate and what passed in the House. Pundits online immediately came up with clever things to say about the passed tax reform bill, such as:

 

Permanent tax cuts for corporations, temporary tax cuts for individuals

Tax hikes on the middle class, tax breaks for the wealthy

Christmas comes early for US corporations

 

While some people are arguing about the finer points of the bill, we still must see what the Senate comes up with. The two bills will need to go to a reconciliation process, which will likely end up with major changes being made to the bills. There are broad points that are alike and unlikely to change in the bills, such as lowering the corporate tax rate and increasing the standard deduction for individual tax returns. Aside from those two items, almost everything is different, with one of the biggest differences being the timing of a corporate tax rate cut. The House bill has the rate cut start in 2018, while the current Senate version delays the start until 2019. In general, the financial markets want the tax breaks sooner rather than later and are likely to move down if the breaks are delayed until 2019, should the reform process get to that point. With such a slim majority in the Senate, Republicans cannot afford many defectors voting against the bill. Last week, Wisconsin Republican Senator Ron Johnson became the first Republican to come out against the bill as it was being discussed, leaving only 51 potential Yes votes in the Senate when 50 votes are needed to pass the bill. Other Republicans being closely watched by Wall Street include Jeff Flake and John McCain from Arizona, Susan Collins from Maine and Bob Corker from Tennessee. One action taken by the Senate last week that only adds to the difficulty in passing legislation is that the bill now repeals the ACA mandate on everyone having health insurance. With both the House and the Senate in recess for the Thanksgiving holiday this week, there will likely be no movement on tax reform this week. However, when they return to work next week, they must get going very quickly because tax reform isn’t the only clock that is ticking. Other items with clocks ticking include the Children’s Health insurance program, Federal Budget (runs out December 8th) and the discretionary budget for the US (everything outside of the Social Security and Medicare systems). There is a lot of work to be done and the financial markets are likely to become more volatile as we move closer to the end of the year if nothing is getting done in Washington DC. One other wildcard that is always in play is President Trump himself, who is probably more than willing to cross the aisle and work with Democrats to get a “meaningful” piece of legislation done during his first year, a feat that so far has alluded him.

 

US news impacting the financial markets:

 

Tax reform remained the primary focal point for media here in the US last week as the Republican controlled House managed to pass the tax reform bill and move the discussion fully onto the shoulders of the Senate. Aside from tax reform, the end of earnings season also made a few headlines as companies such as Target and Wal-Mart both reported their latest results last week.

 

Last week we saw earnings season for the third quarter move past the 95 percent mark as we continue to see the rapid decline in the number of companies reporting results. Below is a table of the well-known companies that released earnings last week with earnings that missed expectations highlighted in red, while earnings that beat expectations by more than 10 percent are highlighted in green:

 

Advance Auto Parts 19% Home Depot 2% Splunk 21%
Applied Materials 2% Helmerich & Payne 38% Target 6%
Best Buy -1% JD.com 130% TJX Companies 0%
Cisco Systems 2% Post Holdings -5% Tyson Foods 4%
Dicks Sporting Goods 15% Ross Stores 7% Wal-Mart Stores 3%
Gap 5% Sally Beauty -2% Williams-Sonoma 0%

 

Chinese online retailer JD.com saw the largest surprise increase in earnings last week in the above table as online sales in China and around the world continue to increase. Big data company Splunk turned in a strong quarter, beating expectations by more than 20 percent as the company continues to grow and expand within the big data market space. Wal-Mart announced its 13th consecutive quarter of sales increases at its physical locations last week and the company beat analyst expectations, thanks to strong growth in online sales as well as grocery and delivery business operations. On the news of the positive performance for the quarter, Wal-Mart stock increased by nearly 11 percent, its largest single day move in more than 18 months. Target missed the boat once again, despite beating analysts’ expectations. The company is now far behind Wal-Mart and Amazon for online sales and it looks like it may not be able to even meaningfully enter the race. Without the evolution of business operations being seen during the third quarter, Wall Street pushed the stock of Target lower by almost 10 percent on the day it announced its results. Best Buy’s woes continued during the third quarter as the company missed its earnings expectations as online competition continues to be fierce for many of the products the company sells at its physical location.

 

According to Factset, we have seen 476 (95 percent) of the S&P 500 companies release results for the third quarter of 2017. Of the 476 companies that have released earnings, 74 percent have beaten earnings estimates, while 8 percent have met expectations and 18 percent have fallen short of expectations. When looking at revenue, of the companies that have reported, 66 percent of the companies have beaten estimates, while 34 percent have fallen short. The overall earnings growth rate for the S&P 500 thus far stands at 6.2 percent. Top performing sectors of the markets are Energy, Information Technology and Materials. So far during the third quarter reporting, 93 companies have issued guidance for the fourth quarter of 2017, with 61 issuing negative guidance, while 32 have issued positive guidance. Over the course of the previous week, very few of the above figures changed as we are close to being done with third quarter 2017 earnings season. While there are still about 5 percent of the companies in the S&P 500 needing to report earnings, it is highly unlikely that the above figures will change in a meaningful way.

 

This week is the last week for an earnings table as the following weeks have too few companies reporting results to warrant a table being included. Consumer facing companies make up the bulk of the reports released this week. The table below shows the companies that will be releasing their earnings this week, with those that have the greatest potential to move the markets highlighted in green:

Agilent Technologies Deere & Company HP
Barclays Dollar Tree Intuit
Burlington Stores Dsw Medtronic
Campbell Soup Guess Palo Alto Networks
SalesForce.com GameStop Urban Outfitters

 

Investors will be closely monitoring Intuit’s earnings report and conference call this week as there is a lot of concern that the company could lose a significant amount of revenue from its tax preparation software, TurboTax, if the tax reform bills ultimately pass in Washington DC. One of the things TurboTax does very well is find deductions that someone may have overlooked. With the current tax reforms, many of these deductions will likely be going away, leaving consumers wondering if it is worth paying for TurboTax software or if they should just prepare their taxes online for free elsewhere. Deer and Company is one of the companies closely watched by Wall Street to determine the health of farming in the US and around the world as much of the company’s revenues is generated from large agricultural machinery. A group of interesting technology companies including HP, Agilent Technologies, Salesforce and Palo Alto Networks round out the meaningful earnings releases this week as they report earnings on the heels of the technology sector doing very well so far during the reporting season.

 

Global news impacting the markets:

 

There were several interesting developments over the last week in the global financial media as Europe took most of the headlines. Germany seems to be headed for some political problems as the coalition round of discussions in Germany fell apart over the past weekend. This leaves German Chancellor Angela Merkel in a very difficult spot as she either must try to form a minor coalition government with another political party or call for new elections in Germany. Germany last held an election in September and the outcome of the election is depicted to the right. The problem with Chancellor Merkel calling for another round of elections to be held in Germany is that in September the mainstream political parties in Germany received far fewer votes than they had been expecting, as voters gravitated toward more fringe parties. The most concerning of the new parties to Merkel’s CDU party is the rise of the Alternative for Germany Party (AfD), which is a self-described German nationalist, right-wing populist, and Eurosceptic party. The party, which was formed in 2013, went from having no representation in Parliament to gaining 94 seats, making it the third largest party by representation. The financial market reaction was expected following the announcement of the coalition talks breaking down, with the Euro declining and German banking stocks moving lower. If Germany sees a drastic change in the political landscape, it could mean major problem for the Euro and the Eurozone in general, as a lack of support for the group by Germany would certainly mean an ending to the group is likely. All of this comes while Brexit negotiations are not going very well.

 

Brexit is a topic that will likely make headlines for the next 18 months, with negotiations likely to continue up to and even through the actual hard deadline. Last week, like it has been for the past several weeks, the topic was the divorce financial payment with the UK saying it will pay something, but not committing to any hard figures. The EU looks to be calling the UK’s bluff, calling for something from the UK in the next two weeks. If nothing is done, the Europeans look set to end talks until at least the Spring of 2018 and, even then, they will only talk about the divorce payments until they are settled upon before starting to discuss things such as trade agreements. In the meantime, Scotland is trying to break away from the UK and stay within the EU, but this doesn’t seem possible as only a country recognized as independent by the EU can apply for membership in the EU. Since Scotland is recognized as part of the UK, this would be a very difficult move on Scotland’s part. Until there is some type of agreement pertaining to Brexit, most companies that have international operations in the UK will be picking up the pace on what they should do if a hard Brexit is to occur and the UK is essentially dropped from all EU membership.

 

Asia made a few headlines last week as the numbers from singles day shopping came rolling in higher than ever. Singles day has become a Chinese holiday with a significant impact on online sales as it is a day that people buy things for themselves. Alibaba, China’s largest online retailer, takes the lion’s share of the sales from the holiday. In 2017, Alibaba saw $17.8 billion in sales on Singles day. In 2017, however, the company racked up $1.5 billion in sales in the first three minutes of the holiday and $12 billion in the first two hours. In total, Alibaba saw $25.3 billion spent across 1.48 billion transactions during the day. For comparison purposes, Black Friday sales in total in the US amount to about $3 billion, while Cyber Monday sales account for $3.45 billion. The singles day online sales goes to show how much of an impact a company can feel when it does business with billions of people every day.

 

The final global headlines last week came out of a country that rarely makes global headlines, Zimbabwe, as the military took over the government and has tried to sac long-serving (37 years) President Robert Mugabe. There were many arrests and President Mugabe was under house arrest, but so far, the violence has been minimal in the country that has been known for its violent clashes in the past. With the deadline for Mugabe to resign having passed, the ruling Zanu political party is now moving forward with impeachment proceedings against President Mugabe. The biggest potential impact on the global markets from the situation in Zimbabwe is in the mining sector as a lot of natural resources including gold, nickel and diamonds are exported by the poor African country.

 

Hybrid model performance and update

For the trading week ending on 11/17/2017, returns in the hybrid and quant hypothetical models* (net of a 1% annual management fee) were as follows:

 

  Last Week 2017 YTD Since 6/30/2015
Aggressive Model 0.28% 8.10% 13.99%
Aggressive Benchmark -0.20% 15.93% 15.71%
Growth Model 0.23% 7.43% 12.34%
Growth Benchmark -0.15% 12.37% 12.53%
Moderate Model 0.19% 5.95% 9.86%
Moderate Benchmark -0.11% 8.89% 9.29%
Income Model 0.18% 5.53% 9.22%
Income Benchmark -0.04% 4.69% 5.18%
Quant Model -0.29% 11.69%
S&P 500 -0.13% 15.19% 25.00%

*Model performance does not represent any specific account performance but rather a model of holdings based on risk levels that are like my actual holdings, the hypothetical models are rebalanced daily to model targets.

 

There were no changes in the hybrid models over the course of the previous week as the defensive nature of many of the holdings in the models performed well in the increasing market volatility. Wal-Mart was one of the best performing holdings last week as the stock gained more than 7 percent for the week after reporting better than expected earnings and increasing its outlook for the future. Wal-Mart also turned in a 63 percent increase in online sales during the quarter, making it the most viable competition for Amazon; however, it is still far behind the online marketplace leader.

 

Market Statistics:

 

Volume moved back below the one-year average levels on two of the three major US indexes last week as the performance of the broad indexes was mixed:

 

Index Change Volume
NASDAQ 0.47% Below Average
S&P 500 -0.13% Below Average
Dow -0.27% Average

 

NASDAQ turned in the top performance for the week last week as technology companies that had been pushed down two weeks ago saw more of a bounce back than other companies. The Dow was weighed down by earnings last week and concerns that the corporate tax reform that the markets seem to be betting on could be delayed until 2019. One other factor that led to the decline seen on the Dow was the worldwide tax on cash and cash like holdings that was discussed last week in the tax reform dialog. This new tax would impact far more of the Dow component stocks than any of the other indexes.

 

The following were the top 5 and bottom 5 performing sectors over the course of the previous week:

 

Top 5 Sectors Change   Bottom 5 Sectors Change
Multimedia Networking 3.11%   Industrials -0.90%
Regional Banks 2.13%   Infrastructure -1.07%
Home Construction 2.10%   Natural Resources -2.76%
Telecommunications 1.75%   Energy -3.30%
Consumer Service 1.42%   Oil & Gas Exploration -3.37%

 

The mix of sector performance last week was unusual in that there were very few trends among sectors. Rather, the movements were due to outsized individual company movements due to earnings or other announcements throughout the week. On the negative side of performance, the decline in the price of oil and the announcement that Norway’s sovereign wealth fund (largest fund in the world) wants to divest itself of oil and gas holdings seemed to adversely impact the sector, taking down Oil and Gas Exploration as well as Energy and Natural Resources.

 

US government bonds were positive last week as the financial markets are still thinking that a rate hike is likely to come at the December meeting of the FOMC:

 

Fixed Income Change
Long (20+ years) 1.85%
Middle (7-10 years) 0.33%
Short (less than 1 year) 0.01%
TIPS 0.36%

 

Best and Worst Currencies Change
US Dollar -0.81%
South Africa rand 2.73%
Venezuela bolivar -4.50%

 

 

Overall, the US dollar decreased last week by 0.81 percent against the value of a basket of foreign currencies, as uncertainty over the future of the tax reform bill in the Senate seemed to push the dollar lower. When looking at global currencies, the South African Rand took the top spot, gaining 2.73 percent against the US dollar. The Venezuelan Bolivar performed the worst last week, giving up 4.5 percent against the US dollar, as the country officially defaulted on some of its payments to creditors.

 

Commodities were mixed last week, as the metals moved higher, while all the other commodities pushed lower:

Metals Change   Commodity Change
Gold 1.43%   GS Commodity Index -0.82%
Silver 2.26%   Oil -0.61%
Copper 0.01%   Livestock -2.61%
      Grains -0.63%
      Agriculture -1.45%

 

The GS commodity index declined 0.82 percent last week, as gains in metals were offset by losses in all other commodities. Oil declined by 0.61 percent, on the announcements out of Norway and no further developments in the situation in Saudi Arabia. Gold, Silver and Copper increased 1.43, 2.26 and 0.01 percent, respectively, last week. Soft commodities declined last week across the board, with Agriculture overall falling by 1.45 percent, while Grains declined 0.63 percent and Livestock declined 2.61 percent for the week.

 

Top 2 Indexes Country Change   Bottom 2 Indexes Country Change
Sao Paulo Bovespa Brazil 1.76%   ATX Austria -2.31%
Dow Jones China 88 China 1.57%   BIST 100 Turkey -2.49%

Last week was a very difficult week for the global stock indexes, with only 17 percent of the global markets posting gains. Brazil’s Sao Paulo based Bovespa Index posted the highest return for the week, gaining 1.76 percent, as the worst of the corruption cases in the country may be in the past. On the negative side, Turkey’s BIST 100 index slid 2.49 percent last week, as political uncertainty in the Middle East continues to reverberate throughout the region.

After gaining more than 23 percent two weeks ago, the VIX last week took a bit of breather, advancing only 1.24 percent for the week last week. Last week the VIX closed out the week almost exactly on top of the one-year average level that we have seen on the VIX. With this week being the Thanksgiving holiday, it is generally a slow week for the markets and for the VIX. The current reading of 11.43 implies that a move of 3.30 percent is likely to occur over the next 30 days. As always, the direction of the move over the next 30 days is unknown.

Economic Release Calendar:

 

Last week was a busy week for economic news releases in terms of the number of releases, but it was an unusual week in that there were no releases that came out significantly better or worse than the market had been expecting:

 

Economic Impact Date Economic News Release Date Range Actual Expectation
Slightly Positive 11/14/2017 Core PPI October 2017 0.40% 0.20%
Slightly Positive 11/14/2017 PPI October 2017 0.40% 0.10%
Neutral 11/15/2017 Core CPI October 2017 0.20% 0.20%
Neutral 11/15/2017 CPI October 2017 0.10% 0.10%
Slightly Negative 11/15/2017 Empire Manufacturing November 2017 19.4 26
Neutral 11/15/2017 Retail Sales October 2017 0.20% 0.10%
Neutral 11/15/2017 Retail Sales ex-auto October 2017 0.10% 0.20%
Slightly Negative 11/16/2017 Philadelphia Fed November 2017 22.7 24.6
Neutral 11/17/2017 Building Permits October 2017 1297K 1243K
Slightly Positive 11/17/2017 Housing Starts October 2017 1290K 1198K

Data for table from Econoday.com, Bloomberg and Yahoo Finance

 

Last week, the economic news releases started on Tuesday with the release of the Producer Price Index (PPI) for the month of October, which came in slightly higher than the expected very low reading, but not high enough to trigger fears of inflation. The surprises to the upside on the readings of the PPI were not continued Wednesday when the Consumer Price Index (CPI) was released as these two figures came in as expected, very close to zero. Also released on Wednesday, the Empire Manufacturing index disappointed slightly as the index showed manufacturing increasing at a slower pace than was expected by the markets. Retail sales for the month of October were also released on Wednesday and came in very low, but as expected caused little impact to be seen in the markets. Let’s hope the anemic retail sales figures that occurred in October do not spill over and adversely impact the holiday shopping season, which is vital to many retailers in the US. Wrapping up the week last week was the start of the October housing data as the building permits and housing starts figures were both released. Both housing permits and building starts came in above market expectations with much of the surprise increase due to construction spending in the hurricane hit areas of the US.

