361 Capital Market Commentary | December 9th, 2019

A banana duct-taped to a wall for $120,000? There is clearly too much money in this world. With markets at all-time highs and volatility non-existent, another title for the art pictured above could be “The Risk-Averse Investor in 2019”.

The investing world continues to see no risks. Trade wars get lots of ink but market prices do not care. Stronger economic data causing interest rates shocks and the markets brush it off. Impeachment? Who cares. It is almost comical, but corporate buybacks and institutions want to buy stocks. Even retail flows are now turning into buying after years of selling. It’s all fun and games until someone walks into the art gallery and eats the banana.

It looks like the stock market’s banana is safe for now as investors are shrugging off bad data in favor of good. Just last week the markets praised the Markit Manufacturing PMI data while hip checking the ISM Manufacturing series. And it loved the Department of Labor Jobs data while dismissing the ADP Employment weakness. Factory orders were better than expected but durable goods weaker. It even talked up the University of Michigan Sentiment data over any potential weakness in retail shopping. Chalk it up to holiday spirits because this market wants to be bought, not sold.

That said, this is a bigger week. The Fed will have their December meeting and they will likely stay on rates given the bounce in some of the economic data series. But they could always throw an icy snowball at the market if they want to send a signal about irrational exuberance in the markets or specific sector or asset overvaluations. Then there is the scheduled December 15th tariff hike on the rest of China’s imports. This item has been talked up and down more than the water levels in the White House toilets. But here we are and it is decision time. I’d expect another delay, but you just never know with this trade team.


Okay, that was a big recovery in the nonfarm payroll data…

US Nonfarm Payrolls MoM
(WSJ/DailyShot)

And a nice recovery in Consumer Sentiment going right into the holidays…

U. Michigan Consumer Sentiment Index
(WSJ/DailyShot)

There is little volatility in the financial markets…

If you want to see real volatility, go check out your nearest Federal Reserve Bank GDP forecast!

Evolution of Atlanta Fed GDPNow real
(@AtlantaFed)

J.P. Morgan also likes the bounce in the data but still warns to keep an eye on the Trade Wars…

Tweet from @carlquintanilla

The bounce in some of the economic data series has not yet been felt in corporate earnings estimates…

Tweet from @EarningsScout

Deutsche Bank thinks the market has gotten a bit ahead of earnings as they move to a neutral stance for the first time in a decade…

S&P 500 Price and Trailing 12m Earnings

If you are a retailer, you have to love this weather outlook going into Christmas…

But lumps of coal if you are in the energy industry or looking to sell long sleeve shirts in Florida this December.

Temperature Probability
(NOAA)

Speaking of retail companies, if tariffs don’t get delayed this week, the companies on the right will have higher costs in Q1…

Softline Companies
(UBS)

Small cap stocks breakout last week and Barron’s gives it the cover story this weekend…

Economic recoveries “tend to be the best phase for small-caps,” says Jill Carey Hall, an equity and quant strategist at Bank of America Merrill Lynch. “That’s one key reason we think we could be poised for a shift from large to small.” Small-cap outperformance is one of Bank of America’s biggest bullish predictions for 2020, strategists there said this past week.

Small-cap stocks will get creamed in a recession. But if the economy accelerates—which some recent data suggest is possible—they probably will rise more than the S&P 500…

By Carey Hall’s estimates, small-caps are at a 17-year valuation low in relation to large-caps. “Small-caps are historically very inexpensive relative to large-caps, even though both are trading above their own histories,” she says.

During economic recoveries like the one that Bank of America expects to see in the coming months, small-caps outpace large-caps 90% of the time. And they tend to do best in the period from November to March.

(Barron’s)

Barron's Cover December 9, 2019


Time for some return catch up by small caps?

Large-cap vs. Small-cap
(Goldman Sachs)

Most all of these stocks were small (or mid) caps when they started their runs…

@charliebilello: Best performing stocks in the S&P 500 over the last 5, 10, 15, and 20 years.

Best Performing Stocks in the S&P 500

I agree with Morgan Stanley here…

Would prefer to play in the cyclical and value areas of the stock market right now.

“We still think the greatest risk in the equity market remains in growth stocks where expectations are too high and priced. From a sector standpoint, this is consumer discretionary broadly and expensive software and secular growth stocks. Since the Fed began cutting, these groups have underperformed the S&P 500 and appear to be breaking down on a relative basis. Importantly, these groups underperformed on Friday when the market was up and earlier in the week when the market was down” (Morgan Stanley)

(@themarketear)

Great holiday party trick question…

Over the last 20 years, which has performed better: stocks or long-term bonds?

Vanguard Long-Term Corporate Fund

The underperformance of European financials is incredible…

Vanguard Long-Term Corporate Fund

(@Schuldensuehner)

Thinking about private equity…

“The great illusion in the last cycle was an insane notion that home prices can never fall on a national basis,” said the CIO. “In this cycle, it is that illiquid investments are superior to liquid investments,” he said. “It may be true that allocating heavily to private equity allows certain investors to hold on to their jobs by enabling them to leverage equity exposure and mark it in ways that make the investment appear less risky than it really is.” Private equity managers are paying record multiples for companies and have an estimated $2trln in dry powder, giving them 3yrs of buying power at today’s acquisition pace. “But it is categorically untrue that illiquid investments are superior to liquid investments. The idea that holding the S&P 500 is obviously inferior to purchasing the equity and debt of these private companies that lack an exit in all but the most benign market environments is patently absurd.”

(EricPeters/OneRiverAM)

Buyout valuations have surged as PE capital tries to deploy…

With so much money flooding the market, the problem is “how to achieve scale in the asset class in a very competitive, illiquid market environment,” Stephen McCourt, co-CEO of consulting firm Meketa Investment Group, told the Calpers board Nov. 18.

