Stocks move higher once again as rumors circulated that a trade agreement was imminent and that both sides would be rolling back tariffs.

While the Chinese seemed to embrace this story, reports from the White House were conflicting. We have been here before. Rumors, both good news ones and bad news ones, simply don’t turn into reality. It makes sense for both sides that some sort of deal will happen, but it isn’t likely to be a major one. Leaders on both sides of the ocean will overplay the significance of any deal, but reality is that tariffs will remain in place, as will threats of new tariffs in the future. U.S. companies will continue efforts to diversify supply chains no matter what the outcome. The timing of some short-term purchases may be affected whether some tariffs are rolled back or not, but it is hard to believe that a small deal will bring a surge in investment spending.

One measure of GDP growth is to multiply the percentage increase in our workforce by improvement in productivity. GDP is a measure of economic output. When you take all your productive workers and make them more productive, you get more growth. But improved productivity doesn’t happen magically. New investments in hardware and software make people more productive, whether it be a software program or an industrial robot. Without incremental investment and accompanying productivity gains, the only way to grow is to add more workers. That is why monthly employment growth has been so strong. There are plenty who will argue that is all good news. Wouldn’t you like more workers earning a salary than more robots?

That’s true up to a point. But what happens when you run out of new workers? There has been an argument that we are close to full employment. Yet every month, the economy continues to add 150,000-200,000 new jobs.

But there is a fly in the ointment. Wages are rising and they are starting to rise at an accelerated pace, particularly at or near entry level positions. Wage growth is now near 3% and it is higher than that at entry level. So far, that can be absorbed. But the closer one gets to full employment, the more wage pressures will increase. Without increases in investment spending, productivity falters. This week, we learned that productivity actually fell in the third quarter and is only up 1.4% year-over-year. That level is right in synch where productivity gains were in the Obama years. But wasn’t the large corporate tax cut designed to provide more free cash flow to fund more investment? It turns out that tariff-related uncertainties caused corporations to allocate more free cash to dividends and stock buybacks. There were many who predicted just such an outcome when the tax bill became law although, to be fair, tariffs were not yet on the table when the law was passed.

The bottom line is that despite the continued strength in the labor market, our economy has settled into the same growth pattern that has existed since the Great Recession: 2% growth and 2% inflation. That combination has kept interest rates low and asset prices high. Hence, we are in record territory in the stock market. All good!

While growth can continue, and with overcapacity still in place, inflation will remain low. That is a healthy combination for equities. As I point out almost continuously, stock prices are a function largely of earnings and interest rates. If wages continue to accelerate, margins, and therefore profits, could be squeezed. The pressure will vary from industry to industry, but it could become real. When there is labor slack, the employer has the negotiating advantage. When labor is tight, the advantage shifts to the employee. It has been a very long time since the employee has had the advantage. If you remember back to the 1970s or the second half of the 1990s, you can see the impact of wage pressures on margins.

If interest rates stay low, earnings can still be strong enough to allow the stock market to stay at elevated levels. But to grow to the 3300 or 3500 price targets that some are espousing for next year, either profits have to reaccelerate or interest rates have to keep trending lower. The former requires economic strength. The latter requires economic weakness. It is unlikely that we will witness economic acceleration and declining interest rates at the same time. In fact, over the past month or so, as stocks pushed back to record highs on the back of strong performances by economically sensitive sectors, yields on 10-year Treasuries have advanced by about 50 basis points. So far, markets have ignored that, but they won’t forever.

I can’t predict when momentum will slow. Seasonally, this is often one of the best times of the year for the stock market. A lot of investors with large unrealized profits want to hold off selling until January. It isn’t hard to make a case for stocks moving forward until year end. But valuation does matter. Right now, stocks sell for 17.5-18.0 times forward earnings, not wildly expensive but certainly not cheap by any historic standard. Yes, compared to bonds, stocks still look like the better bet, and I wouldn’t be a big seller here. But I wouldn’t be an aggressive buyer either. Many of the industrial, financial and energy laggards have rallied 20% in the last month. Despite a somewhat better outlook, many still face significant economic challenges. 2020 growth isn’t assured. In the short run, momentum takes over and you shouldn’t fight it. But bull markets are two steps forward and one step back. If I had sideline cash today, I would wait for the next step back. What could cause a pullback? Almost anything. Stocks now are largely pricing in a trade agreement. Any pothole on the road to conclusion would certainly send equities lower. If 10-year Treasuries continue to rise at their current pace, that could set off a correction as well. Election 2020 fears will increase over the next 12 months. Life on Wall Street isn’t a one-way affair. Stay invested but invest with care.

Today, David Muir is 46. Restauranteur Gordon Ramsay is 53.

James M. Meyer, CFA 610-260-2220

Copyright © 2019 Tower Bridge Advisors

Additional information on companies in this report is available on request. This report is not a complete analysis of every material fact representing company, industry or security mentioned herein. This firm or its officers, stockholders, employees and clients, in the normal course of business, may have or acquire a position including options, if any, in the securities mentioned. This communication shall not be deemed to constitute an offer, or solicitation on our part with respect to the sale or purchase of any securities. The information above has been obtained from sources believed reliable, but is not necessarily complete and is not guaranteed. This report is prepared for general information only.

Boenning & Scattergood, Inc. – Member FINRA / SIPC.

It does not have regard to the specific investment objectives, financial situation or the particular needs of any specific person who may receive this report. Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed in this report and should understand that statements regarding future prospects may not be realized. Opinions are subject to change without notice.

Stocks were mixed yesterday and market rotation continued.

Former high flyers continued to weaken and the year’s weakest sectors, especially energy, had another strong session. More on that in a moment.

A couple of months ago, economists were worried that bond markets were signaling recession with near record low interest rates and an inverted yield curve. Today, 10-year Treasuries are up about 40 basis points from summer lows and the curve is no longer inverted. In fact, it is steepening, a clear signal of rising economic confidence.

What happened? For one, the Fed has reversed course, lowering the Federal Funds rate three times since the summer after four increases in 2018. Monthly employment gains have continued strong even as we get closer to full employment. Inflation is stable within a cross current of higher labor costs and weak commodity prices.

It isn’t that the economy has suddenly gained new animal spirits. Investment spending remains very weak, a consequence of political uncertainty and tariff policy. Manufacturers have been working down excess inventories most of the year. Tariffs have slowed the flow of trade. Overcapacity continues to pressure commodity prices.

But there are hints of improvement coming. Continued consumer strength around the world will help to reduce excess inventories over time. Commodity prices seem to have stopped falling. Housing activity has picked up thanks to the three Fed rate cuts. Trade negotiations with China could result in a slight rollback in tariffs. The stock market senses these trends and has moved to new highs. But to sustain the rally, earnings have to reaccelerate.

Where there has been economic strength, in technology and health care for instance, good times continue. Rising rates and a steepening yield curve will help the banks and other financials. Their stocks have been strong performers lately. Industrials would be a big beneficiary if trade friction were to be reduced. Their stocks have had a glorious few weeks.

With that all said, let me get back to rotation. Often in mature bull markets, leadership narrows. Growth slows down and investors all concentrate in the few growth segments left. In 2019, at least through the summer, that meant technology, most specifically software, cloud and medtech. The strength in consumer spending helped lift restaurant stocks. They were big winners as well.

But investors often overplay their hand; their collective urge to buy the same hot stocks leads to overvaluation. As investors all flood to the same hot names, they abandon the losers. In 2019, that meant energy and industrials. There were good reasons to leave the energy complex. Prices were weak, drilling activity slowed and there was a lot of talk of alternative fuels and peak energy. But that story was probably overplayed. I suspect electric cars will remain a niche market for many more years than most believe. As for autonomous vehicles, maybe in a few years there will be some niche applications in a few markets. But the crossover point where the economic and safety equations strongly favor autonomous vehicles is still many years away. The Jetsons are still cartoon characters. Yes, we are all wearing Dick Tracy watches today and, someday, autonomous vehicles will be the real deal. But not in the near-term investment horizon that would threaten the existence of the fossil fuel industry. Moreover, existing oil wells pump less and less oil every year. New oil has to be produced to fill the gap. The industry isn’t exactly a growth industry, but it does have value. While I am not suggesting investors load up on energy names, they simply got undervalued as investors rotated to growth.

In fact, the spread between growth and value this summer got wider than at any time since 2000. We all remember what happened then. The internet bubble went poof! What we are experiencing right now is a modest repetition of 2000. It is modest because the bubble never got anywhere near as big this time around. I don’t think the rotation is over. But given the sharp recent gains in energy and manufacturing stocks, I would expect some backing and filling to occur soon. Stocks simply don’t move in a straight line. At the same time, I don’t believe the correction in valuation of high-flying growth stocks is over yet either. The failure of many of 2019’s most high-profile IPOs is actually healthy. What happens to all the private equity unicorns lined up waiting to come public is an open question. Hedge funds have had their wake up call over the past decade. I suspect the bloom will come off the rose of some portions of the private equity market over the next few years.

In the meantime, we enter a fairly quiet period in the market as everyone awaits the Christmas season. Generally, it is a time for optimism. Stocks often do well in November and December. But not always, as 2018 demonstrated. However, with economic data showing health and perhaps even acceleration, further gains are more likely than not.

Today, Ethan Hawke is 49. Sally Field turns 73.

James M. Meyer, CFA 610-260-2220

Copyright © 2019 Tower Bridge Advisors

Additional information on companies in this report is available on request. This report is not a complete analysis of every material fact representing company, industry or security mentioned herein. This firm or its officers, stockholders, employees and clients, in the normal course of business, may have or acquire a position including options, if any, in the securities mentioned. This communication shall not be deemed to constitute an offer, or solicitation on our part with respect to the sale or purchase of any securities. The information above has been obtained from sources believed reliable, but is not necessarily complete and is not guaranteed. This report is prepared for general information only.

Boenning & Scattergood, Inc. – Member FINRA / SIPC.

It does not have regard to the specific investment objectives, financial situation or the particular needs of any specific person who may receive this report. Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed in this report and should understand that statements regarding future prospects may not be realized. Opinions are subject to change without notice.

Stocks rose sharply on Friday in reaction to a stronger than expected employment report and upward revisions to data from the previous two months.

Wages also showed solid gains. More people working at higher wages is obviously good economic news and should put to rest any thoughts of recession, at least for now, barring any negative news on the trade front. They will get an additional thrust this morning as leaks from Washington suggest trade talks are going well. While we often hear this said at random times, and it is hard to attach too much credibility to any trade rumors, good or bad, these stories are market moving in the short run.

This morning, I want to direct my comments most directly to those who feel President Trump and his policies are going to lead to economic ruin and a collapse in the stock market. Trump haters are much more fearful investors today than Trump admirers. Without remotely attempting to take side in the pro vs. anti-Trump debate, I think it is very important to understand that stock markets react to earnings and interest rates. They react to very little else. They didn’t care that President Clinton was impeached. While the stock market declined as the impeachment proceedings began, they rallied strongly and continued to rally by the time the trial in the Senate began. The stock market did fall sharply in 1973 and 1974 as the drip of Watergate was making headlines. But that was in reaction to the sharpest recession since the Great Depression and escalating stagflation. By the time Nixon resigned in August of 1974, the market was already in recovery mode. Economics, not politics, dictated what happened in the markets. Watergate didn’t change our economy but expanding the money supply too fast ignited inflation.

It is infuriating to watch President Trump declare he is now a Florida resident after being mistreated in New York knowing full well, along with everyone except perhaps for a few within his base, that he is changing residences because the tax law he signed last year no longer allows the deduction of state and local taxes over $10,000. Florida has no state income tax and New York’s is high. It was jolt to many to see him pull troops out of Syria against all military advice. But markets are simply not affected by Syrian politics, impeachment proceedings or quid pro quo or crude tweets. Some or all of the above may infuriate many. Some infuriate me. But they aren’t going to change the economic realities.

The realities of today are as follows:
1. Our economy is growing at the same 2% it has been growing at for the past decade. Any benefit from the tax cuts or accelerated government spending has been offset by slower trade and investment. Yes, the last two factors may be scored as Trump faults, but the first two are Trump positives. So, let’s call it about even in economic terms.
2. Inflation remains almost non-existent largely because there is too much capacity worldwide. Trump has nothing to do with the excesses.
3. Resulting low interest rates have been a help to owners of financial assets.
4. Corporate earnings have been flat for the past four quarters. While expectations are for some improvement ahead, that is likely to be muted and it will depend, in part, on any changes in tariff policy. To that extent, Mr. Trump bears watching.
5. The outlook for next year, in economic terms, isn’t remarkably good or bad. Earnings might move a bit higher, inflation doesn’t appear likely to move much in either direction, interest rates should remain low (meaning they could rise or fall a bit from current levels) and no recession is in sight.
6. Frankly, markets are more fearful of some of the Progressive Democratic tax and spending policies than they are about the economic future in a second Trump term of office.

I say all this because clients who view Trump neutrally or positively have a very different investment perspective than those who feel he is a clear and present danger. The media, which means MSNBC, CNN and Fox, the three major networks, and leading newspapers like the Washington Post or The New York Times overplay almost every story. Their job is to hook us, to make us tune in 24/7. They all learned long ago that the middle ground is boring and doesn’t produce the highest ratings. But the economic reality is that what really moves our world are forces beyond government control. Big changes require legislative action. Over the past decade, except for Obamacare and the Trump tax cut, there has been very little done legislatively, and nothing is expected between now and the 2020 election. Presidential Executive Orders can matter around the edges but they don’t stand the test of time. There is a long history of presidents undoing Executive Orders of their predecessors. Yes, the President can start wars (that certainly would be disruptive) but, in Trump’s defense, it is clear he doesn’t want to do that.

That leads me to the Progressive agendas. Senator Elizabeth Warren outlined how she would pay for Medicare-for-all last week. I don’t want to tear it apart, but it is a pipe dream. There is no way her funding plans will generate anywhere near the revenue she would need to fund such a program. Let me give you just one example. She wants to tax billionaires’ wealth. Therefore, no one will want to be a billionaire. How does one avoid that? By splitting assets into various parts. If you are a billionaire, divide your assets between you, your wife and your kids. If that isn’t enough, set up trusts to slice and dice the pie further. I don’t have the details and Senator Warren hasn’t provided them either. But suffice it to say that if the rules are written, smart lawyers will find their way around them, if not in whole, at least in part. What that will mean is that funding for her plan will come up short without taxing the middle class. Guess what? The middle class probably knows that. So do Democrats in Congress, who will be asked to vote for such a plan. That is probably why Medicare-for-all, at least the variety proposed by Senator Warren, isn’t going to happen as proposed.

I am not trying to play politics. All I am trying to do is stimulate thought that, economically, Mr. Trump may be less dangerous that those who dislike Trump believe. But the real question, as we move into 2020, is whether he is more dangerous than the alternatives. That answer will go beyond economics and is beyond the scope of my letters.

I started this note focusing on the fears of those who distrust Trump. Their fears are holding them back from investing in stocks. I think, at least at the moment, those fears are somewhat misguided. I think our President, without major legislative action, simply doesn’t move the economy in a major way. He can tweet, he can taunt, he can threaten, but he can’t make a huge difference except with tariffs. He knows 2020 is an election year. He may make threats and, short term, he may even increase tariffs, but it is hard to believe he wants economic chaos next summer or fall.

For the stock market, the Trump alternatives are wide ranging and, in time, will become important considerations. But for now, it is still a Trump world, at least to the stock market. And whatever you think of him, economically, he isn’t doing all that much harm or good. As always, demographics have a more profound influence on markets than Washington politics.

Today, Sean Combs is 50, as is Matthew McConaughey. Ralph Macchio, the Karate Kid, is 58. Kathy Griffin turns 59. Finally, Laura Bush is 73.

James M. Meyer, CFA 610-260-2220

Copyright © 2019 Tower Bridge Advisors

Additional information on companies in this report is available on request. This report is not a complete analysis of every material fact representing company, industry or security mentioned herein. This firm or its officers, stockholders, employees and clients, in the normal course of business, may have or acquire a position including options, if any, in the securities mentioned. This communication shall not be deemed to constitute an offer, or solicitation on our part with respect to the sale or purchase of any securities. The information above has been obtained from sources believed reliable, but is not necessarily complete and is not guaranteed. This report is prepared for general information only.

Boenning & Scattergood, Inc. – Member FINRA / SIPC.

It does not have regard to the specific investment objectives, financial situation or the particular needs of any specific person who may receive this report. Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed in this report and should understand that statements regarding future prospects may not be realized. Opinions are subject to change without notice.

Stocks had their worst day in almost two weeks yesterday, although they finished off their lows.

Part was due to profit taking and month-end rebalancing. Part was due to suggestions that trade talks with China were getting bogged down. I think anyone who has more than modest expectations regarding likely trade agreements is probably overly optimistic anyway. Corporations have shown to be fairly resilient to tariff costs so far. Headlines seem to be moving markets a bit more than reality. Finally, the Chicago PMI, a regional index for manufacturing activity, was surprisingly low in September.

We will get a lot more data today, the first day of the new month. National manufacturing data will be released at 10am. We will also see the October employment report.

