The greying of America’s workforce runs the risk of inflation?

The greying of America’s workforce runs the risk of inflation?

We here at Tematica have been discussing the growing number of headwinds to the global economy, but one that even we have not zeroed in on is a somewhat hidden cost associated with our Aging of the Population investing theme. We know people are living longer than ever before, which means they either need to either amass more retirement savings or they will be working longer lest they fall victim to the downside of our Middle-class Squeeze investing theme. In some cases, would be retirees may want to work longer to remain active as well as get paid and keep health benefits.

There are two headwinds associated with this. First, the longer working time frame limits the number of jobs, particularly non-entry level ones, that in the past would have opened up to other workers. Second, older workers tend to drive up the cost of wages and benefits, which means companies potentially face a wave of higher expenses in the coming years. To combat that pressure and keep delivering on the bottom line to shareholders, we could see price increases become the norm in the next coming years… just as the Federal Reserve is re-thinking its inflation target.

America’s workforce is getting grayer by the second, a phenomenon that some employers regard as a competitive disadvantage: older workers drive up the cost of wages and benefits, and can impede the progress of younger workers—or so the conventional thinking goes.

People age 55 and older are expected to make up a quarter of the U.S. workforce by 2026, and the number of workers ages 65 to 74 is projected to grow by 4.2% a year between 2016 and 2026—versus just 0.6% for the workforce overall.

While more people are staying on the job longer because they haven’t saved enough to retire, many older workers are extending their careers by choice. “More people want to work longer because they’re living longer,” says Steve Vernon, a consulting research scholar at the Stanford Center on Longevity and author of Retirement Game-Changers.

Source: Perks for Older Workers Are the Next Big Workplace Trend – Barron’s

Weekly Issue: Looking Around the Bend of the Current Rebound Rally

Weekly Issue: Looking Around the Bend of the Current Rebound Rally

 

Stock futures are surging this morning in a move that has all the major domestic stock market indices pointing up between 1.5% for the S&P 500 to 2.2% for the Nasdaq Composite Index. This surge follows the G20 Summit meeting of President Trump and Chinese President Xi Jinping news that the US and China will hold off on additional tariffs on each other’s goods at the start of 2019 with trade talks to continue. What this means is for a period of time as the two countries look to hammer out a trade deal during the March quarter, the US will leave existing tariffs of 10% on more than $200 million worth of Chinese products in place rather than increase them to 25%.  If after 90 days the two countries are unable to reach an agreement, the tariff rate will be raised to 25% percent.

In my view, what we are seeing this morning is in our view similar to what we saw last week when Fed Chair Powell served up some dovish comments regarding the speed of interest rate hikes over the coming year – a sigh of relief in the stock market as expected drags on the economy may not be the headwinds previously expected. On the trade front, it’s that tariffs won’t escalate at the end of 2018 and at least for now it means one less negative revision to 2019 EPS expectations. In recent weeks, we’ve started to see the market price in the slowing economy and potential tariff hikes as 2019 EPS expectations for the S&P 500 slipped over the last two months from 10%+ EPS growth in 2019 to “just” 8.7% year over year. That’s down considerably from the now expected EPS growth of 21.6% this year vs. 2017, but we have to remember the benefit of tax reform will fade as it anniversaries. I expect this to ignite a question of what the appropriate market multiple should be for the 2019 rate of EPS growth as investors look past trade and the Fed in the coming weeks. More on that as it develops.

For now, I’ll take the positive performance these two events will have on the Thematic Leaders and the Select List; however, it should not be lost on us that issues remain. These include the slowing global economy that is allowing the Fed more breathing room in the pace of interest rate hikes as well as pending Brexit issues and the ongoing Italy-EU drama. New findings from Lending Tree (TREE) point to consumer debt hitting $4 trillion by the end of 2018, $1 trillion higher than less five years ago and at interest rates that are higher than five years ago. Talk about a confirming data point for our Middle-class Squeeze investing theme. And while oil prices have collapsed, offering a respite at the gas pump, we are seeing more signs of wage inflation that along with other input and freight costs will put a crimp in margins in the coming quarters. In other words, headwinds to the economy and corporate earnings persist.

On the US-China trade front, the new timeline equates to three months to negotiate a number of issues that have proved difficult in the past. These include forced technology transfer by U.S. companies doing business in China; intellectual-property protection that the U.S. wants China to strengthen; nontariff barriers that impede U.S. access to Chinese markets; and cyberespionage.

So, while the market gaps up today in its second sigh of relief in as many weeks, I’ll continue to be prudent with the portfolio and deploying capital in the near-term.  At the end of the day, what we need to see on the trade front is results – that better deal President Trump keeps talking about – rather than promises and platitudes. Until then, the existing tariffs will remain, and we run the risk of their eventual escalation if promises and platitudes do not progress into results.

 

The Stock Market Last Week

Last week we closed the books on November, and as we did that the stock market received a life preserver from Federal Reserve Chair Powell, which rescued them from turning in a largely across-the-board negative performance for the month. Powell’s comments eased the market’s concern over the pace of rate hikes in 2019 and the subsequent Fed November FOMC meeting minutes served to reaffirm that. As we shared Thursday, we see recent economic data, which has painted a picture of a slowing domestic as well as global economy, giving the Fed ample room to slow its pace of rate hikes. 

While expectations still call for a rate increase later this month, for 2019 the consensus is now looking for one to two hikes compared to the prior expectation of up to four. As we watch the velocity of the economy, we’ll also continue to watch the inflation front carefully given recent declines in the PCE Price Index on a year-over-year basis vs. wage growth and other areas that are ripe for inflation.

Despite Powell’s late-month “rescue,” quarter to date, the stock market is still well in the red no matter which major market index one chooses to look at. And as much as we like the action of the past week, the decline this quarter has erased much of the 2018 year-to-date gains. 

 

Holiday Shopping 2018 embraces the Digital Lifestyle

Also last week, we had the conclusion of the official kickoff to the 2018 holiday shopping season that spanned Thanksgiving to Cyber Monday, and in some cases “extended Tuesday.” The short version is consumers did open their wallets over those several days, but as expected, there was a pronounced shift to online and mobile shopping this year, while bricks-and-mortar traffic continued to suffer. 

According to ShopperTrak, shopper visits were down 1% for the two-day period compared to last year, with a 1.7% decline in traffic on Black Friday and versus 2017. Another firm, RetailNext, found traffic to U.S. stores fell between 5% and 9% during Thanksgiving and Black Friday compared with the same days last year. For the Thanksgiving to Sunday 2018 period, RetailNext’s traffic tally fell 6.6% year over year. 

Where were shoppers? Sitting at home or elsewhere as they shopped on their computers, tablets and increasingly their mobile devices. According to the National Retail Federation, 41.4 million people shopped only online from Thanksgiving Day to Cyber Monday. That’s 6.4 million more than the 34.7 million who shopped exclusively in stores. Thanksgiving 2018 was also the first day in 2018 to see $1 billion in sales from smartphones, according to Adobe, with shoppers spending 8% more online on Thursday compared with a year ago. Per Adobe, Black Friday online sales hit $6.22 billion, an increase of 23.7% from 2017, of which roughly 33% were made on smartphones, up from 29% in 2017.

