Financial Review

Carving Pumpkins

…..Nasdaq record high close. Big 5 tech stocks rule. Valuations high. Consumer confidence up. Employment costs up. Housing formation down. Home prices up. Fed meets to do nothing. Waiting on tax text, which might be the scariest thing this week.

Financial Review by Sinclair Noe for 10-31-2017


DOW + 28 = 23,377
SPX + 2 = 2575
NAS + 28 = 6727
RUT + 11 = 1502
10 Y  unchanged 2.38%
OIL + .49 = 54.64
GOLD – 5.60 = 1271.40


The Nasdaq Composite closed at a record high for the 62nd time this year, matching its longest such streak since 1980. The Nasdaq gained 3.6% in October. The Dow Industrial Average was up 4.3% for the month. And the S&P 500 posted a 2.2% monthly gain. October was the biggest monthly percentage gain for the 3 major indexes since February, and the seventh straight positive month for both the Dow and the S&P, while the posted its fourth straight monthly gain. Over the past 12 months, the Dow is up 18.3%, the S&P at 16.8%, and the Nasdaq at 25.9%. For the month of October, Intel was the top performing stock among the Dow Industrials, with a 17% gain – while General Electric dropped 16%. Five stocks in the Dow posted double digit percentage gains in October: Intel, Microsoft, Wal-Mart, Caterpillar and 3M.  Oil prices have jumped about 10% for the month and are back at the highest levels since March.


But the big gainers remain the big 5 tech stocks: Shares of Apple, which is getting fairly solid reviews for its new iPhone X, are now up 45 percent this year. Amazon has surged nearly 50 percent while Facebook is up more than 55 percent. Alphabet and Microsoft are both up more than 30 percent too. In fact, all five stocks are trading either at or very close to their all-time highs. Apple is now worth a staggering $870 billion; all five sport market caps in excess of half a trillion dollars. Apple, Alphabet, Microsoft, Amazon and Facebook are collectively worth nearly $3.3 trillion. That’s up from a combined valuation of about $2.2 trillion just two years ago. I know – you’ve heard this story before. True, but you don’t have to reinvent the wheel in order to turn a profit. Seriously, you can Google it.


There is an old saying – “Sell in May and stay away.” Normally, that is good advice. The 6 months from May to the end of October are typically the worst 6 months of the year for stock investing; while November to May is the best 6 months for trading stocks. It didn’t work this year, the market just kept inching higher and higher. No reason to sell; the bulls ruled the day. So, now we head into the best 6 months for stocks. There is no guarantee stocks will go higher but a strong October sets the tone for the coming 6 months. But that doesn’t mean you can throw caution to the wind. Stocks are overvalued after this long bull run. The Shiller CAPE ration or cyclically adjusted price to earnings ratio, is at 31.43, about where it was when then-Fed Chairman Alan Greenspan gave his widely cited “irrational exuberance” speech in December 1996. The only time valuations were higher was around the time of the stock market crash and beginning of the Great Depression in 1929 and during the dot-com boom in the late 1990s.


Consumer confidence rose in October to the highest in almost 17 years as Americans grew more confident about the economy and job market. Confidence index rose to 125.9 from 120.6 in September. The share of respondents who say jobs are plentiful rose to 36.3 percent, the most since June 2001, while people reporting good business conditions increased to 34.5 percent, matching the highest since 2001.


The employment cost index rose 0.7% in the third quarter, pushing the gain over the past 12 months close to a nine-year high. Wages climbed 0.7% in the third quarter. Wages represent 70% of employment costs. Benefits advanced 0.8%. Over the past year labor costs have risen 2.5%, the second highest level since 2008; and while that still sounds tame, when you compare 2.5% in employment costs to PCE core inflation running around 1.4%, it means we are actually starting to see signs of wage-push inflation.