Another factor hitting markets yesterday was the aftermath of the Fed rate decision on Wednesday. Fed Chair Jerome Powell rather strongly suggested that any further cuts would be data dependent. Dovish investors who want to see more cuts didn’t like that response. Bond yields fell but the curve did not invert once again. Any significant further move down might suggest further economic deceleration to come, but a one- or two-day reaction may just be a sign of the normal ebb and flow of trading.

Earnings season is now starting to wind down and the numbers strongly suggest more of the same. Revenue growth has been fairly anemic. Manufacturing and capital investment has been notably weak. So has the energy sector. Commodity prices in general have been weak, impacting broad swaths of the economy. On the other hand, tech spending has been solid, particularly for software and services. Healthcare has been another strong segment of the economy. But the real hero has been the consumer. And that has been the truth worldwide. Thus, while many economies are struggling to stay out of recession, the commonality has been a strong and buoyant consumer. What has been the negative offset is political uncertainty and tariffs that have slowed the wheels of trade and capital spending.

That is why there has been so much focus on the U.S. trade talks with China. We still want the Chinese to respect intellectual property, halt forced technology transfers and allow U.S. companies greater and easier entrée into Chinese markets. The Chinese want none of the above but might be willing to take baby steps to get some of the tariffs reduced or eliminated. As a sign of peace, they will buy agricultural products in greater quantity if we agree to roll back some or all of the tariffs in place. We don’t want to roll anything back until the Chinese agree to do more than simply buy some more soybeans. Even the small deal agreed to verbally last month isn’t finding its way onto hard copy very easily.

The unknown is President Trump. He can be impetuous and temperamental at times. Even facing an election, that could lead him to lash out and impose more tariffs. He already has a big round of tariffs set to go into effect in December. While most don’t believe that will happen, Mr. Trump relishes in keeping opponents off balance. It wouldn’t be out of character, even with election season approaching, for him to at least threaten to move forward as a negotiating tool to get the Chinese to move in his direction. Markets, of course, don’t want to see any tariffs, including the ones already in force. Any such threat or action would be viewed negatively. What are the odds that Mr. Trump will be more aggressive, at least in the short run? Your guess is as good as mine. Many think they know, but I would suggest that no one really does as Mr. Trump has proven time and again that he is his own boss. All I can say right now is that markets are assuming that the December tariffs are not implemented. The upside is a signed agreement to take them off the table. That is still the most likely outcome. But the odds of some forceful action will increase quickly if talks stop making any progress.

In the meantime, we will get a lot of economic data over the next week of so, and then we enter that mid-quarter vacuum period of little relevant economic or corporate data. That can lead to volatility if some unexpected news occurs. Otherwise, I expect the bond market to lead the stock market. There are no signs of earnings momentum in either direction, which suggests that valuation will depend more on changes in rates over the short term rather than earnings. As noted before, rates are falling in the wake of Wednesday’s FOMC meeting. Two days doesn’t make a trend, but the change in direction bears watching.

Today, Jenny McCarthy is 47. Apple CEO Tim Cook is 59.

James M. Meyer, CFA 610-260-2220

Copyright © 2019 Tower Bridge Advisors

Additional information on companies in this report is available on request. This report is not a complete analysis of every material fact representing company, industry or security mentioned herein. This firm or its officers, stockholders, employees and clients, in the normal course of business, may have or acquire a position including options, if any, in the securities mentioned. This communication shall not be deemed to constitute an offer, or solicitation on our part with respect to the sale or purchase of any securities. The information above has been obtained from sources believed reliable, but is not necessarily complete and is not guaranteed. This report is prepared for general information only.

Boenning & Scattergood, Inc. – Member FINRA / SIPC.

It does not have regard to the specific investment objectives, financial situation or the particular needs of any specific person who may receive this report. Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed in this report and should understand that statements regarding future prospects may not be realized. Opinions are subject to change without notice.

Stocks finished mixed yesterday with a slight downward bias.

The modest net changes, however, disguised the fact that about 100 stocks rose or fell by more than $4 per share. This is a thin market, especially when everyone wants to buy or sell the same security at the same time. One could argue that more volatility with overall directional movement is a negative indicator. With stocks one day into new record territory, at least as measured by the S&P 500, there are reasons to be apprehensive, although the VIX, an index related to volatility, remains very low around 13.

While earnings will still be front and center today, the focus will shift this afternoon to the Federal Reserve. Two things are virtually certain. First, the FOMC is likely to cut rates by 25 basis points down to 1.75%. Second, President Trump is likely to bash the Fed for whatever it does short of taking rates to zero. Beyond that, however, there will be an ongoing debate about how far lower rates need to go to stabilize both economic growth and inflation expectations.

One school of thought suggests that rates need to go lower to stimulate growth in a fragile economy. With inflation still largely absent, the argument suggests that the risks associated with lower rates is much less than the risk of doing too little and watching economic growth whither away and morph into recession.

The other school says 2% growth and inflation close to 2% is pretty much ideal. Now that the yield curve is no longer inverted, why not pause after today’s cut and assess whether there is need for more? As you might guess, I support this view.

Very simply said, financial markets do best most of the time without outside interference. Certainly, there are times when liquidity needs or financial crisis mandates action. But now simply isn’t one of those times. World currency markets are relatively stable. Most economies are growing. Worldwide growth is still close to 3%. I get the pressure from the President, who would like even faster growth in an election year. As a real estate guy whose empire is built on debt, lower rates are always preferred. But it is becoming increasingly clear that incremental changes in interest rates are not having the same impact they had in the past. Negative rates throughout Europe, which are exerting a downward pull on our rates and an upward tug on the value of the dollar, simply have lost most of their impact. Once rates go negative, any incremental gain from going more negative is either miniscule or non-existent.

That doesn’t mean markets won’t react negatively if Fed Chair Jerome Powell suggests at his post-meeting press conference that the Fed is leaning toward a pause before taking further action. Equity investors are addicted to low rates. Low rates mean high P/E ratios, which, in turn, mean higher stock prices. Many, therefore, will be disappointed at any notion that rate cuts are done, at least for now. But these traders are just that, traders. They aren’t necessarily investors looking longer term.

However, in the end, it is the longer-term course of our economy and those overseas that will dictate the future course of earnings. Central bank policy isn’t the only influence. Tariffs and fiscal policy matter as well. But central bank policy is important and can’t be ignored.

The facts today suggest that any slowdown in growth rates is ebbing. Granted there are still weak pockets in manufacturing and energy, but the consumer is still employed, taking home more pay and spending it. As long as that is the case, our economy and most economies around the world will be in good shape. Obviously, they would be in better shape if tariffs are reduced. But that is outside of the control of the Fed.

Bottom line, this afternoon’s trading is likely to be volatile and highly dependent on what the Fed says and how Mr. Powell says it. He doesn’t always do the best job of messaging, although he has gotten better over time. Assuming he doesn’t appear overly hawkish or bearish (consistent is always best), whatever happens this afternoon shouldn’t have long-range implications.

Today, model Ashley Graham is 32. Ivanka Trump is 38. Henry Winkler turns 74.

James M. Meyer, CFA 610-260-2220

Copyright © 2019 Tower Bridge Advisors

Additional information on companies in this report is available on request. This report is not a complete analysis of every material fact representing company, industry or security mentioned herein. This firm or its officers, stockholders, employees and clients, in the normal course of business, may have or acquire a position including options, if any, in the securities mentioned. This communication shall not be deemed to constitute an offer, or solicitation on our part with respect to the sale or purchase of any securities. The information above has been obtained from sources believed reliable, but is not necessarily complete and is not guaranteed. This report is prepared for general information only.

Boenning & Scattergood, Inc. – Member FINRA / SIPC.

It does not have regard to the specific investment objectives, financial situation or the particular needs of any specific person who may receive this report. Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed in this report and should understand that statements regarding future prospects may not be realized. Opinions are subject to change without notice.

Stocks staged a solid rally Friday and finished just a whisker below all-time highs.

Earnings and rumors that trade negotiations with China were going well spared the advance.

Here is what we have learned so far from earnings season. Overall, earnings and revenues once again show a slight upward bias against lowered expectations, consistent with what we have been witnessing for several quarters. The weakest sector to date has been multi-national industrials. For the most part, earnings have come in below already lowered guidance. But in almost all cases, a sharp initial drop in stock prices was reversed, a sign that the bad news had largely been baked into their stock prices. That isn’t exactly an all-clear signal. For that to happen, forward expectations would have to stabilize. But it clearly is a positive sign, especially if one accepts the notion that the economic slowdown is coming to an end and some signs of actual growth acceleration are starting to appear. On the other hand, bank earnings have been a bit better than expected. With the yield curve both rising and steepening, it is reasonable to expect improved fundamentals going forward. That has been reflected in some moderate price increases for bank stocks. This suggests banks could participate in further rallies. But the news, while good, isn’t exactly buoyant. Loan growth remains muted and the yield curve isn’t very steep, at least not yet. Thus, I don’t look for banks to be leaders if stocks make a charge to new highs.

We haven’t heard from many energy companies yet. The oil service leaders have reported, and their results remain punk. The big international oil companies mostly report later this week. The news will be ugly. The only question is how much of that is already priced in. If industrials are a good guideline, the answer is a lot. Retailers mostly have fiscal quarters a month later than most other companies. Therefore, they won’t report for another few weeks.

That leaves technology and healthcare. Technology results so far have been mixed. Results in the semiconductor world were mixed. Companies that serve the industrial complex had the most difficult time.

The bottom line is that results have largely been about as expected, maybe a bit better. That, by itself, is not enough to move stocks materially in either direction.

Next up is the Fed meeting that will conclude Wednesday. A 25-basis point cut in the Fed Funds rate is a foregone conclusion. What is in doubt is the future path in rates. While many want to hear that the Fed is leaning toward more cuts, beginning in December, it is likely that Chairman Jerome Powell will leave himself a lot of wiggle room relative to that option. If economic data continues to strengthen and the yield curve stays positively sloped, he could well keep rates flat in December and look to late January as a more opportune moment to consider cutting rates further. There is a significant minority of FOMC voting members who would like the Fed to stop cutting rates now. That coalition is still a minority, but it is big enough to carry a relevant voice.

On Friday, we start to get a lot of economic data relative to December, including the monthly employment report. I expect the pace of job growth to consider to slow gradually. The September number will probably be lower than the recent past. The government should break that number out so that economists can work with a relatively clean number. Monthly figures can be quite volatile. That is why I try to focus on rolling 3-month averages. That number should continue to come down for several reasons. First, it is taking longer for employers to find the right hire. Second, the number of openings is declining. While layoffs remain small, the lack of new jobs will impact the number of new hires. Third, the level of political and economic uncertainty remains high and could become more elevated next year if the Democratic candidate has a substantive chance of winning. Investments in fixed assets have 10-40 year lives. Short-term tax and tariff uncertainty will impact the decision-making process, lengthening the time needed in some cases.

Seasonally, we are entering the strongest time of the year for the stock market. Investors focus on 2020 prospects and, for the most part, they appear brighter than 2019. Mutual fund tax selling season is over and, with earnings reports soon in the rear-view mirror, corporations can start to buy back stock once again. The only obvious headwind is possible high liquidation requests from hedge fund owners. Hedge funds continue to underperform expectations. Most liquidation requests must be submitted before Friday. Funds will then have two months to meet liquidity needs. With that said, I think liquidation requests will be less than last year, when markets were already in steep decline. Similarly, given the overall strength in stocks this year, there will be less year-end tax selling. What there is will be concentrated in this year’s losers. As a result, don’t look for a rally in energy stocks, for instance, until well into December, if then. There also may be some selling pressure related to year-end rebalancing given the 20% rise in stocks so far this year.

While the path of least resistance is higher, without an upswing in earnings expectations or a resumption of the decline in interest rates, it is hard to see how stocks make a big, sustainable surge from here. Seasonal factors may feed some near-term optimism, but that probably isn’t sustainable. There is no obvious reason to be a seller here given current momentum, but I wouldn’t be an aggressive buyer either. Cherry picking among 2019’s weakest performers may be opportune as Thanksgiving approaches.

Joaquin Phoenix is 45 today. Brad Paisley is 47. Julia Roberts turns 52. Bill Gates is 64.

James M. Meyer, CFA 610-260-2220

Copyright © 2019 Tower Bridge Advisors

Additional information on companies in this report is available on request. This report is not a complete analysis of every material fact representing company, industry or security mentioned herein. This firm or its officers, stockholders, employees and clients, in the normal course of business, may have or acquire a position including options, if any, in the securities mentioned. This communication shall not be deemed to constitute an offer, or solicitation on our part with respect to the sale or purchase of any securities. The information above has been obtained from sources believed reliable, but is not necessarily complete and is not guaranteed. This report is prepared for general information only.

Boenning & Scattergood, Inc. – Member FINRA / SIPC.

It does not have regard to the specific investment objectives, financial situation or the particular needs of any specific person who may receive this report. Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed in this report and should understand that statements regarding future prospects may not be realized. Opinions are subject to change without notice.

Stocks finished mixed with a bias to the downside yesterday amid mixed earnings news.

So far this earnings season, good news gets rewarded but bad news gets slaughtered. With stocks within 1% of all-time highs and political headlines leaving investors jittery, there is little margin for error.

If the economy isn’t a concern to investors, the political environment certainly remains problematic. While President Trump retains his core support, virtually every day something new, whether from a Presidential tweet to testimony in Congress, raises concern. While Mr. Trump has never had much support from Democrats, Republicans have remained unified in their support. But recent events like the impetuous decision to remove troops from Syria and the decision to hold the next G-7 meeting at his Doral resort has begun to try the patience of many Republicans. So far, any dissent has been isolated to individual issues. But there are only so many of these faux pas that his supporters in government are going to be willing to ignore. More and more, Wall Street research firms are beginning to ask what if some of the leading Democrats win. What might the consequences be? For the most part, they are viewed as negative for the stock market. How negative depends on the observer but no one suggests the election of one of the more progressive liberals will lift stock prices. 

It is important, when doing this intellectual exercise, to separate possible executive orders from possible legislation. Even should Democrats win both chambers of Congress (still unlikely), 60 votes would be needed for legislation to pass the Senate. While it is possible to change the rules in ways that all legislation can be passed with 51 votes, getting all Democrats to vote for large tax increases, a ban on fracking or Medicare-for-all would be a stretch. What would be more likely would be Executive Orders to tighten banking regulations, bans on fracking on public lands and tighter environmental legislation. While such changes would affect specific industries, the notion that a wholesale disruption of the American economy would be in store is probably an overstatement. While many might disagree with my thoughts, so far markets seem to agree. Bank stocks today are reacting far more to a steeper yield curve than they are to the thought of tighter regulation.

 The bottom line is as follows: 

1. The economy worldwide is starting to grow a touch faster thanks to easy monetary policy. The Federal Reserve is almost certain to cut rates one more time next week. 
2. Stocks are fairly priced. In some cases, they are fully priced. Bad news won’t be tolerated. 
3. Political noise is rising. So far, markets have ignored the news. Markets aren’t directly concerned with whether President Trump is impeached or not, but they are if Democrats nominate a progressive liberal and the nominee looks likely to win. That will become more apparent next summer but investors won’t wait until then to adjust portfolios. 
4. A changing yield curve that is steeping and rising suggests better times ahead for now. It also is good news for lenders such as the banks and credit card companies.
5. Given the impetuous nature of President Trump and the fact that there are few, if any, left in the White House to challenge him, the risk of a wayward tweet is higher today than it has been. While the Syrian-Turkish affair or the decision to hold a conference at the Doral are not market moving, a sudden change in trade or tariffs could move markets quickly (in either direction). 

For the rest of this week and next, earnings will dominate. The overall market shows little momentum. Stocks remain within spitting distance of all-time highs but without a surge from earnings. It seems premature for a significant upward push from here. Perhaps a modest increase past the July 2018 highs is the most likely outcome. The bond market suggests a slow recovery in interest rates, which will pressure any further P/E increases. Earnings remain flat as they have all year. That suggests there are not enough tailwinds at the moment to justify a big move higher. Conversely, solid earnings and a sign of some economic acceleration give stocks a floor. S&P dividend yields are still higher than yields on 10-year Treasuries. 

We remain stuck in a trading range. 

Today, Ryan Reynolds is 43. Weird Al Yankovic is 60. Pele turns 89.

James M. Meyer, CFA 610-260-2220

Copyright © 2019 Tower Bridge Advisors

Additional information on companies in this report is available on request. This report is not a complete analysis of every material fact representing company, industry or security mentioned herein. This firm or its officers, stockholders, employees and clients, in the normal course of business, may have or acquire a position including options, if any, in the securities mentioned. This communication shall not be deemed to constitute an offer, or solicitation on our part with respect to the sale or purchase of any securities. The information above has been obtained from sources believed reliable, but is not necessarily complete and is not guaranteed. This report is prepared for general information only.

Boenning & Scattergood, Inc. – Member FINRA / SIPC.

It does not have regard to the specific investment objectives, financial situation or the particular needs of any specific person who may receive this report. Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed in this report and should understand that statements regarding future prospects may not be realized. Opinions are subject to change without notice.

Stocks fell on Friday as bad company-specific news hit bellwethers.

In addition, many of the tech high flyers that show great promise but little or no earnings lost ground as investors increasingly show concern about the valuation of those stocks.

