May 16, 2018

The major stock market averages opened mixed this morning (Dow flat; SPX +.17%). Cyclical sectors—consumer discretion, materials, tech, industrials—are leading the way. Utilities and real estate, however, are extending declines. Emerging markets are up 1% (now flat on the year). The VIX Index is trading back down under 14. Trade volume is light. The dollar is up again today and commodities are mixed. WTI crude oil is down .4% to trade around $71/barrel. And by the way, the DOE says total US oil production is up around 10.7 million barrels per day—a record high. Bonds are selling off again. The 5-year Treasury yield is up around 2.92% and the 10-year yield is up around 3.08%. 

US housing starts—ground-breaking on new developments—sank 3.7% in April to an annualized rate of 1.29 million units. Normally, this would be bad news. But the decline in construction activity was driven by fewer multi-family projects, which are saturated at this point. What we need is more entry-level single-family homes because that’s where the unmet demand is. And that’s what the report showed. Single-family starts rose .1% in the month. What we need to see in the housing market is a gradual shift away from renting and toward homeownership. According to Bloomberg, homeownership rates hit a 50-year low in 2016 but since then have begun to recover. 

US industrial production decelerated very slightly in April, but the move is nothing to worry about. The level of total production—including factory, utilities & mining output—rose 3.5% from year-ago levels. That rate of growth is near the high end of the 6-year range. In other words, factory output has fully recovered from the damage done in 2015 from the oil price crash, slowing economic growth and the stronger dollar. Capacity utilization at the nation’s factories ticked up to 78% for the first time since March 2015. Production will be additive to first quarter economic growth. 

Leuthold Group’s Jim Paulsen discussed his market outlook on CNBC. He acknowledged that “inflation data has backed off and the profit story still real good.” But he’s having “trouble finding where the path is for this market.” Faster economic growth along with full employment should translate to higher inflation and therefore lower P/E multiples on the stock market. That scenario implies further weakness in stocks. On the other hand, if economic growth slows from here, recession fears are bound to knock the market around even worse. Of course, a strong increase in productivity could help solve the problem in a positive way, but he doesn’t see enough business capital spending to push productivity higher in the near-term. Therefore, Mr. Paulsen believes the market may move lower in the near-term in order to reset valuations. But he is still constructive on the long-term and doesn’t see the economic cycle ending anytime soon. He likes materials, energy, industrials, and foreign equity. He also has a little cash on the side, anticipating another downdraft that will be a long-term buying opportunity. 

Another old timer, Ron Baron of Baron Capital, says interest rates and inflation are clearly moving higher, but that’s balanced against faster economic growth. He notes “conflicting developments” which are making stocks relatively flat. But the big picture is that the economy is growing, and stocks prices are closely tied to the economy. Every ten or twelve years, the stock market will double because the economy will double. Therefore, he says, this is a good time to buy stocks. 

Hedge fund investor Dan Niles, on the other hand, says winter is coming. He predicts a 20-50% correction late in 2019. He explains that “a lot of the themes that are really good right now…are going to turn out to be really bad.” He says higher commodity prices will lead to damaging inflation, both for businesses and consumers. Also, really low unemployment will begin to feed higher wages, further impeding corporate profit margins. Finally, the European Central Bank (ECB) will probably begin to tighten monetary policy in Europe next year and this be a headwind for stocks. 

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