With the release of the FOMC minutes, it looks like September will begin the unwinding of the Fed’s $4.5 trillion balance sheet. New York Fed President William Dudley has said that the private sector should be willing and able to absorb nearly $2 trillion in Treasuries and agency mortgage backed securities (MBS) in the next few years. His view is based on a steady 2% growth rate for the economy for several years, and a tame inflation rate. The mild, low-volatility environment the Fed envisions in the near-to-intermediate term is one that is difficult to reconcile based on some of the numbers we’re seeing. There’s a historical risk in the Fed reducing its balance sheet. The central bank has embarked on this reduction six times in the past – 1921/1922, 1928/1930, 1937, 1941, 1948/1950, and 2000; all but one of those episodes ended in recession.
Consumer Spending – 70% of U.S. GDP can be attributed to the consumer. Low interest rates and a strong jobs market have led consumers to load up on goods and services. However we are seeing an uptrend in credit card and auto loan delinquencies for a third-straight quarter. A three-quarter-in-a-row uptrend in delinquencies is not one we’ve seen since 2009. The New York Fed’s report on household debt and credit indicated that household debt balances increased in Q2, 2017 for the 12th consecutive quarter, and are now $164 billion higher than the previous peak of $12.7 trillion in Q3, 2008.
Stock Valuations – The S&P’s P/E ratio is getting pricey. At the beginning of 2013, the P/E ratio was a bargain price of 13x. Today, it’s nearly 19x. Since August of 2012, the trailing 12-month adjusted earnings per share of the index has risen only 12%, roughly the rate of inflation over that time span. Meanwhile, the index itself has risen over 70%. Without tax reform to increase company earnings, stock prices will likely correct and revert to historical valuations.
Breath of the Stock Market – The breadth of the rally in equities is shrinking. In the following chart we show the S&P 500 against the percentage of NYSE stocks that have closed above their 200-day moving average. Momentum may seem strong, but the underlying current’s strength is waning. Apple, Amazon, Facebook, Microsoft, and Google are responsible for a third of the markets gains in 2017.
Corporate Debt Market – As investors continue to search for yield in a low interest rate environment, U.S. corporations continue to tap the debt markets. Companies have raised nearly $1.2 trillion through U.S. debt markets this year, a record pace, according to Dealogic, a data provider. The latest jumbo sales have added pressure to the broader credit market, which had weakened alongside a defensive shift in equity markets that culminated in the S&P 500’s largest weekly loss since March last week. Amazon sealed the year’s fourth-largest corporate bond sale as the technology and online retail group locked in $16 billion to fund its takeover of premium grocer Whole Foods. U.S corporate debt may be so high that it’s a threat to global stability according to the International Monetary Fund (IMF).
While none of these events directly point to an imminent recession, Shamrock Asset Management is constantly looking past the horizon to see the storm before it approaches the shore. The Investment Committee feels the U.S. economy has entered into late cycle expansion and thus you have seen our tactical strategies shift to more defensive U.S. sectors. We continue to favor international equities and could become more bullish on U.S. equities if we see positive movement on corporate tax reform, infrastructure spending, and deregulation. Geopolitical risks regarding North Korea are factored into Shamrock’s investment decisions but understanding the rationale of a mad man (Kim Jung-un) is difficult at best. Please contact Melissa Terrill at 214-265-9400 or at mterrill@ShamrockAdvisors.com to schedule a call with your dedicated Shamrock Relationship Manager to discuss your portfolio’s positioning and our outlook for the remainder of 2017.