 

With the Thanksgiving holiday being this Thursday, all the potentially meaningful economic news releases are crammed into Wednesday this week. The releases with the greatest potential to impact the markets are highlighted in green below:

 

Date Release Release Range Market Expectation
11/22/2017 Durable Goods Orders October 2017 0.3%
11/22/2017 Durable Goods –ex transportation October 2017 0.5%
11/22/2017 Michigan Sentiment – Final November 2017 98.0
11/22/2017 FOMC Minutes Previous Meeting N/A

Data for table from Econoday.com, Bloomberg and Yahoo Finance

 

This week the economic news releases start and end on Wednesday. Durable goods orders for the month of October are set to be released first, with overall orders and order excluding transportation expected to post small gains. If this sales reading follows the same trend as overall retail sales released last week, these releases could slightly disappoint the markets. The FOMC meeting minutes from the November meeting will be released on Wednesday as well, but as is typical, they are not expected to hold any new meaningful information, especially since at the time of the FOMC meeting in November the next Fed chair had not been appointed by President Trump. Wrapping up the week this week is the release of the University of Michigan’s Consumer Sentiment index for the month of November (mid-month reading), which is expected to show very little change over the beginning of November reading. With this week being a holiday week there are no Fed officials making any speeches as much of Washington DC has cleared out for the holiday.

 

Interesting Fact — Where did Singles’ Day come from?

 

Chinese Singles’ Day (November 11th) or Bachelors’ Day, which originated from Nanjing University in 1993, was initially celebrated at various universities in Nanjing during the 1990s. It got the name “Singles’ Day” because the date consists of four “one”s. Upon graduating, these college students carried the university tradition into society. In 2012, Alibaba capitalized on Singles’ Day by trade marking a Chinese term that means “Double 11” and threatened legal action against any media outlets that accept advertising from any of Alibaba’s competitors that used the term. Alibaba essentially trademarked and then marketed what has turned into one of the largest spending holidays in the world!

 

Source: investorplace.com

Advertisements

For a PDF version of the below commentary please click here Weekly Letter 11-13-2017

Commentary quick take:

 

  • Major developments:
    • Markets posted losses
    • Senate Tax reform bill unveiled
    • Earnings continue to be strong

 

  • US:
    • Senate Tax reform bill details
      • Increase standard deduction
      • Keep 7 tax brackets
      • Many deductions disappearing
      • Delay corporate tax decrease to 2019
    • Q3 earnings season ending
      • 91 percent complete
      • Current growth rate is 5.8 percent

 

  • Global:
    • President Trump in Asia
    • North Korea
    • Brexit still up in the air

 

  • Hybrid investments strategy update:
    • Sold one ETF
    • Sold two stocks
    • Bought one new ETF

 

  • This week for the markets:
    • Tax reform negotiations
    • Middle East uncertainty
    • North Korea is overdue to do something

 

  • Interesting Fact: How high has the upper tax bracket been?

 

 

Major theme of the markets last week: Tax reform—this could get ugly

Tax reform in the US was the primary focal point of the financial media around the world last week and for good reason. The reforms could have far reaching impacts on companies that operate both in and outside of the US. Two weeks ago, the House of Representatives released its version of tax reform and it was covered in last week’s commentary. Last week, it was the Senate’s turn to release its bill. Some of the key points of the Senate bill include:

 

  • Keep seven tax brackets and lower the top bracket to 38.5 percent
  • Increase the size of the standard deduction
  • Keep mortgage interest rate deduction (but not for cash out refinances)
  • Eliminate SALT
  • Eliminate all property tax deductions
  • Keep medical expense deduction
  • Increase child tax credit
  • Eliminate AMT
  • Lower corporate tax rate to 20 percent starting in 2019
  • Foreign corporate holdings tax
  • Keep Estate tax with higher limits

 

Much like the House Bill released two weeks ago, there are a lot of moving parts and calculations that need to be run to figure out how much either bill could help the economy grow and who the bills would benefit the most. The common thread in both bills is that the upper wage earners would likely end up with larger tax benefits from both bills than the middle class, which may very well see their taxes increase under both plans. One area of concern to some investors that needs to be closely watched pertains to Roth IRA conversions. Under current rules, someone can reclassify their Roth IRA conversion back to the original IRA if they would like to. This is most commonly done if investment losses are incurred in the Roth IRAs. Under the proposals, investors would lose the ability to reclassify their conversions. One of the biggest points of contention between the two plans that could materially impact the financial markets is the delaying of a corporate tax cut to 20 percent in the Senate bill until 2019. The financial markets are currently counting on tax reform being complete for the 2018 tax year. If we do not see tax reforms for 2018, the markets will likely push lower as analysts would have to recalculate their expectations for 2018 with the higher tax rate still in place.

 

While we are still very far from knowing what, if anything, comes from the current tax reform debate, there are some key things to think about as the debate moves forward. First, Republicans are sledding uphill from a procedural standpoint in the Senate. Under current Senate rules, the Republicans can pass tax reform under a reconciliation process, which requires only 50 votes for passage. This alone seems difficult with the current fractions that have been showing up in the Republican party in the Senate. One sticking point on the Senate side is that in order to use this reconciliation process, the tax reform bill would have to be revenue neutral, unlike the House bill, which added $1.5 trillion to the deficit over 10 years. If the deficit is increased by the Senate tax reform then the Republicans would need to get 60 votes to pass the bill, which is flatly not going to happen. That problem is not just on the Senate side. The tax reform bill in the House will not be smooth sailing either and if both sides manage to pass tax reform bills, they would still need to reconcile the bills to smooth out the differences. They are trying to complete all of this by the end of November, with a holiday in between now and then as well. It is easy to see why the stock market appears to be getting more and more skeptical about the ability for anything to actually get done on the tax reform front.

 

US news impacting the financial markets:

 

The focus of the financial media here in the US last week was the tax reform bills being worked on in Washington DC in both the House and the Senate, as discussed above, as well as corporate earnings, which are still coming in, but starting to slow down meaningfully when compared to how many reports were released over the past few weeks.

 

Last week we saw earnings season for the third quarter move past the 90 percent mark as we are now starting to see the rapid decline in the number of companies reporting results. Below is a table of the well-known companies that released earnings last week with earnings that missed expectations highlighted in red, while earnings that beat expectations by more than 10 percent are highlighted in green:

 

CenturyLink -7% Johnson Controls 0% Nintendo 25%
CVS Caremark 1% JC Penney 23% Office Depot 0%
Dillard’s 116% J&J Snack Foods 3% Priceline.com 3%
DR Horton 0% Jack Henry & Associates -4% EchoStar 3700%
Walt Disney -4% Nordstrom 6% Time 29%
Equifax 3% Kohl’s -3% Truecar 0%
Energizer 13% Macy’s 21% Hostess Brands -31%
Twenty-First Century Fox 2% Marriott International 12% Wendy’s Arby’s Group -25%

 

The biggest release to jump out of the table above is the 3,700 percent increase in earnings that EchoStar experienced during the third quarter. This number, just like most of the extreme values in the results tables, is a little misleading. Yes, the company had a great quarter, but the 3,700 percent figure is derived from analysts expecting earnings of -$0.01 and the company turning in a $0.36 per share figure. This positive surprise by EchoStar was not seen in the other major telecommunications company that reported earnings last week, CenturyLink, as the company missed market expectations. Retailers were the primary focus of earnings reports last week; results between retailers were very mixed. On the low-end, JC Penny saw a very positive quarter, while Kohl’s missed expectations. Higher end retailers Dillard’s, Macy’s and Nordstrom all beat expectations as consumers focused more on the higher end of the retailer market during the quarter. Nintendo posted a strong quarter after better than expected sales from the company’s new Switch gaming system, which was released earlier during the year. Walt Disney was in focus last week as the company’s ESPN network continued to struggle for viewers and content. The theme parks even saw a little dip during the quarter as hurricanes in the Florida area adversely impacted park attendance.

 

According to Factset, we have seen 455 (91 percent) of the S&P 500 companies release results for the third quarter of 2017. Of the 455 companies that have released earnings, 74 percent have beaten earnings estimates, while 8 percent have met expectations and 18 percent have fallen short of expectations. When looking at revenue, of the companies that have reported, 66 percent of the companies have beaten estimates, while 34 percent have fallen short. The overall earnings growth rate for the S&P 500 thus far stands at 5.8 percent. Top performing sectors of the markets are Energy, Information Technology and Materials. So far during the third quarter reporting, 86 companies have issued guidance for the fourth quarter of 2017, with 58 issuing negative guidance, while 28 have issued positive guidance. As we are now very close to the end of the third quarter reporting season it becomes very difficult for the above-mentioned numbers to materially change. One phenomenon that occurred during the second quarter reporting season and seems to still be having some impact on the current round of reports is the low amount of market movement on positive earnings surprises. The chart to the right shows what happened to a stock’s price following a positive earnings surprise so far during the third quarter of 2017.

As you can see on the far right, if a company has reported a positive surprise on earnings so far for the third quarter of 2017, their stock price has only moved up on average 0.4 percent. This is far below the average positive move of 1.2 percent seen over the past 5 years, but it is also a drastic increase from the -0.3 percent move we saw following a positive earnings surprise during the second quarter of 2017 reporting season. One factor that is playing a part in the numbers here is the uncertainty surrounding the political situation in Washington DC, uncertainty surrounding Congress’s ability to pass meaningful legislation on tax reforms. The market rally so far in 2017 has been largely on the hopes of the new administration making sweeping changes in many different areas of business and, so far, there has been no meaningful legislation passed in Congress and signed by the President.

 

This week we continue to see a drop off in the number of companies reporting as well as the size of the companies releasing results. Consumer facing companies make up the bulk of the reports released this week. The table below shows the companies that will be releasing their earnings this week, with those that have the greatest potential to move the markets highlighted in green:

 

Advance Auto Parts Home Depot Splunk
Applied Materials Helmerich & Payne Target
Best Buy JD.com TJX Companies
Cisco Systems Post Holdings Tyson Foods
Dicks Sporting Goods Ross Stores Wal-Mart Stores
Gap Sally Beauty Williams-Sonoma

 

Wal-Mart and Target will take the bulk of the media headlines this week regarding earnings reports as they are two of the largest brick and mortar retailers in the US. One item that will be closely watched by Wall Street as they report earnings will be their online sales figures as both try to compete with Amazon. Wal-Mart, during the past few quarters, has shown a significant increase in online sales, thanks to things like in-store pick up, delivery from stores, curb side delivery and online to in-store purchase returns. Target has long been falling behind in all online categories and it should be interesting to see what, if any, changes the company has decided upon for its business strategy. Lower end retailers TJX (parent of TJ Maxx) and Ross will also post their results this week; adverse impacts from the storms during the quarter could materially impact these two companies’ results as nearly all their business is done in store, in person as online sales are not very conducive to their business models. Best Buy and Dick’s Sporting Goods are also consumer facing big box retailers that report their results this week and it could be interesting to see how these faired against Amazon during the quarter. Splunk is a big data company, one of the few that are publicly traded, that will be closely watched by Wall Street as it is a proxy company for many smaller big data companies that have yet to go public.

 

Global news impacting the markets:

 

The global financial news last week focused on US President Donald Trump’s first trip to Asia since he took office. President Trump has met with leaders of many countries in Asia and has so far called the trip a huge success, but there seems to be a general lack of anything concrete coming out of any of the high-level meetings. President Trump’s main topic he wanted to talk about on this trip was trade agreements and how they are not fair toward the US. While he has mentioned the topic several times in various speeches, it has not been a topic that any of the world leaders have discussed with him in a one on one setting and there have been no significant announcements on the part of the US during the trip. There were a few deals that looked like President Trump may have had something to do with in China after his meeting with President Xi Jinping, but upon closer look, the deals were announced well in advance of President Trump getting involved. North Korea was also a hot button topic during many stages of the trip as President Trump called for all countries of the world to come together and deal with the problem at hand. This sounded nice, but no actions were taken by any countries involved. Russia even made a few headlines during Trump’s Asian tour as President Trump spoke with Russian President Putin on the sidelines of an Asian region meeting held in Vietnam. Much like other meetings on this trip, nothing of substance came from the brief talk with President Putin either.

Brexit was the other major topic of the international financial media last week as negotiations seem to be spiraling out of control. The chief EU negotiator threatened last week that there are about two more weeks to go before the EU will be done talking about the Brexit until at least Spring of 2018 if the UK does not bring something substantial to the table on the divorce settlement. The money owed by the UK to the EU to fulfill its previously agreed upon financial obligations has long been a sticking point between the two sides and it appears to be a point the EU is not going to look past for any reason until it is worked out. Over the course of the previous week, there were even more announcements from companies operating in the UK that they have sped up their analysis of potential moves should a hard Brexit come in 2019 if no deal is made between the UK and the EU. Much like many financial institutions that have already begun leasing office space within the EU, other industries are starting to get ready to jump ship as well. The UK can certainly not afford to have very wealthy businesses move operations out of the UK as it would leave a serious dent in the UK’s tax revenues, something the country was counting on to help the UK stay afloat after it leaves the EU. One area of the UK economy to watch closely as the Brexit deadline draws nearer is agriculture. Many of the crops grown in the UK need a lot of manual labor to pick and process; the labor has historically almost all come from Eastern Europe. If the UK is left out in the cold with the EU seasonal labor needed for agriculture unable to come into the country to work, lots of food would be left rotting in the fields.

 

Hybrid model performance and update

For the trading week ending on 11/10/2017, returns in the hybrid and quant hypothetical models* (net of a 1% annual management fee) were as follows:

 

  Last Week 2017 YTD Since 6/30/2015
Aggressive Model -0.29% 7.79% 13.66%
Aggressive Benchmark -0.18% 16.16% 15.94%
Growth Model -0.27% 7.17% 12.06%
Growth Benchmark -0.14% 12.53% 12.69%
Moderate Model -0.21% 5.74% 9.64%
Moderate Benchmark -0.09% 9.00% 9.40%
Income Model -0.14% 5.32% 9.00%
Income Benchmark -0.04% 4.73% 5.22%
Quant Model 0.55% 12.01%
S&P 500 -0.21% 15.34% 25.17%

*Model performance does not represent any specific account performance but rather a model of holdings based on risk levels that are like my actual holdings, the hypothetical models are rebalanced daily to model targets.

 

There were several changes to the hybrid models over the course of the previous week as we continue to shift some of the holdings toward new opportunities. There were three sales that took place last week, two individual stocks and one ETF. The two stocks that were sold were Kimberly Clark (KMB) and JM Smucker (SJM). Both stocks were sold as they hit and broke through long term support levels on their stock prices. For those of you who have been in the hybrid model since the original purchases of both SJM and KMB, the gains on the two positions that were sold were 27 and 57 percent, respectively. The ETF that was sold last week was the Powershares Global High Yield fixed income fund (PGHY) as the fund hit a trailing stop that had been increasing through much of 2017. The purchases last week were two steps into a new ETF that is the Wisdom Tree Quality Dividend Growth ETF (DGRW). The fund focused on investing in companies that are high quality and growing their dividends. The fund was chosen for its very strong risk to reward ratio as well as the differentiations between the fund and the individual stock holdings within the hybrid models. For instance, the hybrid models during the first three quarter of 2017 were greatly lacking large technology companies that were driving most of the overall stock market gains. DGRW is more than 20 percent information technology companies with Apple and Microsoft having significant weighting within the fund. Healthcare and Industrials are two other focal points of the ETF, which are also under-represented and have been outperforming in the individual equity holdings of the hybrid models. While there are still several individual stocks being evaluated for inclusion in the hybrid models, the valuations are extremely high and it seems to make more sense given the performance we have seen in 2017 thus far to invest more broadly in tradable ETFs than to increase individual stock holdings.

 

Market Statistics:

 

Volume finally moved above the one-year average levels on two of the three major US indexes last week:

 

Index Change Volume
NASDAQ -0.20% Above Average
S&P 500 -0.21% Above Average
Dow -0.50% Average

 

All three of the major US indexes declined in value last week, ending the streak of weeks in a row of positive gains at six, which is still an impressive feat. Much of the decline seen in the US markets last week was due to uncertainty over the timing of a corporate tax rate decline after the Senate’s first pass at tax reform showed the tax cut for corporations being pushed out to 2019. While the declines last week were relatively small, we could see an acceleration of selling in the broad markets if tax reform looks less and less likely to be passed as we get closer to the Thanksgiving holiday.

 

The following were the top 5 and bottom 5 performing sectors over the course of the previous week:

 

Top 5 Sectors Change   Bottom 5 Sectors Change
Real Estate 2.59%   Healthcare Providers -1.74%
Home Construction 2.38%   Telecommunications -1.86%
Oil & Gas Exploration 1.66%   Transportation -2.59%
Energy 1.52%   Financial Services -2.94%
Consumer Goods 1.32%   Regional Banks -5.08%

 

Real Estate led the way higher last week as home builders continued to rise with new homes sales, combined with rebuilding in the southern US. Oil and Gas Exploration as well as the broader Energy sector took the third and fourth spots last week as the price of oil continued to gain following the political uncertainty coming out of the Middle East. Consumer Goods rounded out the top five performing sectors last week after what looked like investors moving back into the sector that had been badly beaten down over the past month. On the flip side, Regional Banks and Financial Services declined the most last week as lower interest rates, combined with the prospects of higher inflation in the US, seemed to dampen the excitement the sectors had been experiencing the past few months. Transportation took a hit last week, turning in the third worst performance of the week as the price of oil increasing adversely impacted the sector. The Telecommunications sector hit a snag on a big merger as the US government stepped in against the deal last week, sending the sector lower. Rounding out the bottom five sectors last week was the Healthcare Providers sector as uncertainty over the fate of the Affordable Care Act and plan pricing for 2018 seems to be having an adverse impact on the group as a whole.

 

US government bonds were mixed last week as the financial markets continued to weight how they felt about Jerome Powell being tapped as the next Fed Chairman:

 

Fixed Income Change
Long (20+ years) -1.23%
Middle (7-10 years) -0.51%
Short (less than 1 year) 0.00%
TIPS -0.21%

 

Best and Worst Currencies Change
US Dollar -0.61%
Iceland krona 2.68%
Israel shekel -1.12%

 

 

Overall, the US dollar decreased last week by 0.61 percent against the value of a basket of foreign currencies, during a week that saw lighter than usual trading volume in global currencies as traders waited for any actions coming out of either the Brexit or President Trump’s Asian trip. When looking at global currencies, the Icelandic Krona took the top spot, gaining 2.68 percent against the US dollar. The Israeli Shekel performed the worst last week, giving up 1.12 percent against the US dollar, as the political situation with many of the country’s neighbors seems to be heating up.

