September 18, 2017

Stocks opened higher this morning ( Dow +82 pts; SPX +.25%). Gains are broadbased, led by semiconductors, banks, and industrials. Only real estate and utilities are in the red. This is now officially the second-longest stock market rally in US history. The S&P 500 Index is up about 270% since March 2009 without a major correction (that is, more than 20% decline). Commodities are mixed in early trading. Oil is down 1% to trade around $49.30/barrel. Gold is down 1% today but has risen about 13% this year. Bonds are selling off as yields tick higher. The 5-year Treasury yield spiked to 1.83%. The 10-year Treasury yield is up to 2.23%. Remember, the 10-year was just over 2% a week ago, so this is a big move in rates. Last week’s Consumer Price Index (CPI) report suggested inflation is rising. And by the way, wholesale inflation is also picking up a bit. 

So now we have a debate as to whether it is a good or bad thing to see inflation moving back toward the Federal Reserve’s 2% target. It is true that rising inflation tends to result in lower P/E multiples for the stock market. In addition, higher inflation tends to encourage the Federal Reserve to raise short-term interest rates. And of course, many investors are afraid the Fed could do so too quickly and choke off this rally. I believe the debate is premature and that inflation is only making a modest move back to a more normal level. Famed stock strategist Tom Lee believes the economy needs a little more inflation to be healthy. “Unless inflation picks up, the stock market is really outpacing underlying growth.” Jim Paulsen, Chief Investment Strategist of The Leuthold Group, says, “if we got some inflation evidence, I think it’d be a bullish indication that the economy is doing well.” At the moment, he favors cyclical—not defensive—investments, such as industrials, financials, materials and energy. 

CNBC ran an article this morning positing that if interest rates continue to move upward, investors will likely shy away from utilities and real estate investment trusts (REITs). These are often viewed as bond-proxy investments, so when bond rates rise, they look less and less attractive. Last week as rates rose sharply, the S&P 500 Index rose 1.6%. At the same time, the utilities sector fell .4% and the real estate sector was roughly flat. 

Northrop Grumman (NOC) announced a deal to acquire Orbital ATK (OA) for about $134.50/share in cash. That’s a roughly 20% premium from Friday’s closing price. Both companies focus on aerospace & defense equipment. An analyst at Jeffries notes NOC is a leader in sensors and networks, and OA will give them a leading position in solid rocket propulsion. The combined company will likely be a strong player in ballistic missile defense. OA is up about 20% this morning. 

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