Opinion

Sun, 12/18/2016 - 9:00pm

John Davidson

This week, economic releases were somewhat softer for November, but the flash reports for December were a bit more positive. Yet, monetary policy appeared to have more influence on the capital markets than economic releases. The US FOMC met and raised interest rates by 25 basis points as widely expected; they also released the Fed's forecasts, which suggested more interest rate hikes in the next few years than projected in their September forecasts. Equity markets were mixed across the globe for the week, higher in Europe and Japan, but lower in China. US Interest rates were higher on the week, but mixed elsewhere. Credit spreads continued to narrow. The US dollar and Oil Commodity prices were higher, but metals and Corn commodity prices were lower on the week.

Perspective:

The rise in equity prices and high valuation (17.1 times forward S&P 500 earnings) have been the subject of these Perspectives these past few week. Some of the readers have chimed in to add their perspective. One suggested that the anticipated change in corporate taxes could be a reason; $100 dollars of revenues taxed at 18% or 22% has more benefit to after-tax earnings than those revenues taxed at 35%. The logic makes sense, but analysts have increased the 12-month forward earnings by only 1.1% since the election. It may be that analysts are reticent to make changes to their forecast until the code changes. Alternatively, high equity valuations may be reflect increases in earnings in 2018 and beyond. The simplistic P/E ratio only reflects the next 12 months.

In economic news, this week the Trump transition team announced that Larry Kudlow would be appointed as the Chairman of the White House Council of Economic Advisors. Unlike his predecessors, Kudlow does not hold a Ph.D in economics; Wikipedia reported that he left a graduate program at Princeton before completing the requirements of masters degree. Furthermore, none of the 21 economic advisors named so far by Trump have that basic credential in the profession. I like Larry Kudlow and have enjoyed his show on CNBC, but view him as a cheerleader for lower tax rates, not a deep thinker on economic issues; he is a talk-show host, not someone who has contributed to the body of knowledge in the profession. Not every one of the economic advisors needs a Ph.D, but someone, especially the Chairman, should understand, if not have contributed to, the economic research on public policies.

The FOMC met and raised its Fed Funds rate 25 basis points, to a range between 0.50% to 0.75%, as widely expected. They also released the Fed's forecasts as shown on the chart below. Also shown and worth scrutiny, are the differences from their forecast in September. The table shows that they forecast a slight tick up in GDP, a decrease in the Unemployment Rate, but very little change in inflation expectations. Of note is the increase in expected Fed Funds rate, which could be a signal that the Fed anticipates monetary policies that could offset expectations for greater fiscal stimulus related to the incoming administration; these forecasts project 3 hikes of 25 basis points each in each of the next three years.

December 2016 Median Forecasts	2016	2017	2018	2019	Long Run
Change in Real GDP	1.8%	2.1%	2.0%	1.9%	1.8%
Change from September	+0.1%	+0.1%	0	+0.1%	0
Unemployment Rate	4.7%	4.5%	4.5%	4.5%	4.8%
Change from September	-0.1%	-0.3%	0	-0.1%	0%
PCE Inflation	1.5%	1.9%	2.0%	2.0%	2.0%
Change from September	+0.2	0	0		0
Core PCE Inflation	1.7%	1.8%	2.0%	2.0%	N/A
Change from September	0	-0.1%	0	0	0
Federal Funds Rate	0.6%	1.4%	2.1%	2.9%	3.0%
Change from September	0	+0.3%	+0.2	+0.3%	0.1%

Source: St Louis Federal Reserve, FRED, Econoday via WSJ.com

Other US Releases:

November Retail Sales rose only +0.1% in November, the bottom of the range of expectation; October Sales were revised down two ticks to +0.6%; even without the more volatile automobile component, Retail Sales still only rose +0.2%, also on the low end of the range of expectations. Industrial Production fell -0.4% in November since warmer-than-usual weather lowered demand from the utility sector. Capacity Utilization dropped 3 ticks ti 75%. Housing starts fell in November to 1.09 million, below the range of expectations; Housing Permits also dropped to 1.201 million. On the positive side of Housing, the National Association of Home Builders Housing Market Index rose 7 points to 70 in December. Also positive, the Initial Claims for Unemployment Benefits fell 4,000 to 254,000 the week of December 10th; the 4-week moving average of Claims rose to 257,750.

Source: Econoday and the Wall Street Journal

Economic Releases outside the US

Purchasing Managers' Indices
Flash for December	Manufacturing	Composite	Services
European Union	+54.9	-53.9	-53.1
Germany	+55.5	-54.8	-53.8
France	+53.5	+52.8	52.6

European Union Manufacturing Purchasing Managers Indices (PMIs) increased in the December Flash reports shown in the table above; Services PMIs pulled down the Composite for both the EU as a whole and Germany. Yet, all PMIs remained solidly in the expansion zone. Germany's Zew Survey on Current Conditions increased, but the Business Expectations was unchanged in December. The Business Climate Index in France improved in December.