The number of occupied housing units in the US, a measure used to track household formation, rose by just 0.3 percent in the year through September, marking the slowest rate of growth since 2010. The main culprit was a 0.8 percent drop in the number of renter-occupied units. The Census Bureau reports the number of owner-occupied units rose 1 percent, down from the 1.7 percent pace of growth logged in the four quarters through June. Renter-occupied housing has been on the rise since the 2008-09 recession, consistently outpacing growth in owner-occupied housing. High rental inflation and a tightening labor market may be starting to shift the calculus in favor of homeownership, but so far, the switch hasn’t been happening quickly enough to prevent a slide in the overall rate of household formation.


The S&P CoreLogic Case-Shiller home price index hit an all-time high in August – that means that prices are higher than the peak before the bubble burst, at least on a national basis. National home prices grew at a 6.1 percent annual pace. The 20-city composite posted a 5.9% year-over-year gain. Seattle was the fastest growing city, up 13.2% year-over-year. For the 3-month period through August, Phoenix existing home prices rose 0.8% and Phoenix home prices are up 5.8% for the past 12 months. Low mortgage rates and a strong labor market and an improving economy all support home prices. But we all know home prices will not rise forever. Measures of affordability are beginning to slide and that means the pool of buyers is starting to shrink. And the Federal Reserve is looking at raising interest rates at least one more time before the end of the year.


The Federal Reserve FOMC policy meeting is happening today and tomorrow. Nobody expects any changes to come out of this meeting. Look for a rate hike in 6 weeks, at the December meeting but not tomorrow. Based on the preliminary estimates for the third quarter, the U.S. economy grew in the first nine months of this year at an annual rate of 2.2 percent, marking a considerable acceleration from a 1.4 percent growth during the same period of 2016. Predictably, that has led to the strengthening demand for labor. The jobless rate declined to 4.2 percent in September from 4.9 percent a year earlier, leading to an increase, over that period, of real average hourly earnings by 0.7 percent. The U.S. cost and price inflation picture looks benign. The core consumer prices rose 1.7 percent in the year to September, the personal consumption expenditure index (PCEI) has stabilized at an annual rate of 1.4 percent in the three months to August. That should be enough for the Fed to hike rates and then Janet Yellen will ride off into the sunset. It is widely anticipated that Jay Powell will be nominated on Thursday to replace Yellen when her term expires in February.


House Republicans plan to release legislative text for the tax plan on Wednesday. That text will tell a lot of people they’re going to get screwed under the plan, and it will become even more unpopular than it already is. The latest polls show just 28% support for tax cuts compared to 44% who do not approve. Respondents are strongly opposed to tax cuts for the wealthy and for corporations. Republican tax reformers face a math problem. They want to do about $5 trillion worth of tax cuts over a decade, but they only want to grow the budget deficit by $1.5 trillion. That means they have to find ways to raise about $3.5 trillion in offsetting revenue. A lot of the support for the tax overhaul comes from people who think they will get something specific out of the tax plan. But the need to fit the plan in the $1.5 trillion box will require telling a lot of those people that they won’t get what they expected. For example, homebuilders thought they’d be getting a new tax credit for homeownership in the bill, which would offset the loss of mortgage tax deductions, but Republican congressional leaders decided not to create such a credit after all.


Then there is the idea of much lower contribution caps on tax deferred 401k savings accounts. Trump said 401ks would be protected, then someone looked at the math, and the caps are back. On the corporate side, the plan is to cut the tax rate from 35% to 20%, but that would require offsets, such as eliminating the deduction for business interest expenses. This could be bad news for highly leveraged businesses. And one of the biggest stumbling blocks might be eliminating deductions for state and local taxes.  A whole bunch of lawmakers would have a hard time explaining that tax increase when they get home. A usual strategy for dealing with political problems like this is by caving to each lobby group. Multinational corporations don’t like the global minimum tax? OK, eliminate it, or set the rate so low it doesn’t matter. Let anyone who claims to be a “businessperson” take the 25% tax preference. Create a new tax credit to buy off the homebuilders. But the restrictions imposed by budget reconciliation greatly limit Republicans’ options for legislative maneuvering around a tax overhaul. They can’t buy everyone off in the ways they might try with a normal bill. Right now, it looks like lawmakers are trying to make up for cuts by increasing taxes elsewhere. It is a complex scheme to take money out of one pocket and put it in another pocket. Most people know how that game ends.


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