 

Commodities were mixed last week, as the overall GS commodity index made it two weeks in a row of gains, advancing almost 1 percent:

Metals Change   Commodity Change
Gold 0.42%   GS Commodity Index 0.95%
Silver 0.19%   Oil 2.15%
Copper -1.46%   Livestock -5.00%
      Grains -0.39%
      Agriculture -0.31%

 

The GS commodity index advanced 0.95 percent last week, as gains in oil drove the majority of the positive performance. Oil advanced by 2.15 percent, thanks mostly to the actions of Saudi Arabia and Lebanon fighting a proxy war in Yemen that last week, seeing a rocket take off in Yamen that almost hit the airport in Riyadh, Saudi Arabia. Gold and Silver increased 0.42 and 0.19 percent, respectively, last week, while Copper declined by 1.46 percent over fears of future demand softening pushed the industrial metal lower. Soft commodities excluding oil declined last week across the board, with Agriculture overall falling by 0.31 percent, while Grains declined 0.39 percent. The run of three weeks in a row of gains for Livestock came to a crashing end last week as Livestock declined by 5 percent for the week.

 

Top 2 Indexes Country Change   Bottom 2 Indexes Country Change
RTS Index Russia 4.27%   SX All Share Sweden -3.02%
Dow Jones China 88 China 2.83%   Merval Argentina -3.21%

Last week was a difficult week for the global stock indexes, with only 26 percent of the global markets posting gains. Russia’s RTS Index posted the highest return for the week, gaining 4.27 percent, as President Trump briefly spoke with Russian President Putin and Washington DC was too caught up in tax reforms to worry about the ongoing Russia investigation. On the negative side, Argentina’s Merval index slid 3.21 percent last week, as many of the specialty miners within the country pushed lower during trading last week.

The VIX came back to life last week, jumping higher by more than 23 percent as uncertainty over the tax reform bills finally seemed to materialize in Wall Street’s favorite fear gauge. Last week was the first move of the VIX that was greater than ten percent in either direction since early September. One thing that stays constant about the VIX is that when there is a spike there is almost always more volatility that immediately follows. It is amazing how fast the VIX can jump from new all-time lows, where it closed two weeks ago, all the way back to the average level we have seen over the past year, which is where it closed last week. The current reading of 11.29 implies that a move of 3.26 percent is likely to occur over the next 30 days. As always, the direction of the move over the next 30 days is unknown.

Economic Release Calendar:

 

Last week was tied for the slowest week of the year for economic news releases, with only two releases that had no noticeable impact on the overall markets:

 

Economic Impact Date Economic News Release Date Range Actual Expectation
Neutral 11/7/2017 Consumer Credit September 2017 $20.8B $18.3B
Neutral 11/10/2017 University of Michigan Consumer Sentiment Index November 2017 101.0 100.5

Data for table from Econoday.com, Bloomberg and Yahoo Finance

 

The consumer credit report for the month of September kicked off the two economic news releases last week on Tuesday, coming in very close to market expectations, indicating that credit in the US did expand in the aftermath of the hurricanes. On Friday, the preliminary early November reading of consumer sentiment was released by the University of Michigan and indicated that sentiment was little changed when compared to the end of October reading. Both releases were largely ignored by the markets last week as the markets chose to focus on the tax bills in Washington DC and some of the corporate earnings reports released during the week.

 

Following the slowest week of 2017 thus far for economic news releases, this week the calendar is fully back to normal in terms of the number of economic news releases. The releases with the greatest potential to impact the markets are highlighted in green below:

 

Date Release Release Range Market Expectation
11/14/2017 Core PPI October 2017 0.20%
11/14/2017 PPI October 2017 0.10%
11/15/2017 Core CPI October 2017 0.20%
11/15/2017 CPI October 2017 0.10%
11/15/2017 Empire Manufacturing November 2017 26
11/15/2017 Retail Sales October 2017 0.10%
11/15/2017 Retail Sales ex-auto October 2017 0.20%
11/16/2017 Philadelphia Fed November 2017 24.6
11/17/2017 Building Permits October 2017 1243K
11/17/2017 Housing Starts October 2017 1198K

Data for table from Econoday.com, Bloomberg and Yahoo Finance

 

This week the economic news releases start on Tuesday with the release of the Producer Price Index (PPI) for the month of October, which is expected to show a very slow rate of inflation being seen at the producer level in the US during the month. The low levels of inflation are expected to be repeated on Wednesday when the Consumer Price Index (CPI) is set to be released as these two figures are expected to mirror the figures seen on Tuesday when the PPI is released. Having potentially more weight on the financial markets on Wednesday is the release of retail sales for the month of October, which will provide a vital reading about the health of the US consumer going into the most important shopping season of the year. We need to see better than the expected 0.1 percent growth in overall retail sales if the US economy will get any kind of boost from the US consumer this holiday season. Wrapping up the week this week is the start of the October housing data as the building permits and housing starts figures are both released, with both expected to produce figures that are close to where they were in September. In addition to the above mentioned economic news releases, there are also ten speeches being given this week by Fed officials, including one by current Chair Yellen that will likely be closely watched by Wall Street.

 

Interesting Fact — How high has the upper tax bracket been?

One of the big points of the tax bills currently being debated has to do with the individual tax brackets. The people with the highest incomes in the US currently experience an upper tax bracket of 39.6 percent, which is a bargain historically. In 1944 and 1945, the upper margin tax bracket rate was 94% and from 1951 until 1963 the upper bracket was 91 percent or higher. The upper bracket moving below 50% is a relatively new phenomenon, first occurring in 1987.

 

Source: http://www.taxpolicycenter.org

For a PDF version of the below commentary please click here Weekly Letter 11-6-2017

Commentary quick take:

 

  • Major developments:
    • Technology drove markets higher again
    • Six consecutive weeks of gains
    • Tax reform bill unveiled
    • New Fed Chair next year
    • Earnings continue to be strong
    • Apple closing in on a trillion-dollar market cap

 

  • US:
    • Tax reform bill details
      • Double standard deduction
      • Consolidate tax brackets from 7 to 4
      • Many deductions disappearing
      • SALT fight
    • Q3 earnings season rolls onward
      • 81 percent complete
      • Current growth rate is 5.9 percent
    • Jerome Powell officially announced as next Fed chair
    • No rate hike at November FOMC meeting

 

  • Global:
    • Venezuela debt restructuring
    • Turkey political situation
    • Saudi Arabia arrests

 

  • Hybrid investments strategy update:
    • Sold one ETF
    • Bought two ETFs
    • Repositioning some cash

 

  • This week for the markets:
    • Trump in Asia—What could go wrong?
    • Tax reform horse trading begins
    • Global uncertainty from oil rich countries

 

  • Interesting Fact: Imperial House of Japan

 

 

Major theme of the markets last week: Technology continued to push higher

Technology companies continued to push higher last week, driving the bull markets forward. Following the release of its third quarter earnings numbers and the start of iPhone X sales, Apple last week inched closer to becoming the first US listed trillion-dollar market cap company. As is typically the case when Apple has a good week (last week it was up 5.8 percent), the NASDAQ had a good week as well, gaining 0.94 percent, with 0.7 percent being directly attributed to Apple’s move. With most of the large technology companies having already reported earnings for the third quarter of 2017, it looks like it could be smooth sailing for the group going into the holiday shopping season. One obvious potential road bump is any kind of US tax on foreign held corporate cash. It is well known that Apple keeps a considerable sum of money offshore and if this were to become subject to a 12 percent tax, like the current tax reform bill proposes, it could present a significant impact on the company’s bottom line. The recent movements in the markets are not limited to just the NASDAQ, however. Following last week’s positive results on all three of the major US indexes, we have now seen six straight weeks of all three US indexes moving higher. Looking back at the historical data, it is exactly the same weeks as now back in 2015 that we had a run of 6 consecutive weeks of gains on all three US indexes. The seventh week in that string of gains back in 2015 saw a decline of more than 3.5 percent on each of the indexes, with the NASDAQ leading the way down, giving up 4.26 percent.

 

US news impacting the financial markets:

 

Last week, the main US news impacting the financial markets included the tax reform plan coming to light in Congress, the US Federal Reserve and third quarter earnings. Tax reform took the majority of the headlines in the US after the Republicans released their 429-page plan with details on Thursday—so much for a simple plan. Some of the basic figures from the plan that was released include:

  • Naming the bill “Tax Cuts and Jobs Act”
  • Increasing the US deficit by $1.5 trillion over 10 years
  • 7 current tax brackets going down to four; 12%, 25%, 35% and 39.6%
  • Doubling the standard deduction
  • Increasing the child credit and expanding a “family credit”
  • Eliminating SALT (state and local tax) deduction
  • Cutting the max mortgage interest rate deduction in half
  • Ending AMT
  • Ending the estate tax
  • Lowering corporate tax rate to 20 percent
  • 12 percent mandatory tax on cash backed foreign retained earnings for corporations
  • Lower tax rate on “Pass-through” corporation
  • Eliminates the special-interest deduction

 

While many of the items mentioned above sound good to most everyday Americans, there will be a lot of fighting and horse trading to get this bill to pass both the Senate and the House. Add in the fact that the Senate has announced it wants to get this legislation done by the Thanksgiving holiday and you can see it will be a very busy three weeks in Washington DC. The largest, potentially impactful pieces of the legislation for the stock market will be the corporate tax reform and the potential 12 percent tax on cash held earnings that are outside of the US. An interesting observation, from what I have read so far in the bill, is that it will be difficult for Republicans to say the changes do not benefit the wealthy more than the middle and lower-class tax payers. Eliminating AMT and the estate tax only positively benefits the wealthy in the US. While the bill does narrow the number of tax brackets, it is still possible for some families that itemize their deductions to end up paying more in taxes under the current bill than they would otherwise, even when doubling the standard deduction. Another observation is that Democrats will not like the SALT plan, as residents in very high tax states such as New York, California and New Jersey could see their tax burden increase significantly. Finally, special interest groups representing the Energy and Pharmaceutical industries are likely to oppose the elimination of the special interest deduction for corporations as this will likely curtail a lot of subsidies to their companies. While this bill provides some details, the final bill, if one is passed, will likely look very different than this first pass. There will certainly be a lot of fighting between the parties as well as within the Republican party itself.

 

The next Fed Chair of the Federal Reserve has officially been announced. Before departing for his Asian tour last week, President Trump announced Jerome Powell as his pick for the next Fed chair when current Chair Janet Yellen’s term expires in February of 2018. His pick of Powell over the other leading candidate, John Taylor out of Stanford, represents a “safe” pick for the Fed chair position. Jerome Powell has been a member of the Fed for a long time and is very likely to keep everything on the same path as Chair Yellen. He will still push for at least three rate hikes in 2018 and will continue the tapering of the Fed’s outsized balance sheet. The market reaction to this official announcement was very muted as it was widely circulated that he would be the pick about a week in advance of the actual announcement. Jerome Powell is expected to get bipartisan support during his confirmation hearing, which will be a pleasant change from other recent presidential appointments that have been hung up for political reasons. Remember that Powell is just the first pick President Trump can make to the Federal Reserve, as there are several other open seats that will likely need to be filled over the coming months. Taking a backseat to the Fed Chair speculation last week was the November FOMC meeting, at which it was decided that there would not be a rate hike in the Fed funds rate. This was fully priced into the markets well ahead of the meeting, so there was no reaction from the markets. In addition to the tax reform bill, the announcement of the next Fed chair and the November FOMC meeting last week, it was also a very busy week in the US for corporate earnings releases.

 

Last week, the earnings season for the third quarter of 2017 moved past the three quarters point. Below is a table of the well-known companies that released earnings last week with earnings that missed expectations highlighted in red, while earnings that beat expectations by more than 10 percent are highlighted in green:

 

Apple 11% DowDuPont 22% Prudential Financial 11%
Archer Daniels Midland -18% FaceBook 23% Ferrari NV 21%
ADP 7% Flowserve 9% Revlon -193%
Aetna 19% GoPro 650% Polo Ralph Lauren 5%
AutoNation 29% Groupon 0% Republic Services 6%
Arrow Electronics 0% Hyatt Hotels 53% Starbucks 0%
Alibaba Group 24% Kellogg 13% Shake Shack 13%
Sotheby’s 35% Kraft Heinz 0% E W Scripps 40%
Bloomin Brands -20% Loews 2200% Tesla Motors -19%
BP 14% Liberty Broadband pushed Texas Roadhouse 0%
Berkshire Hathaway -26% Level 3 sold Under Armour 22%
Cheesecake Factory -7% Mastercard 9% Marriott Vacations Worldwide 24%
Church & Dwight 4% Moody’s 9% Aqua America 0%
Clorox 4% Newell Rubbermaid -7% US Steel 37%
CenturyLink pushed Occidental Petroleum 64% Alleghany 28%
3D Systems -282% Pfizer 3% Yum Brands 3%

 

Apple provided the biggest market movement last week, as expected, when the company announced its earnings for the third quarter of 2017. Tagging along on the coattails of the strong Apple earnings last week were several other large technology companies, such as Facebook, Alibaba and GoPro, all of which easily surpassed market expectations for their earnings. Tesla was the odd man out last week, missing expectations by 19 percent and holding an interesting quarterly conference call, during which there seemed to be some pivoting away from the company’s historical get-it-done-at-break-neck-speed mentality. Berkshire Hathaway had one of its worst quarters during the third quarter and revealed massive losses in its insurance and reinsurance business lines due to the hurricanes that hit the US and the earthquakes that hit Mexico during the quarter. 3D Systems, making 3D printers on both consumer and industrial scales, provided the markets with the largest miss in the table above last week as 3D printing technology still struggles with low adoption rates, as has been the case since the creation of the industry several years ago.

 

According to Factset, we have seen 405 (81 percent) of the S&P 500 companies release results for the third quarter of 2017. Of the 405 companies that have released earnings, 74 percent have beaten earnings estimates, while 8 percent have met expectations and 18 percent have fallen short of expectations. When looking at revenue, of the companies that have reported, 66 percent of the companies have beaten estimates, while 34 percent have fallen short. The overall earnings growth rate for the S&P 500 thus far stands at 5.9 percent. Top performing sectors of the markets are Energy, Information Technology and Materials. So far during the third quarter reporting, 77 companies have issued guidance for the fourth quarter of 2017, with 51 issuing negative guidance while 26 have issued positive guidance. Earnings growth expectations for the fourth quarter are a strong 10.4 percent currently and being revised lower at a much slower pace than typically occurs with only two months left during the quarter.

 

Last week was the peak week for earnings announcements in terms of the number of companies reporting. This week we start to see a drop off in the number of companies reporting as well as the size of the companies releasing results. Consumer facing companies make up the bulk of the reports released this week. The table below shows the companies that will be releasing their earnings this week, with those that have the greatest potential to move the markets highlighted in green:

 

CenturyLink Johnson Controls Nintendo
CVS Caremark JC Penney Office Depot
Dillard’s J&J Snack Foods Priceline.com
DR Horton Jack Henry & Associates EchoStar
Walt Disney Nordstrom Time
Equifax Kohl’s Truecar
Energizer Macy’s Hostess Brands
Twenty-First Century Fox Marriott International Wendy’s Arby’s Group

 

Equifax will likely receive more attention than normal this week as it reports earnings for a quarter during which the huge security breach of 145 million consumer data files being compromised was announced. Equifax’s report also comes on the heels of last week’s internal finding that the four executives of the company that dumped stock a week before the security breach announcement were found to have done nothing wrong in their timing of the sales. Earnings from retailers will be closely watched this week as both high end (Macy’s, Nordstrom and Dillard’s) and lower end retailers (Kohl’s and JC Penny) report results. Given the spending number from the quarter and the consumer confidence readings for the same time, it would not be surprising to see the higher end retailers perform better than the lower end stores during this round of earnings reports. Home builder DR Horton will be closely followed by Wall Street to see if management comments on the impact the tax proposal could have on the US housing market. In particular, the mortgage interest deduction changes and how these could adversely affect the upper end of the US housing market, which is the majority of DR Horton’s business.

 

Global news impacting the markets:

 

Global financial news was slow to start last week, but picked up at the end of the trading week and over the weekend. Venezuela made headlines and adversely impacted several neighboring economies when the government called for a meeting with the country’s creditors to be held on November 13th in Caracas. This came after the government announced it had plans drawn up to restructure $60 billion in debts, if needed in the future. The country has been on the finical ropes for several years as the price of oil has come way down from the more than $100 per barrel seen in the middle of 2014. This debt restructuring seems to be the next economic step before the country goes bankrupt. Inflation within the country continues to be out of control with the IMF’s latest estimate for inflation during 2017 hitting more than 2,000 percent. Oil markets were the most impacted by the Venezuelan announcement as it helped push prices higher, which inadvertently helped the financial situation in the country.

 

Oil was the focus of another political dispute last week in Turkey as the government in Turkey rejected the vote for independence from its Kurdish southern region. In rejecting the vote, Turkey also said it would block all Kurdish oil from making it to the international markets. Much like the situation in Catalonia, the situation in southern Turkey could turn into a major headache for all trading partners of the region. Oil movement was also a byproduct of the third major international news development that impacted the markets last week—Saudi Arabia arrests. The newly elevated Prince in Saudi Arabia had many people arrested on corruption charges over the weekend, including the wealthiest man in Saudi Arabia who is also the 17th wealthiest person in the world, according to Forbes. The arrests were all part of a consolidation of power by the prince to ensure that no one will stand up to his newly found authority. After the announcement of the arrests had been made known internationally, the price of oil jumped higher by about 3 percent as outsiders are very uncertain about how this political situation will play out in Saudi Arabia and what, if any, impact there will be on the production of Saudi oil, with Saudi Arabia being one of the most vital countries in the world to global oil production. Oil has been on an uptrend since the middle of June and the actions being taken by the three above mentioned countries seem like they will only extend the gains for the commodity in the near term.