The most popular day to shop online was Cyber Monday, cited by 67.4 million shoppers, followed by Black Friday with 65.2 million shoppers. On Cyber Monday alone, mobile transactions surged more than 55%, helping make the day the single largest online shopping day of all time in the United States at $7.9 billion, up 19% year over year. It also smashed the smartphone shopping record set on Thanksgiving as sales coming from smartphones hit $2 billion.

As Lenore Hawkins, Tematica’s Chief Macro Strategist, and I discussed on last week’s Cocktail Investing podcast, the holiday shopping happenings were very confirming for our Digital Lifestyle investing theme. It was also served to deliver positive data points for several positions on the Select List and the Thematic Leader that is Amazon (AMZN). These include United Parcel Service (UPS), which I have long viewed as a “second derivative” play on the shift to digital shopping, but also Costco Wholesale (COST) and Alphabet/Google (GOOGL). Let’s remember that while we love McCormick & Co. (MKC) for “season’s eatings” the same can be said for Costco given its food offering, both fresh and packaged, as well as its beer and wine selection. For Google, as more consumers shop online it means utilizing its search features that also drive its core advertising business.

As we inch toward the Christmas holiday, I expect more data points to emerge as well as more deals from brick & mortar retailers in a bid to capture what consumer spending they can. The risk I see for those is profitless sales given rising labor and freight costs but also the investments in digital commerce they have made to fend off Amazon. Sales are great, but it has to translate into profits, which are the mother’s milk of EPS, and that as we know is one of the core drivers to stock prices.

 

Marriott hack reminds of cyber spending needs

Also last week, we learned of one of the larger cyber attacks in recent history as Marriott (MAR) shared that up to 500 million guests saw their personal information ranging from passport numbers, travel details and payment card data hacked at its Starwood business. As I wrote in the Thematic Signal in which I discussed this attack, it is the latest reminder in the need for companies to continually beef up their cybersecurity, and this is a profound tailwind for our Safety & Security investing theme as well as the  ETFMG Prime Cyber Security ETF (HACK) shares that are on the Select List.

 

The Week Ahead

Today, we enter the final month of 2018, and given the performance of the stock market so far in the December quarter it could very well be a photo finish to determine how the market finishes for the year. Helping determine that will not only be the outcome of the weekend’s G-20 summit, but the start of November economic data that begins with today’s ISM Manufacturing Index and the IHS Markit PMI data, and ends the week with the monthly Employment Report. Inside those two reports, we here at Tematica be assessing the speed of the economy in terms of order growth and job creation, as well as inflation in the form of wage growth. These data points and the others to be had in the coming weeks will help firm up current quarter consensus GDP expectations of 2.6%, per The Wall Street Journal’s Economic Forecasting Survey that is based on more than 60 economists, vs. 3.5% in the September quarter.

Ahead of Wednesday’s testimony by Federal Reserve Chair Powell on “The Economic Outlook” before Congress’s Joint Economic Committee, we’ll have several Fed heads making the rounds and giving speeches. Odds are they will reinforce the comments made by Powell and the November Fed FOMC meeting minutes that we talked about above. During Powell’s testimony, we can expect investors to parse his words in order to have a clear sense as to what the Fed’s view is on the speed of the economy, inflation and the need to adjust monetary policy, in terms of both the speed of future rate hikes and unwinding its balance sheet. Based on what we learn, Powell’s comments could either lead the market higher or douse this week’s sharp move higher in the stock market with cold water.

On the earnings front this week, we have no Thematic Leaders or Select List companies reporting but I’ll be monitoring results from Toll Brothers (TOL), American Eagle (AEO), Lululemon Athletica (LULU), Broadcom (AVGO) and Kroger (KR), among others. Toll Brothers should help us understand the demand for higher-end homes, something to watch relating to our Living the Life investing theme, while American Eagle and lululemon’s comments will no doubt offer some insight to the holiday shopping season. With Broadcom, we’ll be looking at its demand outlook to get a better handle on smartphone demand as well as the timing of 5G infrastructure deployments that are part of our Disruptive Innovators investing theme. Finally, with Kroger, it’s all about our Clean Living investing theme and to what degree Kroger is capturing that tailwind.

 

Special Alert – Our battle plan for the next few weeks

Special Alert – Our battle plan for the next few weeks

To say the last several days have been the roughest in recent memory is somewhat of an understatement. This is what happens when we have a wide swing in investor sentiment due to a confluence of concerns. We’ve talked about them over the last several weeks —  from signs of a slowing US economy to the impact of rising Treasury yields; growing signs of inflation that is questioning the Fed’s velocity of rate hikes, what that may mean for both consumer and corporate borrowings, and subsequent spending; more pain at the gas pump to what looks to be even more escalation in tariffs between the US and China, and Italy-Eurozone concerns – and they are coming home to roost just as we step into the meaty part of the September quarter earnings season.

The question that is likely crossing most investors’ mind is “What will all of this mean when companies issue their outlooks for the December quarter in the coming days and weeks?”

The concern that I’ve voiced is these factors — such as rising input costs and higher freight costs — are likely to lead companies to issue more cautious guidance than the market had been expecting, which called for more than 20% EPS growth year over year in the December quarter. As investors put pencil to paper (or these days, fingers to keys working Excel spreadsheets), they will be adjusting forecasts as comments on demand, input costs and interest costs are had.

We are seeing this weigh on stocks almost across the board, but especially on those like Facebook (FB), Apple (AAPL), Netflix (NFLX) and Alphabet (GOOGL), better known as the FANG stocks, and other high-flying growth stocks like them. Compounding matters is the fact that we are in the blackout period for stock buyback programs, which means companies are not able to step in and repurchase shares, which tends to add some support to stock prices. Also, not helping is the modest level of cash on the sidelines of institutional investors, which stood at 5.1% in September according to the most recent Bank of America Merrill Lynch’s monthly fund manager survey.

The sharp selloff of the last few days has stoked investor fears, marked by the CNN Money Fear & Greed Index hitting 8 (Extreme Fear) vs. 56 (Greed) a month ago. When we see such pronounced shifts to the negative with investor behavior more often than not we get a “shoot first, ask questions later.” Fun times, and yes that was sarcasm.

To sum up, we have a number of concerns hitting the market that is causing investors to question prior expectations at a time when backstops to falling share prices are limited. Odds are this is going to play out over at least the next several days as corporate earnings get hot and heavy, and the market trades on the next economic data point. Today we say the domestic stock market futures recover on a tame relative to expectations September CPI report, but yesterday’s September PPI report that once again showed core PPI prices were up 2.9% year over year fueled the Wednesday selloff.

 

What’s Our Thematic Strategy?