The Central Bank of England also met, but kept monetary policy unchanged with interest rates at 0.25% and Asset Purchases at 435 billion Pounds. UK's CBI Industrial Trends Survey improved in December.

Japan's flash PMI for Manufacturing increased to 51.9 in December.

Source: Econoday and the Wall Street Journal

Equity and Bond Index Returns:

US equity indices were mixed, but European and Japanese prices were higher on the week. Chinese and Hong Kong markets fell on the week. The increase in interest rates generated negative returns for all three Bloomberg Indices for the week. Valuations remained high, at 17.1 times earnings for the S&P 500. Factset reported that analysts are expecting earnings growth of 11.5% and revenue growth of 5.9% for 2017.

Equity Indices % Change	Price	% Chg since:	ETD % Chg	YTD % Chg
	12 /16/ 16	12 /09/ 16	11 /04/ 16	12/31/15
Dow Jones Industrials	19,843	0.4%	10.9%	13.9%
S&P 500 Index	2,258	-0.1%	8.3%	10.5%
Nasdaq	5,437	-0.1%	7.7%	8.6%
S&P/TSX Composite	15,252	-0.4%	5.1%	17.2%
FTSE 100 Index	7,012	0.8%	4.8%	12.3%
CAC 40 Index	4,833	1.7%	10.4%	4.2%
DAX Index	11,404	1.8%	11.2%	6.2%
Swiss Market Index	8,228	1.6%	8.4%	-6.7%
Nikkei 225 Index	19,401	2.1%	14.8%	1.9%
HK Hang Seng Index	22,021	-3.3%	-2.7%	0.5%
Shanghai CSI 300	3346	-4.2%	-0.2%	-10.3%
Bloomberg Treasury Index 6.0	123.0	-0.6%	-4.2%	0.1%
Bloomberg Corporate Index 7.0	141.7	-0.3%	-3.5%	4.5%
Bloomberg High Yield Index 4.2	168.7	-0.1%	1.3%	16.7%
Fwd P/E Ratio of S&P 500	17.1		1.1	1.0
12-month forward S&P 500 EPS	$132.17		1.9%	3.8%

Data Source: Bloomberg app for the Iphone; Earning Estimates from Factset

Bond Yields and Spreads:

US interest rates rose on the week of the FOMC meeting. Although the 25 basis point increase was already priced into the market, the increases of the Fed Funds going forward was more than expected. Credit spreads decreased, but not enough to offset the increases in Government rates. The decrease in the TIPS spread could reflect confidence that future Fed actions will offset the previously anticipated rates of inflation.

Government Bonds	Bond Yields (%)	bp chg since	ETD bp Chg	YTD BP Chg
	12 /16/ 16	12 /09/ 16	11 /04/ 16	12 /31/ 15
UST 2-Year	1.25	12	47	20
UST 10-Year	2.59	12	81	32
US TIP 10-Year	0.70	24	61	1
UST 30-Year	3.17	2	61	15
Canadian 10-Year	1.83	11	68	44
UK 10-Year	1.43	-2	30	-53
French 10-Year	0.76	-4	30	-22
German 10-Year	0.31	-5	18	-32
Swiss 10-Year	0.07	20	48	19
Japan 10-Year	0.05	0	12	-20
Credit Spreads
Bloomberg Corp OAS BUSC	131	-3	-13	-41
Bloomberg HY OAS BUHY	428	-6	-83	-305
Rates
US Mort 30-yr %	4.02	11	53	9
10-Year TIPS Spread	1.89	-12	20	31

Data Source: Bloomberg app for the Iphone

Currency and Commodity Markets:

The US dollar strengthened in anticipation of higher interest rates after the FOMC meeting. Oil prices increased, but other commodity prices decreased on the week.