 

Hybrid model performance and update

For the trading week ending on 11/3/2017, returns in the hybrid and quant hypothetical models* (net of a 1% annual management fee) were as follows:

 

  Last Week 2017 YTD Since 6/30/2015
Aggressive Model -0.17% 8.11% 14.00%
Aggressive Benchmark 0.58% 16.38% 16.16%
Growth Model -0.13% 7.46% 12.37%
Growth Benchmark 0.45% 12.68% 12.85%
Moderate Model -0.08% 5.96% 9.87%
Moderate Benchmark 0.33% 9.10% 9.50%
Income Model -0.05% 5.47% 9.16%
Income Benchmark 0.17% 4.77% 5.26%
Quant Model 0.09% 11.39%
S&P 500 0.26% 15.59% 25.43%

*Model performance does not represent any specific account performance but rather a model of holdings based on risk levels that are like my actual holdings, the hypothetical models are rebalanced daily to model targets.

 

There were three changes to the hybrid models last week as we continue to adjust the model’s holdings for the market environment we are currently seeing. The first change was selling the Frontier market ETF (FRN) as the fund hit my trigger point to the downside and was sold. All of the hybrid models’ trading positions have numerical triggers that adjust upward when the holding increases in value and signal when it is time to sell the position. The other two changes last week to the hybrid models were purchases of two ETFs, one that was filling out a position in technology through RYT and one to establish a new position in JPGE, which is a diversified global return focused fund run by JP Morgan. In selling FRN and purchasing JPGE, the models were able to maintain their foreign markets exposure while moving from a fund that looks to be slowing down to one that looks like there is still a significant upside potential. At this point, cash levels in the hybrid models are under 10 percent across all the different risk levels. The international component performance of the benchmarks above continues to perform very well on a relative basis to both the hybrid models as well as US indexes. Most of the negative performance of the hybrid models last week was due to corporate earnings in the consumer products space that either directly or indirectly negatively impacted stock prices. We are now through all but a few corporate earnings for the individual stock holdings in the hybrid models and should see volatility of the models compared to the indexes return to normal after two weeks of unusual movements based on earnings results reactions.

 

Market Statistics:

 

The US markets were positive last week thanks to earnings, as volume made it two weeks in a row of being average when looking back at the weekly volume seen over the past year:

 

Index Change Volume
NASDAQ 0.94% Average
Dow 0.45% Average
S&P 500 0.26% Average

 

Technology once again drove the overall markets higher last week as Apple helped propel the markets. Volume, as expected given the large number of earnings reports released last week, came in at an average level and will likely stay around average through the Thanksgiving holiday, as investors position for a Santa rally in the markets that looks to be setting up again this year, much like it has during the past several years.

 

The following were the top 5 and bottom 5 performing sectors over the course of the previous week:

 

Top 5 Sectors Change   Bottom 5 Sectors Change
Oil & Gas Exploration 4.93%   Healthcare Providers -0.90%
Semiconductors 2.99%   Consumer Goods -1.32%
Energy 2.35%   Transportation -1.72%
Natural Resources 2.16%   Global Real Estate -2.54%
Technology 1.99%   Telecommunications -6.31%

 

An increase in the price of oil of more than three percent last week was the primary driving force behind the movement of three of the top five performing sectors last week and pushed Oil & Gas Exploration as well as Energy and Natural Resources all higher for the week. Semiconductors and Technology in general also made the top five performing sectors last week thanks to strong earnings boosting stock prices of some of the major companies within the sectors. On the flip side, Telecommunications fell apart last week as the proposed merger of Sprint and T-Mobile ended with no deal being made, sending both stock prices tumbling. Global Real Estate came under pressure last week as well, as the projection of further rate hikes in the US forcing countries around the world to start raising rates as well hit real estate markets around the world. Transportation moved lower thanks to the bump up in fuel costs as the price of oil increased. The downward movement in Consumer Goods and Healthcare Providers was mainly due to individual company earnings reports that helped drive down the overall sectors.

 

US government bonds were all positive last week as Jerome Powell was picked by President Trump to be the next Fed Chairman:

 

Fixed Income Change
Long (20+ years) 2.16%
Middle (7-10 years) 0.65%
Short (less than 1 year) 0.03%
TIPS 0.63%

 

Best and Worst Currencies Change
US Dollar 0.04%
South Korea won 0.87%
Turkey lira -2.54%

 

 

Overall, the US dollar increased last week by 0.04 percent against the value of a basket of foreign currencies, during a week that saw lighter than usual trading in global currencies due to a lack of catalysts. When looking at global currencies, the South Korea Won took the top spot, gaining 0.87 percent against the dollar as the country awaits the arrival of President Trump who is making a stop in South Korea on his Asian tour. The Turkish Lire performed the worst last week, giving up 2.54 percent against the US dollar, as the country made threats against the Kurdish people who voted for independence from the country last week.

 

Commodities were all positive last week, with the exception of Gold, as the overall GS commodity index jumped more than 2 percent:

Metals Change   Commodity Change
Gold -0.23%   GS Commodity Index 2.08%
Silver 0.06%   Oil 3.14%
Copper 0.45%   Livestock 3.97%
      Grains 0.08%
      Agriculture 0.78%

 

The GS commodity index advanced 2.08 percent last week, as gains in oil and soft commodities helped lead the index higher. Oil continued its upward run thanks to action taken in Turkey during the week. Last week, the Kurdish southern region of Turkey held a vote to declare independence from Turkey; the independence vote easily beat the stay vote. In retaliation, Turkey said it would block Kurdish oil from making it to the global markets. Kurdish oil makes up about 15 percent of the total output of Iraq, thus a stoppage of this supply would increase the overall global price of oil. Gold decreased 0.23 percent last week as it was the only commodity that moved lower. Silver and Copper both increased last week, 0.06 and 0.45 percent, respectively. Soft commodities followed oil higher last week across the board, with Agriculture overall advancing by 0.78 percent, while Grains gained 0.08 percent. Livestock made it three weeks in a row of gains, posting a gain of almost four percent for the week, extending the three-week streak of gains to nearly eight percent.

 

Top 2 Indexes Country Change   Bottom 2 Indexes Country Change
BIST 100 Turkey 3.16%   IPC All-Share Mexico -1.37%
Kospi South Korea 2.46%   Sao Paulo Bovespa Brazil -2.71%

Last week was a positive week for the global stock indexes, with 66 percent of the global markets posting gains. Turkey’s BIST 100 posted the higher return for the week, gaining 3.16 percent, as most of Turkey cheered the government announcements against the Kurdish vote last week. On the negative side, Brazil’s Sao Paulo based Bovespa index slid 2.71 percent last week, as the looming defaults in Venezuela negatively impacted other economies in the region.

While the VIX last week experienced the largest weekly move that we have seen since the middle of September, it was still a relatively small move of only 6.73 percent for the week. Much like two weeks ago, the intraweek movement of the VIX was significantly higher, but the fear that made its way into the markets quickly dissipated. With the decline last week, the VIX officially closed at a new all-time low on Friday. The current reading of 9.14 implies that a move of 2.64 percent is likely to occur over the next 30 days. As always, the direction of the move over the next 30 days is unknown.

Economic Release Calendar:

 

Last week was a slow week for economic news releases. However, there were a few important releases during the week. There were three releases that beat expectations and one that significantly missed expectations:

 

Economic Impact Date Economic News Release Date Range Actual Expectation
Neutral 10/30/2017 Personal Income September 2017 0.4% 0.4%
Positive 10/30/2017 Personal Spending September 2017 1.0% 0.8%
Neutral 10/30/2017 PCE Prices September 2017 0.4% 0.4%
Neutral 10/30/2017 PCE Prices – Core September 2017 0.1% 0.1%
Positive 10/31/2017 Chicago PMI October 2017 66.20 60.50
Positive 10/31/2017 Consumer Confidence October 2017 125.9 121.0
Neutral 11/1/2017 ADP Employment Change October 2017 235K 200K
Neutral 11/1/2017 ISM Index October 2017 58.7 59.5
Neutral 11/1/2017 FOMC Rate Decision November Meeting No Change No Change
Slightly Negative 11/3/2017 Nonfarm Payrolls October 2017 261K 310K
Slightly Negative 11/3/2017 Nonfarm Private Payrolls October 2017 252K 300K
Slightly Positive 11/3/2017 Unemployment Rate October 2017 4.1% 4.2%
Negative 11/3/2017 Avg. Hourly Earnings October 2017 0.0% 0.2%
Neutral 11/3/2017 ISM Services October 2017 60.1 58.6

Data for table from Econoday.com, Bloomberg and Yahoo Finance

 

Personal income, spending and PCE prices kicked things off on Monday last week with a pleasant surprise on spending, which was shown to have increased by 1 percent during September. However, the increase in spending can be attributed to repair and rebuilding from the hurricanes, so it is not as great as it looks on the surface. On Tuesday, the latest reading of the consumer confidence index for the month of October was released and came in at a 17-year high level reading of 125.9, which was slightly ahead of expectations. On Wednesday, the November FOMC meeting concluded with no rate hike and no market reaction to the announcement. Friday was a busy day with employment related figures as the nonfarm public and private payroll data, as well as the overall unemployment rate in the US, were released. Payroll rebounded from the artificially low hurricane impacted payroll numbers of September, but the October payroll figures still came in below market expectations. Overall, the unemployment rate in the US ticked down to 4.1 percent, while average hourly earnings missed expectations and posted zero growth during the month. Maybe the tax reform bill will have a positive impact on this area of the economy as stagnant wage growth seems to be one of the primary driving forces behind the slow growth the US economy has been experiencing for the past several years.

 

After such a busy week of economic news releases last week, this week is about as slow as it can get, with only two releases, neither of which should have any noticeable impact on the overall markets:

 

Date Release Release Range Market Expectation
11/7/2017 Consumer Credit September 2017 $18.3B
11/10/2017 University of Michigan Consumer Sentiment Index November 2017 100.5

Data for table from Econoday.com, Bloomberg and Yahoo Finance

 

This week, the consumer credit report for the month of September will be released on Tuesday and is expected to show an increase of about $5 billion over the August level. Much of this increase is due to hurricane repairs in the Southern US. On Friday, the preliminary early November reading of consumer sentiment released by the University of Michigan will come out and, much like the consumer confidence figure released last week by the government, this report is expected to show very elevated consumer sentiment.

 

Interesting Fact — President Trump met with Emperor Akihito in Japan

Emperor Akihito is the only remaining Emperor on the throne today. He is expected to abdicate the throne in March of 2019, making him the first Emperor in 200 years to step down. Emperor Akihito is the 125th head of an unbroken line of descendants from the first Emperor of Japan, Emperor Jimmu, who was crowned Emperor in 600 BC. However, there is some speculation about the 25 Emperors of Japan between 600 BC and 500 AD; after 500 AD the lineage is very well known.

 

Source: New York Times

For a PDF version of the below commentary please click here Weekly Letter 10-30-2017

Commentary quick take:

 

  • Major developments:
    • Technology earnings saved the day
    • Amazon beats by 5,100 percent
    • Bull market carries onward
    • Fed Chair pick locked?

 

  • US:
    • House passed the budget
    • Q3 earnings season rolls onward
      • 55 percent complete
      • Current growth rate is 4.7 percent
      • Insurance has been a drag
    • Jerome Powell is likely the next Fed chair
    • Increased chance of rate hike in December

 

  • Global:
    • Chinese People’s Congress
    • Spain mess
    • Central bank meetings

 

  • Hybrid investments strategy update:
    • One change to the hybrid models last week

 

  • This week for the markets:
    • Time is ticking on tax reform
    • North Korea

 

  • Interesting Fact: Early Halloween Celebration

 

 

Major theme of the markets last week: Amazon earnings

The major theme of the markets last week was earnings and the earnings reports from a few technology giants. Amazon was the most surprising after the company reported an earnings surprise of 5,100 percent. The surprise helped propel the stock of amazon over $1,000 per share and boost founder and CEO Jeff Bezos to the position of wealthiest person in the world. Amazon, however, was not the only large gainer last week in the technology sector as Microsoft, Google, Intel, Rambus and Twitter also posted strong gains and were rewarded with strong upward movements in their stock prices. Aside from the strong gains in big technology, however, the movements in the markets were negative last week. This was especially the case on Friday as the equal weighted technology ETFs struggled to post gains, while the overall NASDAQ increased more than 2 percent. This movement and leadership by a few companies is troubling and is causing some concerns about the health of the overall markets as the current bull market continues to age.

 

US news impacting the financial markets:

 

Earnings were the primary driver of the US markets last week as they managed to steal the spotlight away from politics with some of the outsized gains seen, especially in the technology sector. The third quarter earnings season was fully under way last week as many industry leaders reported results. Below is a table of the well-known companies that released earnings last week with earnings that missed expectations highlighted in red, while earnings that beat expectations by more than 10 percent are highlighted in green:

 

Arthur J Gallagher 4% Halliburton 11% Sprint 50%
Amgen 6% Hilton 12% Sherwin-Williams 1%
Amazon.com 5100% Hershey 4% Simon Property -43%
Anthem 10% Intel 26% AT&T -1%
Boeing 3% JetBlue Airways 6% T-MOBILE 43%
Bristol-Myers Squibb -3% Kimberly-Clark 5% Tesla Motors pushed
Anheuser-Busch Inbev -13% Coca-Cola 2% Twitter 67%
Caterpillar 60% Eli Lilly & Company 2% Texas Instruments 13%
Colgate-Palmolive 0% Lockheed Martin 0% Union Pacific 1%
Comcast 6% Southwest Airlines 1% UPS 1%
Chipotle Mexican Grill -15% McDonald’s 1% United Technologies 3%
Canadian National Railway -1% McKesson 18% Visa 6%
ConocoPhillips 78% 3M Company 5% V F 10%
Chevron 4% Altria 3% Walgreens 7%
Dr Pepper Snapple -4% Microsoft 17% Waste Connections 3%
Ford Motor 30% Northrop Grumman 26% Whirlpool -2%
General Dynamics 4% PulteGroup 2% Waste Management 2%
General Motors 23% Phillips 66 2% Weyerhaeuser 10%
Google 14% Rambus 12% Xcel Energy 5%
Goodyear Tire & Rubber 6% Raytheon 4% Exxon Mobil 4%

 

Amazon was the biggest earnings announcement of the week last week, as the company beat expectations by 5,100 percent, helping to propel Jeff Bezos to the top of the world wealth list ahead of Bill Gates. As is almost always the case, however, the 5,100 percent surprise is a little misleading as the company was expected to post a gain of $0.01 and instead posted a gain of $0.51, making it technically a 5,100 percent surprise. There were many surprises in excess of 30 percent to the upside over the course of the last week with even the US automakers beating expectations, despite the rising competition from electric car manufacturers. On the downside last week, Chipotle continues to try to recover from its health scares from more than 18 months ago; its new queso has seen a lack luster roll out so far.

 

According to Factset, we have seen 275 (55 percent) of the S&P 500 companies release results for the third quarter of 2017. Of the 275 companies that have released earnings, 76 percent have beaten earnings estimates, while 8 percent have met expectations and 15 percent have fallen short of expectations. When looking at revenue, of the companies that have reported, 67 percent of the companies have beaten estimates, while 33 percent have fallen short. The overall earnings growth rate for the S&P 500 thus far stands at 4.7 percent, following last week’s results, which is a significant improvement from the 1.7 percent growth rate seen two weeks ago on the same figure. Energy continues to be the driving force behind the positive numbers seen this reporting season. Insurance companies are the primary drag on performance so far this quarter, as the earnings growth rate excluding insurance for the S&P 500 would be 7.4 percent.

 

This week is the peak week for earnings announcements for the third quarter of 2017 with more than 1,100 companies reporting results. The table below shows the companies that will be releasing their earnings this week, with those that have the greatest potential to move the markets highlighted in green:

 

Apple Dow DuPont Prudential Financial
Archer Daniels Midland Facebook Ferrari NV
Automatic Data Processing Flowserve Revlon
Aetna GoPro Polo Ralph Lauren
AutoNation Groupon Republic Services
Arrow Electronics Hyatt Hotels Starbucks
Alibaba Group Kellogg Shake Shack
Sotheby’s Kraft Heinz E W Scripps
Bloomin Brands Loews Tesla Motors
BP Liberty Broadband Texas Roadhouse
Berkshire Hathaway Level 3 Under Armour
Cheesecake Factory Mastercard Marriott Vacations Worldwide
Church & Dwight Moody’s Aqua America
Clorox Newell Rubbermaid US Steel
CenturyLink Occidental Petroleum Alleghany
3D Systems Pfizer Yum Brands

 

All eyes will be on Apple’s earnings this week as its release is always a market moving event. Investors will be looking very closely at the sales of Apple 8 iPhone and any additional information that may come out about iPhone X, which is set to be released late this year. Tesla reports this week, having pushed the reporting from last week to this week. Inventors will be very interested in the production numbers for the quarter as well as any guidance the company provides about the future production numbers for each of Tesla’s models. An update on the giga factory being produced in Nevada (currently having its roof being used as a makeshift campsite) could also provide a reason for the stock to move this week. Following so many positive results from technology giants of the past two weeks, Facebook has a tall order to keep up the pace as it releases its results for the quarter this week. Pfizer will be closely watched to see if to the company will be adversely impacted, much like Celgene last week, by downward pressure on the biotechnology and pharmaceuticals industries.

