July 12, 2018

Stocks are rebounding from yesterday’s rout (Dow +209 pts; SPX .7%). The tech sector is up 1.5% in early trading; industrials and healthcare sectors are up 1%. Consumer staples and utilities are down slightly. The VIX Index crated back down to 12.8 and VIX August futures are trading around 14.5. So market volatility isn’t expected to spike in the near future. Bonds are mostly unchanged today and we’ve noticed that over the last month bond market volatility has tanked. The 5-year and 10-year Treasury note yields are at 2.76% and 2.85%, respectively. 

The Consumer Price Index (CPI) accelerated to 2.9% y/y growth in June vs. 2.8% in the prior month. Economists widely anticipated slightly higher inflation. Core CPI (excluding food & energy) rose to 2.3% y/y growth. There are a couple of takeaways here. First, it turns out the Federal Reserve was right back in 2016 when it predicted inflation would rebound to more normal levels and would make interest rate hikes necessary. Second, while consumer-facing inflation is rising throughout most of the economy, the pace is moderate and manageable. Third, producer prices are rising faster but so far that’s not spilling over to consumer prices. 

Famed investor Rich Bernstein says investors shouldn’t be so worried about the flattening yield curve...for now. First, watching the curve “blip by blip” and trying to figure out when it might invert is a fool’s errand. Typically, the stock market continues to rise for 6-12 months after inversion. And “history shows that when you have a flattish curve, very similar to what we have today, you have some of the highest prospective 12-month returns for the S&P 500.” Further, he points out that most other widely expected forecasting tools do not suggest a bear market is on the way. Economic growth & corporate earnings remain strong. And critically, there is no sign of euphoria among investors. 

I want to highlight a couple of ridiculous headlines today. First, CNBC ran an article warning that a “price bubble” in the housing market is about to burst because the supply of homes for sale is finally soaring. The article is based on a report from Trulia that during the second quarter of 2018 inventory of for-sale homes increased at a much higher rate than they did back in the second quarter of 2017. Wow, that’s creative use of stats. As an afterthought, the article does mention that inventory is still 5% below where it was last year, and also that it has been falling on a year-over-year basis for the past 14 quarters. The simple truth is that we’ve underbuilt homes for years and supply just isn’t up to the level of demand. 
Second, Bloomberg attributes today’s market gains to a “Lull in Trade War.” That’s because China didn’t immediately (i.e. within 24 hours) respond to the Trump Administration’s proposed 10% tariffs on $200bil in imported Chinese goods. The obvious implication is that the stock market is supposed to immediately react to every political taunt, rant, Tweet, speech, etc. on a daily basis. This is absurd, and not at all normal. And it serves to highlight the fact that this is not an investor’s market, it’s a trader’s market.  

Famed bank analyst Mike Mayo says investors should own US banks. Yes, the flatter yield curve is a headwind, but there are historical precedents for banks outperforming in the same situation back in the 1950s and 1990s. And importantly, he doesn’t believe the yield curve will invert. In his opinion, the positives far outweigh the negatives for this group. Loan delinquenciess are at their lowest level over the last 3 decades. Loan books are growing modestly. We all know the capital return story is huge in this sector (i.e. buybacks and dividends). And profit growth is strong.

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