Over the past many months, you have read of my concerns related to overcapacity. At the depths of the Great Recession, capacity utilization in this country dipped below 67%. In the 1970s, it was not uncommon for readings approaching 88%. At such high rates, demand exceeds supply and inflation occurs. Tight capacity wasn’t the only reason for the hyperinflation we saw in the 1970s, but it was an important contributing factor. By the 1990s, the rate was down to the 80-85% range. Most economists suggest that is an ideal range, one that balances supply and demand without putting undue pressure on prices in either direction.

Today, however, capacity utilization is about 77.5%, and that is trending lower. At that rate, there is clear excess supply. The rate is certainly higher than it was at the depths of the Great Recession, but what is most disturbing is that the recent trend is lower, i.e. capacity is now growing faster than demand. While tight labor markets put some upward pressure on inflation, the growing overcapacity has the opposite impact, helping to push prices lower, raising the specter of deflation.

It takes about a decade for the damage of a real financial crisis, as we saw in 2007-2009, to heal. Indeed, by November 2014, the rate was back to 79.24%, very close to the balancing point I talked about above. But over the past five years, two factors unique to this recovery occurred. First, China, which had become a major contract manufacturer to the rest of the world, continued to rapidly expand capacity. That includes both manufacturing capacity as well as residential and commercial real estate. Second, central banks around the world worked to keep key interest rates as close to zero as possible in an effort to sustain what they collectively felt to be fragile economies.

But, as almost always is the case, when one tampers with normal voices to achieve one objective, there are unintended consequences. Low rates foster bad investment decisions. Investments that one wouldn’t make in a rate environment where there was a real cost to borrow are executed when “free” money is available. As a result, capacity started to rise faster than demand, and corporations piled up record amounts of debt in the process. Collectively, governments and central banks adopted policies that, to date, have perpetuated that process. The Fed has begun to cut rates again with growth hovering around 2% and inflation just a bit below. Such moves may stabilize or even push those rates higher in the short run, but they will also serve to keep pushing capacity utilization lower if the continuation of free money stimulates more investment than necessary.

So, what might be a solution? The obvious one would be for central banks to stop trying to artificially move an economy that is pretty close to what most economists would deem to be long-term sustainable growth and inflation rates. Perhaps the Fed was spooked by an inverted yield curve. But that has now reversed itself. One more rate cut at the end of this month should be more than sufficient to keep the economy on course. President Trump and others of like mind want to see rates materially lower. But, in real terms, money is already free. Any rate dependent investment that can’t pass muster today likely won’t pass it if rates are another percentage point lower. The President has the mind of a real estate investor. For them, rates can never be too low. But rates that, in fact, are too low finance projects that shouldn’t be built. In New York, the median sales price of a condominium in August of this year was 12% lower than it was last year. The last thing New York needs is more supply of condos for sale. That is just one for instance.

Oversupply won’t disappear overnight. If demand grows by 2% and supply remains flat for a year, capacity utilization still wouldn’t reach 80%. If demand would grow 2%, new investments were limited to projects that were truly needed and cost inefficient supply were removed from the market, balance could be restored sooner rather than later.

The problem isn’t lack of demand; it’s too much supply.

When government policy finally understands this point, central banks and collective fiscal policy would be altered and balance could return. Once balance is restored, investment will resume, inflation will stabilize and growth can continue along its long-term glidepath. Simply said, if market forces were allowed to do the heavy lifting, markets and the economy would operate more efficiently. Central bank intervention is necessary in times of stress. It is not necessary each time GDP growth waivers half a percentage point off trend. Between 2008 and 2015, the Fed left interest rates alone and the economy did just fine. Perhaps it could have grown slightly faster without some of the post-recession regulations, but it was essentially OK. Stock and bond markets were relatively stable, except for brief periods when Europe went through sovereign debt stress (and their central banks intervened as they should have). Note that when Europe was in stress and we escaped most damage, our Federal Reserve held rates steady. Instead, it pumped liquidity into the system until world markets stabilized.

If the Fed persists in employing easy monetary policy at a time of modest stress, it runs the risk of magnifying the unintended consequences and leading to more problems ahead.

Today, Kim Kardashian is 39. Judge Judy Sheindlin is 77.

James M. Meyer, CFA 610-260-2220

Copyright © 2019 Tower Bridge Advisors

Additional information on companies in this report is available on request. This report is not a complete analysis of every material fact representing company, industry or security mentioned herein. This firm or its officers, stockholders, employees and clients, in the normal course of business, may have or acquire a position including options, if any, in the securities mentioned. This communication shall not be deemed to constitute an offer, or solicitation on our part with respect to the sale or purchase of any securities. The information above has been obtained from sources believed reliable, but is not necessarily complete and is not guaranteed. This report is prepared for general information only.

Boenning & Scattergood, Inc. – Member FINRA / SIPC.

It does not have regard to the specific investment objectives, financial situation or the particular needs of any specific person who may receive this report. Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed in this report and should understand that statements regarding future prospects may not be realized. Opinions are subject to change without notice.

Earnings season got off with a bang as several major banks along with Dow components reported results that, for the most part, exceeded expectations.

That lifted the market by almost 1%. As earnings season continues, day-to-day fluctuations are likely to be somewhat random, reflecting what the major companies reporting results do on any specific day.

Overall, it appears that the pace of decelerating growth, so obvious through the summer, is stabilizing both here and abroad. We have often noted that the combination of demographic factors and normalized gains in productivity suggest a steady state growth rate in the United States of about 2% or slightly better. Tariffs provide a bit of a headwind, but that pressure should lessen at least through the election season. The recent rate cuts by the Fed and other monetary accommodations by central banks around the world will be an offset, helping to give economies a bit of a boost. Thus, all together, the crosscurrents should allow growth close to trendline over the next year or so.

With growth somewhat normalized, one turns to valuation measures to decipher the future path for stocks. P/E ratios are slightly high, but lower than average interest rates and inflation expectations argue that higher than normal P/Es are reasonable. Should the market end the year where it is today, 2019 will see gains in equity values of about 20%. That clearly is not a sustainable glide path. But if one looks at 2018 and 2019 together, that annualized rate of gain is much closer to 10%. Going forward, barring major changes in inflation assumptions, therefore it would seem that 2020 can be a fairly average year for stocks, all other factors being considered.

But alas, 2020 isn’t going to be just another typical year. It is an election year, and it is a year that could decide whether President Trump survives his presidency or not. Discussions of impeachment are beyond the scope of my letters that concentrate on the economic world. But I will say that if President Trump survives efforts to remove him from office, which would seem to be the current consensus, the American public will get its vote next November.

Today, I want to look at next November through an economic lens, the only lens that I want to focus on. Let us start with Mr. Trump. In 2016, he laid out a set of promises and for the last almost three years, he has been focused on achieving them. Whatever your opinion of the President might be, few can argue that he tries to fulfill his promises. The corporate tax cut has been done. If reelected, he most likely will try to reduce taxes further. He has gone to economic war with China. Results to date don’t show a lot of progress, but you can be sure that, if reelected, he will reengage China and spend most of the rest of his presidency trying to force the Chinese to change the ways it does business with the West. He also is a fan of low prices and low interest rates. He will continue to beat on the Fed to keep rates low and lower them further. Mr. Trump is not afraid of debt and deficits. Count on more of both. The pain, if any, will only come if rates rise. So far, so good. But some day, debt service costs will come back to haunt us all. Hopefully for Mr. Trump, that might be a problem for a subsequent president. As for low prices, he will continue to press for lower drug and oil prices. To support the latter, he will do whatever he can to facilitate additional oil and gas drilling. As for the former, legislation may be required to, for instance, allow the government to negotiate Medicare-related drug prices.

Put all together, his economic agenda will largely remain the same. Stock prices are near record levels today, and most investors would probably surmise that market conditions would be favorable in a second term. The only major caveat is that the President began his presidency surrounded by a lot of high quality, but often strong minded, people. Most of them are now gone, and most of the replacements are both less intelligent and less likely to challenge Mr. Trump’s tendency to make impulsive decisions. That has to be a risk factor we can’t ignore.

But the uncertainties surrounding a Trump reelection are far less than the uncertainties attached to any of the democratic candidates. Today, Elizabeth Warren and Joe Biden are the front runners. Few of the others have gained much traction. The overall mood of democrats running for election is much more aligned with the progressive movement and, perhaps, further away from the centrist views of most Americans than many voters would like. So far, the key platform agenda is the Medicare for All concept.

Americans care deeply about a few issues. The ones they care most about are the ones directly impacting them. Syria is once again in the headlines, and those who pay attention to the news have their own opinions about how important Mr. Trump’s moves over the last two weeks might prove in the long run. But unless some ISIS escapees create havoc on our shores, most of us will not see our daily lives altered by what is happening today in Syria and Turkey.

The same cannot be said about the way healthcare is provided in this country and how it will be paid for. To those who thought Obamacare was the answer to better healthcare, watching democrats call for a complete do over is a bit head scratching. Our government runs a lot of consumer services. Three highly visible ones are Veterans hospitals, the post office and Amtrak. I think it is safe to say that satisfaction with the levels of service of all three are lukewarm at best and all are money pits for taxpayers. There are obvious reasons why. First, the government has limited resources to spend. Asking for more money annually is difficult, and Congress only reluctantly provides more money. That almost certainly means that all three are inadequately staffed and technologically behind where they should otherwise be. Second, Congress interferes. There are thousands of unnecessary post offices open today. No member of the House wants to see a post office in their district closed. Amtrak still operates lines to nowhere because a few hundred people would be deprived of a nearby station. VA hospitals have long waits.

America is the world’s richest nation and all Americans deserve basic healthcare, even if they can’t afford it. Healthcare costs per capita in the U.S. are the highest in the world. On the other hand, Americans are used to our system and most don’t want to see it changed in a major way. While healthcare outcomes in many developed nations equal or exceed American standards, in many countries the choices available to consumers are limited, wait times can be every bit as long or longer than what is currently experienced in the VA systems and one cannot always choose their own doctor. While there are tens of millions of Americans who are either inadequately covered or not covered at all by healthcare insurance, the vast majority of Americans are covered, and they are comfortable with their coverage.

Would they like to see improvement? Yes. Would they like their out-of-pocket costs reduced? Undoubtedly. But most don’t want to just scrap what they have today and start over. The leading proponents of universal healthcare, moreover, will tell you the associated incremental costs will be in the trillions of dollars over the next decade, but none will tell you how it will be financed. All Americans know that even with the most progressive tax system, the wealthy alone cannot support such a system. If a progressive democrat is going to become our next president, they are not going to be able to dance around the financing issue.

As I started this discussion, I pointed to healthcare and taxes as two, perhaps the two, issues that will decide our next president. Americans want improvement and change. Most deplore the current political atmosphere. Some despise Trump so much they would be willing to support any alternative, no matter the cost. But the majority of Americans remain centrists. They could accept some tax increases if they felt the resultant level of government services would improve and benefit them. But those advocating bold change are going to have a tough time convincing the centrists that their approach will be the better one. That is the challenge for whoever is the nominee.

How the election battle plays out could impact markets as 2020 progresses. As noted, markets are comfortable that Trump would not ruin their economy. Should events suggest that Trump might not survive his first term, that could add volatility to the market. So far, we aren’t close to that moment. Should polls suggest a progressive candidate could win the election, markets will also react even with the understanding that fulfilling campaign pledges is far from a certainty, particularly if republicans control one or both chambers of Congress. Simply said, so far politics has had limited market impact. It has been a headwind for parts of the healthcare industry but not much else. That could change as the election season becomes more active. And it could lead to greater market volatility in the year ahead. Predicting the economy is tough enough. Rarely do politics become so great an economic factor as they could be in 2020. There is little to do today but watch. As time moves forward, however, adjustments may be needed.

Today, tennis star Naomi Osaka turns 22.

James M. Meyer, CFA 610-260-2220

Copyright © 2019 Tower Bridge Advisors

Additional information on companies in this report is available on request. This report is not a complete analysis of every material fact representing company, industry or security mentioned herein. This firm or its officers, stockholders, employees and clients, in the normal course of business, may have or acquire a position including options, if any, in the securities mentioned. This communication shall not be deemed to constitute an offer, or solicitation on our part with respect to the sale or purchase of any securities. The information above has been obtained from sources believed reliable, but is not necessarily complete and is not guaranteed. This report is prepared for general information only.

Boenning & Scattergood, Inc. – Member FINRA / SIPC.

It does not have regard to the specific investment objectives, financial situation or the particular needs of any specific person who may receive this report. Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed in this report and should understand that statements regarding future prospects may not be realized. Opinions are subject to change without notice.

Stocks rallied once again on Friday as trade talks with China reached an endpoint.

But they fell a bit at the close as the agreement appeared to be less encompassing than first thought.

Actually, despite efforts by the administration to label the agreement as important and pivotal, it wasn’t much of an agreement at all and remains subject to getting the written words to match the oral agreements. China will buy more agricultural goods and we will defer the October round of tariffs. There appears to be some language that forces China to support its currency as well. Beyond that, not much was finalized. President Trump keeps score by the numbers. If China fulfills its promise to buy more soybeans and our trade deficit with China is reduced, he can claim some level of victory. The door also seemed to be opened a bit wider to allow American financial services firms to operate more openly in China. But despite Secretary Mnuchin’s repeated comments that the agreement includes a chapter on intellectual property, there are no signs that China is changing its fundamental positions on intellectual property and forced technology transfer.

When President Trump began the trade war by increasing tariffs, the goal was to achieve some fundamental change in the way China does business. Many months later, as tariffs escalated, very little, if anything, has been accomplished on that front. That is not to say that a phase II or phase III won’t yield results, but any such conclusion would seem problematic at this point in time. To the extent there was substantive good news for the markets, President Trump removed the October tariff increases, slated to go into effect tomorrow. That will relieve some immediate term pressure. However, he did not take the more important December tariffs off the table, as some hoped.

The net result is that tariffs and an escalating trade war has moved off the front page but remains an active issue. Corporates who have been deferring capital projects waiting for uncertainties to be resolved are likely to still face the same level of uncertainty today. The front page, at least for the next several weeks, will be dominated by earnings. Based on current estimates, reported results should be a couple of percentage points below those of last year. However, historically, companies beat forecasts by 2-3%, and I would expect the same this time around. That suggests the best forecast is for flat year-over-year earnings and, perhaps, muted guidance for Q4 once again impacted by trade and tax policy uncertainties.

With last week’s rally, stocks once again are pushing toward record highs. To get through, my guess is that earnings are going to have to be much better than expected. That is probably a reach.

Beneath all of the trade headlines last week, the bond market was sending rather robust signals. The 3-month to 10-year yield curve uninverted for the first time in months, sending a dual message of better economic expectations and a firm expectation that the Fed will cut rates again at the end of October and perhaps once more in December. The absolute rise in yields along the curve suggests, at least from a bond market perspective, that the growth slowdown of the past two quarters, both here and abroad, is starting to abate, coincident with easier monetary policy. Economic data normally trails Fed actions by 6-12 months, suggesting the impact of the 2018 rate increases has finally been fully reflected in the economic data. The impact of the new cycle of rate cuts will begin to be reflected either this quarter or next. Those truths are consistent with the bond market’s message. If the bond market is right, economic activity and earnings should improve through 2019. That presumes no further escalation of trade wars, either against China or Europe, and it presumes that the presidential campaign season will not have an immediate economic impact.

Historically, year 4 of a presidential term is fairly good for markets. The current administration obviously wants to prime the economy for good growth. What is different this time around is that the current president faces impeachment proceedings and his opponent could well be a candidate with a highly progressive agenda that investors will fear. At this moment, those headlines need a lot of details filled in. No one knows what further damaging information will surface relative to impeachment proceedings, and it is much too early to label any democratic front runner as the next president. Current poll leaders clearly scare many conservatives, but they also scare independents and voting classes critical to their chances for election. We have a long way to go. Markets have yet to react to the election battle ahead.

Where that leaves us is (1) at the top of the recent trading range with no obvious catalyst to power stocks materially higher, and (2) at the cusp of earnings season where investors can separate the wheat (those companies doing fine in a soft economy) from the chaff.

The companies most likely to succeed are those most in control of their own destiny. These are companies that can:

1. Gain market share
2. Execute better than their competition
3. Are not dominated by macro factors beyond their control
4. Provide products and services that are most in demand

While this combination may suggest that technology is the key factor, it isn’t the only factor. Best execution is the most important factor. Owning world class companies isn’t the only way to win in the stock market, but it isn’t a bad place to start.

Today, Usher is 41. Stephen A. Smith is 52. Ralph Lauren turns 80.

James M. Meyer, CFA 610-260-2220

Copyright © 2019 Tower Bridge Advisors

Additional information on companies in this report is available on request. This report is not a complete analysis of every material fact representing company, industry or security mentioned herein. This firm or its officers, stockholders, employees and clients, in the normal course of business, may have or acquire a position including options, if any, in the securities mentioned. This communication shall not be deemed to constitute an offer, or solicitation on our part with respect to the sale or purchase of any securities. The information above has been obtained from sources believed reliable, but is not necessarily complete and is not guaranteed. This report is prepared for general information only.

