January 18, 2017

The major market averages gapped down at the open but quickly recovered this morning. At the moment, the Dow and SPX are down 27 up pts & flat, respectively. Semiconductors, biotechs and transports are leading the way. Remember, they were laggards yesterday. Retailers, transports and telecoms are lower in early trading. The VIX Index is  up 3% to trade around 12.2; traders are watching the fear index closely because they believe a rising VIX will signal the end of the Trump Rally. The dollar is a bit stronger today and commodities are down slightly. WTI crude oil is down slightly to trade around $52/barrel. Bonds are slightly lower in price, higher in yield. The 5- and 10-year Treasury yields are currently at 1.87% and 2.38%, respectively. 
 
Liz Ann Sonders, Chief Investment Strategist of Charles Schwab, says the stock market will experience a “slow melt-up” this year. She notes the economy was already improving by the time Donald Trump was elected. So the election was not solely responsible for the recent stock move. In addition, corporate earnings growth is accelerating. She says Wall Street currently expects 13% earnings growth in 2017. But—and this is where she differs from a lot of equity strategists—that doesn’t really incorporate a lot of pro-growth policy expectations from the upcoming Trump Administration. Therefore, she says the stock market is not overvalued, and could have further to run if some of Trump’s policies are enacted. She also says the stock market’s P/E multiple is “not at an unreasonable” level. Of course, inflation needs to stay in check or P/E ratios will drop. But she believes it will; rates should move up slowly. Ms. Sonders believes we are going “from a deflationary environment to an inflationary environment.” So for now, it’s ok to see bond yields and the stock market moving in the same direction. At some point rising rates will choke off growth, but she doesn’t think that will come anytime soon. Finally, she reminds us that a stronger dollar is not always disastrous for the stock market. The dollar can strengthen for two different reasons: either foreigners are piling into the dollar to escape weakness in their own economies (i.e. 2014 and 2015), or the US is experiencing a “positive growth surprise.” She suspects the latter is the case for 2017. 

Goldman Sachs (GS) reported a strong fourth quarter, beating both revenue and earnings expectations. The firm managed to grow earnings per share by 12% y/y. The stock is essentially flat this morning. Fixed income/currency/commodity trading revenue shot up  78%. Investment banking revenue declined a bit y/y and investment management revenue posted a small increase. Goldman the firm has been in retrenchment (cutting costs, working through legal issues, adjusting to tighter regulations) for nine years. And in fact, total revenue in 2016 was the lowest in five years. But the firm (and Wall Street) is more upbeat about the future and it looks as though the business is finally accelerating. 

The Consumer Price Index (CPI) accelerated in December to a 2.1% y/y growth rate. That’s the highest rate of retail inflation growth in 2 ½ years. Excluding the more volatile food & energy categories, CPI edged up to a 2.2% y/y growth rate. So we all know that the Federal Reserve’s long-term inflation target is about 2%, but that Fed Chair Janet Yellen has implied she can be patient with interest rate hikes even in a “high pressure” economy. And high pressure likely means rising inflation. By the way, inflation in most areas of the economy is very much in hand. But there are some areas that continue to experience very high inflation: utility gas service 6% y/y; water and sewer maintenance 4% y/y; health insurance 6%; prescription drugs 6%; tax preparation 5.2%; banking services 5.1%. 


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