Currencies vs $	Closing	% Chg since	ETD % Chg	YTD % Chg
	12 /16/ 16	12 /09/ 16	11 /04/ 16	12 /31/ 15
Yen	84.80	-2.2%	-12.6%	1.9%
British Pound	1.25	-0.7%	-0.2%	-15.3%
Euro	1.05	-1.0%	-6.2%	-3.8%
Canadian Dollar	74.99	-1.2%	0.5%	3.7%
China Renminbi	14.46	-0.1%	-2.3%	-6.1%
Commodities
West Texas Intermediate	$51.90	0.8%	17.8%	40.1%
Brent Crude	$55.21	1.6%	21.1%	48.1%
Natural Gas	$3.42	-8.9%	23.3%	46.6%
Spot Gold	$1135	-2.2%	-13.0%	7.0%
Spot Silver	$16.10	-4.5%	-12.7%	16.3%
CBOT Corn	$356.25	-0.9%	2.2%	-0.7%
Spreads
Brent-WTI	$3.31	108.5%	18.9%	19.9%

Data Source: Bloomberg app for the Iphone

Equity Index Gains in US dollar terms:

The equity table above shows the percent change of different stock indices in terms of its local currency. To calculate the return to the US dollar investor one must combine the change of each index with the change in the applicable currency. The following table shows the 5-day, quarter-to-date and year-to-date results of investments made in each index in US dollar terms:

Return to USD Investor		% Chg	% Chg	YTD % Chg
12 /16/ 16	since:	12 /09/ 16	11 /04/ 16	12/31/15
S&P 500 Index:	USD	-0.1%	8.3%	10.5%
Nikkei 225 Index:	Yen	-0.1%	0.4%	3.9%
FTSE 100 Index:	Pound	0.1%	4.5%	-4.9%
DAX Index:	Euro	0.7%	4.3%	2.1%
CAC 40 Index:	Euro	0.6%	3.6%	0.2%
S&P/TSX Composite:	CAD	-1.6%	5.7%	21.6%
Shanghai CSI 300:	Yuan	-4.3%	-2.5%	-15.8%

For US dollar investors, the strong dollar was not enough to offset better equity returns in Europe this week.

Disclaimer:

The views discussed herein are exclusively those of John W. Davidson. These views are not meant as investment advice, and are subject to change. Information contained herein is derived from sources believed to be reliable, however, Mr. Davidson does not represent that the information is complete or accurate and therefore, should not be relied upon as such. All opinions expressed herein are subject to change without notice. This information is prepared for general information purposes only, and does not pertain to specific investment objectives, the financial situation or the particular needs of any specific person or investor who might receive this report. Investors should seek financial advice regarding the appropriateness of investing in any security or utilizing any investment strategy discussed or recommended in this report, and should understand that statements regarding future investment prospects may not be realized. No part of this report may be reproduced in any manner without the express written permission of Mr. John W. Davidson. Should you wish to be removed from this distribution please utilize the Safe Unsubscribe link below.

Who is John Davidson?

John W. Davidson, CFA, started writing these Comments more than a decade ago as a personal discipline when he was promoted from portfolio manager to chief investment officer and CEO.

Most recently, he was the president of PartnerRe Asset Management Corporation, responsible for the management of PartnerRe's invested assets, which grew from $4 billion to $12 billion during his tenure. After joining PartnerRe in the fall of 2001, he hired the staff, built the trading floor and created the infrastructure to manage both fixed income and equity assets internally. He retired from PartnerRe at the end of 2008 and moved to Maine, where he focused on board work.

He has more than 35 years of industry experience, including positions with investment management responsibility for separate institutional accounts, mutual funds, trusts and insurance assets. Prior to joining PartnerRe, he served as president and chief executive officer of two other investment management companies. For various companies he has held positions as chief investment officer, chief economist, head of fixed income and portfolio manager. As a portfolio manager, Davidson managed and traded U.S. Government Securities as well as futures and options on fixed income instruments.

His real world experience is backed by a strong academic foundation, which includes earning a Master of Business Administration in finance and a Master of Arts in mathematics from Boston College, as well as a Bachelor of Arts, cum laude, in economics from Amherst College. He holds the professional designation of chartered financial analyst.

His experiences and credentials have brought him to the public as a television commentator and conference speaker. In addition to his frequent past appearances on CNBC, CNNfn, Bloomberg TV and Yahoo FinanceVision, he appeared as a special guest on Wall $treet Week with Louis Rukeyser. Reuters, Bloomberg and other business press services have quoted his views on the market. He has taught CFA preparation programs, as well as other courses offered by the Stamford and Boston CFA Societies, and the National Graduate Trust Officers' School.

Davidson is a natural leader in both his professional and personal life, having developed those skills early in his career as a naval officer. He spent three years on active duty, which included a year on the rivers of Vietnam, and 24 years in the Naval Reserve, from which he retired as a captain in 1994.

Davidson is treasurer and board member of the Camden Conference. He is also on the investment committee of the Pen Bay Health Foundation. He serves as an independent trustee for mutual funds.

In his leisure time, he is an active sailor, tennis player and skier. With his wife, Barbara, he renovated a 100+-year-old home in Camden, where they enjoy spending time with their two golden retrievers and having visits from their five children. He can be reached at jwdbond@me.com.