July 25, 2018

Stocks opened mixed (Dow -75 pts; SPX +.17%). This is essentially the mirror image of yesterday’s trade. Utilities, real estate and consumer staples are in the green, whereas industrials, financials and consumer discretionary sectors are trading lower. It’s just more of the same back-and-forth without a discernible trend. Whereas European markets were up nicely yesterday, they’re poised to close down today. Bloomberg’s Macro Man column calls it “unremarkably quiet” as a result of “global confusion.” Anyway, commodities are trading a bit higher today (gold, copper, oil). WTI crude oil is trading flat at $68.60/barrel. Bonds are mostly unchanged. The 5-year Treasury yield, after a brief run higher last week, is sitting at 2.81% and the 10-year yield dipped to 2.94%. 

Speaking at an emerging markets summit, Chinese President Xi Jinping said the escalating trade war between the US and his country will leave “no winner.” He called on other countries to reject protectionism, and said developed countries (read United States) “must increase support to developing countries” (read China). This is the heart of the debate: can China, the world’s second-largest economy, continue claiming it is a developing economy? Can he really believe China needs to continue its own extremely protectionist trade regime because it’s not a “developed” nation yet?  

Leuthold’s Jim Paulsen, interviewed on CNBC today, says there is one indicator that worries him. The real earnings yield on the S&P 500 Index has declined to very low level. Earnings yield is simply the aggregate corporate profits divided by the price of the stock market. For example, S&P 500 companies earned $134/share last year and the current price of the index is $2821, which gives you an earnings yield of 4.7%. He says that’s an historically low level and it suggests that future returns on the S&P 500 Index will be limited to perhaps 5% per year. Mr. Paulsen sees the risk of future economic recession rising, but doesn’t predict the end of the end of the business cycle just yet. Why? The economy is strong, the yield curve hasn’t yet inverted, the US Index of Leading Indicators (LEI) hasn’t gone negative, and investors aren’t exhibiting euphoric behavior. So he urges investors to “stay in the market and diversify” into international equities and commodities. He prefers to avoid utilities and real estate and instead buy into sectors that do well in inflationary envirionments (i.e. industrials, energy, materials). 

New home sales fell 5.3% in June from prior month levels, to an annualized rate of 631,000 units. May sales were revised lower as well. This report comes on the heels of a weak existing home sales report last Monday, and some economists are wondering if housing demand is beginning to soften. We know that mortgage rates recently jumped to nearly 4.5% from 3.8% a year ago. And of course, affordability is pretty low with home prices rising 5-6%/yr but wages rising only about 2.5% to 3%. Finally, the inventory of homes has been persistently low. All these factors are conspiring against homebuyers. Bloomberg says residential investment probably won’t add anything to economic growth (“GDP”) this quarter. It seems clear that if this trend persists, home price growth will slow down. 

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