For now, our strategy will be to sit on the sidelines building our shopping list and listening to a wide swath of corporate earnings as well as new thematic data points to update our investing mosaic as we wait for less turbulent waters. This also means looking for opportunistic price points to improve our positions on both the Thematic Leaders as well as the Select List. I’ll continue to focus on those companies that are riding the might of thematic tailwinds, asking questions like “Where will the company’s business be in 12-18 months as these tailwinds and its own maneuverings play out?”

A great example is Amazon (AMZN), which as you know continues to benefit from the Digital Lifestyle investment theme primarily and the shift to digital shopping, as well as cloud adoption, which is part of our Digital Infrastructure theme. And before too long, Amazon will own online pharmacy PillPack and become a key player in our Aging of the Population theme. Amid the market selloff, however, the company continues to improve its thematic position. First, a home insurance partnership with insurance company Travelers (TRV) should help spur sales of Amazon Echo speakers and security devices. This follows a similar partnering with ADT (ADT), and both arrangements mean Amazon is indeed focused on improving its position in our Safety & Security investing theme. Second, Bloomberg is reporting that Amazon Web Services has inked a total of $1 billion in new cloud deals with SAP (SAP) and Symantec (SYMC). That’s a hefty shot in the arm for the Amazon business that is a central part of our Digital Infrastructure theme and is one that delivered revenue of $6.1 billion and roughly half of the Amazon’s overall profits in the June 2018 quarter.

At almost the same time, Alphabet/Google (GOOGL) announced it has dropped out of the bidding for the $10 billion cloud computing contract with the Department of Defense. Google cited concerns over the use of Artificial Intelligence as well as certain aspects of the contract being out of the scope of its current government certifications. This move likely cements the view that Amazon Web Services is the front-runner for the Joint Enterprise Defense Infrastructure cloud (JEDI), but we can’t rule our Microsoft or others as yet. I’ll continue to monitor these developments in the coming days and weeks, but winning that contract would mean Wall Street will have to adjust its expectations for one of Amazon’s most profitable businesses higher.

Those are a number of positives for Amazon that will play out not in the next few days but in the coming 12-18+ months. It’s those kinds of signals that I’ll be focused on even more so in the coming days and weeks.

Tomorrow we will see several banks report their September quarter results, and they will offer ample insight into not only the economy and demand for capital but default rates and other warning indicators. Odds are they will also share their views on interest rates and prospects for forthcoming action by the Fed. As I digest those insights, I’ll also be reading Tematica Research’s ® Chief Macro Strategist Lenore Hawkins’ latest global macro thoughts and market insights. If I think it’s a must read, my suggestion is you should be reading it as well. Also, on this week’s podcast, which will be published shortly, Lenore and I talk about all of this so if you’re looking for a more in-depth discussion and a few laughs along the way, I’d recommend you check it out.

 

WEEKLY ISSUE: Confirming Data Points for Apple and Universal Display

WEEKLY ISSUE: Confirming Data Points for Apple and Universal Display

Key points inside this issue:

  • The Business Roundtable and recent data suggest trade worries are growing.
  • Our price target on Costco Wholesale (COST) shares remains $250.
  • Our price target on Apple (AAPL) and Universal Display (OLED) shares remain $225 and $150, respectively.
  • Changes afoot at S&P, but they still lag our thematic investing approach

 

While investors and the stock market have largely shaken off concerns of a trade war thus far, this week the stakes moved higher. The U.S. initiated the second leg of its tariffs on China, slapping on $200 billion of tariffs on Chinese imports of food ingredients, auto parts, art, chemicals, paper products, apparel, refrigerators, air conditioners, toys, furniture, handbags, and electronics.

China responded, not only by canceling expected trade talks, but by also implementing tariffs of its own to the tune of $60 billion on U.S. exports to China. Those tariffs include medium-sized aircraft, metals, tires, golf clubs, crude oil and liquified natural gas (LNG). Factoring in those latest steps, there are tariffs on nearly half of all U.S. imports from China and over 50% of U.S. export to China.

Should President Trump take the next stated step and put tariffs on an additional $267 billion of products, it would basically cover all U.S. imports from China. In terms of timing, let’s remember that we have the U.S. mid-term elections coming up before too long — and one risk we see here at Tematica is China holding off trade talks until after those elections.

On Monday, the latest Business Roundtable survey found that two-thirds of chief executives believed recent tariffs and future trade tension would have a negative impact on their capital investment decisions over the next six months. Roughly one-third expected no impact on their business, while only 2% forecast a positive effect.

That news echoed the recent September Flash U.S. PMI reading from IHS Markit, which included the following commentary:

“The escalation of trade wars, and the accompanying rise in prices, contributed to a darkening of the outlook, with business expectations for the year ahead dropping sharply during the month. While business activity may rebound after the storms, the drop in optimism suggests the longer term outlook has deteriorated, at least in the sense that growth may have peaked.”

Also found in the IHS Markit report:

“Manufacturers widely noted that trade tariffs had led to higher prices for metals and encouraged the forward purchasing of materials… Future expectations meanwhile fell to the lowest so far in 2018, and the second-lowest in over two years, as optimism deteriorated in both the manufacturing and service sectors.”

As if those growing worries weren’t enough, there has been a continued rise in oil prices as OPEC ruled out any immediate increase in production, the latest round of political intrigue inside the Washington Beltway, the growing spending struggle for the coming Italian government budget and Brexit.

Any of these on their own could lead to a reversal in the CNN Money Fear & Greed Index, which has been hanging out in “Greed” territory for the better part of the last month. Taken together, though, it could lead companies to be conservative in terms of guidance in the soon-to-arrive September quarter earnings season, despite the benefits of tax reform on their businesses and on consumer wallets. In other words, these mounting headwinds could weigh on stocks and lead investors to question growth expectations for the fourth quarter.

What’s more, even though S&P 500 EPS expectations still call for 22% EPS growth in 2018 vs. 2017, we’ve started to see some downward revisions in projections for the September and December quarters, which have softened 2018 EPS estimates to $162.01, down from $162.60 several weeks ago. Not a huge drop, but when looking at the current stock market valuation of 18x expected 2018 EPS, remember those expectations hinge on the S&P 500 group of companies growing their EPS more than 21% year over year in the second half of 2018.

 

Any and all of the above factors could weigh on corporate guidance or just rattle investor’s nerves and likely means a bumpy ride over the ensuing weeks as trade and political headlines heat up. As it stands right now, according to data tabulated from FactSet, heading into September quarter earnings, 74 of 98 companies in the S&P 500 that issued guidance, issued negative guidance marking the highest percentage (76%) since 1Q 2016 and compares to the five year average of 71%.

Not alarmingly high, but still higher than the norm, which means I’ll be paying even closer than usual attention to what is said over the coming weeks ahead of the “official” start to September quarter earnings that is Alcoa’s (AA) results on Oct. 17 and what it means for both the Thematic Leaders and the other positions on the Select List.