That’s left the biggest asset managers turning away a lot of deals even as they struggle to allocate capital earmarked for PE, according to McCourt, who advises Calpers and the California State Teachers’ Retirement System among others.

“We think we have a reached a peak in the private-equity market,” Morgan Stanley Wealth Chief Investment Officer Lisa Shalett wrote in an Oct. 28 note. “Investors tempted to chase the double-digit returns that many earned in private investment vehicles this past decade need to downgrade their expectations. The environment for private investing has gotten tougher.”

Investors can expect annual returns from private-investment funds of less than 10% in the future, below the 20%-plus that many of them delivered in past years, she predicted.

(Bloomberg)

Paying the Price

This California pension wants even more PE…

Mr Meng says investments in faster-growing economies such as India, and private markets, mostly private equity, are where Calpers can generate juicier returns.

Soon after returning to Calpers, Mr Meng demonstrated an almost messianic zeal for private equity where valuations are at nosebleed levels. Of Calpers’ $385bn of assets, nearly $28bn or 7.3 per cent is in private markets. But Mr Meng wants to grow that to 10 per cent or higher.

It seems odd that a giant investor such as Calpers should so publicly signal its ambitious private equity growth plans when that risks prices moving against it.

(FinancialTimes)

Incredible what the Global Trade Wars and Climate Change have done to U.S. farmer incomes this year…

Heartland Hurts
(WSJ/DailyShot)

If only Midwest farmers could convert to Christmas trees…

Consumers in the market for a Christmas tree can expect to pay more this year, as a shortage of Christmas trees has led to higher prices, thanks in part to the lingering effects of the 2008 financial crisis.

The average price per tree reached $78 last year, compared to $37 in 2008, RBC analyst Paul Quinn wrote in a note.

The crisis was responsible for the closure of many farms and the under-planting of seedlings, Quinn said. “Most market participants expect the shortage, which began around 2016, to last for several years,” he said.

(Bloomberg)

Christmas Trees for Sale
(Maddie McGarvey, Bloomberg)

Apple is running low on AirPod Pros. Do you think these accessories will be as hot?

Tweet from @allstarcharts

With homeowners staying put for longer, the average age of all home buyers is moving on up…

Tweet from @UPFINAcom

Global warming should increase housing transactions in the future as these residents of the Florida Keys are discovering…

Officials in the Florida Keys announced what many coastal governments nationwide have long feared, but few have been willing to admit: As seas rise and flooding gets worse, not everyone can be saved.

And in some places, it doesn’t even make sense to try.

On Wednesday morning, Rhonda Haag, the county’s sustainability director, released the first results of the county’s yearslong effort to calculate how high its 300 miles of roads must be elevated to stay dry, and at what cost. Those costs were far higher than her team expected — and those numbers, she said, show that some places can’t be protected, at least at a price that taxpayers can be expected to pay.

“I never would have dreamed we would say ‘no,’” Ms. Haag said in an interview. “But now, with the real estimates coming in, it’s a different story. And it’s not all doable.”

The results released Wednesday focus on a single three-mile stretch of road at the southern tip of Sugarloaf Key, a small island 15 miles up Highway 1 from Key West. To keep those three miles of road dry year-round in 2025 would require raising it by 1.3 feet, at a cost of $75 million, or $25 million per mile. Keeping the road dry in 2045 would mean elevating it 2.2 feet, at a cost of $128 million. To protect against expected flooding levels in 2060, the cost would jump to $181 million.

(NYTimes)

Florida Keys
(Angel Valentin, The New York Times)

But the good news about moving in this age of wild VC funding is that bed mattresses are now free!

Online mattress startups popularized the 100-day free home trial. Karan Bir devised his own home trial that could last for years.

Over the course of 15 months, Mr. Bir slept on five different mattresses, each one purchased and returned consecutively using the free-trial policies of dozens of bed-in-a-box startups.

It all began in 2016, when Mr. Bir, a new arrival to New York City, was uncertain about how long he would stay, and in need of a cheap short-term sleeping surface.

“I didn’t have the intention of churning through so many,” said Mr. Bir, 31, a technical architect at Slack Technologies Inc.

What began as a makeshift solution soon grew into an elaborate scheme, calculated to stretch the trials as far as they would go. “You could literally do this and never pay for a mattress,” he realized.

(WSJ)

Yes Missouri, the entire U.S. is raising its eyebrows at you…

Montana gets a hall pass since there is only one car on the road at the same time. But last time that I looked, Missouri still had a few people and a few cars. If you still have elected officials, this should be there number one priority for 2020. Lives lost to distracted texting should not even be issue. Ask your kids.

Laws restricting phone use while driving
(Bloomberg)

Finally, the best story of the week…

But in Utah — deeply conservative, deeply devout, predominantly white Utah — the response has been altogether different. The governor, a Republican who aligns with Trump on most issues, wrote the president a letter in late October.

He didn’t want to keep refugees out. He didn’t want to reduce their numbers. He wanted Trump to send more.

“We empathize deeply with individuals and groups who have been forced from their homes and we love giving them a new home and a new life,” Gov. Gary R. Herbert wrote. Such newcomers, he added, have become “productive employees and responsible citizens.” They have been an asset to Utah, he said, not a liability.

Republicans in the state legislature quickly backed up their governor, daring to defy a president who has repeatedly shown an unwillingness to tolerate intraparty dissent. So did Republican members of the state’s congressional delegation. So did Republicans in city halls. Democrats across Utah added their support.

“I have to be honest: I don’t have any idea why it’s a partisan issue nationally. It’s never been one here,” said Brad Wilson, the state’s Republican speaker of the House. “Regardless of political party, we value these people.”

(WashingtonPost)

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