Boenning & Scattergood, Inc. – Member FINRA / SIPC.

It does not have regard to the specific investment objectives, financial situation or the particular needs of any specific person who may receive this report. Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed in this report and should understand that statements regarding future prospects may not be realized. Opinions are subject to change without notice.

Stocks turned sharply lower yesterday as noise from Washington suggested trade negotiators for both the U.S. and China were taking hard line stances that mitigated the possibility of an interim deal to calm to tariff wars.

Intraday comments from Fed Chair Jerome Powell that suggested ongoing monetary accommodation helped lift stocks momentarily, but trade worries ended up dominating trading and equities closed at their lowest level of the day.

The press spends a lot of time trying to decipher Donald Trump’s attitude toward trade. Listening to his words appears to be a fruitless effort. In an effort to create a bit of negotiating chaos, Mr. Trump plays good cop and bad cop himself. One day, especially after the stock market starts to swoon, he delivers conciliatory messages. On other days, he tries to present a hard line. All the chatter in front of any deal is meaningless. Both sides know where each other stands and both sides to date have been reluctant to give ground and move toward the center. That isn’t uncommon in negotiations, but how this battle ends remains uncertain. The standard line is that Trump wants a deal reasonably soon to help avoid any possibility of recession in 2019. If he takes the big step on invoking tariffs on most of China’s exports of consumer goods in December, there will be a clear negative impact on our economy. Of course, there will be an impact on China as well, which could be more severe than the impact on ours. But it is the state of our economy next fall that has a major bearing on the outcome of the 2020 Presidential election. For that reason alone, most pundits predict that Trump will somehow find a way to delay or defer the December wave of new tariffs.

But let’s look at it from the Chinese standpoint. Let me start by not making an assumption on who China might favor in the 2020 election. Long term, this escalating economic battle will transcend the Trump presidency whether it be four years or eight years. China’s 2025 economic plan is to reach economic and technological parity with the developed world by then at the latest. To do so, China has a big road to climb. Despite all of its economic growth to date, China has succeeded by being efficient more than being technologically innovative. It knows it will lose some of its competitive advantage to its Asian neighbors as it moves toward becoming a developed nation. Rising standards of living mean higher wages and higher costs. To offset this, China must innovate and raise its level of technological expertise. To do this sooner rather than later, China has invoked forced technology transfers among other steps.

China also knows that deal or no deal, U.S. companies, sensing a heightened competitiveness between the two countries, will work to diversify their supply chains with or without a deal. It is hard to believe that current trade negotiations will be the end of economic conflict between the two nations. China will be both our economic and political adversary for many years to come. From the end of the cold war and the fall of communism in the late 1980s until recently, the U.S. has been the dominating world power without strong direct competition. While Russia and others in the Middle East remain political and military threats, it is clear that the 800-pound gorilla for years to come will be China. When we backed out of the Trans-Pacific Partnership (TPP), countries along the Pacific Rim looked to China to fill the gaps. China’s silk road game plan is to provide economic support that strengthens trade relationships all around the world. And that includes China and the Western Hemisphere.

Undoubtedly, China will feel the pain of further American tariffs. It doesn’t want to see more tariffs implemented later this month or in December. A weaker economy is bad for Chinese political leaders just as it is for President Trump. But President Xi doesn’t face an election next year. China can afford to make Trump squirm for several more months. Perhaps it is in their interests to better understand what relationship they might have with the Democratic candidate that emerges as Trump’s opponent. While any president will view China as an economic and political adversary, each will employ different tactics. Joe Biden would seem to take positions similar to Barack Obama. Elizabeth Warren’s stances are less fully developed. Certainly, she wants a level playing field and will take tough stances, but it isn’t clear how she stands on tariffs. Perhaps, if the pain of tariffs increases over the coming months, she will suggest her own alternatives that play to her base and the overall public.

Thus, I come to the following conclusions without having any knowledge of how trade talks might progress in the coming weeks.

1. China would like to avoid more tariffs in the short run if it can do so without slowing its ultimate path to economic and technological parity. If it can strike an interim, good-faith deal by committing to buy a lot of soybeans and planes, it will grab the opportunity to buy some time and defer the hard issues.
2. China might even accept some changes in ground rules that won’t seriously slow its progress toward its 2025 goals. But in no way will it simply accept what it views as a one-sided deal that allows the U.S. to set both the rules and the enforcement penalties.
3. Trump has more to lose if escalating tariffs lead to recession worldwide. China knows this and, therefore, might let Trump squirm a bit to see if he is more willing to give ground in the coming months to make a deal that China can accept that will allow the U.S. to avoid a recession.
4. Despite all of the above, U.S. companies will diversify supply chains across all of Asia. That process will take many years and it will occur regardless of the outcome of trade negotiations.
5. Despite all the rhetoric back and forth, as the two largest economic powers, the U.S. and China are interlocked in ways that cannot be decoupled. We both need each other. It has taken 25 years to get to where we are today, and that can’t be unwound whether there is a trade deal near term or not.

None of what I said changes the likelihood of some sort of first step deal in the coming weeks. That may or may not happen. A fully encompassing deal will take much longer, perhaps years. As in any major negotiation, a lot depends on the respect and trust the two sides have for each other. Can Trump and Xi make a big deal? I have no idea. Trump persistently states that the two have great respect for each other, but we don’t really know. Can Biden or Warren make a better deal? That, too, is an open question. What we do know, in the short run, is that tariff escalation is painful and could get more painful. It is Trump’s weapon of choice. He uses it everywhere as a threat and, as was the case with Mexico and migrants recently, there are times tariff threats prove effective. But they don’t always work. We will find out soon whether that is the case or not with China.

Wall Street hates uncertainty and clearly there is plenty of it today as more tariff deadlines approach. Markets are assuming that somehow, the December tariff increases don’t happen. Clearly, if they do, Trump will be increasing economic pain on the U.S. at an inopportune time. But he needs some give from China to allow him to pull back. The real question, therefore, is whether it is in China’s long-term interest to reach a short-term deal now or let Trump squirm a bit to see whether they can extract a better deal. In the meantime, Wall Street will continue to go through a period of volatility, at least until the resolution of the December tariff threat is resolved. Obviously, should they be implemented, the outlook for stocks would deteriorate. That remains an if. Hopefully, we will learn more over the next week.

Today, Sean Lennon, the only child of John Lennon and Yoko Ono, is 44. It also happens to be the birthday of John Lennon, who would have been 79 today.

James M. Meyer, CFA 610-260-2220

Copyright © 2019 Tower Bridge Advisors

Additional information on companies in this report is available on request. This report is not a complete analysis of every material fact representing company, industry or security mentioned herein. This firm or its officers, stockholders, employees and clients, in the normal course of business, may have or acquire a position including options, if any, in the securities mentioned. This communication shall not be deemed to constitute an offer, or solicitation on our part with respect to the sale or purchase of any securities. The information above has been obtained from sources believed reliable, but is not necessarily complete and is not guaranteed. This report is prepared for general information only.

Boenning & Scattergood, Inc. – Member FINRA / SIPC.

It does not have regard to the specific investment objectives, financial situation or the particular needs of any specific person who may receive this report. Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed in this report and should understand that statements regarding future prospects may not be realized. Opinions are subject to change without notice.

Stocks rallied again on Friday after a somewhat tepid employment report convinced investors that the Fed would lower rates again at the end of October.

I have counseled many times that there is only one way to look at these monthly reports. A big gain in jobs is good. A small gain or a loss of jobs is bad. Friday’s report was somewhere in the middle, certainly not a figure normally worth a 1.5%+ gain in equity values. But given the weaker than expected economic data earlier in the week, a number within the range of expectations was a relief. In addition, equity investors are addicted to low rates. If sloppy data increases the odds of another rate cut, that would seem to enhance values.

Neither I nor anyone else can say today with conviction that we will or won’t enter recession next year. We can say with some degree of certainty that the economy is growing more slowly today than it has in the recent past. On the plus side, continued employment growth and strong consumer spending worldwide suggest that recession will be averted. On the other hand, investment is down, confidence is drifting lower and policy uncertainty, particularly related to tariffs, has everyone confused and a bit concerned. The Fed may continue to cut rates and that will undoubtedly help. But rate cuts alone may not be enough to reverse trends, especially if China and the U.S. cannot come to some sort of trade truce in the fourth quarter.

Earnings season is close at hand. Results should resemble those of the past several quarters, a bit ahead of measured expectations. But, as always, it is the forward-looking guidance that is most important. Given that the fourth quarter is normally the most important of the year, guidance this time around will be especially important. With that said, industrial companies, commodity producers and multi-national companies most impacted by trade policy will have a tough time being assertive and optimistic given all of the uncertainties in front of us. Another round of tariffs is due to be implemented early next week. This round has already been postponed once, allegedly in deference to the 70th anniversary celebrations in China at the start of October. Without some progress between now and then, it would seem likely these tariffs will be initiated and markets would not like that.

Thus, the near-term outlook is close enough that it seems unlikely that stocks will move quickly to new highs unless earnings offer a big upside surprise. I should note that bond yields across the curve have come down quite a bit over the past couple of weeks. The 2-10 year Treasury spread is now positive again by more than 10 basis points and the 3-month to 10-year negative spread, which has averaged over 40 basis points for several months, is now down to less than 15 basis points. Should the Fed lower rates in October, it could possibly end its rate inversion. That would be viewed positively, but the drop in rates across the curve is the bond market’s expression of slower growth, no recession and inflation missing in action.

There are many who suggest that the bull market is long in the tooth and, perhaps, coming to an end. Slower growth helps to support that conclusion. So does the fact that this is already the longest bull market in history. But there is no rule dictating that bull markets have to end at any time. Australia, for instance, has avoided recession for over 25 years. Bull markets often (usually?) end with a bout of euphoria. We really haven’t seen that this time around. Sure, there are individual stocks that have invited speculative interest and whose market value is far apart from intrinsic value. But one-offs don’t define a euphoric state. There has been an active new issue market this year and there have been some very notable hot new names. But there have also been some high profile disasters.

I would contend, however, that right before our eyes there have been not one, but two massive bubbles that have formed and both are set to burst, if they haven’t already.

The first is the private equity market.

If you remember the Internet bubble of the late 1990s, I would suggest only one company became a superstar company in the long run. All the others failed to live up to promise. Most failed altogether. The big difference between then and now is that most of the 1990s failures happened in the public marketplace. This time around, most of the failures will be in the private marketplace as the vast majority of unicorns have not come public yet and, as noted, several have failed to live up to expectations. The two worlds are not that much different. Both gave birth to exciting ideas. Most fail but several become very successful. In the euphoric stage, which I argue peaked earlier this year, valuations were woefully extended. From here forward, the carnage will start to get worse. Yes, there is still time for some with true paths to profitability to come public. But for most, will either fail or their extended valuations will have to reset materially lower. Most venture capital and private equity investments are made via limited partnerships and funds with life expectancies of less than 10 years. Investors in these funds are not long-term investors; they want to see exits. If the public markets become restricted to those either profitable or with clear paths to profitability, the remaining exit opportunities are to be sold to larger companies at rational prices.

This time around, private companies waited too long to go public. They wanted the sweet spot of market appreciation for themselves. If several had come public earlier, their initial valuation might have been less, but the exit doors would have been open. If there is a recession or bear market over the next 12-18 months, the exit doors will slam shut completely.

This is just one bubble.

The other is in the bond market. Bonds are supposed to reflect inflation expectations plus a small real return to compensate investors for the risk of ownership. There is no logic that supports the notion of negative interest rates unless one wants to assume persistent deflation over the life of a bond. With unemployment at 3.5% and wages rising 3% annually, there is no logic for imminent deflation even if you accept my argument for worldwide oversupply and lower commodity prices. In the U.S., that is particularly true because we have converted to a services-based economy from a manufacturing base since World War II. Services have a much higher labor component. Pick whatever inflation number you want. A 1.5% 10-year Treasury simply doesn’t given owners a real return. That isn’t sustainable. Obviously, the negative interest rate environment in Europe and Japan is even more non-sensical.

So, why would anyone buy a bond with a negative interest rate? One reason is if the buyer expected negative sentiment to get worse, leading to rates becoming even more negative. The other would be if one expected a world where deflation would be so severe that the pace of price deceleration exceeded a bond’s negative return. Both explanations are big stretches.

Bubbles burst when they get so large that the outer membrane has to burst. As we all know, when bubbles burst, the air escapes quickly. As for the bond market, there suddenly seems to be universal acceptance that moving rates even further into negative territory is counter productive and of no economic value. It is just a matter of time before the negative rates disappear and bonds once again are priced to give buyers a real return above the rate of inflation.

When a hurricane hits, the last place you want to be in is the path of the eye. At the fringes, there can still be damage, but it won’t be intense. In financial markets, the eyes are the private equity and bond markets. The stock market is impacted but at the fringes. Since World War II, the average recession has seen about a 13% decline in profits and a 20% decline in equity valuations. 2008 wasn’t typical; it just left behind the greatest amount of fear. If a mild recession does occur (and that remains a minority view), it should be short, and the damage will be limited. There is a large cloud out there in the future that centers around the massive buildup of debt but for that storm to turn into a hurricane, interest rates have to be much higher than they are today. In hurricane watcher terms, know the storm is out there, but it is more than 2,000 miles away.

Today, Simon Cowell is 60. Yo-yo Ma is 64. Vladimir Putin turns 67.

James M. Meyer, CFA 610-260-2220

Copyright © 2019 Tower Bridge Advisors

Additional information on companies in this report is available on request. This report is not a complete analysis of every material fact representing company, industry or security mentioned herein. This firm or its officers, stockholders, employees and clients, in the normal course of business, may have or acquire a position including options, if any, in the securities mentioned. This communication shall not be deemed to constitute an offer, or solicitation on our part with respect to the sale or purchase of any securities. The information above has been obtained from sources believed reliable, but is not necessarily complete and is not guaranteed. This report is prepared for general information only.

Boenning & Scattergood, Inc. – Member FINRA / SIPC.

It does not have regard to the specific investment objectives, financial situation or the particular needs of any specific person who may receive this report. Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed in this report and should understand that statements regarding future prospects may not be realized. Opinions are subject to change without notice.

Stocks staged a rather wobbly recovery yesterday despite another disappointing economic report, this time the ISM non-manufacturing survey of business activity in September.

Getting less attention was the report of weekly jobless claims filed, which continued to remain close to record lows. Clearly, the bulk of economic reports have suggested slower economic growth. As growth decelerates, the specter of recession increases. But while the data is discouraging, it still doesn’t point to an actual recession, at least not yet. Clearly, tariffs, Brexit and a possible impeachment process have some impact on confidence but none of the above appear, as of yet, to materially change consumer habits. As long as consumers are working, secure in their jobs and getting paid well, a recession seems a much less likely outcome than slower growth.

One factor that will help keep us out of recession is the steps taken by the Federal Reserve to keep the monetary environment favorable to growth. It has already initiated two rate cuts this year and the tepid data this week virtually insures at least one more this month. Markets expect a fourth cut in December, undoing all the rate increases the Fed initiated in 2018, but we don’t want to put the cart before the horse. December’s rate decision will depend on economic data between now and then.

Certainly, a persistent positive has been the labor market. Today’s employment report reinforces that trend. Employment growth in September was 136,000 jobs. Including upward revisions to July and August numbers, the increase was about 157,000. That is a very healthy number despite a slight decline in manufacturing jobs signaled earlier this week by the September manufacturing surveys. The average work week was flat as were wages. Year-over-year increases in wages of 2.9% remain well above the rate of inflation. Workers are getting real gains in income. The unemployment rate fell to 3.5%, the lowest since 1969. In order to have a recession with employment growth as strong as it is would require a huge drop in productivity, something that doesn’t appear likely over the near term.

While the employment numbers were at least as good as expected, the flat work week and decelerating wage growth suggest that we can’t label anything about this economy as robust. The most likely path is that economic growth over the next year will range between 1.5% and 2.5% before considering short term fluctuations in inventories. The headwinds created by the 2018 rate increases have just about worked their way through the economy while the impact of the rate cuts is just beginning to be felt.

Let me give an example. Housing is one of the industries most impacted by rate changes. The Fed’s first rate cut was in July and bond markets responded over the summer. There was a moderate but healthy increase in mortgage refinancing activity almost immediately. But it can take as long as 60-90 days to complete a mortgage refinancing. Similarly, while orders for new homes and new building permits are starting to respond to the lower rates, the impact to GDP is only reflected when a newly built home is completed and sold. That could take as long as a year. Corporations are taking advantage of lower rates and refinancing debt obligations. But once again, the time to complete a complex refinancing can take several months. Thus, over the summer, the delayed impact of higher rates instituted in 2018 was more impactful to actual economic activity than the impact of lower rates associated with a rate cut cycle that just began in July.

Playing this out further, the cyclical bottom in U.S. growth should be the second half of this year. Overseas, there are also signs of stabilization, particularly in Asia. While Europe is basically flat, consumers around the world are still confident and spending. Most of the world’s economic weakness relates to manufacturing, trade and capital spending. Not to beat a dead horse, but in a world that is oversupplied with almost everything but labor, the solution to overcapacity is less investment and increased demand. It is going to take years to absorb the excesses existing today. China, for one, has to stop building zombie plants and apartments. China alone can supply all of the world’s steel needs and then some. 5% of world oil supply goes off market briefly and despite a brief spike in prices, the cost of a barrel of oil today is less than it was before the missile attack on Saudi facilities.