 

Today is Fed Day

This afternoon the Fed’s FOMC will break from its September meeting, and it is widely expected to boost interest rates. No surprise there, but given what we’ve seen on the trade front and in hard economic data of late, my attention will be on what is said during the post-meeting press conference and what’s contained in the Fed’s updated economic forecast. The big risk I see in the coming months on the Fed front is should the escalating tariff situation lead to a pick-up in inflation, the Fed could feel it is behind the interest rate hike curve leading to not only a more hawkish tone but a quicker pace of rate hikes than is currently expected.

We here at Tematica have talked quite a bit over consumer debt levels and the recent climb in both oil and gas prices is likely putting some extra squeeze on consumers, especially those that fall into our Middle-Class Squeeze investing theme. Any pick up in Fed rate hikes means higher interest costs for consumers, taking a bigger bite out of disposable income, which means a step up in their effort to stretch spending dollars. Despite its recent sell-off, I continue to see Costco Wholesale (COST) as extremely well positioned to grab more share of those cash-strapped wallets, particularly as it continues to open new warehouse locations.

  • Our price target on Costco Wholesale (COST) shares remains $250.

 

Favorable Apple and Universal Display News

Outside of those positions, we’d note some favorable news for our Apple (AAPL) shares in the last 24 hours. First, the iPhone XS Max OLED display has reclaimed the “Best Smartphone Display” crown for Apple, which in our view augurs well for other smartphone vendors adopting the technology. This is also a good thing for our Universal Display (OLED) shares as organic light emitting diode displays are present in two-thirds of the new iPhone offerings. In addition to Apple and other smartphone vendors adopting the technology, we are also seeing more TV models adoption it as well. We are also starting to see ultra high-end cars include the technology, which means we are at the beginning of a long adoption road into the automotive lighting market. We see this confirming Universal’s view that demand for the technology and its chemicals bottomed during the June quarter. As a reminder, that view includes 2018 revenue guidance of $280 million-$310 million vs. the $99.7 million recorded in the first half of the year.

Second, Apple has partnered with Salesforce (CRM) as part of the latest step in Apple’s move to leverage the iPhone and iPad in the enterprise market. Other partners for this strategy include IBM (IBM), Cisco Systems (CSCO), Accenture (ACN) CDW Corp. (CDW) and Deloitte. I see this as Apple continuing to chip away at the enterprise market, one that it historically has had limited exposure.

  • Our price target on Apple (AAPL) and Universal Display (OLED) shares remain $225 and $150, respectively.

 

Changes afoot at S&P, but they still lag our thematic investing approach

Before we close out this week’s issue, I wanted to address something big that is happening in markets that I suspect most individuals have not focused on. This week, S&P will roll out the largest revision to its Global Industry Classification Standard (GICS) since 1999. Before we dismiss it as yet another piece of Wall Street lingo, it’s important to know that GICS is widely used by portfolio managers and investors to classify companies across 11 sectors. With the inclusion of a new category – Communication Services – it means big changes that can alter an investor’s holdings in a mutual fund or ETF that tracks one of several indices. That shifting of trillions of dollars makes it a pretty big deal on a number of fronts, but it also confirms the shortcomings associated with sector-based investing that we here at Tematica have been calling out for quite some time.

The new GICS category, Communications Services, will replace the Telecom Sector category and include companies that are seen as providing platforms for communication. It will also include companies in the Consumer Discretionary Sector that have been classified in the Media and Internet & Direct Marketing Retail subindustries and some companies from the Information Technology sector. According to S&P, 16 Consumer Discretionary stocks (22% of the sector) will be reclassified as Communications Services as will 7 Information Technology stocks (20% of that sector) as will AT&T (T), Verizon (VZ) and CenturyLink (CTL). Other companies that are folded in include Apple (AAPL), Google (GOOGL), Disney (DIS), Twitter (TWTR), Snap (SNAP), Netflix (NFLX), Comcast (CMCSA), and DISH Network (DISH) among others.

After these maneuverings are complete, it’s estimated Communication services will be the largest category in the S&P 500 at around 10% of the index leaving weightings for the other 11 sectors in a very different place compared to their history. In other words, some 50 companies are moving into this category and out of others. That will have meaningful implications for mutual funds and ETFs that track these various index components and could lead to some extra volatility as investors and management companies make their adjustments. For example, the Technology Select Sector SPDR ETF (XLK), which tracks the S&P Technology Select Sector Index, contained 10 companies among its 74 holdings that are being rechristened as part of Communications Services. It so happens that XLK is one of the two largest sector funds by assets under management – the other one is the Consumer Discretionary Select Sector SPDR Fund (XLY), which had exposure to 16 companies that are moving into Communications Services.

So what are these moves really trying to accomplish?

The simple answer is they taking an out-of-date classification system of 11 sectors – and are attempting to make them more relevant to changes and developments that have occurred over the last 20 years. For example:

  • Was Apple a smartphone company 20 years ago? No.
  • Did Netflix exist 20 years ago? No.
  • Did Amazon have Amazon Prime Video let alone Amazon Prime 20 year ago? No.
  • Was Facebook around back then? Nope. Should it have been in Consumer Discretionary, to begin with alongside McDonald’s (MCD) and Ralph Lauren (RL)? Certainly not.
  • Did Verizon even consider owning Yahoo or AOL in 1999? Probably not.

 

What we’ve seen with these companies and others has been a morphing of their business models as the various economic, technological, psychographic, demographic and other landscapes around them have changed. It’s what they should be doing, and is the basis for our thematic investment approach — the strong companies will adapt to these evolving tailwinds, while others will sadly fall by the wayside.

These changes, however, expose the shortcomings of sector-based investing. Simply viewing the market through a sector lens fails to capture the real world tailwinds and catalysts that are driving structural changes inside industries, forcing companies to adapt. That’s far better captured in thematic investing, which focuses on those changing landscapes and the tailwinds as well as headwinds that arise and are driving not just sales but operating profit inside of companies.

For example, under the new schema, Microsoft (MSFT) will be in the Communications Services category, but the vast majority of its sales and profits are derived from Office. While Disney owns ESPN and is embarking on its own streaming services, both are far from generating the lion’s share of sales and profits. This likely means their movement into Communications Services is cosmetic in nature and could be premature. This echoes recent concern over the recent changes in the S&P 500 and S&P 100 indices, which have been criticized as S&P trying to make them more relevant than actually reflecting their stated investment strategy. For the S&P 500 that is being a market-capitalization-weighted index of the 500 largest U.S. publicly traded companies by market value.

As much as we could find fault with the changes, we can’t help it if those institutions, at their core, stick to their outdated thinking. As I have said before about other companies, change is difficult and takes time. And to be fair, for what they do, S&P is good at it, which is why we use them to calculate the NJCU New Jersey 50 Index as part of my work New Jersey City University.

Is this reclassification to update GICS and corresponding indices a step in the right direction?