 

Politics played a small part in the movement of the markets last week as the list for potential Fed chairs has been shortened to one or two candidates, depending on who you listen to in the administration. The clear leader currently is Federal Reserve Governor Jerome Powell, who was appointed by then President Obama. Powell’s economic policies are likely to be very close to outgoing Chair Yellen’s policies and he is the candidate that will rock the boat the least. He is also unlikely to change the Fed’s plans that have been outlaid so diligently by Chair Yellen, regarding shrinking the balance sheet and the pace at which rate hikes are likely to occur in the future. Powell is also a data heavy Fed governor, which means the Fed will likely remain data dependent, rather than making policies based on assumptions of how future economic data will come in. Powell should also have an easy time getting through the nomination process before Congress as he is supported by both sides of the aisle.

 

The other big news last week in politics was that the House of Representatives on Thursday passed the budget that was sent over from the Senate two weeks ago. The vote was a lot closer than it should have been had it fallen on party lines, with the final tally being 216 for 212 against. With the $4 trillion budget passed, Congress can now get to work on the tax reforms they have been talking about for a very long time. However, as seen in the House vote last week, there remain large divisions in the Republican party and these divisions will likely come more to light in the tax debate, so passage of a tax reform bill still seems like a tall order. The White House warned last week that if tax reform is not passed, the blame for likely downward movement of the financial markets will far squarely on Congress. With warnings like these, it is hard to imagine that everything is going well in Congress surrounding tax reform.

 

Global news impacting the markets:

 

With so much happening in the US in terms of earnings results and the corresponding market movements, attention was largely directed away from the international news last week. China did make some headlines last week as the People’s Congress concluded with the announcement of the new standing committee for the Politburo. The biggest surprise from the selection of leaders to lead China for the next 5 years was that no successor to President Xi Jinping was announced and only two of the 18th standing committee members will be returning to serve on the 19th standing committee. Now that President Xi has consolidated his political power and become even more powerful, we will likely see China move forward with changes that were politically less desirable over the past 5 years. Areas that will likely see changes include curbing excess capacity and reigning in the use of financial leverage as well as the shadow banking system in China. Prior to being able to announce people who are fully on his side, like the standing committee and the Politburo elected last week, President Xi did receive some moderate political push back on his ideas and actions. Any such pushback will now be nonexistent; we will have to wait and see if the changes are positive or negative for the Chinese economy and the global financial markets.

 

Spain made other major headlines last week as the Catalonia region declared itself independent from Spain. This is a big step for the Catalonia government to take as it forced Madrid to take actions in invoking article 155, which is the first step in suspending the regional government of Catalonia. Madrid arrested many political leaders in Catalonia over the past week to make it impossible for the region to operate smoothly. We are a long way from seeing how this plays out for Spain and for Catalonia, but investors in Europe seem to be more concerned with how the EU is handling the situation. Many of the nationalist European movements that had been gaining strength up until earlier this year see a lot riding on the situation in Catalonia as the region was the best chance for a breakaway of any of the potential breakaway regions in Europe.

 

The European Central Bank (ECB) and the Bank of Canada (BoC) also made a few headlines last week as they both held rate setting meetings during the week. The ECB, as expected, left rates unchanged, but at the same time, the statement from the ECB held a few notable changes. First, the currently running quantitative easing programs will now be lowered by an estimated €270 billion during 2018 and, second, the statement removed the timeline for the QE program, saying the program will continue to run at least through September of 2018 and beyond, if necessary. The BoC, at its rate setting meeting, also made no changes to its key interest rates, as expected by the global markets.

 

Hybrid model performance and update

For the trading week ending on 10/27/2017, returns in the hybrid and quant hypothetical models* (net of a 1% annual management fee) were as follows:

 

  Last Week 2017 YTD Since 6/30/2015
Aggressive Model -0.78% 8.26% 14.15%
Aggressive Benchmark -0.13% 15.70% 15.49%
Growth Model -0.47% 7.58% 12.49%
Growth Benchmark -0.09% 12.18% 12.34%
Moderate Model -0.15% 6.04% 9.95%
Moderate Benchmark -0.06% 8.75% 9.14%
Income Model 0.08% 5.52% 9.21%
Income Benchmark -0.02% 4.59% 5.08%
Quant Model -2.09% 11.28%
S&P 500 0.23% 15.85% 25.72%

*Model performance does not represent any specific account performance but rather a model of holdings based on risk levels that are like my actual holdings, the hypothetical models are rebalanced daily to model targets.

 

There was one adjustment made to the hybrid models over the course of the previous week: the selling of Owens and Minor (OMI). Owens and Minor had been a core equity position since late 2011 in the hybrid models, but the time had come to sell. OMI is a healthcare related company primarily operating in the supply chain logistics and delivery business to hospitals and small medical clinics around the US. The company has recently come under pressure due to the stepped-up scrutiny on the opioid problems in the US. You may remember that earlier this year, when the problem was really starting to make headlines, we sold our holdings in Amerisource Bergen (ABC), which is the second largest distributor of opioids in the US and came under negative light after the latest 60 minutes report about opioid addiction. With the outlook looking politically uncertain and with OMI breaking down last week, the stock triggered my sell point. Currently, the proceeds from the sale of the stock are being held in cash, but they will likely be reinvested shortly. The quant model had a difficult week last week as Biotechnology and Pharmaceuticals had a very difficult week and the model was invested in these two sectors for part of the week.

 

Market Statistics:

 

The US markets were positive last week, and we finally saw volume pick up to average or above average on all three of the indexes:

 

Index Change Volume
NASDAQ 1.09% Above Average
Dow 0.45% Average
S&P 500 0.23% Above Average

 

The performance of the major US indexes was almost entirely driven by large technology companies last week as earnings reports boosted the stock prices of several key companies. Without the positive earnings boost from Amazon, Microsoft and Google last week, it is likely that all three indexes would have turned in a loss for the week. With such large companies making such significant moves on Friday, it was not surprising to see that volume made it to above average on both the NASDAQ and the S&P 500. This week we continue to see may companies reporting earnings and could still see elevated volume on the US indexes.

 

The following were the top 5 and bottom 5 performing sectors over the course of the previous week:

 

Top 5 Sectors Change   Bottom 5 Sectors Change
Technology 2.98%   Telecommunications -1.40%
Semiconductors 2.56%   Aerospace & Defense -1.83%
Home Construction 2.15%   Healthcare -2.51%
Software 1.76%   Pharmaceuticals -4.30%
Healthcare Providers 1.41%   Biotechnology -4.73%

 

Technology in general last week led the way higher thanks to a push of more than 12 percent by Amazon after the company beat earnings expectations. Semiconductors received a lift from an earnings beat by Intel, which rallied almost 10 percent for the week, while Software got a bump from Microsoft, which gained more than 6 percent last week. Home Construction got a bump last week as the third quarter GDP figure helped boost the sector higher on the rebuilding jobs currently being done in the hurricane hit areas of the US. On the negative side last week, almost any stocks in the Biotechnology and Pharmaceuticals sector had a very difficult week as both sectors were down more than 4 percent. The main reason for the declines in the sectors was the poor performance of a very large bio/pharm companies called Celgene. Celgene declined more than 20 percent last week as the company struggles with several of the drugs in its pipelines and current drugs being marketed, lowered forward guidance and released a poor earnings report for the third quarter of 2017. While this news may not be uncommon in investments, it is uncommon for a company that was worth more than $100 billion less than a month ago to go so bad so quickly. This single company movement was more than half of the decline seen across several of the health-related sectors of the markets. Aerospace and Defense as well as the Telecommunications sector also had a difficult week last week as both sectors were also hit by poor earnings results from a few of the major companies within each sector.

 

US government bonds were mixed last week as the likelihood of a rate increase in December increased and the potential list of Fed chair candidates grew smaller or disappeared completely:

 

Fixed Income Change
Long (20+ years) -0.60%
Middle (7-10 years) -0.18%
Short (less than 1 year) -0.02%
TIPS 0.04%

 

Best and Worst Currencies Change
US Dollar 1.36%
Uruguay peso 0.77%
South Africa rand -3.27%

 

 

Overall, the US dollar increased last week by 1.36 percent against the value of a basket of foreign currencies, in what was one of the most positive weeks for the currency that we have seen all year. Increasing odds of a Fed rate hike in December was one of the primary driving forces behind the increase in the US dollar, as was the announcement that Jerome Powell is the likely pick for the next Fed chair. When looking at global currencies, the Uruguay Peso took the top spot, gaining 0.77 percent against the dollar, while the South African Rand performed the worst, giving up 3.27 percent against the US dollar.

 

Commodities were mixed last week as the overall GS commodity index jumped more than 2.5 percent:

Metals Change   Commodity Change
Gold -0.58%   GS Commodity Index 2.53%
Silver -1.06%   Oil 3.93%
Copper -2.29%   Livestock 2.52%
      Grains 0.59%
      Agriculture 1.47%

 

The GS commodity index advanced 2.53 percent last week, as gains in oil and soft commodities were enough to overcome losses in the precious metals. Rumblings out of OPEC last week that supply reductions could be further increased in the coming months was the primary driver behind the price of crude oil increasing last week and breaking above $60 per barrel for the first time since June of 2015. Gold, Silver and Copper decreased 0.58, 1.06 and 2.29 percent, respectively, as a lack of demand from investors, due to the technology risk-on trade, led investors to shun safe haven assets like precious metals. Soft commodities followed oil higher last week across the board, with Agriculture overall advancing by 1.47 percent, while Grains gained 0.59 percent. Livestock made it two weeks in a row of gains, posting a gain of 2.52 percent over the course of the week and a gain of nearly 4 percent over the last two weeks.

 

Top 2 Indexes Country Change   Bottom 2 Indexes Country Change
China 88 China 2.87%   PSEi Philippines -1.48%
Nikkei 225 Japan 2.57%   IPC All-Share Mexico -1.56%

Last week was a mixed week for the global stock indexes, with 60 percent of the global markets posting gains. China posted the best performance of the week last week, as the country normally does following the conclusion of the People’s Congress. With power consolidated at the top, President Xi Jinping now has at least 5 more years, if not significantly more than that, to layout and achieve many of the economic goals of China. On the negative side, Mexico’s IPC All-Share index slid 1.56 percent last week as the relationship between the administrators of the US and Mexico remain very strained on everything from trade to immigration policies and the border wall that President Trump continues to insist will be built.

There have now been five weeks in a row of tame movement for the VIX as the fear gauge decreased only 1.71 percent last week. While the point to point change in the VIX on a weekly basis looks very tame, the intraweek movements of the VIX were a bit wilder last week. On Wednesday, we hit an intraday high on the VIX of 13.2, which is a nearly 30 percent increase from current levels. However, this gain was very temporary as the VIX came crashing back down by almost 30 percent thanks to the positive technology earnings boosting the markets at the end of the week. The current reading of 9.80 implies that a move of 2.83 percent is likely to occur over the next 30 days. As always, the direction of the move over the next 30 days is unknown.

Economic Release Calendar:

 

Last week was a slow week for economic news releases. However, there were a few important releases during the week. There was one release that beat expectations and none that significantly missed expectations:

 

Economic Impact Date Economic News Release Date Range Actual Expectation
Neutral 10/25/2017 Durable Orders September 2017 1.2% 1.1%
Neutral 10/25/2017 Durable Goods –ex transportation September 2017 0.6% 0.5%
Slightly Positive 10/25/2017 New Home Sales September 2017 667K 560K
Slightly Negative 10/26/2017 Pending Home Sales September 2017 0.0% 0.2%
Positive 10/27/2017 GDP-Adv. Q3 2017 3.0% 2.6%
Neutral 10/27/2017 University of Michigan Consumer Sentiment Index October 2017 100.7 101.0

Data for table from Econoday.com, Bloomberg and Yahoo Finance

 

Durable goods order figures, both including and excluding transportation, were released on Wednesday last week with both calculations of the orders coming in very close to market expectations and leading to no reaction by the markets. US housing data for the month of September was mixed last week as pending home sales missed expectations, while new home sales were slightly better than expected. The big release of the week last week was the positive surprise in the advanced release of the third quarter GDP figure for the US, which came in at a 3 percent reading, significantly above the expected 2.6 percent reading. The hurricanes that some economists had feared would have a negative financial impact on GDP seemed to be having a positive impact if this first estimate of GDP turns out to be correct. Remember that there will be at least two revisions to this number over the coming months, but currently the GDP figure looks very good. Wrapping up the week last week was the University of Michigan’s Consumer Sentiment index for the month of October (final reading), which showed very little change from the mid-month reading of 101.0 and had no notable impact on the markets, which were jumping higher on the technology earnings surprises during the day.

 

This week is a busy week in terms of the number of economic news releases being released, as it is a month end employment release week. The releases with the greatest potential to impact the markets are highlighted in green below:

 

Date Release Release Range Market Expectation
10/30/2017 Personal Income September 2017 0.4%
10/30/2017 Personal Spending September 2017 0.8%
10/30/2017 PCE Prices September 2017 0.4%
10/30/2017 PCE Prices – Core September 2017 0.1%
10/31/2017 Chicago PMI October 2017 60.5
10/31/2017 Consumer Confidence October 2017 121.0
11/1/2017 ADP Employment Change October 2017 200K
11/1/2017 ISM Index October 2017 59.5
11/1/2017 FOMC Rate Decision November Meeting No Change
11/3/2017 Nonfarm Payrolls October 2017 310K
11/3/2017 Nonfarm Private Payrolls October 2017 300K
11/3/2017 Unemployment Rate October 2017 4.2%
11/3/2017 Avg. Hourly Earnings October 2017 0.2%
11/3/2017 ISM Services October 2017 58.6

Data for table from Econoday.com, Bloomberg and Yahoo Finance

 

Personal income, spending and PCE prices kick things off on Monday with expectations of very little change during September when compared to August on each of the readings. The markets will likely react the most to any surprises on personal spending as this is a key part of the overall US economy. On Tuesday, the latest reading of the consumer confidence index for the month of October is set to be released with expectations that the index will continue to rise as consumers look very confident moving into the holiday shopping season. On Wednesday, the FOMC rate decision for the November meeting will be released. With the current chance of a rate hike at this meeting being about 2 percent, this meeting will likely have no noticeable impact on the markets. On Friday, as is always the case during employment week, the nonfarm public and private payroll data, as well as the overall unemployment rate in the US will be released. Expectations are for the payroll numbers to rebound a lot from the declines of about 40,000 jobs on each seen in September, as they post gains of around 300,000 during the month of October. The drastic swing in the payroll numbers is due to the filings that took place in the aftermath of the hurricanes, or at least that is what economists are saying the difference is. Overall unemployment is expected to be unchanged at 4.2 percent, while average hourly earnings is expected to post a very small gain of 0.2 percent during the month. In addition to the scheduled economic news releases this week, there are four speeches being given by Fed officials. Thursday will be particularly interesting as Jerome Powell is supposed to give a speech. This also happens to be the same day President Trump is rumored to be announcing his pick for the next Fed chair, which will likely be Powell.

 

Interesting Fact — Early Halloween Celebration

According to ancient Roman records, tribes located in today’s Germany and France traditionally wore costumes of animal heads and skins to connect to spirits of the dead. This tradition continued into modern day celebrations of Samhain, the Celtic holiday that inspired Halloween in America. This ancient Celtic holiday pays tribute to the dead, to the ancestors and to the coming winter.

 

Source: huffpost.com

For a PDF version of the below commentary please click here Weekly Letter 10-23-2017

Commentary quick take:

 

  • Major developments:
    • Markets increased on earnings
    • IBM had best day in years
    • North Korean rhetoric picked up

 

  • US:
    • The Senate passed a budget
    • Q3 earnings season rolls onward
      • 17 percent complete
      • Current growth rate is 1.7 percent
    • Manufacturing in the US is picking up
    • Increased chance of rate hike in December
    • Fed chair nomination rumors

 

  • Global:
    • Chinese People’s Congress
    • Brexit gridlock
    • Spain uncertainty
    • Japan Snap elections
      • Landslide victory for PM Abe
      • Immediate task is dealing with North Korea

 

  • Hybrid investments strategy update:
    • No changes to the hybrid models last week
    • Earnings season for individual holdings has begun

 

  • This week for the markets:
    • China People’s Congress continues
    • North Korea
    • Budget and tax reform in the US
    • Changes in Japanese politics

 

  • Interesting Fact: Dynastic politics at work

 

 

Major theme of the markets last week: Markets move higher on earnings

Last week, the US financial markets continued to march higher, making new all-time highs along the way. Valuations of the US markets continue to look stretched, as they have for more than a year, with many well-known investors calling for people to be very cautious with the current markets, thinking a correction is likely only a brief time away. Last week, another milestone was crossed without much fanfare; October 19th was the 30-year anniversary of the crash of 1987 when the Dow lost more than 22 percent in a single day. Early last week there were numerous comparisons made to market valuation then and now, with emphasis on the similarities. On Thursday, the markets did open lower by more than half a percent, which is a significant downward move with the current bull market, but minuscule by historical standards. However, the S&P 500 and the Dow managed to climb all the way back from the negative open to close slightly higher for the day. From a historical standpoint, October 19th is the single worst day to be invested of any day of the year, but most of that is due to the outsized downward movement that occurred on that day in 1987. If that day’s decline is removed from the historical data set, October 19th is only a little worse than an average day for returns. Currently, the bull market is running higher, driven primarily by earnings that have so far been pretty good, but have been seeing weaker growth than was seen in the second quarter. Movement in the markets over the next few weeks will likely be more volatile than we have seen over the past several weeks as earnings come in, both ahead and short of expectations.

 

US news impacting the financial markets:

 

Earnings and politics took most of the financial media headlines here in the US over the course of the past week as third quarter earnings season started to get rolling and Congress started moving on some of its plans with hopes of completing significant legislation before the end of the year.

