December 15, 2016

Stocks Climbed yet again in today's session (Dow +60 pts; SPX +.39%). Financials led the way, up 1% after yesterday’s Fed announcement (see below). WTI crude oil opened lower but reversed course to trade up over $51/barrel. Bonds are selling off again. The 5-year Treasury yield is trading up to 2.09% and the 10-year is up to 2.60% (2+ year high).

The SPX and Dow are now up 6% and 8.7%, respectively since the election. The Nasdaq is up 5.2%. In the same period, the financial sector is up over 18% while the utilities sector is down 1.8%. So lots of dispersion. 

Wells Fargo (WFC) has been found in violation of the Dodd-Frank Act’s “living will” regulation. Last April, the Federal Reserve rejected the bank’s living will plan, along with Bank of America’s, Bank of New York Mellon’s, State Street’s and JP Morgan Chase’s plans. Since then, all but Wells Fargo have corrected deficiencies. The living will is essentially a plan to break up or dissolve large financial institutions in the case of another dire financial crisis. As a consequence, Wells Fargo is now temporarily banned from setting up international business units or acquiring non-bank financial services companies. The bank is scheduled to re-submit a revised living will plan by the end of March. What exactly is deficient about the current plan is hard to understand. Regulators said Wells has problems with the way it organized various “legal entities” and also with its method of sharing services between business units. The stock was down yesterday, but closed up 1% today. 

Yesterday, the Federal Reserve’s Open Market Committee (FOMC) decided to raise its short-term policy interest rate by .25% to .50%. Here are the main takeaways from Fed Chair Janet Yellen’s subsequent press conference: 
The GDP outlook is improved very slightly but she says we're still in for another two years of ~2% economic growth. She expects the unemployment rate to fall further to 4.5% by the end of 2017. And inflation will begin to accelerate from 1.5% today to 1.9% at the end of 2017 to 2.0% at the end of 2018. She now expects the Fed to raise short-term interest rates to about 1.4% by the end of 2017 and to 2.1% at the end of 2018. So putting it all together, the Fed expects a really tight job market, rising inflation, rising interest rates, and sort of disappointing economic growth. If you believe Mrs. Yellen, the outlook is not terribly encouraging; she characterizes it as “highly uncertain." In the aftermath of the announcement, the 10-year Treasury yield spiked to 2.56%, the highest since September 2014.

Retail sales disappointed in November, decelerating a bit to 3.8% y/y growth. I would note that still puts the growth rate at the higher end of the range we’ve seen over the past 2 years. Retailers apparently saw some weakness after two very strong months. Auto sales fell but restaurants and furniture sales improved. Despite the disappointment, Barron’s says “much of this report is constructive and won’t likely be holding down expectations for the holiday shopping season.” 

The Consumer Price Index (CPI)—a closely watched gauge of retail inflation—accelerated to 1.7% y/y growth in November from 1.6% in the prior month. The so-called “core” rate of inflation, which excludes food & energy, held steady at 2.1% y/y growth. Overall inflation levels are very tame but two areas are concerning: rent and medical costs. Rent for primary residence is up 3.9% y/y and medical care costs are up 4% y/y. And within that medical care category, health insurance inflation is 6%!. 

Improving economic data has pushed the Citigroup Economic Surprise Index up to +37. This is a gauge of trending strength in the economy, measuring whether economic data are coming in ahead or behind economists’ expectations. The index fell to -55 last winter but has staged a strong recovery.

Jim Paulsen of Wells Capital Management says the current market environment reminds him of the 1985-1988 time period. Weak economic growth, negative y/y corporate earnings, and poor investor sentiment reigned for a while, but those trends turned around the market was able to stage a huge rally. He cites the following positive factors: 
-    Earnings growth is now trending in the right direction
-    GDP growth is improving
-    Trump “pro-biz hope” could be stimulative
-    German and Japanese bonds yields are off of zero rates
-    Confidence in the recovery is taking hold

Mr. Paulsen believes stocks will lead bonds and cyclical sectors will lead the stock market. This could go on for a while before the rally “runs out of gas against higher rates.”

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