It is, but it is more like a half step or even a quarter step. There is far more work to be done to make GICS as relevant as it needs to be, not just in today’s world, but the one we are moving into. For that, I’ll continue to stick with our thematic lens-based approach.

 

Breaking down the ISM Manufacturing Report plus Paccar and Costco updates

Breaking down the ISM Manufacturing Report plus Paccar and Costco updates

Key points inside this issue

  • While the August ISM Manufacturing Report shows an improving economy, it also confirms inflation is percolating as well.
  • An earnings beat and robust outlook at heavy truck and engine company Navistar (NAV), keeps us bullish on Paccar (PCAR). Our PCAR price target remains $85.
  • Our price target on Costco Wholesale (COST) shares remains $230 heading into the company’s same-store-sales report after tonight’s market close.

This week we started to get our first firm look at the domestic economy for the month of August. The first piece of data was the ISM Manufacturing Index for August, which came in at 61.3, the highest reading in the last 12 months and a sequential improvement from 58.1 in July. In pulling back the covers on the index’s components, we find the forward-looking components – net orders and the backlog of orders – move up nicely month over month suggesting the manufacturing economy will continue to grow this month. The same, however, can be said for the Price component, which registered 72.1 for August. While down from July’s 73.2 figure, sixteen of the surveyed 18 industries reported paying increased prices for raw materials in August. With the August Prices reading well above the expansion vs. contraction line that is 50, the modest tick down in that sub-index does little to suggest the FOMC won’t boost interest when it meets later this month.

With regard to the report and the current trade wars, new export orders in August ticked lower to 55.2, down a meager 0.1 month over month. We’ll continue to monitor this and related data to assess the actual impact of the current trade wars for as long as they are occurring. As a reminder, by the end of this week, the US could impose tariffs on roughly half of all Chinese goods entering the country. Estimates put that figure at $200 billion, a step up from the $34 billion that had tariffs placed on them in July and the additional $16 billion last month. Should this latest round of tariffs go into effect, odds are we will see China follow suit with another round of its own tariff increases on US goods.

Drilling into the employment component of the ISM Manufacturing Report, it jumped to 58.5 in August, up from 56.5 in July. Given the historical relationship between this component and the Bureau of Labor Statistics (BLS) Employment Report – a reading in the ISM employment index above 50.8 percent, is generally consistent with an increase in the (BLS) data on manufacturing employment – odds are Friday’s Employment Report could surprise to the upside. To us, the real figure to watch inside that report, however, will be average hourly earnings to see how it stacks up against the data pointing to mounting inflation to be had in the economy. As we’ve said before, if wage growth lags relative to that data, it could put the brakes on the robust consumer spending we’ve seen in recent months.

 

An update on Paccar and a reminder on Costco Wholesale

Turning to the portfolio, this morning heavy truck and engine company Navistar (NAV) reported better than expected quarterly earnings due to continued strength in the heavy truck market. We see that as well as Navistar’s upsized heavy truck industry delivery forecast to 260,000-280,000 from the prior 250,000-280,000 as a positive for our Paccar (PCAR) shares. The same can be said from the recent July report on truck tonnage released by the American Trucking Association that showed an 8.6% year over year increase for the month, sequentially stronger than the 7.7% increase in June. The activity had with that ATA report suggest not only a pick up in the domestic economy, but the pain point of the current truck shortage continues to be felt, which bodes well for continued new order flow.

  • Our price target on Paccar (PCAR) shares remains $85.

After tonight’s close, Costco Wholesale (COST) will report its August same-store-sales figures, which we expect will continue the recent string of favorable reports. We’ll also be looking for an update on the number of open warehouses, a leading indicator for its high margin membership fee revenue stream. Based on the report, we will look to revisit our current $230 price target on COST shares.

  • Our price target on Costco Wholesale (COST) shares remains $230 for now.

 

A Middle-class Squeeze recipe: Flat real wage growth with prices poised to move higher

A Middle-class Squeeze recipe: Flat real wage growth with prices poised to move higher

We’ve been witnessing inflationary pressures in the monthly economic data over the last several months. Some of this has been higher raw material due in part to trade tariffs and other input costs, such as climbing freight costs, as well as the impact of increased minimum wages in certain states. Habit Restaurant (HABT) noticeably called out the impact of wage gains as one of the primary drivers in its recent menu price increase.

This June 2018 earnings season, we’ve heard from a growing number of companies – from materials and food to semiconductor and restaurants –  that contending with inflationary pressures are looking to pass it through to consumers in the form of higher prices as best they can. The thing is, wage growth has been elusive for the vast majority of workers, especially on an inflation-adjusted basis. Keep in mind that is before we factor in the inflationary effect to be had if these escalating rounds of trade tariffs are in effect longer than expected.

As these price increases take hold and interest rates creep higher, it means consumer spending dollars will not stretch as far as they did previously.  Not good for consumers and not good for the economy but it offers support for the Fed to boost rates in the coming quarters and keeps our Middle-Class Squeeze investing theme in vogue.

 

U.S. average hourly earnings adjusted for inflation fell 0.2 percent in July from a year earlier, data released on Friday showed, notching the lowest reading since 2012. While inflation isn’t high in historical terms, after years of being too low following the 2007-2009 recession, its recent gains are taking a bigger bite out of U.S. paychecks.

“Inflation has been climbing and wage growth, meanwhile, has been flat as a pancake,” said Laura Rosner, senior economist at MacroPolicy Perspectives LLC in New York. “In a very tight labor market you would expect that workers would negotiate their wages to at least keep up with the cost of living, and the picture tells you that they’re not.”

Source: American Workers Just Got a Pay Cut in Economy Trump Calls Great – Bloomberg

Silver Screen

Coming soon to theaters: higher prices. Movie theater operator Cinemark Holdings Inc. plans to pass costs along to customers, partly due to seating upgrades.

“Our average ticket price also increased 3.7 percent to $8.08, largely as a result of inflation, incremental pricing opportunities associated with recliner conversions, and favorable adult-versus-child ticket type mix,” said Chief Financial Officer Sean Gamble. “As we’ve continued to roll out recliners, our general tactic has been to go forward with limited pricing upfront and then when we see the demand opportunity increase there, and I’d say there’s still — we still believe there is further opportunity as we look to the back half of this year and forward in that regard.”

To be fair, movie ticket prices have been marching steadily higher in recent years. But theaters aren’t the only ones planning to pass on costs.

Sugar Boost

The maker of Twinkies and Ding Dongs wants to charge more for its sugary snacks.

“We will implement a retail price increase and incremental retailer programs to help offset the inflationary headwinds we and others in the industry are experiencing,” Hostess Brands Inc. Chief Executive Officer Andrew Callahan said on a call, explaining that the company is researching how to do so without choking off growth. The majority of the change will come in 2019, he said.

Bubble Wrap

Sealed Air Corp., the maker of Bubble Wrap and other packaging materials, is trying “to do everything we can operationally to keep our freight costs low,” Chief Financial Officer William Stiehl said in apresentation. “Where I’ve been very happy with the company’s success is our ability to pass along price increases to our customers for our relevant input cost.”