Obviously, the absorption of excess capacity, and that includes everything from manufacturing plants to retail space, takes time. It causes weak prices and squeezes profit margins. That is why in 2019, our economy is growing about 2% in real terms and 4% in nominal terms while, at the same time, corporate profits are flat to down slightly. Earnings per share are held up by stock repurchases. Rising cash flows, a result of less need for capital investment, also leads to rising dividends.

One of Wall Street’s pet expressions is that the Fed is your friend when it is accommodative. Despite the outlook for flat or slowly rising earnings over the next year, low interest rates and rising dividends should support equity prices. Today’s employment report should provide some stability to the market, at least for the short term. October is a volatile month and most corporations are forbidden to buy back stock at the moment until they report third quarter earnings. There will be more tariff news this month and Brexit is an ongoing concern. But with that said, at least at the moment, the swoon earlier this week, which eerily resembled the start of the 20% decline that began last October, appears to be just a two-day swoon. With that said, we haven’t had anything close to a 10% correction so far this year and the S&P 500 remains locked in the 2600-3000 trading range. There is room for a 10% decline without violating the range. Managements are going to be wary discussing their fourth quarter outlooks without clarity on tariffs. Therefore, the best counsel at the moment is to be vigilant, expect higher than normal volatility and pick entry and exit points carefully.

Today, Alicia Silverstone is 43. Liev Schreiber is 52. Susan Sarandon turns 73.

James M. Meyer, CFA 610-260-2220

Copyright © 2019 Tower Bridge Advisors

Additional information on companies in this report is available on request. This report is not a complete analysis of every material fact representing company, industry or security mentioned herein. This firm or its officers, stockholders, employees and clients, in the normal course of business, may have or acquire a position including options, if any, in the securities mentioned. This communication shall not be deemed to constitute an offer, or solicitation on our part with respect to the sale or purchase of any securities. The information above has been obtained from sources believed reliable, but is not necessarily complete and is not guaranteed. This report is prepared for general information only.

Boenning & Scattergood, Inc. – Member FINRA / SIPC.

It does not have regard to the specific investment objectives, financial situation or the particular needs of any specific person who may receive this report. Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed in this report and should understand that statements regarding future prospects may not be realized. Opinions are subject to change without notice.

After a relatively quiet September, October opened with a thud after a stunningly weak manufacturing survey showed decided weakness last month.

While noting that this was a survey and not actual data, and the survey was weaker than expected in part due to inventory liquidation, when combined with moderating consumer confidence and overall economic slowness, investors got spooked. The timing of yesterday’s decline was also eerie as it came almost precisely one year to the day from the start of last year’s 20% slide in the fourth quarter.

While not all data is weakening, the preponderance of information suggests an economy losing steam. While the 2-10 year Treasury yield curve is no longer inverted, the 3-month to 10-year curve is still inverted, a telltale warning that a recession isn’t far away. Growth in Europe has stagnated, Japan remains in a funk and China is being impacted by tariff concerns and too much debt.

The Federal Reserve is caught in the middle. Before yesterday, I would have said the Fed has good reasons to skip cutting rates in October. It could afford to wait until December. There is a lot more data to come this week with the biggie, the monthly employment numbers, coming out on Friday. But just based on the manufacturing survey alone, the odds of another cut at the end of this month have increased. With that said, investors increasingly wonder how effective interest rate policy can be as a prime driver of economic growth. In a world where tariffs are slowing trade and serving as an added tax, and where fiscal policy drivers for growth around the globe are hardly existent, monetary policy alone cannot reignite growth.

A year ago, the Fed had just initiated its third of four rate increases in 2018. Corporate profits, courtesy of a large tax cut, were rising at double digit rates. Interest rates overall were rising. The U.S. 10-year Treasury yield was pushing toward 3%. But growth was slowing after peaking in the second quarter. The outlook for 2019 a year ago was for earnings per share growth to moderate to mid-high single digits. A year later, that proved to be rather optimistic. But lower interest rates helped to keep stock valuations elevated.

Since early 2018, the S&P 500 has flirted with the 3000 level, sometimes exceeding it by a bit and sometimes coming up a bit short. To break through, earnings estimates will have to rise from current expectations, something that doesn’t seem likely as long as the trade wars continue. At the moment, the timetable for tariffs suggests further escalation in mid-October and again in December. So far, those are threats; not commitments written in stone. But the threats overhang the market. The escalating impeachment concerns threaten to further polarize Congress and put the new trade agreement with Canada and Mexico in jeopardy, although House Speaker Nancy Pelosi and Trade Representative Robert Lighthizer are trying hard to get a deal done. One shouldn’t expect any other significant legislation between now and the Presidential election.

All this somber news suggests the possibility of a repeat of last year’s weak fourth quarter. Indeed, if I look back over the past several years, when traders get negative, markets fall sharply. So much volume is concentrated today in so few hands that when all get negative at the same time, as they are prone to do at economic inflection points, the declines can feel very painful. But without real fundamental data to back up the declines, they have tended to be short-lived. Last year’s September-December swoon was entirely reversed by April. That is a far cry from bear markets we have seen in the past, most recently in 2008-2009. For that kind of a decline to persist requires major changes in consumer behavior, something that is hard to fathom as long as most Americans are gainfully employed with wages rising faster than inflation. Moreover, there are some bright spots. Low interest rates have reignited some interest in housing. That market is clearly off its lows. Technology spending, mostly for software and infrastructure, remains robust as companies move more to the Cloud. Internet retailing is robust and growing at double-digit rates.

One key is to try and differentiate a wobble in the economy’s growth rate from the start of a true recession. Here are some keys to watch:

1. Weekly unemployment claims – They have stayed persistently in the 200,000-225,000 range for many months. Any move above that range would be a warning. Anything above 250,000 would be dangerous.
2. Housing starts – If despite low rates, housing demand wanes, that would be a true indicator of the impotence of monetary policy. So far at least, housing appears to be perking up, a good sign.
3. A significant drop in consumer confidence – While surveys suggest some increase in apprehension, so far consumers are confident. Lower energy prices help. Could impeachment talk soil the mood? I don’t think it does directly. But if events played out in a way that the future of a Trump Presidency was in doubt, related uncertainties could give way to some pause. Interestingly, polls today show an overwhelming support for the impeachment process in Congressional districts with a Democratic Representative and overwhelming opposition in Republican-help districts. Should those opinions change in either direction in a meaningful way, the future would change accordingly. Members of Congress follow the polls.
4. The JOLTS survey of job openings – This monthly survey has been showing measurable declines in recent months. Further declines would be disconcerting.
5. The stock and bond markets – Paul Samuelson, the noted economist, noted that markets have predicted nine of the last five recessions. That means almost as many false signals as positive ones. But virtually all recessions are preceded by some stock market decline. With rates declining, bond markets are signaling lower inflation expectations, although recent rallies suggest that maybe the lows in rates for this cycle are behind us. However, a meaningful deterioration in the economy would lower inflation expectations further and could invert the 2-10 year spread once again. If that were to happen, it would raise a pretty vivid warning sign. So far, over the past few weeks, the spread has actually widened a touch.

The bottom line is that growth is slowing but signs of recession are still not visible. We see some points of concern but no real sense that recession is imminent. That could change, of course, particularly if the full package of proposed Chinese tariffs is implemented by the end of 2019. However, given the economic and political climate today, I still believe it is unlikely we see the full package implemented. Right now, the President needs few wins, not more pain.

These conclusions don’t preclude a brief sharp correction. We haven’t had one yet this year, October is often a volatile month and stock valuations are full. But I don’t see any correction likely to be long lasting without a commensurate recession. So far, data doesn’t support a recession thesis.

Today, Kelly Ripa is 49. Sting is 68. Singer Don McLean is 74. He has been spending the last 48 years singing one song, “American Pie,” as the centerpiece of his concert tours.

James M. Meyer, CFA 610-260-2220

Copyright © 2019 Tower Bridge Advisors

Additional information on companies in this report is available on request. This report is not a complete analysis of every material fact representing company, industry or security mentioned herein. This firm or its officers, stockholders, employees and clients, in the normal course of business, may have or acquire a position including options, if any, in the securities mentioned. This communication shall not be deemed to constitute an offer, or solicitation on our part with respect to the sale or purchase of any securities. The information above has been obtained from sources believed reliable, but is not necessarily complete and is not guaranteed. This report is prepared for general information only.

Boenning & Scattergood, Inc. – Member FINRA / SIPC.

It does not have regard to the specific investment objectives, financial situation or the particular needs of any specific person who may receive this report. Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed in this report and should understand that statements regarding future prospects may not be realized. Opinions are subject to change without notice.

Stocks fell Friday after it was disclosed that the Trump administration was contemplating restrictions on investment in Chinese businesses.

Also last week, President Trump suggested that trade talks with China were going well and an agreement might come sooner rather than later. Let me try to put both into context. The comments regarding investment in China most likely refers to an SEC effort to make Chinese companies with shares listed in the U.S. be required to follow the same reporting standards as American companies do. Under the Obama administration, exemptions were granted in order to allow Americans to invest in fast-growing Chinese companies and permit some of those companies to list on American exchanges. That was never a good idea. Bad accounting or voids in the relevant information provided only leads to bad results. Every company choosing to list their shares on American exchanges should follow the same set of rules. If one wants to attract U.S. investors, one needs to pay the price of financial transparency and integrity. Kudos to the SEC for attempting to require full and proper disclosure for all.

As for the progress in trade talks, I think those comments, mostly from the President’s tweets, should be regarded as virtually meaningless. The only substantive talks so far have been among mid-level negotiators. Anyone involved in complex negotiations knows that it is the last sticking points that are the hardest. Obviously, I am not a party to the trade talks and maybe some easy agreements have actually been reached. But I suspect the positive remarks on trade last week were as much to divert attention away from impeachment and the Ukraine as it was a substantive comment on the future of trade between China and the U.S.

As I suggested, we were in a period toward the end of each quarter where the news flow was light and little change in the economic outlook was to be expected. Of course, political turmoil grabbed all the headlines, not only from Washington but from London and Tel Aviv as well. The rancor certainly reached high levels but from an economic point of view, nothing happened. In the U.S., as impeachment inquiries begin, the big question is can Congress get any other business accomplished. There are still spending bills that need to pass and there is little doubt that will happen. Less certain is the outlook for the certification of trade agreements with Canada and Mexico. House Speaker Nancy Pelosi is trying hard to keep the legislative calendar on track. She has a good working relationship with Trade Representative Robert Lighthizer, and he has the respect of Congress. With all the political infighting, first term Democrats who want to get elected next year have to show constituents that they can get something done. So far, they have done very little. Getting a trade deal through is important for all, and I still think the odds are better than 50-50 that it will happen. Beyond that, look for very little from Congress between now and next year’s election. Unfortunately, that isn’t much different than what we have witnessed for the past decade.

The uncertainties in Britain are a bit more concerning. There are still a whole range of possible outcomes between now and the Brexit deadline next month. New Prime Minister Boris Johnson seems to have lost whatever control he started with, and the headlines there are at least as rancorous as they are here. There remains no obvious outcome. Anything from another delay to a hard withdrawal remain real possibilities.

As for the big headline story (the efforts by House Democrats to move down the path of impeachment), history shows that these events have very little impact on the stock market. While the news grabs headlines, it doesn’t change the way Americans conduct their daily lives. This week will bring a stream of economic data likely to show a continuation of a slow growth economy. Once again, the most important item will be Friday’s employment report. As long as Americans are gainfully employed and real wages continue to rise, our economic growth path should remain in place. Inflation remains low but not non-existent. Indeed, if I were a Federal Reserve banker (and last time I checked, I wasn’t), I would find little incentive to tinker with lending conditions any further, at least from the perspective of interest rates. Another quarter point cut at the end of October remains a possibility, but it is equally possible that the Fed takes a pass this time around and waits until December to see if another cut is needed. Negative rates continue in Europe, but central bankers everywhere are starting to believe that moving rates even further into economic territory might be more damaging than beneficial. As a result, rate changes have calmed down in active markets with the 10-year Treasury hovering around 1.7%. If the Fed must do something, it should take steps to increase liquidity in the overnight repo market. It can do that by injecting cash into markets via open market purchases and allowing its balance sheet to grow in line with money supply. The Fed is likely to formalize that over the next several weeks.

Otherwise, we wait for earnings season and, perhaps, some real progress on trade later in the fourth quarter, which starts tomorrow. Today’s market will be dominated by window dressing as fund managers pretty up their balance sheets for third quarter reporting. Earnings in the third quarter should be OK with a bit less currency related pressure than was felt in the first two quarters. But as always, it will be management forward-looking commentary that will get the most attention. Cyclical, industrial, commodity and financial companies should all have relatively guarded outlooks. Virtually all multi-national companies will note the risks of higher tariffs. Companies that cater mostly to consumers and tech companies focused on software and the transition to the cloud should have better news. Recent high profile IPO failures will remove some luster from that market, but if you believe either should be profitable or on an obvious path to profitability in order to be a public company, that should be good news, not bad.

Today, Academy Award winner Marion Cotillard is 44. Johnny Mathis turns 84.

James M. Meyer, CFA 610-260-2220

Copyright © 2019 Tower Bridge Advisors

Additional information on companies in this report is available on request. This report is not a complete analysis of every material fact representing company, industry or security mentioned herein. This firm or its officers, stockholders, employees and clients, in the normal course of business, may have or acquire a position including options, if any, in the securities mentioned. This communication shall not be deemed to constitute an offer, or solicitation on our part with respect to the sale or purchase of any securities. The information above has been obtained from sources believed reliable, but is not necessarily complete and is not guaranteed. This report is prepared for general information only.

Boenning & Scattergood, Inc. – Member FINRA / SIPC.

It does not have regard to the specific investment objectives, financial situation or the particular needs of any specific person who may receive this report. Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed in this report and should understand that statements regarding future prospects may not be realized. Opinions are subject to change without notice.

Stocks have generally drifted lower this week after two strong weeks of gains that challenged old highs.

Bond yields have also traded within a narrow range. The Federal Reserve cut interest rates by 25 basis points, as expected, and suggested that future cuts would be dependent on economic data.

While expressing concerns about global weakness, the Fed seems to have developed a consensus that no recession is near at hand, but cuts are a legitimate consequence of a need to protect a slow growing economy from being infected by weaknesses caused by global deceleration and higher tariffs. At the same time, the Fed majority doesn’t appear to be in the mood to be very aggressive in its rate cutting posture. The whole world, in fact, seems to be ready finally to reconsider the notion that negative interest rates are a growth stimulant. Growth in both Europe and Japan hover near zero even as their respective central banks pursue a policy of negative rates and quantitative easing. While negative rates certainly penalize holding cash, they don’t necessarily force the holders to spend it. Rather, they react by taking more risks and invest in other financial assets that offer positive returns. In the short run, that might be great for stock and bond values, but once the lid is put back on the cookie jar and rates normalize, then what?

The answer is complicated. First, central bankers in those geographies living with negative rates are fearful reversing course will lead to recession or worse. Said a different way, they simply don’t have any idea how to exit bad policy without doing great damage. The scary answer is that quite possibly, there isn’t an easy way out. Buying all the bonds in sight as a way of pumping more money into the system creates chaos. More and more cash is looking for a place to park, but the amount of high-quality debt not already sopped up by central banks keeps shrinking. More demand and less supply mean higher prices. In the bond world, that means lower interest rates. With rates already negative, lower rates means the negative rates go even deeper into the red.

In our country, the chaos has begun to appear in the repo market, the prime market that supports overnight lending. Without getting deep into the weeds, the reduction of the Fed’s balance sheet has led to less cash and more collateral in the system. If too many banks at once need more cash to settle transactions in the normal course of business, there is a mismatch of too much collateral and too little cash. That causes temporary spikes in overnight lending rates. In turn, that has forced the New York Fed, which handles daily transactions, to infuse more cash into the system. This isn’t a systemic problem that should worry anyone at the moment, but it does point out that steps to effectuate monetary policy require adequate liquidity. When the Fed wants to hold rates relatively stable at the same time the Treasury needs to sell over $1.25 trillion in new debt every year to fund deficits, these clashes occur and they will occur more often unless other sources of cash (e.g. foreign buyers) emerge.

As for the markets near term, there is little news expected for the balance of this month. Low level trade talks between China and the U.S. are ending today, and it would be logical to expect a tweet that all is going well. The Chinese may even visit some farmers and promise to buy more soybeans. While markets expect some sort of agreement before Christmas, it isn’t likely to be substantive enough to move markets materially higher. Yes, the suspension of the next planned round of tariffs in December would be a pleasant outcome, but the recent rally has largely discounted that. Any reduction of tariffs already in place, matched with Chinese promises to be more respectful of intellectual property, could be a propellant, but it is too early to go that far. Nothing this week will lead anyone to that conclusion.

Economic data has generally been good. The most pleasant surprise was the increase in industrial production in August. Markets will await September data, which is still 10 days or more away. There may be a smattering of earnings news over the next week, including a few preannouncements from companies that are doing much better or worse than expected. But, for the most part, earnings news is 3-4 weeks away.