 

The third quarter earnings season was fully under way last week as many industry leaders reported results. Below is a table of the well-known companies that released earnings last week with earnings that missed expectations highlighted in red, while earnings that beat expectations by more than 10 percent are highlighted in green:

 

Alcoa Corp -4% Harley-Davidson 0% Progressive 21%
Abbott Labs 2% Honeywell 1% Philip Morris -9%
Athenahealth 12% IBM 1% PayPal 5%
American Express 2% Johnson & Johnson 6% Charles Schwab 2%
Bank Of New York 5% Kinder Morgan 7% United Continental 2%
Csx 0% ManpowerGroup 4% UnitedHealth 4%
Ebay 0% Morgan Stanley 15% United Rentals 8%
General Electric -41% Netflix -9% US Bancorp 0%
Genuine Parts Company -9% Nucor 1% Verizon 0%
Goldman Sachs 16% Procter & Gamble 2% Wd-40 4%

 

Large financial institutions kept up the robust performance that kicked off the third quarter earnings season two weeks ago. Goldman Sachs and Morgan Stanley both beat expectations by about 15 percent, despite seeing falling bond trading revenue, as other areas of their business operations picked up. In a big miss by one of the FAANG stocks, Netflix missed expectations by 9 percent, as rising costs and slightly slower subscriber growth hampered the quarter. Healthcare was another concentration of earnings reports last week with all healthcare related companies in the above table beating or meeting expectations and awaiting any changes that could come to the Affordable Care Act. General Electric had a very difficult quarter under the leadership of a new CEO, missing market expectations by more than 40 percent. This quarter’s miss, while ugly, could be a situation where management is choosing to divulge all of the bad news they can find within the company at once, making things seems worse than they really are.

 

According to Factset, we have seen 85 (17 percent) of the S&P 500 companies release their results for the third quarter of 2017. Of the 85 companies that have released earnings, 76 percent have beaten earnings estimates, while 10 percent have met expectations and 14 percent have fallen short of expectations. When looking at revenue, of the companies that have reported, 72 percent of the companies have beaten estimates, while 28 percent have fallen short. The overall earnings growth rate for the S&P 500 thus far stands at 1.7 percent with the energy sector leading the way. When looking toward the fourth quarter of 2017, there have been 18 companies that have issued guidance with 12 issuing lower guidance and 6 raising their guidance. While the above numbers may seem good, they represent only a small portion of the overall S&P 500 and are likely to change as more companies report their results. We should have a better feel for this quarter’s earnings season following this week’s results as 189 of the S&P 500 companies are reporting results, as are 12 of the 30 Dow component companies.

 

This week is the week we start to see a full ramp up of earnings reports as there are more than 850 companies reporting results. The table below shows the companies that will be releasing their earnings this week, with those that have the greatest potential to move the markets highlighted in green:

 

Arthur J Gallagher Halliburton Sprint
Amgen Hilton Sherwin-Williams
Amazon.com Hershey Simon Property
Anthem Intel AT&T
Boeing JetBlue Airways T-MOBILE
Bristol-Myers Squibb Kimberly-Clark Tesla Motors
Anheuser-Busch Inbev Coca-Cola Twitter
Caterpillar Eli Lilly & Company Texas Instruments
Colgate-Palmolive Lockheed Martin Union Pacific
Comcast Southwest Airlines United Parcel Service
Chipotle Mexican Grill McDonald’s United Technologies
Canadian National Railway McKesson Visa
ConocoPhillips 3M Company V F
Chevron Altria Walgreens
Dr Pepper Snapple Microsoft Waste Connections
Ford Motor Northrop Grumman Whirlpool
General Dynamics PulteGroup Waste Management
General Motors Phillips 66 Weyerhaeuser
Google Rambus Xcel Energy
Goodyear Tire & Rubber Raytheon Exxon Mobil

 

Many industry and sector leaders will be posting results this week and several are likely to move the overall markets. Two of the FAANG stocks report this week, Amazon and Google, as well as other technology heavyweights: Tesla, Intel and Microsoft. Tesla’s Model 3 delays will be of interest to investors as it now looks all but impossible for Tesla to hit its attempted production numbers by the end of 2017. Forward looking production numbers will be key to how the markets react to the earnings announcement. Large integrated energy companies will also make their presence known this week as Exxon, Chevron, ConocoPhillips and Halliburton all report results. Oil, being up by a little more than 10 percent for the quarter, should provide many of these energy companies with a nice tailwind. The sector will likely continue to be the top performer in terms of the number of companies beating expectations. Aerospace and Defense will be in the spotlight as well, as three of companies in the industry (Raytheon, General Dynamics and Lockheed Martin) report results as well, with many sales to foreign countries being booked during the quarter. Visa is another company reporting earnings this week that will be closely watched by Wall Street as the company touches many different industries and small businesses across the US, creating a treasure trove of consumer spending information.

 

On the political side of the media last week, the big announcement was the US Senate passing a budget on Thursday evening, thus opening the door to potential tax code reform by the end of the year. The budget that was passed in the Senate allows for expanding the Federal deficit by $1.5 trillion over the next 10 years and adds a procedural maneuver that allows the Senate to pass tax legislation in the future with a simple majority of 50 votes. There is also a provision that allows the House to vote on the Senate bill as it is, without having to send two different bills to committee for reconciliation, which typically takes weeks to complete. Speed is currently required in Congress because time is running out to get to the tax reform debate before the end of the year so it may affect the 2018 tax year. The other political news last week continued to be speculation over who President Trump will pick to replace Fed Chair Janet Yellen when her terms expires early next year.

 

The chair of the US Federal Reserve is by far the world’s most powerful banker and, some could argue, one of the world’s most powerful people. The chair helps set the monetary policy for the US, which has ripple effects almost everywhere else in the world. The President appoints the chair of the Fed to a four-year term. Currently, it looks like Current Fed Governor Jerome Powell and Stanford economic professor John Taylor are the two leading candidates for the position as members of the administration have spoken highly about both candidates. Jerome Powell is the safer pick, when looking at the two, and would likely lead to more of the same monetary policies that we have seen from Chair Yellen. He would also not likely rock the boat, in terms of an adverse reaction from the financial markets, should he be nominated. John Taylor is much more of a wild card in the eyes of the financial markets as no one really knows what direction he would take the Fed if he were to be named to the chair position. John Taylor has worked almost exclusively in academics with short stints on Presidential economic advisory councils and as undersecretary of the treasury under Bush, all while still teaching. These two were the names most spoken about last week, but there is certainly still a chance that someone else is tapped to be the Fed Chair, or even Yellen being reappointed. We will just have to wait and see when an official announcement is made.

 

Global news impacting the markets:

Last week, the primary focus of the international financial media was on two different areas of the world—China and Europe. In China, the focus was on the once every five-year gathering of the People’s Congress, which was taking place in Beijing. This is a big political party meeting at which the President is voted on. In this case, it is highly unlikely that current President Xi Jinping will be removed from power. If anything, this meeting will likely increase his power within Chinese politics, making him the strongest President since Communist leader Mao Zedong, the founder of modern China. While the biggest speeches of the Congress have yet to be given (they come at the end of the weeklong event), the theme so far during this year’s meeting seems to be China’s growing economic and political might. President Xi Jinping opened this Congress with a 3.5-hour speech, during which he called out many of his successes during his first 5 years in office, successes which included China’s increasing control in the South China Sea and his domestic repression plan that has been used to crack down on free expression and civil society within China. He also took aim at Taiwan during his speech, saying that mainland China needs to have more control over the island China still views as a renegade province of China. With the voting that takes place at the end of the Congress Session, President Xi Jinping could become even more emboldened if he picks up power within Chinese politics and he could take a much more hard-line approach in everything related to dealing with the US and other countries such as North Korea. While this large political meeting was being held in China last week, there were also a number of political meetings being held in both the UK and Spain, as both countries are trying to navigate some very uncertain waters.

 

The Brexit negotiations remain stalled for the most part as there were very few new developments last week. The lack of movement seems to be starting to have an adverse impact on some of the global businesses with large operations in the UK. Last week, the Goldman Sachs CEO said the company was leasing more office space in Berlin and looked forward to being in Berlin much more frequently in the future. This was taken as a threat to the UK, that Goldman Sachs will pull operations from the UK if the Brexit negotiations do not go smoothly. Both sides of the Brexit negotiations pointed the finger at the other as being unwilling to budge on the divorce settlement. The EU seemed to take an even harder stance with the Catalonia region of Spain, however, once again saying the EU would never recognize Catalonia as a free and independent state. Spain is currently trying to deal with Catalonia as an internal problem and invoked article 155 over the past weekend. This article is being used to remove all provincial control from the region, returning all the powers back to the government in Madrid. Of course, the people who voted to leave Spain are not happy about this development, but Spain can deal with the region in a very heavy-handed way and will likely get its way in the situation.

 

Last weekend, the snap elections Prime Minister (PM) Shinzo Abe called for about a month ago were held in Japan. Unlike other elections around the world that have been very close when the final numbers were counted, this weekend’s election in Japan was a landslide victory. PM Abe’s Liberal Democratic Party won enough seats in Parliament to have a super majority, winning more than 2/3rds of the seats. This resounding victory for the party allows PM Abe to disband the coalition government that had been in place prior to the election and run everything through his party. PM Abe has pledged to push his new mandate of overhauling the country’s defense strategy as well as its long-standing pacifist stance. However, his immediate task will be to deal with North Korea, as PM Abe will not stand by as the hermit country launches missiles over Japan, missiles that could malfunction and easily hit very populated areas of Japan. One thing PM Abe didn’t mention in his victory speech was anything about getting the Japanese economy growing faster or dealing with its looming population issues. For now, we will just have to wait and see what, if any, innovative approaches are taken on these fronts in Japan.

 

Hybrid model performance and update

For the trading week ending on 10/20/2017, returns in the hybrid and quant hypothetical models* (net of a 1% annual management fee) were as follows:

 

  Last Week 2017 YTD Since 6/30/2015
Aggressive Model 0.43% 9.12% 15.07%
Aggressive Benchmark 0.24% 15.85% 15.63%
Growth Model 0.30% 8.09% 13.03%
Growth Benchmark 0.19% 12.28% 12.44%
Moderate Model 0.14% 6.20% 10.12%
Moderate Benchmark 0.14% 8.81% 9.21%
Income Model 0.08% 5.44% 9.12%
Income Benchmark 0.07% 4.61% 5.10%
Quant Model 0.38% 13.68%
S&P 500 0.86% 15.02% 24.82%

*Model performance does not represent any specific account performance but rather a model of holdings based on risk levels that are like my actual holdings, the hypothetical models are rebalanced daily to model targets.

 

There were no changes to the hybrid models over the course of the previous week. Earnings season has started for our individual equity holdings with Johnson and Johnson (JNJ) as well as Proctor and Gamble (PG) turning in their results last week. JNJ beat Wall Street estimates by more than 5 percent and saw a subsequent positive move in the markets. PG, on the other hand, also beat expectations and reaffirmed its outlook for 2017 and was rewarded with a drop of nearly 4 percent on the day following the announcement. Immediate movements following earnings announcements are normally best ignored, provided the company is still on track with its business operations. These knee jerk reactions are also typically overdone to either the up or down side, as was likely the case in the downward movement of PG on Friday. We will continue to monitor all our equity holdings very closely during the coming several weeks of earnings announcements.

 

Market Statistics:

 

The US markets were positive last week as volume remained below average:

 

Index Change Volume
Dow 2.00% Below Average
S&P 500 0.86% Below Average
NASDAQ 0.35% Below Average

 

Earnings reports drove the performance figures last week with IBM, one of the 30 Dow member companies, beating expectations and seeing its stock increase nearly 9 percent the day following the announcement. With IBM being a nearly 5 percent weighting in the Dow, that single stock movement accounted for almost a quarter of the overall movement of the index during the week. The cap weighted indexes are susceptible to large movements based on individual companies, especially during earnings season. With the relatively small number of companies that reported earnings during the week last week, the volume on all three of the indexes remained below the one year weekly average volume level.

 

The following were the top 5 and bottom 5 performing sectors over the course of the previous week:

 

Top 5 Sectors Change   Bottom 5 Sectors Change
Healthcare Providers 4.75%   Natural Resources -1.01%
Home Construction 2.94%   Telecommunications -1.04%
Medical Devices 2.12%   Real Estate -1.31%
Regional Banks 2.08%   Biotechnology -1.36%
Software 2.08%   Consumer Staples -1.62%

 

After being two of the more hard-hit sectors of the markets two weeks ago, Healthcare and Medical Devices turned in a solid week last week as Congress seemed more interested in moving on to a budget for 2018 and tax reform than another attempt at a healthcare repeal. Home Construction, Regional Banks and Software rounded out the top five performing sectors last week as all three sectors saw strong performance from some of the largest companies within each sector during the week help boost the overall sector performance. Earnings was the primary driving force behind the bottom five performing sectors of the markets last week, as weaker earnings due to hurricanes and other extraneous factors seemed to adversely impact some of the releases.

 

US government bonds were mixed last week as the likelihood of a rate increase in December increased and the potential list of Fed chair candidates seemed to get smaller:

 

Fixed Income Change
Long (20+ years) -1.49%
Middle (7-10 years) -0.77%
Short (less than 1 year) 0.02%
TIPS -0.63%

 

Best and Worst Currencies Change
US Dollar 0.70%
Macau pataca 0.50%
New Zealand dollar -3.15%

 

 

Overall, the US dollar increased last week by 0.70 percent against the value of a basket of foreign currencies. Increasing odds of a Fed rate hike in December were one of the primary driving forces behind the increase in the US dollar. When looking at global currencies, the Macau Pataca took the top spot, gaining 0.50 percent against the dollar, while the New Zealand dollar performed the worst, giving up 3.15 percent against the US dollar. The decline in the New Zealand dollar was due to the election results, which, a month after the election was held, produced a liberal Prime Minister for the first time in the last nine years.

 

Commodities were mixed last week as the overall GS commodity index turned in a nearly flat week, giving up only 0.07 percent:

Metals Change   Commodity Change
Gold -1.78%   GS Commodity Index -0.07%
Silver -2.01%   Oil 0.58%
Copper 1.34%   Livestock 1.32%
      Grains -2.74%
      Agriculture -0.78%

 

The GS commodity index was flat last week, as gains in oil and some of the soft commodities were offset by losses in the precious metals. After restraint seemed to be shown by both sides in the Iran nuclear deal, oil settled down and turned in a week of very little movement, ending with a gain of 0.58 percent. Gold and Silver decreased 1.78 and 2.01 percent, respectively, while Copper bucked the trend and gained 1.34 percent on the hopes of increased demand out of China for the industrial metal. Soft commodities were mixed last week as well, with Agriculture overall declining by 0.78 percent, while Grains fell by 2.74 percent. Livestock was a bright spot in the soft commodities, last week gaining 1.32 percent for the week.

 

Top 2 Indexes Country Change   Bottom 2 Indexes Country Change
BIST 100 Turkey 2.13%   RTS Index Russia -1.92%
S & P/ASX 200 Australia 1.60%   WIG Poland -2.45%

Last week was a mixed week for the global stock indexes, with 53 percent of the global markets posting gains. Turkey turned in the best performance of the global markets, with a bump seen in the BIST 100 following the announcement that ISIS had been driven out of their Syrian strong hold of Raqqa. On the negative side, Poland’s WIG index slid 2.45 percent last.

There have been four weeks in a row of tame movement for the VIX as the fear gauge increased only 3.75 percent. A strong start to earnings season in the US only seems to be adding to the ongoing complacency that we have been seeing in the VIX. At this point, it would take a true black swan event for the markets to get life back into the VIX. The current reading of 9.97 implies that a move of 2.88 percent is likely to occur over the next 30 days. As always, the direction of the move over the next 30 days is unknown.

Economic Release Calendar:

 

Last week was a slow week for economic news releases, with manufacturing taking the spotlight. There were two releases that beat expectations and none that significantly missed expectations:

 

Economic Impact Date Economic News Release Date Range Actual Expectation
Positive 10/16/2017 Empire Manufacturing October 2017 30.2 20.7
Neutral 10/18/2017 Housing Starts September 2017 1127K 1180K
Neutral 10/18/2017 Building Permits September 2017 1215K 1250K
Positive 10/19/2017 Philadelphia Fed October 2017 27.9 22.0
Neutral 10/20/2017 Existing Home Sales September 2017 5.39M 5.30M

Data for table from Econoday.com, Bloomberg and Yahoo Finance

 

Empire manufacturing data kicked things off on Monday last week with a surprise of nearly 50 percent as manufacturing was shown to be very strong and accelerating in the greater New York area during October. This enthusiasm in manufacturing data was carried over into Thursday when the Philly Fed released its latest business conditions and manufacturing report, which also came out significantly ahead of market expectations. Manufacturing is the backbone of President Trump’s make American great again plan and if the numbers that we have been seeing are any sign, it looks like manufacturing in the US is going the correct way. In between the manufacturing data last week was the start of the housing related releases for the month of September as housing starts and building permits were released with both coming in close to market expectations and having a negligible impact on the overall markets. The Friday release of existing home sales also had a negligible impact on the markets as they came in very close to market expectations.