Steel Prices

Tariffs are hitting home at Otter Tail Corp.’s metal fabrication unit BTD, but leadership doesn’t sound especially concerned. Thank pricing power.

“We do not anticipate higher steel prices from tariffs having a significant impact on BTD’s margins as steel costs are largely passed through to customers,” Chief Executive Officer Charles MacFarlane said on a call. “BTD is working to enhance productivity in a period of increased volume and tight labor markets.”

Tariff Tag

The trade impact pass-through is equally real at semiconductor device maker Diodes Inc.

“Products that we import into the U.S. from China, all of those products are going to be ultimately affected by the tariffs,” Chief Financial Officer Richard White said on a call. Between U.S. levies that began July 6 and additional rounds planned to follow, “it’s about $3.6 million per quarter, but we plan to pass these tariff charges on to our customers.”

Home Costs

Housing developer LGI Homes Inc. is “consistently” seeing sales price increases as costs bump higher — a sign that pricing power exists even in big-ticket markets like housing.

“We’re able to and need to raise our prices to keep our gross margins consistent,” Chairman Eric Lipar said on a call. “In the market that we’re in, which I’d characterize as a good, solid, strong demand market with a tight supply of houses and the labor challenges, the material challenges that we all face, we see at least for the next couple quarters, that trend continuing. Prices are going to have to increase on a same-store basis if you will in order to offset increased costs.”

“We’re dealing with a higher monthly payment for the buyer now because of the rising interest rates from nine months ago. Demand seems to be there,” he said, adding that the company may need to examine ways to address the situation. “Rather than reducing the price, we may have to look at smaller square footages. The buyer may have to choose.”

People Problems

Not everyone is finding opportunities to pass along costs: Civitas Solutions Inc., a health and human services provider that caters to those with disabilities and youth with behavioral or medical challenges, is seeing slimmer margins.

“The number of people that are exiting the company are still a concern to us and I think it’s driven largely by the full, robust economy,” Chairman Bruce Nardella said on a call, citing workers seeing opportunities to leave to get higher wages. “Over the last two years, our margins have eroded because of that labor pressure.”

Pizza Pain

As if a leadership feud and sales slump weren’t problematic enough, pizza chain Papa John’s International Inc. also has to deal with wage pressures and rising costs. It’s responding by attempting to eke out efficiency gains, rather than by raising prices, to defend its margins.

“We have employed third party efficiency experts to review the potential for improvements within our restaurants,” Chief Executive Officer Steve Ritchie said on a call. “They are also conducting time and motion studies. Their work will directly supplement the work we are doing within our restaurant design of the future.”

Addressing Pressures

As some companies maintain profits by pushing costs to customers, Flowers Foods Inc., the maker of Tastykake pastries and Mi Casa tortillas, is finding work-arounds. It increased prices in the first quarter to help offset input inflation, but has also eaten some of the cost.

“Our margins were impacted by inflationary pressures from higher transportation cost, a tight labor market, and increasingly volatile commodity markets,” Chief Executive Officer Allen Shiver said on a call. “To address these inflationary pressures, we are aggressively working to capture greater efficiencies and cost reductions.”

 

Source: Inflation Is Coming to Theater Near You as U.S. Companies Flex Pricing Power – Bloomberg

WEEKLY ISSUE: Trade Concerns and Tariffs Continue to Hold Center Stage

WEEKLY ISSUE: Trade Concerns and Tariffs Continue to Hold Center Stage

Key Points From This Week’s Issue

  • News from Harley Davidson (HOG) and Universal Stainless & Alloy Products Inc. (USAP) confirm tariffs and rising costs will be a hotbed of conversation in the upcoming earnings season.
  • That conversation is likely to lead to a major re-think on earnings growth expectations for the back half of 2018.
  • We are closing out our position in Corning (GLW) shares;
  • We are closing out our position in LSI Industries (LYTS) shares;
  • We are closing out our position in shares of Universal Display (OLED).

 

Trade concerns and tariffs taking center stage

As we saw in Monday’s stock market, where the four major U.S. market indices fell from 1.3% to 2.1%, trade wars and escalating tariffs increasingly are on the minds of investors. Something that at first was thought would be short-lived has grown into something far more pronounced and widespread, with tariffs potentially being exchanged among the U.S., China, the European Union, Mexico and Canada.

In last week’s issue of Tematica Investing, shared how the Tematica Investing Select List has a number of domestically focused business, such as Costco Wholesale (COST), Habit Restaurants (HABT) and recently added Farmland Partners (FPI) to name a few. While the majority of stocks on the Select List traded down with the market, those domestic-focused ones are, generally speaking, higher week over week. Hardly a surprise as that escalating tariff talk is leading investors to safer stocks like a horse to water.

I cautioned this would likely be a longer than expected road to trade renegotiations, with more than a helping of uncertainty along the way that would likely see the stock market gyrate like a roller coaster. That’s exactly what we’ve been seeing these last few weeks, and like any good roller coaster, there tends to be an unexpected drop that scares its riders. For us as investors that could be the upcoming June quarter earnings season.

As we prepare to exit the current quarter, there tend to be a handful or more of companies that report their quarterly results. These tend to offer some insight into what we’re likely going to hear over the ensuing months. In my view, the growing question in investors’ minds is likely to center on the potential impact in the second half of 2018 from these tariffs if they are enacted for something longer than a short period.

Remember that earlier this year, investors were expecting earnings to rise as the benefits of tax reform were thought to jumpstart the economy. While GDP expectations for the current quarter have climbed, the growing concern of late is the cost side of the equation for both companies and consumers. We saw this rear its head during first-quarter earnings season and the widening of inflationary pressures is likely to make this a key topic in the back half of 2018, especially as interest costs for businesses and consumers creep higher.

 

Harley Davidson spills the tariff beans

Well, we didn’t need to wait too long to hear companies talk on those tariff and inflation cost concerns. Earlier this week Harley-Davidson Inc. (HOG) shared that its motorcycle business will be whacked by President Trump’s decision to impose a new 25% tariff on steel imports from the EU and a 10% tariff on imported aluminum.

For Harley-Davidson, its duty paid on imported steel and aluminum from the EU will be 31%, up from 6%. The impact is not small potatoes, considering that the EU has been Harley’s second-largest market, accounting for roughly 16% of total sales last year. On an annualized basis, the company estimates the new tariffs will translate into $90 million to $100 million in incremental costs. That would be a big hit to the company’s overall operating profit, as its annualized March quarter operating income was $254.3 million. With news like that it’s a wonder that HOG shares are down only 6.5% or so this week.

Meanwhile, Universal Stainless & Alloy Products Inc. (USAP), a company that makes semi-finished and finished specialty steel products that include stainless steel, tool steel and aircraft-quality low-alloy steels, announced this week it would increase prices on all specialty and premium products by 3% to 7%. Universal Steel also said all current material and energy surcharges will remain in effect.