Thus, we don’t expect a major move in either direction until rates change materially or there is a real adjustment to earnings expectations. Stocks are flirting with recent highs, but the gains since the January 2018 peak have been small. Flat earnings for three quarters have resulted in slightly lower expectations offset by lower rates. Unless recession indicators flash yellow or red soon, it is logical that the path of least resistance for rates is higher. That means earnings expectations need to rise for stocks to move solidly higher. Q4 is often a good time for stocks. I think management commentary that will accompany Q3 earnings will be relatively cautious given the announced intent to increase tariffs in December. But if those tariffs don’t happen, there could be a move to new highs. That won’t happen until there is more clarity on tariffs and that isn’t something we are likely to hear this week or next.

Today, Sophia Loren is 85.

James M. Meyer, CFA 610-260-2220

Copyright © 2019 Tower Bridge Advisors

Additional information on companies in this report is available on request. This report is not a complete analysis of every material fact representing company, industry or security mentioned herein. This firm or its officers, stockholders, employees and clients, in the normal course of business, may have or acquire a position including options, if any, in the securities mentioned. This communication shall not be deemed to constitute an offer, or solicitation on our part with respect to the sale or purchase of any securities. The information above has been obtained from sources believed reliable, but is not necessarily complete and is not guaranteed. This report is prepared for general information only.

Boenning & Scattergood, Inc. – Member FINRA / SIPC.

It does not have regard to the specific investment objectives, financial situation or the particular needs of any specific person who may receive this report. Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed in this report and should understand that statements regarding future prospects may not be realized. Opinions are subject to change without notice.

Stocks continued their winning streak on Friday, at least from the viewpoint of the Dow Industrials, which rose for an eighth straight session.

But the S&P 500 and NASDAQ Composite finished lower. Over the weekend, a drone missile attack against Saudi Arabia knocked out over 2 million barrels of oil production instantly. How long it will take to restore the field to normal production is unknown at this time, but it will certainly be months if not longer. Houthi rebels from Yemen, in war with Saudi Arabia, claimed responsibility, but the U.S. State Department was quick to blame Iran. Whatever the cause, the price of oil jumped by over 8% and will certainly have an impact on world economics. Futures point to a lower open.

If this attack had happened a few decades ago, the impact would have been much more severe. However, in the interim, both the U.S. and the Soviet Union have developed into oil producers about the size of Saudi Arabia. Moreover, after the oil embargo of the late 1970s, the U.S. built up a large Strategic Petroleum Reserve (SPR) to protect against sudden shortages, whether they be created politically or by Mother Nature. President Trump has already stated that he will use oil from that reserve to compensate, if needed, for the lost production.

Saudi and Russia officials are due to meet today. You should remember that the two countries have reduced production recently to compensate for lower world demand growth. While the Saudis may not be in a position to raise production today from other fields to compensate fully for the lost production, the Russians could increase somewhat. In addition, should prices stay elevated, U.S. production from the Permian basin and other fracked oil fields will accelerate production to take advantage of higher prices. The net result is that the loss of 2-3 million barrels per day is a jolt to world oil markets but will not cripple the industry or world economies.

All this presumes no further missile strikes or any further production cuts. The U.S., as noted, has been quick to blame Iran, a likely supplier of missiles to the Houthi rebels with enough range and capacity to strike Saudi oil fields. Certainly, key in the days ahead is the Saudi reaction. If they refuse to blame the Iranians outright, it will be harder for the U.S. to make the case to the rest of the world that Iran is to blame and should be punished further. The annual United Nations General Assembly meetings come up imminently and world reaction to the missile strikes will be front and center. Clearly, Iran has become economically isolated, even assuming some tacit support from the Soviet Union and China. But the U.S. has isolated itself over the past few years and building a coalition to support bold action against Iran will be difficult. With that said, I will leave the politics to others. The economic reality is a body shot to oil markets but not a knockout blow either to the oil industry or to world economic growth. The muted reaction from the futures markets this morning seems to agree with that conclusion.

Elsewhere, the big news last week was the sharp rebound in bond yields. In a matter of just a couple of weeks, yields on 10-year Treasuries fell from roughly 2% to under 1.5%, only to rebound within a matter of days to over 1.9%. Overnight, they slipped back again because of the missile attack, but the 2-10 year curve is no longer inverted and recent data suggest strongly that no recession is imminent. Of course, if tariff wars escalate or oil production is impacted further by additional missile attacks, all bets are off. But there are always red herring risks. President Trump has already hinted at the possibility of an interim trade deal that would allow economic pressure from increased tariffs to be reduced. You don’t have to be a rocket scientist to realize that if the economy in 2020 is under pressure from accelerating tariffs, Mr. Trump’s reelection chances would be reduced. He realizes this. Of course, so do the Chinese and there remains a risk that the Chinese will overplay their hand and not give Mr. Trump enough space to find an interim solution that would allow him to still appear strong against Chinese perceived trade violations. The world is full of ifs.

But while the stock market takes ifs into consideration, the bottom line is always earnings and dividends. Solid economic data over the past two weeks support a conclusion that earnings will recover a bit over the next few quarters. Interest rates remain low. In theory, the recent jump in 10-year bond yields should have been a headwind to stocks, but a P/E of 17-18 times forward earnings is more consistent with a 10-year yield of 2% or a bit higher than a yield of 1.5% or lower. Said differently, the stock market never believed that rates of 1.5% or lower were sustainable. Inflation data last week (both PPI and CPI were reported) suggest inflation is running close to 2%. We live in a bifurcated economic world. Consumer and government spending are strong while industrial and capital spending are weak. Prices of commodities and other goods with low labor components are weak, while prices for services and products with high labor components continue to rise. The mixed picture is reflected in the stock market. In general, producers of commodities, industrial products, and capital goods are weak while domestic services for IT consulting to restaurants have been winners. In addition, despite a world economic slowdown, consumers all over the planet continue to spend.

In summary, the oil shock will pass if it is a one-time event. That could be a big if. But until tensions escalate to the point that consumer spending weakens, the economy is OK. Over the next few days, we will see if tensions escalate or not. As we all know, President Trump’s instinct is to hit back harder. But he also wants to avoid war or any event that precipitates war. There isn’t a lot of space in between. As for today, oil stocks and beneficiaries of higher oil prices will be today’s winners while companies highly dependent on oil prices will come under pressure (e.g. airlines).

Today, David Copperfield is 63.

James M. Meyer, CFA 610-260-2220

Additional information is available upon request.
* – Boenning and Scattergood may act as principal in buying this stock from or selling it to the public.
# – The author of this report or accounts under his management at Tower Bridge Advisors owns this security.

Additional information on companies in this report is available on request. This report is not a complete analysis of every material fact representing company, industry, or security mentioned herein. This firm or its officers, stockholders, employees, and clients, in the normal course of business, may have or acquire a position including options, if any, in the securities mentioned. This communication shall not be deemed to constitute an offer, or solicitation on our part with respect to the sale or purchase of any securities. The information above has been obtained from sources believed reliable, but is not necessarily complete and is not guaranteed. This report is prepared for general information only.

Boenning & Scattergood, Inc. – Member FINRA / SIPC.

It does not have regard to the specific investment objectives, financial situation, or the particular needs of any specific person who may receive this report. Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed in this report and should understand that statements regarding future prospects may not be realized. Opinions are subject to change without notice.

Stocks finished higher yesterday. The Dow Jones Industrials extended their winning streak to 7 straight sessions.

But after pushing toward new all-time highs, stocks retreated in the afternoon and finished well off their best levels of the day. A 7-day rally showed signs of exhaustion, although futures are higher again in the overnight hours.

President Trump, in an after hours tweet, suggested that an “interim” trade deal was a possibility. Translation: there is no way that China is going to give in to all our demands any time soon so a compromise that releases some of the tariff pressure in front of elections may be a necessary step. That means no conclusions related to forced technology transfers, intellectual property theft, and all the other hard issues. But it also suggests China will buy more soybeans and make efforts to reduce its trade surplus with us. In other words, back to square one, saving as much face as politically possible while still keeping a modicum of political pressure on the Chinese to consider our wish list. For the past few weeks, markets have been on the rise expecting just such a path, one followed fairly often by the President since taking office.

From a stock market standpoint, this might all be good news. The chance that China would cave and give in to all our demands was always remote. President Trump picked a fight that was very difficult to win outright, if at all. With an election approaching, an interim deal was the best outcome. Interim takes away the opposition argument that the deal is weak or less than desired because the word interim defines the deal as a work in process. Of course, an interim deal may never result in a final deal that meets all our objectives, but that is the beauty of labeling it interim. There is no deadline to a final agreement. As we have noted many times, China has very little incentive to change its ways in any significant manner today. Over time, if it wants to sit on the same economic stage as the rest of the developed world, change will be necessary, but that will happen on Chinese terms, not because of American tariffs.

The stock market’s recent rally suggests that investors felt an interim deal was the most likely outcome. No one should have doubted that with an election approaching, Mr. Trump would play hardball all the way to election day. Of course, nothing is carved in stone. Should the President feel China is taking advantage of him, he could still escalate tariffs. But both sides want interim calm before the election, and that remains the most likely outcome.

Although trade optimism sparked the recent rally and sets the market up for an attack on all-time highs once again, valuation remains tied to interest rates and earnings, not tariffs. As a result, with earnings estimates still coming down a bit, and with the lows in long-term rates possibly now behind us, further gains in stock prices from the near-record highs of today demand either raised earnings estimates or lower interest rates. Both are problematic at best. That suggests with the good trade news now priced in, a further thrust must come from elsewhere. One might argue that fears of recession have receded, but there has been no real change in economic data recently that either increased or decreased the odds of recession. Today’s retail sales report for August is the one data item that could be market moving. The consumer has been the rock bed of this economy. A weak sales report wouldn’t be well received.

The short-term shift toward banks, energy, and industrials versus a decline in high-tech, big multiple stocks may have already run its course. Or, more likely, banks, etc. will still get attention from investors seeking value while the rapid retreat in growth stocks also sends investors looking for bargains. Yesterday, oil stocks gave back a bit and the growth stocks bounced. But the bounce needs to continue to be convincing. After seven straight up days, some consolidation is probably appropriate. What is apparent is that the growth stocks remain in an uptrend despite recent corrective moves, and the banks, industrials, and oil stocks seem to be better positioned than they have for months. That means all stocks are in better technical condition than they were a few weeks ago and an attack to new highs is therefore quite possible. But given that earnings estimates continue to fall and interest rates are rising from recent lows, one has to question how much further the rally can go without improved economic news. The good trade news is out. Central banks are easing but not as aggressively as expected just a few days ago. There is a better than 50:50 chance that the bond yields won’t revisit their recent lows. Serious forward progress that takes stocks meaningfully higher demands better earnings prospects. We will learn more as earnings season arrives about a month from now.

Today, Tyler Perry turns 50.

James M. Meyer, CFA 610-260-2220

Additional information is available upon request.
* – Boenning and Scattergood may act as principal in buying this stock from or selling it to the public.
# – The author of this report or accounts under his management at Tower Bridge Advisors owns this security.

Additional information on companies in this report is available on request. This report is not a complete analysis of every material fact representing company, industry, or security mentioned herein. This firm or its officers, stockholders, employees, and clients, in the normal course of business, may have or acquire a position including options, if any, in the securities mentioned. This communication shall not be deemed to constitute an offer, or solicitation on our part with respect to the sale or purchase of any securities. The information above has been obtained from sources believed reliable, but is not necessarily complete and is not guaranteed. This report is prepared for general information only.

Boenning & Scattergood, Inc. – Member FINRA / SIPC.

It does not have regard to the specific investment objectives, financial situation, or the particular needs of any specific person who may receive this report. Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed in this report and should understand that statements regarding future prospects may not be realized. Opinions are subject to change without notice.

Stocks were mixed once again. It has been an odd week, at least compared to prior trading patterns.

The leaders this week have been the former bull market laggards, namely energy, banks, and industrials. Meanwhile, the former tech darlings, including many prominent IPO names, saw significant profit taking. There must be a message in there somewhere. We’ll take a stab at understanding it.

OK, so the darlings deserve a break. At some point, the break is going to be a lot more painful than a few down days like we saw this week. When the real pain arrives, there will be lots of capitulation. I can’t tell you that correction has started or that the last few days are a momentary head fake. But there will come a time when reality sets in. The new age winners deserve high valuations. Many are true bona fide growth companies. But when multiples of market price to sales start to get near triple digits, clearly euphoria was replacing sanity.

But what about the surge in oil and bank stocks? Perhaps in those cases, investors were throwing out the baby with the bath water. Oil prices normally weaken even before the summer driving season peaks. But they are nowhere near their 2016 lows and supply/demand equations look to be in relative balance today. Many stocks of oil producers were selling for a significant discount to the value of their oil reserves in the ground. They were due for a rebound. As for the banks, everyone seemed fixated on the threat of low interest rates and a flat yield curve to their earnings. While net interest margin is an important factor, it doesn’t move around as quickly as rates change. At worst, bank earnings are going to flatten for a while assuming a recession isn’t just around the corner (more on that in a moment). Meanwhile, banks have much better balance sheets than they had a decade ago, and they generate a lot of cash to pay handsome dividends and buy back stock, often at or below book value. Book value at a bank is a real number comprised mostly of loans, cash, and other financial assets that are easy to value. In most stock markets, investors chase momentum. They buy what’s going up and sell what isn’t. Reversals like we are seeing this week are a reminder that momentum is not always your friend. In the end, valuation matters.

That isn’t to say growth is dead and value is due for a comeback. In fact, many traditional value stocks, like utilities, REITs, and consumer staples, have become market darlings over the past several months as investors searched for yield in a world where a 10-year Treasury only provided less than 1.5%. You have seen me note that when the yield on the S&P 500 is greater than the yield on a 10-year Treasury, as it is today, stocks are much more attractive than bonds. That still holds true and it will limit the downside to some of these safe havens. But they, too, probably went a bit too far and some correction is warranted.

Thus, there is rationality to what is happening now. It doesn’t have to be a long drawn out process. The bounce in bond yields was a triggering factor but valuation, in the end, trumps everything.

As for the economy, everything is fine at the moment. Tariffs to date have served to slow growth. But other than the effect of tariffs, all else is going reasonably well. World slowdowns are affecting manufacturing and capital spending, but consumers all over the world remain confident spenders. Obviously, if trade wars escalate, all this could unravel. If the next round of tariffs is implemented in mid-December, we may have to reassess. But let us not put the cart before the horse. There is a long time and a lot of trade negotiations between now and then. Mr. Trump doesn’t want to create a recession on the eve of elections. He has a lot of incentive to find a less hostile path. Markets today are betting he will. We will see soon whether they are right.

In times of change, pay close attention to valuation. Don’t be afraid to take profits in stocks that moved too far, too fast. And don’t be afraid to buy real bargains. But don’t chase either. Oil stocks aren’t growth stocks. They simply got too cheap for a time. Banks have some growth characteristics, but they aren’t going to grow faster than GDP. Valuation matters once again.

Today Taraji Henson is 49.

James M. Meyer, CFA 610-260-2220

Additional information is available upon request.
* – Boenning and Scattergood may act as principal in buying this stock from or selling it to the public.
# – The author of this report or accounts under his management at Tower Bridge Advisors owns this security.

Additional information on companies in this report is available on request. This report is not a complete analysis of every material fact representing company, industry, or security mentioned herein. This firm or its officers, stockholders, employees, and clients, in the normal course of business, may have or acquire a position including options, if any, in the securities mentioned. This communication shall not be deemed to constitute an offer, or solicitation on our part with respect to the sale or purchase of any securities. The information above has been obtained from sources believed reliable, but is not necessarily complete and is not guaranteed. This report is prepared for general information only.

Boenning & Scattergood, Inc. – Member FINRA / SIPC.

It does not have regard to the specific investment objectives, financial situation, or the particular needs of any specific person who may receive this report. Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed in this report and should understand that statements regarding future prospects may not be realized. Opinions are subject to change without notice.

Stocks moved sideways in listless trading on Friday.

Volatility took a distinct move down after an employment report that was generally within the range of expectations. This week will be a quiet one for both corporate and economic news. Earnings season is still more than a month away. September is generally the most important month of the third quarter, and it is too early to get any read. While recent focus has been on the outlook for Chinese trade talks, little is likely to happen this week. President Trump could, at any time, suggest talks are progressing or not, but, tweets aside, the real target date for anything substantive is mid-November when Trump and Xi could meet in Santiago, Chile.

Next week is the FOMC meeting. But aside from presidential griping about lack of aggressive action to lower rates more than the Fed wants to, the meeting’s outcome is almost a foregone conclusion. There simply isn’t enough economic data for the FOMC to seriously consider a 50-basis point rate reduction at this time and there is enough consensus to do something that standing pat is unlikely as well. Therefore, expect a 25-basis point cut. As for the future, the Fed will leave options open. Mr. Powell is likely to acknowledge weakness overseas amid a low rate environment. But those facts alone won’t cause the Fed to move aggressively to match those rates if the U.S. continues to grow 2%+ and inflation remains reasonably close to 2%. The month-over-month increase in wages of over 4.5% announced on Friday alone suggests sufficient inflationary pressure to give the Fed reason to move cautiously going forward. Furthermore, as noted last week, the rather tepid response of mortgage holders to refinance in the current low rate environment supports the conclusion that central banks, by themselves, cannot move the economic growth curve an awful lot. Fiscal policy, which includes federal spending levels, tax policy, and tariffs, have much more influence. The Fed can try to counterbalance external trends, but, by itself, cannot make the economy grow faster or slower to an appreciable extent.

