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17
Sep

Everyone Feels Great!

Everyone Feels Great!

On Friday the University of Michigan released their preliminary September estimate of consumer sentiment which appears to be on track to exceed a level not seen since 2004.

Econoday stated in their assessment of the report:

“Consumer sentiment is moving higher so far this month, to 100.8 from 96.2 in July and the strongest showing since March this year and after that the strongest since 2004. The gain is led by the assessment of current conditions which is up nearly 6 points to 116.1 in a gain that hints at a jump higher for September consumer spending. Expectations are also a positive, up more than 4 points to 100.8 and a new 15-year high in a showing that points to confidence in the outlook for jobs and also the stock market.”

A strong showing of consumer sentiment is good news for retailers. Any store owner worth their salt knows a happy customer is a buying customer. Also on Friday, the U.S. Census Bureau released their Monthly Retail Trade Survey indicating the continuation of strong growth trend of consumer spending that started in late 2015.

Both reports are good news for stocks and bad for bonds. For stocks, the benefits are obvious with rising sales and increasing profits. Until inflation begins to grow, profit margins should remain constant to recent levels. For the year, the S&P 500 (+8.38%) and Dow Jones Industrial Average (+5.93) are delivering decent returns despite the concerns about tariffs and foreign politics. However, NASDAQ (+14.99%) is following up a stellar 2017 with what may be back to back double digit growth years. Unlike the DJIA index comprised of 30 companies, the NASDAQ index tracks over 4000 companies and its remarkable performance is not due to just a few companies such as Amazon (AMZN) and Apple (APPL).

However, for bonds, the impact is a bit more complicated. As stated in last week's UPdate, the largest labor shortage since WWII will challenge employers to offer better pay to retain and increase their workforce. Rising wages will begin the upward cycle of inflation as companies raise prices to absorb rising labor costs. Due to the Great Recession, employers were forced to downsize, and more importantly trim the inefficiencies to offset declining sales and slowing economy. As we observed in this space, the result was near record levels of profits while revenue was declining. It was a simple race to the bottom of cutting expenses and employees faster than sales were declining. By 2015, corporate America was lean and efficient and perfectly positioned to expand efficiently and profitable when economic conditions improved. As prices potentially begin to rise at a faster annual rate of 2%, the Federal Reserve was already stating a high probability of raising the discount interest rate during their September 25-26 and December 18-19 Federal Open Market Committee meetings to keep inflation at their target rate.

Rising interest rates have the direct opposite impact on bonds with longer duration maturity bonds most negatively affected. Investors keenly aware of the negative correlation between rising interest rates to declining bond values have been reducing their allocation to bonds and selling long-term bonds for shorter duration bonds as indicated by the IShares Core US Aggregate Bond ETF (AGG) down -3.27% YTD.

WHAT DOES THIS MEAN TO ME?

Consumer spending represents 66% of the US economy. High consumer sentiment and strong retail sales are very bullish for the US economy and stock market. We maintain since November 2016 our favorable rating on the US stock market. We also observed in the same Market Alert significant selling of bonds that continues to this day. The cause and effect of a strong economy provide the bandwidth for the Federal Reserve to raise the discount rate from 50-year lows and if the annual pace of rising inflation exceeds 2% the Feds may consider four more rate increases in 2019. Good news for stocks is that everyone feels great! Unfortunately, that is bad news for bonds which is why we have become hyper-selective of the fixed income portion of our client's portfolios, and you should too!

Have a great week!

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