 

What does it mean for earnings in the 2Q 2018 quarterly reporting season?

What these two companies have done is set the stage for what we’re likely to hear in the coming weeks about challenges from prolonged tariffs and the need to boost prices to contend with rising input costs, which we’ve been tracking in the monthly economic data. In our view here at team Tematica, this combination is likely to make for a challenging June quarter earnings season, which kicks off in just a few weeks, as costs and trade take over the spotlight from tax cuts and buybacks.

Here’s the thing – even as trade and tariff talk has taken center stage, we have yet to see any meaningful change to the 2018 consensus earnings forecast for the S&P 500 this year, which currently sits around $160.85 per share, up roughly 12% year over year. With up to $50 billion in additional tariffs being placed on Chinese goods after July 6, continued tariff retaliation by China and others could lead to a major reset of earnings expectations in the back half of 2018.

If we get more comments like those from Harley Davidson and Universal Stainless, and odds are that we will, we could very well see those results and comments lead to expectation changes that run the risk of weighing on the market.  We could see management teams offer “everything and the kitchen sink” explanations should they rejigger their outlooks to factor in potential tariff implications, and their words are likely to be met with a “shoot first, ask questions later” mentality by investors. That’s especially likely with the CNN Money Fear & Greed Index back in the Fear zone from Greed just a week ago.

I’m not the only one paying attention to this, as it was reported that Federal Reserve Chairman Jay Powell remarked that some business had put plans to hire or invest on hold because of trade worries and that “those concerns seem to be rising.”

Now there is a silver lining of sorts. Given the upsizing of corporate buyback programs over the last few months due in part to tax reform, any potential pullback in the stock market could be muted as companies scoop up shares and pave the way for further EPS growth as they shrink their share count.

I’ll continue to be vigilant with the Select List in the coming days so we’ll be at the ready to make moves as needed.

 

Doing some further Select List pruning

As we get ready for the 2Q 2018 earnings season that will commence with some fervor after the July 4th holiday, I’m going to take out the pruning shears and put them to work on the Tematica Investing Select List. As I mentioned above, odds are we will see some unexpected cautionary tales to be had in the coming weeks, and my thinking is that we should get ahead of it, remove some of the weaker positions and return some capital to subscribers that we can put to work during 3Q 2018. With that in mind, I am removing Corning (GLW), LSI Industries (LYTS), and Universal Display (OLED) from the Select List. in closing out these positions, I recognize they’ve been a drag on the Select List’s performance of late but we’ll also likely eliminate any further weight on the rest of the Select List.

  • We are closing out our position in Corning (GLW) shares;
  • We are closing out our position in LSI Industries (LYTS) shares;
  • We are closing out our position in shares of Universal Display (OLED).

 

US Housing market plauged by lack of housing supply and capable buyers as prices climb

US Housing market plauged by lack of housing supply and capable buyers as prices climb

Tematica’s Chief Macro Strategist Lenore Hawkins has been rather vocal on the two issues hitting the domestic housing market – a lack of supply and escalating prices that are shrinking the pool of potential buyers.

While one would think homebuilders would respond with more affordable housing, they are also contending with increases to their own cost structure as commodity prices for steel, aluminum, copper and lumber rise. Some of that increase can be traced back to tariff and trade talks, but given limited supply of these materials there is also the Rise of the New Middle Class factor as well.

Usually when there is a paint point such as this, there is or tends to be an eventual solution. This has and will hold true as well, but it likely means the housing multiplier effect on the economy won’t be what it was in the past… and that’s not counting the demographic impact to be had associated with our Aging of the Population investing theme.

Lest I forget, prospects for continued housing price increases will add wood to the inflation hawk fire. Team Tematica will be looking for signs of this not only in the regular data we watch, but also in the Fed’s comments.

 

After losing over a third of their value a decade ago, which led to the financial crisis and a deep recession, U.S. house prices have regained those losses.

But supply has not been able to keep up with rising demand, making homeownership less affordable.

Annual average earnings growth has remained below 3 percent even as house price rises have averaged more than 5 percent over the last few years.

The latest poll of nearly 45 analysts taken May 16-June 5 showed the S&P/Case Shiller composite index of home prices in 20 cities is expected to gain a further 5.7 percent this year.

That compared to predictions for average earnings growth of 2.8 percent and inflation of 2.5 percent 2018, according to a separate Reuters poll of economists. [ECILT/US]U.S. house prices are then forecast to rise 4.3 percent next year and 3.6 percent in 2020.

A further breakdown of the April data showed the inventory of existing homes had declined for 35 straight months on an annual basis while the median house price was up for a 74th consecutive month.

Source: U.S. house prices to rise at twice the speed of inflation and pay: Reuters poll | Reuters

Uncertainty and volatility to remain in place as we enter 2Q 2018

Uncertainty and volatility to remain in place as we enter 2Q 2018

1Q 2018 – A Return of Volatility and Uncertainty

Last week was not only a shortened week owing to the Good Friday market holiday, but it also brought a close to what was a tumultuous first quarter of 2018. The stock market surged higher in January, hit some rocky roads in February than got even more volatile in March. All told, the S&P 500 ends the first three months of 2018 in a very different place than many expected it would in mid-January. While the four major domestic stock market indices finished March in the black, the only one to finish 1Q 2018 in the black was the Nasdaq Composite Index. Even that, however, was well off its January high. What we saw was a very different market environment than the one we’ve seen between November 2017 and the end of January 2018.

As we begin April, we have China responding to the Trump Administration’s steel and aluminum tariffs with their own on a variety of U.S. goods and President Trump suggested he was ruling out a deal with Democrats on DACA. This likely means the uncertainty and volatility in the stock market over the last several weeks will be with us as we get ready for 1Q 2018 earnings season.

In my view, this should serve as a reminder that “crock pot cooking” does not work when applied to investing — rather than just fix and forget it, there’s a need to be active investors. Not traders, but rather investors that are assessing and re-assessing data much the way we do week in, week out.

Of course, our view is thematic data points, as well as economic ones, offer a better perspective for investors. In last week’s Cocktail Investing Podcast, Lenore Hawkins, Tematica’s Chief Macro Strategist, and I explain how the combination of thematic investing and global macro analysis are the chocolate and peanut butter of investing. Coming out of the holiday weekend, I am seeing several confirming data points for our Safety & Security investing theme in the form of the data breach that hit Saks Fifth Avenue and Lord & Taylor. According to reports, Russian hackers obtained “a cache of five million stolen card numbers.” This comes just a few days after Under Armour (UAA)  disclosed that an unauthorized party acquired data associated with 150 million MyFitnessPal user accounts.

During the quarter, we selectively added shares of Rockwell Collins (ROK) and Paccar (PCAR) to the Tematica Investing Select List and recently pruned Universal Display (OLED) and Facebook (FB) shares. The former two were selected given prospects for capital spending and productivity improvement in the country’s aging plants, while Paccar is poised to benefit from the current truck shortage as well as the increasing shift toward digital commerce that is part of our Connected Society investing theme.