As for markets, relative calm amid a market with positive momentum suggests that the path of least resistance remains higher. Stocks could take a run near term at record levels, which are less than 2% away. One should note, however, that typical of a mature bull market, a minority of issues have been doing the heavy lifting lately. The market’s current march toward record highs has been led by an odd combination of safety names (e.g. utilities, REITs, and consumer staples) and a few high growth companies that have persistently met or exceeded expectations. With that said, many of the leaders, Class of 2018, are not the leaders today, including some high-profile semiconductor companies and FANG components. In other words, this isn’t a record setting market with broad breadth.

Today, Adam Sandler is 53. Hugh Grant turns 59.

James M. Meyer, CFA 610-260-2220

Additional information is available upon request.
* – Boenning and Scattergood may act as principal in buying this stock from or selling it to the public.
# – The author of this report or accounts under his management at Tower Bridge Advisors owns this security.

Additional information on companies in this report is available on request. This report is not a complete analysis of every material fact representing company, industry, or security mentioned herein. This firm or its officers, stockholders, employees, and clients, in the normal course of business, may have or acquire a position including options, if any, in the securities mentioned. This communication shall not be deemed to constitute an offer, or solicitation on our part with respect to the sale or purchase of any securities. The information above has been obtained from sources believed reliable, but is not necessarily complete and is not guaranteed. This report is prepared for general information only.

Boenning & Scattergood, Inc. – Member FINRA / SIPC.

It does not have regard to the specific investment objectives, financial situation, or the particular needs of any specific person who may receive this report. Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed in this report and should understand that statements regarding future prospects may not be realized. Opinions are subject to change without notice.

Stocks continued a sharp 3-day rally as prospects for renewed trade talks with China continue to improve.

Bonds fell and interest rates rose, slowing the recent tailspin in rates.

It is always nice to see a sharp rally given that most of us are long-only equity investors. But we have ridden this roller coaster too often to get too comfortable that talks will turn into a substantive agreement. We have seen President Trump call Chinese President Xi an outstanding man, we have heard him talk of how well trade talks were going, and we have heard him extol the virtues of the American positions on trade balances, forced technology transfers, and intellectual property theft that only he could tackle and solve. We have also heard him accuse the Chinese of reneging on agreements, mistreating American companies, and being our economic enemy. His feelings today could change 180 degrees tomorrow.

Here is the reality of the moment. We have five separate lists of tariffs on Chinese goods — List 1, List 2, List 3, List 4A, and List 4B. As of this past weekend, we have levied tariffs to various degrees against products on the first 4 lists. Small additional tariffs are scheduled for Lists 1, 2, and 3 on October 1. We expect all those to happen. Lists 1 and 2 covered less than $40 billion of goods. List 3 ratcheted that up, placing tariffs on an additional $170 billion of goods. The September 1 action increased tariffs on all List 1-3 goods and started a new level of tariffs on List 4A of another $125 billion in goods. But the biggie is yet to come. That is List 4B. That includes mostly consumer items from golf shirts to iPhones. What is so key about those tariffs is that over 85% of the goods subject to List 4B tariffs are solely sourced from China. For all the other goods, the percentage was below 25%. There have been alternative options. In other words, if List 4B tariffs are implemented on December 15, as President Trump has announced, both China and the U.S. will be impacted in ways much more significant than the tariffs on Lists 1-4A.

This all may sound like mumbo jumbo but its economic impact is real. China knows it. So does Donald Trump. Neither side really wants to see those tariffs implemented. Trump is running for reelection. Xi presides over an economy losing steam and has his hands full with the Hong Kong situation. The problem is how to come to a solution that both sides can live with. There is virtually no chance of a comprehensive agreement between now and December 15. For one, too much bad blood has been spilled. The Chinese are not used to the verbal abuse Mr. Trump dishes out, they don’t like the tariffs already in place, and they don’t appear ready to make major structural changes. Mr. Trump likes the tariffs, believing they give him leverage and provide the government some income. He wants China to help narrow the balance of payment deficits we have with that country. Several times, he has spoken of Chinese commitments to buy huge amounts of our agricultural products only to find out later that they didn’t come through. Mr. Trump wants to keep tariffs in place to ensure Chinese compliance with whatever agreements are reached. The Chinese want assurances that Trump won’t raise tariffs in the future, as he has threatened to do against Mexico to slow the flow of migrants into the U.S. It won’t be easy.

But trade agreements are never easy. Implementing List 4B tariffs would clearly impact U.S. GDP growth that is already slowing, could raise consumer prices of some high-profile items, and would certainly squeeze corporate profits. You can be almost certain that if List 4B tariffs are implemented as announced on December 15, the stock market will be traded at or above where it is today. Investors are betting that the President will find some way to postpone or cancel those tariffs as the calendar turns to 2020 and the Presidential election. There should be little doubt that Americans will not like the economic pain associated with tariffs if there are no substantive concessions from the Chinese.

The most probable outcome is for low level talks to begin soon, higher level talks to happen in October, and then Trump and Xi will find some way to make nice and come to an interim deal when they meet at the APEC summit in mid-November. Such an agreement might include agricultural purchases that are implemented before the December 15th deadline, making a modest rollback in tariffs, allowing the WTO to reclassify China as a developed nation, and some vague language talking about future measures involving intellectual property rights.

While that is the most probable path, there is plenty of room to derail. If both sides draw red lines that never intersect, compromise may not be possible. Both sides have histories of reneging on promises. Whatever deal Trump agrees to, he will be praised by his acolytes and damned by the liberals. How he reacts to the crosscurrent can’t be predicted.

The bottom line is that the news that both sides are willing to enter substantive talks again is a positive sign, but it is only a first step. Don’t expect any real headway to be made until just before Trump and Xi meet in November. Between now and then, there will be two FOMC meetings and third quarter earnings. While a 25-basis point rate cut in September is now a virtual certainty, October’s actions remain an open question. As for earnings, they should be OK but with an asterisk. The asterisk pertains to forward looking commentary by managements. Anyone affected by List 4B tariffs, and there will be many, will couch any comments with lots of warnings of diminished expectations should those tariffs be implemented.

The other big news item today is the August employment report. 130,000 new jobs were added. But private sector employment rose by only 96,000. The balance was a healthy jump in government workers, which might include an increase related to the 2020 census. The unemployment rate was steady at 3.7%. Average wages were up 3.2% versus a year ago, but over 4.5% month-over-month. For all those worried about deflation, rising wages are offsetting pressure. As noted previously, while segments of our economy, especially those tied to commodities, are experiencing deflation, labor intensive businesses, mostly service oriented, continue to raise prices to offset wage increases. Employers continue to complain of the difficulty of finding people to hire. That, undoubtedly, serves to slow the growth in employment and puts upward pressure on wages.

The bottom line is that, to date, there are no signs that weakness in manufacturing or capital spending is spilling over to the rest of the economy. We are not on the brink of recession. But with that said, cost pressures from higher wages, tariffs, and a strong dollar are likely to limit profit growth from the foreseeable future. So far, none of those pressures are abating. Assuming corporate revenues approximate nominal GDP growth at about 4%, only a slight decrease in margins will turn profit growth from positive to negative. This year’s advancing stock market is all about a recovery from last year’s terrible fourth quarter, and the impact of lower interest rates. For a bull market to endure, eventually, profits have to start rising again. The stock market today is essentially where it was in January 2018. The sectors that have done the best — utilities, real estate, and consumer staples — are the primary beneficiaries of lower rates. Without deflation or sharply lower interest rates, for the bull market to be sustained, eventually leadership will have to rotate. How that plays out will be the story of 2020.

Today, Chris Christie is 57. Pink Floyd’s Roger Waters turns 76.

James M. Meyer, CFA 610-260-2220

Additional information is available upon request.
* – Boenning and Scattergood may act as principal in buying this stock from or selling it to the public.
# – The author of this report or accounts under his management at Tower Bridge Advisors owns this security.

Additional information on companies in this report is available on request. This report is not a complete analysis of every material fact representing company, industry, or security mentioned herein. This firm or its officers, stockholders, employees, and clients, in the normal course of business, may have or acquire a position including options, if any, in the securities mentioned. This communication shall not be deemed to constitute an offer, or solicitation on our part with respect to the sale or purchase of any securities. The information above has been obtained from sources believed reliable, but is not necessarily complete and is not guaranteed. This report is prepared for general information only.

Boenning & Scattergood, Inc. – Member FINRA / SIPC.

It does not have regard to the specific investment objectives, financial situation, or the particular needs of any specific person who may receive this report. Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed in this report and should understand that statements regarding future prospects may not be realized. Opinions are subject to change without notice.

Stocks continued a strong rally as optimism grew that trade talks might begin soon to solve the U.S./China tariff war.

Yet even with two very strong sessions and signs the rally will continue this morning, stocks remain locked in a rather narrow trading range. As noted previously, the decision to institute the next round of tariffs this weekend will be a binary event. If they go into effect as planned, I would expect stocks to give back at least some of this week’s gains when stocks resume trading after Labor Day. Resumed trade talks or not, more tariffs will serve as a tax on growth. However, should Trump decide to cancel or defer the tariffs at the last minute, certainly something that wouldn’t be out of character, stocks could march higher and challenge record levels. In either case, the fact that both sides now smile, make nice, and offer to talk is far from an agreement. That still appears a long way off. In the end, it will be the tariffs themselves, and not rumors of trade talks, that will impact worldwide economic growth.

It’s easy to get distracted from the economic realities by all the headlines and tweets. The economic realities have been mixed but the most recent data have actually skewed positive. Employment is still strong, inflation data have stayed consistent, and economic growth is within a normal range approximating 2%. Lower interest rates should help housing. Some make note that refinancing activity has slowed a bit but with the recent rapid drop in rates, if you were thinking of refinancing, wouldn’t you wait to see if rates were going to move still lower before taking the step to refinance? Once rates stabilize, whether tomorrow or six months from tomorrow, refinancing activity will pick up.

Government spending remains high and consumer confidence continues strong. The areas of weakness and concern remain the same. Capital spending is restrained by the government and tariff uncertainty. Inventories are still too high. Trade is slowing, impacted by tariffs. But these are not the largest parts of the economy. Consumer and government spending together account for over 80% of GDP. In other words, the economic world today is fine with very few signs of slowing significantly. Might it deteriorate further if tariffs keep rising? Of course. But slowing doesn’t mean recession.

The sharp recent decline in interest rates is clearly disruptive to markets. Traders look to the twin bottoms of 2012 and 2016 between 1.3% and 1.4% for 10-year Treasuries and expect a repeat for the third time. Renewed optimism this week has slowed the rate decline, but it is far too early to declare a bottom is near. European rates continue to be weak and are near record lows. Clearly, they serve as a drag on our rates. This is no historical guide to determine how low rates can go, but it is hard to ascribe current rates to any economic condition. Rather, they remain symptomatic of the oversupply condition I keep discussing. Oversupply of money means that the price has to drop. In monetary terms, that means lower rates. It’s no different than lower prices for any other commodity. The cure is more demand, not more supply. The central bank mantra so pervasive today to add even more money simply serves to lower rates further, which in Europe means rates further into economic territory. With that said, low rates are a positive for the valuation of financial assets. All year long, stocks have responded to a combination of lowered earnings expectations dragging prices down and lower interest rates lifting prices up.

Comments from former NY Fed President William Dudley this week questioned whether the Fed should act in a more political way. While the Fed rightfully came out immediately and said politics and monetary policy don’t mix, saying they are a toxic combination, the remarks were damaging to the Federal Reserve’s deserved reputation as an independent agency. While I and most others believe politics has played little or no role in rate decisions to date, in the supercharged world we live in today where virtually every action is viewed as part of a conspiracy, comments like those of Mr. Dudley serve no useful purpose. Thankfully, he received no support from any sitting FOMC member.

That leads us to the next binary event, the FOMC meeting to conclude on September 18. It is highly likely that the Fed will cut rates by 25 basis points. It is also highly likely that President Trump will blast the Fed for not lowering rates further. While our rates remain higher than those of the rest of the world, our growth is higher and so is our rate of inflation. Chasing the expansive policies of Europe will only raise deflationary pressures, hardly a goal sought by lowering rates. If the economy does weaken further over the near term, the Fed can cut rates again in six weeks. That is the proper stance. It would also be proper for the Fed to defer any further cuts after September until December or later if economic data suggest we are growing at a healthy rate with inflation close to 2%. If Trump wants to blame the Fed for slower growth than he wants, that’s his prerogative. Perhaps rates were too and had an impact on GDP growth rates. Obviously, tariffs were also a growth retardant. No one can tell how much each contributed. The bottom line today, however, is that rates are now falling, and tariffs continue to rise. As long as that continues, growth should continue but at a depressed rate. The Fed is now doing its job to support economic growth. If the President wants to see growth accelerate, he has more weapons at his disposal than the Fed does.

Today, Cameron Diaz is 47. Warren Buffett turns 89.

James M. Meyer, CFA 610-260-2220

Additional information is available upon request.
* – Boenning and Scattergood may act as principal in buying this stock from or selling it to the public.
# – The author of this report or accounts under his management at Tower Bridge Advisors owns this security.

Additional information on companies in this report is available on request. This report is not a complete analysis of every material fact representing company, industry, or security mentioned herein. This firm or its officers, stockholders, employees, and clients, in the normal course of business, may have or acquire a position including options, if any, in the securities mentioned. This communication shall not be deemed to constitute an offer, or solicitation on our part with respect to the sale or purchase of any securities. The information above has been obtained from sources believed reliable, but is not necessarily complete and is not guaranteed. This report is prepared for general information only.

Boenning & Scattergood, Inc. – Member FINRA / SIPC.

It does not have regard to the specific investment objectives, financial situation, or the particular needs of any specific person who may receive this report. Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed in this report and should understand that statements regarding future prospects may not be realized. Opinions are subject to change without notice.

Stocks fell once again, following the path of interest rates downward as recession fears rose and policy confusion continued to increase.

Energy, bank, industrials, and consumer discretionary stocks were particularly weak. It was clearly a risk-off day for investors. This morning, the trend continues as interest rates continue to fall, inversions widen, and stock futures are under renewed pressure.

There are many who continue to believe that there won’t be a recession any time soon. There is lots of data to support their views. Consumer spending is strong, leading economic indicators have started to tick up once again, and low rates are accelerating mortgage refinancing activity (as they should). Employment remains strong. Overnight data from China showed resilience supporting a forecast of continued solid growth there.

But there are disturbing signs as well. The yield curve has inverted, a telltale warning that recession may not be far off. Global growth is slowing and has been slowing since President Trump started his tariff wars. In fact, since the first announcement of tariffs back in February 2018, the stock market has been flat and interest rates have fallen significantly around the globe.

One of the problems facing investors is that recessions tend to creep up on us. They don’t emit loud warning signs. Look at the chart below, which documents weekly unemployment claims going back to the 1960s. The shaded vertical bars are recessions. Notice how claims always spike up during recession. That correlation should be obvious. When business slows, companies lay off employees. But what may not be obvious is that claims data give very little warning before the recession hits. Claims may begin to creep up shortly before a recession begins but then suddenly rise in parabolic fashion as economic growth falls until the recession ends. Indeed, the end to layoffs is what almost always marks the end of recession. Look at the right side of every recession bar below and you will see that claims peak almost exactly coinciding with the end of a recession.

If you look to the right side of the chart, you see that claims have not hooked up yet; we still are in an all-clear zone. But if there is any one indicator worth watching to see whether recession is imminent, I would suggest this is the one. Even a 10% rise in weekly claims raises a yellow flag, if not a red one.

Obviously, I am not the only person watching this. The Federal Reserve does as well along with other key leading indicators. So far, most still say “no recession”. But many have begun to trend in the wrong direction. The average workweek, for instance, has been declining for three quarters. That is often a prelude to an acceleration in layoffs. The yield curve inversion everyone is talking about is another warning sign.

Clearly, the Fed has ammunition to counteract negative forces. It cut rates in July and will do so again in September and maybe October as well. It can resume buying bonds, adding to money in circulation. However, given the subdued monetary velocity today and tepid loan demand, it is problematic how much stimulus renewed bond buying would achieve unless it is done in massive amounts. The Fed, always worried about inflation, needs to pay more attention to deflationary forces. Not only is the worldwide oversupply I talk about all the time a problem, tariffs add to the headwinds. Simply put, they are a tax and every economist knows that raising taxes when an economy begins to weaken is precisely the wrong step to take. Like everyone else, I understand that President Trump feels tariffs are the best way to force China to alter the way it trades with the rest of the world, but, in the interim, it is increasingly likely that tariffs could precipitate a slower economy, if not a recession.