 

This week is a slow week in terms of the number of economic news releases being released, but an important week in terms of what is being released. The releases with the greatest potential to impact the markets are highlighted in green below:

 

Date Release Release Range Market Expectation
10/25/2017 Durable Orders September 2017 1.1%
10/25/2017 Durable Goods

–ex transportation

September 2017 0.5%
10/25/2017 New Home Sales September 2017 560K
10/26/2017 Pending Home Sales September 2017 0.2%
10/27/2017 GDP-Adv. Q3 2017 2.6%
10/27/2017 University of Michigan Consumer Sentiment Index October 2017 101.0

Data for table from Econoday.com, Bloomberg and Yahoo Finance

 

The economic news releases kick off on Wednesday this week with the release of the durable goods orders, both including and excluding transportation. Overall orders are expected to post a gain of 1.1 percent, which is positive, but still stubbornly low. Auto and plane sales are expected to make up about half of the growth; when the two are taken out of the equation, expectations are for growth of only 0.5 percent. The final two housing data points for the month of September are released on Wednesday and Thursday this week and expectations are for minor changes from the August levels, so there should be little impact on the markets from these two releases. On Friday, the big release of the week is set to be released with the first estimate of Q3 GDP for the US. Expectations are for a half a percent decline in the final second quarter GDP print that we saw, which was 3.1 percent. This quarter’s GDP print, however, is susceptible to being lower than expected due to the negative impact of the hurricanes during the quarter. If we see a print significantly lower than the expected 2.6 percent growth it could make it more difficult for the Fed to raise interest rates at any of their upcoming 2017 meetings. The final release of the week this week is the University of Michigan’s Consumer Sentiment index for the month of October (mid-month calculation), which is expected to show very little change over the end of September reading. In an unusual week, there are no Fed officials making any scheduled speeches this week, leading to speculation that President Trump will nominate a new Fed chair sometime during the week.

 

Interesting Fact — Dynastic politics at work in Japan

 

Dynastic politics seem to play a bigger role in the election of global leaders around the world than one would expect. Japan is a good example of how dynastic leadership can come into play. Shinzo Abe is the third member of his family to be named Prime Minister of Japan. His grandfather, Nobusuke Kishi, was Japan’s prime minister from 1957 to 1960. Abe’s great uncle, Eisuke Sato, was prime minister from 1964 to 1972.

 

Source http://www.cnn.com

For a PDF version of the below commentary please click here Weekly Letter 10-16-2017

Commentary quick take:

 

  • Major developments:
    • Markets turned in positive results
    • Earnings season has started once again
    • Iran deal in crisis

 

  • US:
    • Trump’s executive order on healthcare
    • Iran deal punted to Congress
    • Q3 earnings season has started
    • Consumer Sentiment at 16 year high
    • Lower chance of rate hike in December
    • Inflation data still low

 

  • Global:
    • Iran nuclear deal at risk
    • Iran oil exports could stop flowing
    • UK Brexit negotiations not going well
    • Catalonia is becoming a mess

 

  • Hybrid investments strategy update:
    • No changes to the hybrid models last week
    • Consumer staples performed well

 

  • This week for the markets:
    • China People’s Congress
    • Iran deal
    • North Korea

 

  • Interesting Fact: Would you drive in a snow storm?

 

 

Major theme of the markets last week: Bull market pressed ahead

Nearing the 30-year anniversary of the October 1987 crash in the stock market, last week saw the US financial markets continue their bull run higher. The recent increase is partially attributed to the continued economic stimulus provided by the Federal Reserve, stimulus that looks to be coming out of the system slower than the Fed would like. The start of the US earnings season for the third quarter went well with major financial institutions beating market expectations and setting a positive tone for the rest of corporate America to report earnings.

 

US news impacting the financial markets:

 

Last week was a slow week for US news impacting the financial markets. Overall, the economic data (discussed in more detail in the economic data section) revealed some interesting data points last week, though most of the variance was caused by the hurricanes that hit the US during September. The odds of a rate hike at the November meeting by the FOMC stayed at 2 percent, while the odds of a rate hike at the December meeting decreased to 83 percent after starting the week as high as 93 percent. Aside from the economic data last week, the markets turned their attention to earnings season for the third quarter of 2017.

 

The third quarter earnings season officially kicked off last week with some of the large financial institutions in the US reporting their results. Below is a table of the well-known companies that released earnings last week with earnings that missed expectations highlighted in red, while earnings that beat expectations by more than 10 percent are highlighted in green:

 

Bank of America 4% Delta Air Lines 2% J.B. Hunt Transport -5%
Blackrock 6% Domino’s Pizza 4% J P Morgan Chase 5%
Citigroup 8% Fastenal Companies 0% Wells Fargo 0%

 

As you can see in the above table, the major financial companies that reported earnings last week turned in positive results that were good, but not great. On average, the financial companies that reported earnings beat expectations by about 5 percent for the quarter. One theme emerging on the analyst quarterly results calls that have taken place is the hurricanes’ negative impact on earnings during the quarter. According to Factset, the hurricanes have been mentioned on more than half of the calls so far and will likely remain a prominent topic for the remainder of earnings season. A second prominent theme is that foreign currencies are negatively impacting US results; during the third quarter, the US dollar declined by about 2.3 percent against a basket of international currencies.

 

According to Factset, we have seen 30 (6 percent) of the S&P 500 companies release their results for the second quarter of 2017. Of the 30 companies that have released earnings, 81 percent have beaten earnings estimates, while 6 percent have met expectations and 13 percent have fallen short of expectations. When looking at revenue, of the companies that have reported, 78 percent of the companies have beaten estimates, while 22 percent have fallen short. The overall earnings growth rate for the S&P 500 thus far stands at 2.1 percent, which is significantly below the 12.1 percent rate we saw at the end of the second quarter of 2017. While the above numbers may seem good so far for the quarter, they represent only a very small portion of the overall S&P 500 and are likely to change as more and more companies report their earnings results.

 

The table below shows the companies that will be releasing their earnings this week, with those that have the greatest potential to move the markets highlighted in green:

 

Alcoa Corp Harley-Davidson Progressive
Abbott Labs Honeywell Philip Morris
AthenaHealth IBM PayPal
American Express Johnson & Johnson Charles Schwab
Bank Of New York Kinder Morgan United Continental
CSX ManpowerGroup UnitedHealth
eBay Morgan Stanley United Rentals
General Electric Netflix US Bancorp
Genuine Parts Company Nucor Verizon
Goldman Sachs Procter & Gamble Wd-40

 

This week, earnings season gets fully under way as there are many industry and sector leaders reporting their results. Netflix will likely garner a lot of attention as it is the first of the FAANG (Facebook, Amazon, Apple, Netflix and Google) stocks to post results. The FAANG stocks have been the driving force behind much of the market movement over the past several months, so the results from each will be keenly watched. Progressive Insurance will be watched to assess the impact of the hurricanes and wild fires on the company. Goldman Sachs, Bank of New York and US Bancorp could see the markets push their stocks higher or lower, depending on how their results compare with the results seen last week among other major financial institutions. Athena Health and UnitedHealth will be closely watched for any comments about their Affordable Care Act plans and any potential impact anticipated from the across-state lines competition in healthcare coverage commenced last week by President Trump. Consumer product giants J&J and P&G will kick off earnings for the sector this week for a quarter that saw increased competition from the likes of Amazon. This week, in aggregate, we will see more than 10 percent of the S&P 500 companies report their results as well as 9 of the 30 Dow 30 component companies.

 

Politics made a few headlines last week with one of the main topics being President Trump using an executive order in an attempt to benefit plan participants by increasing competition among health insurers by allowing insurers to sell plans across state lines. In theory, increased competition should drive down costs, but it will take time to see if that theory turns into reality. The other political headline last week was related to Iran as President Trump declined to recertify the nuclear deal that was agreed to back in 2015. By not certifying the deal, he kicked it to Congress, saying he wants Congress to toughen the agreement and impose new sanctions on Tehran. If Congress is not able to deliver, President Trump plans to formally end the deal all together.

 

Global news impacting the markets:

 

The Iranian deal debacle caused by President Trump last week took most of the international headlines as it directly impacts many different regions of the world, largely because of the oil Iran produces. Iran currently pumps about a million barrels per day of crude oil into the global oil markets. It has been steadily increasing its production since the sanctions preventing Iran from shipping oil were lifted back in 2015 by the nuclear deal. If the deal were to officially be cancelled by the US (it is at the President’s sole discretion), the sanctions in place before the deal would immediately take effect, cutting Iran’s oil exports down to essentially zero. This would potentially cause a significant supply side oil disruption, especially in southern Europe as a lot of Iran’s oil makes its way to southern Europe. Curiously, a supply shock to oil in southern Europe would likely occur when Europe becomes more dependent on Russia for both natural gas and oil during the frigid winter months. A supply shock in oil prices would have an inflationary impact around the world and could be a positive development for the US Fed as it would make the decision to raise rates, or not, at future meetings a little easier. There are also concerns that Iran could lash out at the US if the deal is scrapped as the country has already threatened several military bases in the region. Another country that routinely threatens the US military is North Korea, which was largely unheard from last week.

 

North Korea remains one of the tensest situations in the geopolitical landscape around the world. While there were no more tests of missiles or nuclear devices last week, tension seemed to be building as North Korea once again threatened the US Territory of Guam. US Secretary of State Rex Tillerson tried to cool the situation by saying diplomatic negotiations would continue until the first bombs drop, but the world didn’t seem to give his statement much weight as President Trump routinely overrules his positions. The final area of the world that made headlines last week was Europe as the region deals with the Brexit and with Catalonia’s independence vote. It was revealed last week that the Brexit negotiations were not going well at all, which should come as no surprise. Both sides are still fighting over the divorce settlement payment and agree that they cannot move forward on any aspects of the Brexit until something is done about the money. EU leaders know their hand only strengthens as we move closer to the two-year deadline for the UK to be kicked out of the EU. Spain is also starting to move into a precarious limbo state as Catalonia voted to become a sovereign state within Europe and yet the provisional government has failed to announce their independence. The Catalonian government will likely face a very difficult fight with Spain that has threatened martial law within the region if the region declares its independence. The EU has already said it would not recognize Catalonia as an independent state, so Catalonia would not be able to apply for any trading or travel agreements for citizens within the EU. It appears the vote in Catalonia will turn into nothing more than a symbolic vote as nothing will change for the region given the restraints it is currently running into.

 

Hybrid model performance and update

For the trading week ending on 10/13/2017, returns in the hybrid and quant hypothetical models* (net of a 1% annual management fee) were as follows:

 

Last Week 2017 YTD Since 6/30/2015
Aggressive Model 0.49% 8.65% 14.57%
Aggressive Benchmark 0.77% 15.57% 15.35%
Growth Model 0.59% 7.76% 12.68%
Growth Benchmark 0.60% 12.07% 12.23%
Moderate Model 0.68% 6.05% 9.96%
Moderate Benchmark 0.44% 8.66% 6.91%
Income Model 0.81% 5.35% 9.03%
Income Benchmark 0.23% 4.53% 5.02%
Quant Model -0.48% 13.24%
S&P 500 0.15% 14.04% 23.75%

*Model performance does not represent any specific account performance but rather a model of holdings based on risk levels that are like my actual holdings, the hypothetical models are rebalanced daily to model targets.

 

There were no changes to the hybrid models over the course of the previous week. The consumer staple focused individual equity holdings were the primary driving force behind the performance numbers for the week. International positioning continued to be accretive to the models as well over the course of the past week.

 

Market Statistics:

 

The US markets were positive last week. Volume remained below average:

 

Index Change Volume
Dow 0.43% Below Average
NASDAQ 0.24% Below Average
S&P 500 0.15% Below Average

 

Volume overall continued on a downward trend last week, despite a little bump seen late in the week due to corporate earnings reports. We should see volume start to pick up to average or even above average levels of the past year as we move fully into earnings season and investors react to various corporate results.

 

The following were the top 5 and bottom 5 performing sectors over the course of the previous week:

 

Top 5 Sectors Change Bottom 5 Sectors Change
Commodities 2.67% Multimedia Networking -1.28%
Semiconductors 2.64% Pharmaceuticals -1.41%
Consumer Staples 2.38% Regional Banks -1.54%
Utilities 2.18% Telecommunications -1.62%
Real Estate 1.82% Healthcare Providers -4.32%

 

The list of top performing sectors last week was very intriguing as three of the five are risk-off sectors, while the remaining are two of the riskiest sectors available. Commodities led the way higher thanks to increased oil prices last week, while Semiconductors popped higher on hopes of strong holiday sales for some of the new cell phones hitting the market. Consumer Staples, Utilities and Real Estate rounded out the top performing sectors as a lack of any major positive catalysts seemed to be pushing investors toward the perceived safety of these sectors. On the downside last week, Healthcare Providers took the brunt of the impact from Trump’s executive order, falling the most of any sectors of the markets. Pharmaceuticals made the list in a sympathy trade as well. The other three sectors on the list (Multimedia Networking, Regional Banks and Telecommunications) were somewhat random, having very little in common other than negative performance for one reason or another during the week.

 

US government bonds all moved higher last week as the likelihood of a rate increase in December decreased:

 

Fixed Income Change
Long (20+ years) 1.83%
Middle (7-10 years) 0.70%
Short (less than 1 year) 0.04%
TIPS 0.66%

 

Best and Worst Currencies Change
US Dollar -0.78%
South Africa rand 3.43%
Mexico peso -2.04%

 

 

Overall, the US dollar decreased last week by 0.78 percent against the value of a basket of foreign currencies. It seems the US dollar increases when the odds of a Fed rate hike increases, while the value of the US dollar pushes lower when the odds of a rate hike decreases. When looking at global currencies, the South African rand took the top spot, gaining 3.43 percent against the dollar, while the Mexican Peso performed the worst, giving up 2.04 percent against the US dollar.

 

Commodities were all positive last week as the overall GS commodity index turned in a gain of more than two and a half percent:

Metals Change Commodity Change
Gold 2.25% GS Commodity Index 2.67%
Silver 3.53% Oil 4.01%
Copper 3.90% Livestock 0.77%
Grains 1.09%
Agriculture 0.26%

 

The GS commodity index was positive last week, thanks to all of the tracked commodities in the index increasing in value, with Oil providing the biggest boost to the index. As mentioned above, one of the biggest movers in the oil prices last week was concerns over Iranian oil exports being taken back off the markets due to sanctions on Iran being reinstated. Gold, Silver and Copper increased 2.25, 3.53 and 3.90 percent, respectively. Soft commodities were positive last week as well, with Agriculture overall advancing by 0.26 percent, while Livestock and Grains gained 0.77 and 1.09 percent, respectively. It is a somewhat unusual week to see all the commodities move higher in tandem with the equity markets and bond markets, but this market is starting to grow accustomed to the unusual.

 

Top 2 Indexes Country Change Bottom 2 Indexes Country Change
Kospi South Korea 3.31% IPC All-Share Mexico -0.64%
BUX Hungary 2.51% OMX Copenhagen Denmark -0.94%

Last week was a strong week for the global stock indexes, with 81 percent of the global markets posting gains. South Korea took the top spot with a gain of 3.31 percent, as no news out of North Korea for most of the week was taken as a positive development. On the negative side, Denmark slid almost one percent last week as inflation within the country hit a 5 year high last week and is now running ahead of mainland Europe for the first time in several years.

The VIX had its third tame week in a row last week as the fear gauge decreased only 0.41 percent. For the time being, it appears the VIX is perfectly content sitting on the floor as fear does not seem to be very prevalent, as measured by the VIX. The news surrounding the Iran deal didn’t even register on the VIX when it occurred, which implies that either the risk is further than 30 days away or the US markets don’t have anything to fear from rising oil prices if the Iran deal is scrapped. The current reading of 9.61 implies that a move of 2.77 percent is likely to occur over the next 30 days. As always, the direction of the move over the next 30 days is unknown.

Economic Release Calendar:

 

Last week was an eventful week for economic news releases with many releases being watched closely by the Fed. There were two releases that beat expectations and none that significantly missed expectations:

 

Economic Impact Date Economic News Release Date Range Actual Expectation
Neutral 10/12/2017 PPI September 2017 0.4% 0.4%
Neutral 10/12/2017 Core PPI September 2017 0.4% 0.2%
Neutral 10/13/2017 Retail Sales September 2017 1.6% 1.7%
Positive 10/13/2017 Retail Sales ex-auto September 2017 1.0% 0.4%
Neutral 10/13/2017 CPI September 2017 0.5% 0.6%
Neutral 10/13/2017 Core CPI September 2017 0.1% 0.2%
Positive 10/13/2017 University of Michigan Consumer Sentiment Index October 2017 101.1 95.4

Data for table from Econoday.com, Bloomberg and Yahoo Finance

 

Inflation related data points took the spotlight on Thursday last week as the latest reading from the Producer Price Index (PPI) was released, and posted very low, but expected readings for inflation. On Friday, the Consumer Price Index (CPI) posted low readings as well, leaving some investors wondering if the Fed will be able to raise rates at the upcoming December meeting. Retail sales were a surprising bright spot last week when they were released on Friday, as overall sales excluding auto sales increased by one percent during the month of September, thanks in large part to a boost in spending in the areas in the US hit by the hurricanes that have started cleaning up and rebuilding. The last release of the week last week was the latest reading of consumer sentiment, released by the University of Michigan. The chart to the right shows the last 16 years of data for the consumer sentiment index. As you can see, last week’s reading of 101.1 was the highest reading that we have seen on the index since February of 2004. This is a very bullish reading and a very positive sign for future growth of the US economy if this bullishness in sentiment translates into more spending by US consumers, which for a long time has been the missing piece of the economic growth puzzle.

 

This week is a slow week in terms of the number of economic news releases being released. The releases with the greatest potential to impact the markets are highlighted in green below:

 

Date Release Release Range Market Expectation
10/16/2017 Empire Manufacturing October 2017 20.7
10/18/2017 Housing Starts September 2017 1180K
10/18/2017 Building Permits September 2017 1250K
10/19/2017 Philadelphia Fed October 2017 22.0
10/20/2017 Existing Home Sales September 2017 5.30M

Data for table from Econoday.com, Bloomberg and Yahoo Finance

 

When the Empire Manufacturing index and the Philly Fed index are the most potentially impactful economic news releases during any given week, you know it is a very slow week for economic news releases. Manufacturing data is expected to show a slight decline from the September reading when the October data is released on Monday and Thursday this week. US housing market data are the only other economic data points being released this week and all three of the figures—housing starts, building permits and existing home sales—could be materially impacted by the hurricanes during the reporting period so the markets will likely discount these figures heavily. In addition to the economic data and corporate earnings being released, the markets will be watching seven speeches by Federal Reserve officials, including two by Fed Chair Yellen herself. Any of these speeches could impact the US markets if what is said deviates significantly from what the markets are expecting in terms of future FOMC policy decisions.