With Universal Display, it’s a question of expectations catching up with the current bout of digestion for organic light emitting diode display capacity. We’ll look to revisit these shares as we exit 2Q 2018 looking to buy them if not at better prices, at a better risk-to-reward tradeoff. With Facebook, while we see it benefitting from the shift to digital advertising the current privacy and user data issues are a headwind for the shares that could lead advertisers to head elsewhere. Much like OLED shares, we’ll look to revisit FB shares when the current dust-up settles and we understand how Facebook’s solution(s) change its business model. In the near-term, the verbal CEO sparring between Facebook’s Mark Zuckerberg and Apple’s (AAPL) Tim Cook over privacy, trust and business models should prove to be insightful as well as entertaining.

 

The Changing Stock Market Narrative

The narrative that has been powering the market saw a profound shift a third of the way through the quarter to one of mixed economic data, uncertainty over monetary and trade policies emanating from Washington that could disrupt the economy, and now short-lived concerns over inflation. Recently added to that list are user data and privacy concerns that have taken some wind out of the sales of FAANG stocks. This is very different than the prior narrative that hinged on the benefits to be had with tax reform.

 

 

Perhaps the best visual is found in the changes to the Atlanta Fed GDP Now forecast (see above). The forecast sat at more than 5% in January before a number of downward revisions as a growing portion of the quarter’s economic data failed to live up to expectations. And as we can see in the chart, as the economic data rolled in during late February and March, the Atlanta Fed steadily ticked its forecast lower, where it landed at 2.4% as of March 29. To be fair, we will receive March economic data that could prop up that forecast or weigh on it further. We’ll be scrutinizing that data this week, which includes the March readings for the ISM Manufacturing and Services indices, auto & truck sales and the closely watched monthly Employment Report. We’ll also get the last of the February numbers, namely the Construction and Factory Order reports.

As we digest the ISM reports, we’ll be watching the new orders line items as well as prices paid to keep tabs on the speed of the economy entering the second quarter in addition to potential inflation worries. In terms of potential inflation, we, along with the investing herd, will be closely scrutinizing the wage data in the March Employment Report. We will be sure to dig one layer deeper, denoting the difference between supervisory and non-supervisory wages. As you’ll recall, those that didn’t do that failed to realize the would-be worry found in the January Employment Report was rather misleading.

In addition to those items, we’ll also be looking at key data items for several Tematica Investing Select List positions. For example,  the March heavy-duty truck order figures that should validate our thesis on Paccar (PCAR) shares, while Costco Wholesale’s (COST) March same-store sales figures should show continued wallet share gains for Cash-strapped Consumer, and the monthly gaming data from Nevada and Macau will clue us in to how that aspect of our Guilty Pleasure investing theme did in February and March.

 

Gearing Up for 1Q 2018 Earnings Season

Last Friday we officially closed the books on 1Q 2018, and that means before too long we’ll soon be staring down the gauntlet of first-quarter earnings season. With that in mind, let’s get a status check as to where the market is trading. Current expectations for the S&P 500 call for 2018 EPS to grow 18.5% year over year to $157.70. Helping fuel this forecast is the expected benefit of tax reform, which is leading to EPS forecasts for a rise of more than 18% year over year in the first half of 2018 and nearly 21% in the back half of the year. To put some perspective around that, annual EPS growth has averaged 7.6% over the 2002-2017 period. As we parse the data, we’d point out that on a per-share basis, estimated earnings for the first quarter have risen by 5.3% since Dec. 31; historically, analysts have reduced those expectations during the first few months of the year.

 

 

What do we think?

While we remain bullish on the potential investments and incremental cash in consumer pockets because of tax reform, we have to point out the risk that tax reform-infused GDP expectations — and therefore EPS expectations — could be a tad lofty. We’ve already seen a growing number of companies use the incremental cash flow to scale up buyback programs and in some cases dividends. Also, as we’ve seen in the past, consumers, especially those wallowing in debt, may opt to lighten the debt load. Lenore made this point last week when she appeared on Fox News’s Tucker Carlson Tonight.

 

 

Again, this is a possibility and one that we’ll be monitoring as we get more data in the coming weeks and months as we look to position the Tematica Investing Select List for what’s to come in 2018 and beyond. Combined with the rising concern of tariffs and trade that could disrupt supply and goose inflation in the short to medium term, it’s going to be even more of a challenge to parse company guidance to be had in the coming weeks that could be less than clear. I’ll be sure to break out my extra decoder ring as I get my seatbelt secured for what is looking to be a bumpy set of weeks.

As I noted above, we were prudently choosey with the Tematica Investing Select List in 1Q 2018, and while we will continue to be so as share prices come in, I’ll look to take advantage of the improving risk-to-reward profiles to be had.

 

Tematica’s take on the Fed’s monetary policy statement today

Tematica’s take on the Fed’s monetary policy statement today

As expected the Federal Reserve boosted interest rates by one-quarter point putting the target range for the Fed Funds rate to 1-1/2 to 1-3/4 percent. As expected the focus was the Fed’s updated economic projections, and what we saw was a step up in growth expectations this year and in 2019, a step down in the Unemployment Rate this year and next, and no major changes in the Fed’s inflation expectations. Alongside those changes, the Fed also boosted its interest rate hike expectations in 2019 and 2020, by a

Putting all of this into the Fed decoder ring, this suggests the Fed sees the economy on stronger footing than it did in December, which is interesting given the recent rollover in the Citibank Economic Surprise Index (CESI) that is offset by initial March economic data. Even the Fed noted, “Recent data suggest that growth rates of household spending and business fixed investment have moderated from their strong fourth-quarter readings.”

Stepping back and look at the changes in the Fed’s economic forecast – better growth, employment and no prick up in inflation – it seems pretty Goldilocks on its face if you ask me, but the prize goes to Lenore, who called for the Fed to be more hawkish than dovish exiting today’s FOMC meeting. We’ll see in the coming months if forecast becomes fact. As we get more economic data in the coming months, we can expect hawkish viewers to bang the 4thrate hike drum and that means we’ll be back in Fed watching Groundhog Day mode before too long.

While the Fed and the OECD are predicting a synchronized global economic acceleration in 2018, the ECRI, (which accurately forecast the 2017 acceleration) is calling for a synchronized deceleration. We suspect that too much is expected of the impact of the tax cuts and too little is being accounted for from potential trade wars and the shifts in monetary policy.

The Fed has at least 2 more rate hikes planned, which will give us a 200 bps increase in total, the consequence of which will only be felt with a significant lag. We are also getting a roughly 100 basis point equivalent tightening from the Fed’s tapering program, which brings us to 300 basis points of tightening. That is twice the magnitude of tightening pre-1987 market collapse, equivalent to the 1994 tightening that broke Orange County and Mexico and more than what preceded the 1998 Asian crisis and the 2001 dot-com bust.

Now for Fed Chairman Powell’s first Fed news conference…