 

Interesting Fact — Nobel Prize in Economics

 

Last week, this year’s Nobel prize in economics was given to University of Chicago Professor Richard Thaler who has pioneered work in behavioral finance for years. Over the years, he has devised many famous scenarios to get every day people to understand behavioral finance. Some of his more interesting theories are based around these three human behaviors:

  • Why, during a hazardous snowstorm, would we skip driving to a concert if the tickets were free, but risk life and limb to go if we had paid for the tickets? The risk on the roads is the same and we don’t get the money back either way. This illustrates the “sunk cost fallacy.”

 

  • Experiments repeatedly show that people are willing to pay $3 to buy a coffee mug, but demand $6 to sell a mug they have been given. The phenomenon is called the “endowment effect,” where we assign greater value to things we possess.

 

  • You bring $200 to a casino to gamble. You win another $200. If you separate the money and lose only the winnings, you may not feel much pain because you consider that money to be the casino’s anyway. Yet you still lost $200. This is a good example of “mental accounting.”

Source: http://www.chicagotribune.com

For a PDF version of the below commentary please click here Weekly Letter 10-9-2017

Commentary quick take:

 

  • Major developments:
    • A week of new highs and new lows
    • Bulls remain in control of the markets
    • VIX moved into uncharted territory
    • Politics as usual in Washington DC

 

  • US:
    • House passed budget
    • Tax reform is still in the works
    • Unemployment dropped to 4.2 percent
    • Dismal payroll figures
    • Wages picked up
    • Odds of a December rate hike increased

 

  • Global:
    • China People’s Congress next week
    • North Korea quiet—too quiet

 

  • Hybrid investments strategy update:
    • One change in the hybrid models

 

  • This week for the markets:
    • North Korea uncertainty remains
    • Senate in recess this week
    • Gearing up for Q3 earnings season

 

  • Interesting Fact: Unusual hurricane season?

 

 

Major theme of the markets last week: Volatility is still mysteriously missing

Fall is in the air and so too is the VIX. The VIX moved into uncharted territory on Thursday last week, closing at 9.19, an all-time low for the fear gauge. This low level left many pundits on TV wondering if the VIX was broken, something they have been wondering now for several months. There is some sense to the thinking that the underlying components of the VIX calculation have fundamentally changed with the emergence of a multitude of innovative ways for investors to hedge risks out of their investments. Earlier this year, people were identifying 10 as the floor for the VIX; now those same people are starting to talk about 9 as a floor for the VIX. Last week, the VIX moved lower on optimism over the potential tax reform package in Washington DC, which has a high chance of passing both the House and the Senate.

 

US news impacting the financial markets:

 

The focus of the US financial news last week was political and economic. Washington DC was in full swing, addressing many items, including gun control following the mass shooting in Las Vegas last weekend. Some members of Congress immediately jumped into action on tighter gun control laws, but these efforts will likely not get very far. There was an interesting change of heart from the NRA last week, however, which came out against bump stocks being legal, in a rare gesture by the group that is typically a hardliner for the legality of everything gun related.

 

In the House of Representatives, a $4.1 trillion budget plan for 2018 was passed late last week and it held many interesting line items. The plan calls for more than $5 trillion in spending cuts over the coming decade, including a $1 trillion slash to Medicaid and cuts to other health care costs and domestic programs. These spending cuts were added so Republicans could get enough support within its own party to pass the plan. However, all of the cuts mentioned are non-binding, meaning the Republicans can go back and write individual pieces of legislation to undo the nonbinding cuts. Essentially, the tactic would be to pass a budget because of the spending cuts, then reverse the spending cuts and keep the budget. Although the Senate has a say in the budget as well, it seems highly unlikely that any budget Congress comes up with will be very different from what was passed last week. With the spending cuts, Republicans can “on paper” offset some of the reduction in tax revenue resulting from the tax breaks in the tax reform; it is essentially a shell game of pushing money around. In the end, we will likely end up without a budget for 2018 by December 15th, resulting in the passage of another continuing resolution, which is Washington’s way of operating without a budget and kicking the can down the road for spending and budgetary cuts. Further compacting the time table for debate, the Senate is not in session next week. While a lot was happening on Capitol Hill last week, a lot of economic data was being analyzed at the Federal Reserve.

 

With two hurricanes hitting the southern US over the past two months, there were questions about the Fed’s ability to raise rates one more time during 2017, most likely at the December meeting. Last week, some encouraging economic data released increased the likelihood of a Fed rate hike in December. Despite the worst payroll numbers that we have seen since 2010, the overall unemployment rate in the US dropped down to a 16 year low of 4.2 percent during the month of September. Manufacturing data was robust, even as some economists warned about the potentially negative impact of the hurricanes on manufacturing. More than these two releases, however, it was the hourly earnings increase during the month of September that seemed to move the odds of a rate hike the most. Average hourly earnings in the US for the month of September increased 0.5 percent, which tied it for the highest reading that we have seen since February of 2016. The lack of wage growth had been singled out as a major factor for the Fed not increasing rates earlier. With the wage growth data, the odds of a rate hike at the December FOMC meeting went from a 78 percent chance of a hike to a 93 percent chance. The Consumer Price Index and the Producer Price Index for the month of September, which are set to be released next week, could further solidify the likelihood of a December rate hike.

Global news impacting the markets:

 

Global news impacting the financial markets last week was somewhat muted as media coverage focused on the shooting in Las Vegas. China made a few headlines as everyone appears to be waiting for the People’s Congress, which convenes once every 5 years, to convene on October 18th for a week. It is at this political gathering that the government in China outlines its thoughts and some of its plans for the next five years. With China playing such a crucial role in the global economy, the global markets have been known to quickly react to announcements made at this meeting. One topic that is sure to come up is trade. China wants to continue to trade around the world, but also wants to become less dependent on exports, turning its economy into a more internal consumption driven economy.  The countries and indexes most directly impacted by changes in trade with China are countries that export raw materials to China, such as South Korea, Australia, Japan, the United States and Germany; which make up just over 40 percent of China’s imports. Another topic that will likely come up is direct foreign investment within China and the Chinese banking system. China wants to maintain control over its own finances and having many foreign investors with a significant amount of money invested in the country, while positive for the economy, presents a power struggle for the government. When looking at banking, the government in China has already taken steps to stop things it cannot control. The latest step was closing down all crypto currency exchanges that were operating within China in an attempt to stop the use of bitcoin within the country. Following China’s shutting down of the cryptocurrency exchanges, Bitcoin lost more than 20 percent of its value in just two trading days. It will be very interesting to watch what comes out of the People’s Congress in a week and a half.

 

North Korea is the other topic that made headlines last week. After remaining quiet for most of the week, with no verbal punches between the two leaders, the end of the week brought about a remark and reaction concerning to global investors. At a photo op with President Trump and some high-ranking members of the military and their wives, President Trump said to reporters that this was “the calm before the storm.” Reporters took this as a thinly veiled threat against North Korea and North Korea in turn started to fuel up another long-range missile at the end of the week, as reported by a Russian diplomat who had been in Pyongyang and had seen the launch plans, if that diplomat can be believed. North Korea continues to be the most likely culprit of a market downdraft globally and it appears to be a situation that will not be going away any time soon.

 

Hybrid model performance and update

For the trading week ending on 10/6/2017, returns in the hybrid and quant hypothetical models* (net of a 1% annual management fee) were as follows:

 

Last Week 2017 YTD Since 6/30/2015
Aggressive Model 0.33% 7.18% 13.00%
Aggressive Benchmark 0.04% 13.85% 13.63%
Growth Model 0.25% 6.52% 11.37%
Growth Benchmark 0.04% 10.75% 10.92%
Moderate Model 0.11% 5.11% 8.97%
Moderate Benchmark 0.03% 7.73% 8.13%
Income Model 0.03% 4.46% 8.10%
Income Benchmark 0.02% 4.06% 4.55%
Quant Model 0.12% 13.26%
S&P 500 0.68% 12.53% 22.11%

*Model performance does not represent any specific account performance but rather a model of holdings based on risk levels that are like my actual holdings, the hypothetical models are rebalanced daily to model targets.

 

There was one change in the hybrid models at the beginning of last week and that change was to close out the position in Direxion funds S&P 500 short fund (DXSSX). The position had been put in place to help offset any losses that could have occurred in the underlying stock positions within each model. The position was initiated more than a month ago when volatility was higher and we were heading into the month of September, which historically is the worst month in terms of performance for the US markets. Now that we are through September and into October, the need to have a hedging position in place has been greatly diminished. The hedge, while it was in place, was not a significant drag on the hybrid models in terms of overall performance, but ended up being a cheap sort of insurance holding against the potential for a significant downward move in the markets.

 

Market Statistics:

 

The US markets were positive last week. Volume remained below average:

 

Index Change Volume
Dow 1.65% Below Average
NASDAQ 1.45% Below Average
S&P 500 1.19% Below Average

 

Last week was an interesting week in terms of the returns seen on each of the indexes. The Dow led the way higher, which is normally the case when the markets are experiencing a risk-off trade, but that was not the case last week. The NASDAQ came in second, normally the laggard in a risk-off trading week, while the S&P 500 brought up the rear, seeing the lowest performance for the week. The volume last week was well below average on all three of the indexes, as the markets still seem to be in summer trading mode, as far as volume goes.

 

The following were the top 5 and bottom 5 performing sectors over the course of the previous week:

 

Top 5 Sectors Change Bottom 5 Sectors Change
Telecommunications 3.22% Residential Real Estate -0.38%
Pharmaceuticals 2.42% Natural Resources -0.50%
Home Construction 2.33% Infrastructure -0.51%
Software 2.30% Oil & Gas Exploration -0.65%
Aerospace & Defense 2.24% Energy -0.94%

 

The sector performance last week was rather interesting as the top 5 performing sectors had very little in common. Telecommunications led the way after gaining more than 3 percent, followed by Pharmaceuticals, which turned in a good week with several positive FDA announcements causing jumps in key stocks. Home Construction gained on the increased volume anticipated with the hurricane recovery efforts. Software and Aerospace rounded out the top performing sectors. On the negative side, the decline in the price of oil contributed directly or indirectly to the bottom four performing sector of the markets last week with Energy leading the way down. The only non-energy related sector among the bottom five performers last week was Residential Real Estate, which saw a slowdown in general sales across most of the US during the month of September. This could also be attributed to the hurricanes’ negative impact on much of the south during the month.

 

US government bonds all moved lower last week as the likelihood of a rate increase in December increased:

 

Fixed Income Change
Long (20+ years) -0.74%
Middle (7-10 years) -0.23%
Short (less than 1 year) -0.01%
TIPS -0.13%

 

Best and Worst Currencies Change
US Dollar 0.79%
Venezuela bolivar 1.61%
U.K. pound -2.46%

 

 

Overall, the US dollar increased last week by 0.79 percent against the value of a basket of foreign currencies. Much of the movement was due to continued positive movement in the dollar on the hope of corporate and individual tax reform. When looking at global currencies, the Venezuelan Bolivar took the top spot, gaining 1.6 percent against the dollar, while the UK Pound performed the worst, giving up 2.46 percent against the US dollar. The decline in the pound was primarily due to increasing pressure from corporations surrounding the Brexit, as several major financial companies announced the leasing of lots of office space in Germany ahead of uncertainty coming from the UK.

 

Commodities were mixed last week as the overall GS commodity index turned in a decline of almost two percent:

Metals Change Commodity Change
Gold -0.40% GS Commodity Index -1.81%
Silver 0.70% Oil -4.41%
Copper 2.56% Livestock 2.19%
Grains -0.93%
Agriculture 0.58%

 

The GS commodity index was drug down last week, primarily by the more than 4 percent decline in the price of oil, as production in the Gulf of Mexico was slowed down ahead of yet another hurricane passing through. Gold was the sole decliner of the metals last week, falling 0.4 percent, while both Silver and Copper managed to book gains of 0.7 and 2.56 percent, respectively. Soft commodities were mixed last week with Agriculture overall advancing by 0.58 percent, while Livestock gained 2.19 percent and Grains fell 0.93 percent. Now that the US is getting closer to the end of the harvest season, we may start to see the prices of some of the commodities start to level off for the rest of the year.

 

Top 2 Indexes Country Change Bottom 2 Indexes Country Change
Hang Seng Hong Kong 3.28% FTSE MIB Italy -1.34%
Johannesburg All Share South Africa 2.97% IBEX 35 Spain -1.89%

Last week was a strong week for the global stock indexes, with 79 percent of the global markets posting gains. Hong Kong took the top spot with a gain of 3.28 percent. On the negative side, Spain slid almost two percent last week as uncertainty over the Catalonia region wanting to split from Spain continues to drive uncertainty within the country and Europe as well.

The VIX had its second tame week in a row last week as the fear gauge increased only 1.47 percent. As mentioned above, it was the intra week decline to new lows that was the most interesting aspect of the movement of the VIX last week. After an increase on Friday, driven by mounting concerns surrounding North Korea, the index closed little changed from a week-to-week standpoint. The current reading of 9.65 implies that a move of 2.79 percent is likely to occur over the next 30 days. As always, the direction of the move over the next 30 days is unknown.

Economic Release Calendar:

 

Last week was employment week as the majority of the releases pertained to the employment situation in the US. There were two releases that missed expectations and two that significantly beat expectations:

 

Economic Impact Date Economic News Release Date Range Actual Expectation
Positive 10/2/2017 ISM Index September 2017 60.8 57.8
Neutral 10/4/2017 ADP Employment Change September 2017 135K 160K
Positive 10/4/2017 ISM – Services September 2017 59.8 55.3
Negative 10/6/2017 Nonfarm Payrolls September 2017 -33K 75K
Negative 10/6/2017 Nonfarm Private Payrolls September 2017 -40K 98K
Slightly Positive 10/6/2017 Unemployment Rate September 2017 4.2% 4.4%
Neutral 10/6/2017 Hourly Earnings September 2017 0.5% 0.2%

Data for table from Econoday.com, Bloomberg and Yahoo Finance

 

Last week, the economic news releases started on Monday with a positive note as the overall ISM Index for the month of September came in better than expected, especially when you consider that hurricane cleanup was in full swing for part of the southern US during that time frame. On Wednesday, the services side of the ISM was released and came in above expectations as well, despite the potential negative hurricane impact. On Friday, however, we saw the negative impact of the hurricanes in the economic data with the payroll numbers, both public and private, missing expectations by an extremely wide margin. The markets had been expecting a reading sub-100,000 jobs, but still well above 50,000 jobs. Instead, we had two negative prints. Public payrolls declined by 33,000 and private payrolls declined by 40,000 during the month of September. While these numbers are shockingly low (worst numbers since 2010), they can be directly attributed to the hurricanes, so the US financial markets largely discounted the potential negative impact they may have otherwise had on the markets. The overall unemployment rate in the US dipped to 4.2 percent (16-year low) from 4.4 percent, adding to speculation that the Fed is still fully on board with raising rates at the December FOMC meeting. This optimism over a Fed rate hike in December was further compounded by hourly earnings ticking higher by 0.5 percent during the month of September, one of the larger monthly increases that we have seen in 2017.

 

While this week may seem slow in terms of the number of economic news releases being released, all but one of them have the potential to impact the financial markets. The releases with the greatest potential to impact the markets are highlighted in green below:

 

Date Release Release Range Market Expectation
10/12/2017 PPI September 2017 0.4%
10/12/2017 Core PPI September 2017 0.2%
10/13/2017 Retail Sales September 2017 1.7%
10/13/2017 Retail Sales ex-auto September 2017 0.4%
10/13/2017 CPI September 2017 0.6%
10/13/2017 Core CPI September 2017 0.2%
10/13/2017 University of Michigan Consumer Sentiment Index October 2017 95.4

Data for table from Econoday.com, Bloomberg and Yahoo Finance

 

This week the economic news releases will focus on inflation and that could directly impact the Fed’s thinking when it comes to the November and December meetings, at which the Fed will decide if rates should be increased or not. On Thursday, the Producer Price Index (PPI) for the month of September is set to be released, both overall and excluding volatile items. Overall PPI is expected to be double the core figure of 0.2 percent, thanks in large part to a more than 8 percent increase in the price of oil during the month. Core PPI is expected to show a very small increase of only 0.2 percent. On Friday, when looking at the Consumer Price Index (CPI), the same phenomena is expected to be seen with energy costs increasing overall CPI by 0.6 percent, while core CPI is expected to only produce an increase of 0.2 percent. Of potentially more concern to the markets on Friday, however, is the release of the retail sales figure for the month of September, both including and excluding auto sales. Overall sales are expected to have risen by 1.7 percent, which would be very positive. However, auto sales are expected to be 1.3 percent of the 1.7 percent figure, thanks to deep discount selling as new model year cars come in and with people having to replace hurricane damaged cars in the southern US during September. Wrapping up the week this week is the University of Michigan’s Consumer Sentiment Index for the month of October (first estimate), which is not expected to change much from the end of September reading and should have no noticeable impact on the overall markets.

 

Interesting Fact — Unusual hurricane season?

 

So far for the 2017 hurricane season there have been 15 named storms, making this year tied for 12th place in terms of the number of named storms going all the way back to 1851. We also still have a little over a month until the official end of hurricane season, so we could see 2017 move up the list.

 

Source: weatherunderground.com