Over the next three weeks, there are two binary events due to occur. The first is this weekend when the next round of tariffs on Chinese exports to the U.S. are due to take effect. It is certainly possible that Trump could delay or cancel the tariffs. Possible doesn’t mean probable; it means possible. But, simply said, if the tariffs go into effect, the economic headwinds will increase. In stock market terms, no tariffs or delayed tariffs would ignite a stock market rally. But if the tariffs do go into effect with no other trade related news, next week could start off ugly for stocks.

The second event is the mid-September FOMC meeting, a two-day affair scheduled to end September 18. It is highly likely the Fed will cut rates 25 basis points. That may not be enough to cause the end of the interest rate curve inversion. As the inversion steepens, there are increasing calls for a 50-basis point cut. Yet, there are some FOMC members who still don’t see the need for any cut at all given recent solid economic data and stable inflation.

Again, the FOMC meeting represents a binary event. No rate cut would send stocks down sharply. That is unlikely to happen. The impact of a 25-basis point cut would be dependent on how the Fed places the cut into context with future planned actions. But even if it says more cuts will come if needed, markets are likely, at this point in time, to react well to a cut of only 25-basis points. A 50-basis point cut, on the other hand, would be very well received and could stop the inversion from getting worse. Parts of the curve could even uninvert. However, a 50-basis point cut also could send a message that the Committee views the economy as weaker than current data suggest. The quandary the Fed has to wrestle with is whether what is good for markets in the short run is good for the economy in the long run.

With all this said, any investor knows that over the long run, stock prices are a function of earnings and interest rates. The latter is governed by inflation expectations. As interest rates have come down worldwide, so have inflation expectations. That can argue for a higher P/E ratio. Good for stocks. On the other hand, economic headwinds and tariffs in a world where few have pricing power suggest that earnings estimates are too high and have to come down. So, we are left with a ying and yang. Higher P/Es on one hand; lower earnings on the other. Current estimates for this year for the S&P 500 suggest earnings of about $165. Next year’s current estimates are in the $175-180 range, but I think $165-$175 is a better range assuming no end to the tariff wars and no great escalation either. Even if the tariff picture clears, political uncertainty, which will rise if the 2020 election is a close one, will continue to limit capital spending growth. Government spending will increase. Overseas growth will be subdued. The key, once again, will be the consumer. If he hangs in and remains confident, earnings can meet or even exceed the upper end of my range. If, however, businesses start to layoff workers and the consumer retrenches, that is how you get to a recession and even $165 will be too high. If I use 17 times $175, I come close to 3000 as the top end of the range. There is no law restricting P/Es to 17 but that is the top end of the past 5-year range. To assume higher, one would have to ascribe some permanence to lower inflation expectations.

On the downside, 15 times $165 yields a number below 2500. Today, at 2870, we are closer to the top of the range than the bottom. That doesn’t mean stocks have to retreat to the lower end, although they might if tariffs escalate and the Fed disappoints. On the other hand, given that Trump wants to get reelected, at some point over the next 12 months, he could signal a tariff détente in exchange of a deal that might be seen as a stepping stone to a larger deal down the road. In that case, 3000 would be an easy target.

As I said at the start, over the near term, the binary events of tariff escalation and the upcoming Fed meeting will drive stock prices. Recession risks are rising, but a recession certainly isn’t confirmed at this point in time. But given that stocks aren’t cheap here, a more defensive posture is called for.

Again, I remind all that stocks remain much more attractive than bonds as a long-term investment. The S&P 500 this morning yields more than the 30-year Treasury. That might not matter today but it will matter a lot over time. Good companies that pay a solid dividend and can grow steadily over time may not outperform in an ebullient stock market environment, but they will provide a comfortable hiding place in this market environment.

Today, Jack Black is 50. Shania Twain turns 54.

James M. Meyer, CFA 610-260-2220

Additional information is available upon request.
* – Boenning and Scattergood may act as principal in buying this stock from or selling it to the public.
# – The author of this report or accounts under his management at Tower Bridge Advisors owns this security.

Additional information on companies in this report is available on request. This report is not a complete analysis of every material fact representing company, industry, or security mentioned herein. This firm or its officers, stockholders, employees, and clients, in the normal course of business, may have or acquire a position including options, if any, in the securities mentioned. This communication shall not be deemed to constitute an offer, or solicitation on our part with respect to the sale or purchase of any securities. The information above has been obtained from sources believed reliable, but is not necessarily complete and is not guaranteed. This report is prepared for general information only.

Boenning & Scattergood, Inc. – Member FINRA / SIPC.

It does not have regard to the specific investment objectives, financial situation, or the particular needs of any specific person who may receive this report. Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed in this report and should understand that statements regarding future prospects may not be realized. Opinions are subject to change without notice.

Stocks fell sharply on Friday as the trade war escalated.

At the start of the trading session, all eyes were on Jackson Hole, Wyoming awaiting a speech from Federal Reserve Chairman Jerome Powell that might give guidance to the future path of interest rates. Market reaction to his speech, which continued to suggest that the Fed would react to future changes in the economy were slightly positive. But at 11am, President Trump tweeted that he was ordering American businesses to make or accelerate plans to exit China. Stocks immediately fell by close to 3%. The tweet was in response to China’s earlier announcement that it was instituting another round of tariffs in response to American tariffs scheduled to begin on September 1. After the market closed, Mr. Trump followed his earlier tweet with an announcement of even higher tariffs on Chinese imports. Markets reacted even more negatively. When futures opened overnight, futures were down close to another percent. Then this morning, Mr. Trump said his trade negotiators had received two phone calls overnight seeking to renew trade talks. Futures reversed and rose by more than 1% before settling down. 

Mr. Trump, as we all know, looks to the stock market as his barometer. After Friday’s fall and with futures pointing lower again this morning, some comforting news, any comforting news, would serve to settle markets. From China’s perspective, the pace at which the rhetoric ratcheted up over the past few days was also disconcerting. Whatever China hopes to achieve, it does not want to see any acceleration in the pace at which American companies move supply chains out of the country. 

We study history in school because we are supposed to learn from the past. Since the end of World War II, the United States has engaged in four major wars in Korea, Vietnam, Iraq and Afghanistan. In each case, we were the ultimate protagonist. In each case, we had significant military superiority. In each case, the enemy suffered far greater human loss of life, and greater overall damage. Yet, we didn’t win any of the wars. While we hit the enemies with our best shots, they never surrendered. They were hurt but not intimidated enough to back away and give in to our demands that they recreate themselves into a Western style democracy. Indeed, during each successive war, the enemy learned from previous ones that if they persisted long enough, America would grow tired of war and leave. 

In each, the American goal was to force change. Whether it was to defeat communism and prevent its spread, or change political structure, we failed. One could point to the economic and political emergence of South Korea as a qualified success but Korea remains a split nation. North Korea remains both isolated and, now, a nuclear threat. 

Which brings us to our fifth war, the tariff war with China. While this isn’t a military confrontation, it bears resemblance to the previous ones. Again, we are trying to force change using our greater power. We are economically stronger than China. Their economy is more dependent on trade with the U.S. than we are with Chinese trade. To date, the trade war can better be described as a skirmish. That is how all the other four wars started. All, however, ultimately escalated far beyond our original intent. Friday’s news saw clear escalation; this morning’s comments are at least an attempt to pull that back a bit. 

History from our military battles creates a framework China may follow in the tariff war. In simple terms, it appears to be willing to take the necessary short term pain knowing that if the American economy weakens as the battle escalates, eventually the American public will pressure its government to back away from at least some of its key demands. Thus, while President Trump is correct that China will suffer more economic damage than we will if the battle escalates, it is problematic whether more pain will cause the Chinese to capitulate and change practices. History doesn’t always repeat itself exactly but basic patterns often reemerge. 

There is more commonality among China, Korea, Vietnam, Iraq, and Afghanistan. Each has been around for thousands of years. Their ways of life, their customs, have been in place for thousands of years. We may not like how other countries behave but if they have been acting in similar manners for centuries. Getting them to make huge structural change in their DNA via tariffs is a high barrier. 

Some argue, that the Chinese strategy is to wait out the 2020 election and hope Trump loses. That’s certainly a possible tactic. But, perhaps, China never intends to change at its core, at least until it has enough intellectual property to protect and reaches what it perceives to be a level playing field. 

The key word in the tariff war isn’t “pain”; it’s intimidation. If we cannot intimidate China or others to give in to our demands, then we won’t achieve our fundamental goals to change the way China does business. Our economic growth rate has fallen about a full percentage point over the past year largely due to the imposition of tariffs. The impact has spilled over to the rest of the world which has also slowed by a similar amount. Since China and the U.S. account for almost 50% of world growth themselves, it is logical that if the two of us sneeze, the rest of the world will catch our cold. That reduction in growth is before the latest escalation by both China and the U.S. set to begin in about a week. Will news of an overnight phone call set the stage for a rollback of new tariffs scheduled to start this weekend? We will learn more about that as this week progresses. 

There are no signs, absolutely none, to date that suggest China is about to change how it engages in international trade. No one questions the goals of reducing the theft of intellectual property, reducing the barriers for foreign countries to do business in China, or eliminating forced technology transfers. Those have been Chinese rules of engagement to date. No one likes them but, so far, businesses have learned to live with them as entrees to doing business with the world’s second largest economy. 

That doesn’t mean there shouldn’t be changes. The U.S. and its allies should seek changes at the World Trade Organization (WTO) to take away developing market status from China. As the second largest economy in the world, China hardly deserves advantages afforded developing nations. Similarly, when China dumps steel on world markets below cost, tariffs should be imposed. And they should be imposed worldwide. When South Korea dumped washing machines to the U.S. we petitioned and got relief. That is the way world order is designed to work. Trump has decided that the WTO is too slow and ineffective and, therefore, has chosen a unilateral approach. Time will tell whether that was the best tactic or not. 

Military wars have not hurt the stock market over the last 75 years. But an escalating economic war will. How much depends on the extent of the war. There is still time to suspend the September 1 and December 15 tariffs. There is an election in 2020 and clearly a recession created by as escalating tariff war won’t help Trump’s chances for reelection. History suggests that China is not likely to be intimidated into making the major structural changes the President wants between now and next November. They might buy more soybeans or agree to further talks. But the odds of serious change are low and they don’t necessarily rise as the tariffs get increased. 

If we don’t have long memories, the Chinese do. Just one generation ago, they were living in Mao suits. A stiff recession might be painful but if that is what is required to stay the course, keep to its economic 5-year plan, and continue to grow into a dominant world power, they will endure it. If the war escalates to the point where layoffs begin to happen in the U.S. and employment growth goes south, consumer confidence will fall and the recovery of the last 10 years will be over. Americans won’t be willing to accept that pain for very long. 

Bullies succeed as long as they can intimidate. Once, intimidation fails, a bully is neutered. Four wars have resulted in America retreating because (1) we couldn’t intimidate the enemy, and (2) we could only endure so much pain ourselves. This war most likely won’t end any differently. Once we conclude that China won’t agree to alter its DNA, and we tire of the impact of the trade wars upon us, a new approach, other than heavy handed tariffs may yield better results. 

In the interim, the past several days serve as a guide to what we should expect. Tweets and Chinese communiques are going to jerk markets violently in both directions. Ultimately, the course of corporate profits and interest rates will be the final arbiters of stock prices. To the extent, this trade war adds costs and uncertainty, both stocks and interest rates will fall. The odds of recession increase. Corporations will continue to hold back on capital investments impacted by the trade uncertainties. 

Given that Mr. Trump looks to the stock market as his barometer of success, we should note that since Inauguration Day 2017, the stock market is up a bit less than 20%. That is a below average performance for a post-World War II President. Since the start of 2018, a span of almost 20 months, the market is essentially unchanged. The tariff wars have counteracted the benefits of tax cuts and deregulation. More tariffs clearly won’t help in the short run. Forcing structural change is a long term fight and may not be a winnable one. Time will tell. Winning battles isn’t the same as winning a war. China will agree to some changes to protect its core DNA. If those changes are sufficient for Trump to declare a victory, a truce of some sort will follow and life will go on. The hawks within the White House trade team want nothing less than complete structural change. At the moment, they still have Trump’s ear. But as elections get closer, as economic growth slows further, and if China shows no willingness to alter is core DNA, we will see how much pain the White House is willing to endure. 

Today, James Harden is 30. Macaulay Culkin is 39. Melissa McCarthy turns 49. 

James M. Meyer, CFA 610-260-2220 

Additional information is available upon request. 
* – Boenning and Scattergood may act as principal in buying this stock from or selling it to the public. 
# – The author of this report or accounts under his management at Tower Bridge Advisors owns this security. 

Additional information on companies in this report is available on request. This report is not a complete analysis of every material fact representing company, industry or security mentioned herein. This firm or its officers, stockholders, employees and clients, in the normal course of business, may have or acquire a position including options, if any, in the securities mentioned. This communication shall not be deemed to constitute an offer, or solicitation on our part with respect to the sale or purchase of any securities. The information above has been obtained from sources believed reliable, but is not necessarily complete and is not guaranteed. This report is prepared for general information only. 

Boenning & Scattergood, Inc. – Member FINRA / SIPC. 

It does not have regard to the specific investment objectives, financial situation or the particular needs of any specific person who may receive this report. Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed in this report and should understand that statements regarding future prospects may not be realized. Opinions are subject to change without notice. 

Stocks finished mixed yesterday, a day when the yield curve briefly inverted once again.

More about that in a moment. Traders were anxiously awaiting Fed Chair Jerome Powell’s speech this morning that may help to clarify the Fed’s near-term and long-term strategy.

Yesterday’s yield curve inversion was very different than the one last week. But first the similarities. Both were extraordinarily brief; just a few minutes. And both were microscopic. The inversion was less than a single basis point. But last week’s inversion that led to a 3% market drop was caused by a plunge in interest rates. As it happened, the long rates fell faster than short rates, causing a brief inversion. Yesterday’s action was the exact opposite. Rates rose across the board but short rates (i.e. 2-year Treasuries) rose a bit faster than long rates. Even after the inversion, something many traders say signal an impending recession, rates continued to rise all along the curve. Logically, higher rates mean economic strength and rising inflation expectations, hardly a harbinger of recession.

In this case, however, it may be tied to comments from a few Federal Reserve District Presidents questioning the need for any rate cuts either in September or the near term. And there is logic to their thoughts. GDP is still growing close to 2%. Leading economic indicators have started to rise again after several months of decline. They were up in both June and July. The consumer is still spending. Their balance sheets are solid with debt service to income still at a very low percentage and the savings rate over 8%. Employment is at a record high, unemployment is at a historic low, and weekly jobless claims fell once again. Government spending is rising at a rate close to 4%. Thus, they argue, why any rate cuts at all?

But there is a flip side. Manufacturing is floundering. Early indications are that it actually fell in August. Economic growth overseas is weakening. Europe and Japan are teetering with recession and China’s growth is slowing. Negative interest rates beg for the Fed to move rates lower to close the gap. President Trump, who pleads in his own manner for the Fed to cut rates, cites the fact that Germany is issuing long bonds at negative rates, giving it a supposed competitive advantage.

Yet one can respond, what advantage? If negative rates stimulate so much spending and risk taking, why is Germany and much of the rest of Europe moving toward recession? Japan has lived with interest rates either side of zero for 30 years without being able to achieve sustained growth. Negative rates could reflect fears of deflation, but they also could reflect the thinness of European sovereign bond markets given the fact that the ECB owns so much of the same sovereign debt. One could easily argue that negative rates scare both consumers and businesses. Businesses would gladly borrow at negative rates, but they would be reticent to lend. Once again, the key to sustaining economic growth is more demand, not more money.

Which brings me to (1) what might Mr. Powell say, and (2) how might markets react? Given that there isn’t yet consensus among FOMC members on what to do in September, let alone beyond, he is likely to hint at another rate cut but go no farther than that. Markets have built in reduced odds of anything more than a 50-basis point cut in rates in September so a 25-basis point cut would be received reasonably well. But markets are already pricing in 3-5 rate cuts over the next 12-18 months. Should Mr. Powell either throw a wet blanket on that assumption or, more likely, leave that possibility far from certain, markets could respond negatively. I shouldn’t try to guess today’s market. More important are the long-term implications. The key question is whether the Fed should provide cover for future depressant actions by Washington, such as more increased tariffs, or should the Fed stay to its charter, concentrate on maintaining price stability, and keep growth on course subject to the data evident at each meeting? I would suggest that the mood of the Fed majority reflects the latter. It shouldn’t provide cover for future increases in tariffs or economic weakness in Germany. It should stay to its charter of keeping inflation within range of 2% while providing an interest rate environment to support sustainable, longterm growth. There is little evidence that current rates are far from what are needed to support those goals. I conclude that with the evidence of data. Inflation isn’t moving sharply up or down, nor is economic growth.

Markets, of course, love low rates because the corollary is higher P/E ratios and higher stock prices. But short-term gains can lead to long-term pain. A race to zero interest rates has its obvious positives. But zero rates promote more debt. If rates subsequently rise, all that extra debt can result in debt service so high that it could cripple an economy.

My conclusion is that the Fed may need to tweak policy with a measured rate cut or two, but chasing European policy of negative rate and quantitative easing in an economy that is still growing to trend makes little sense no matter how many times the President tweets or tries to satisfy short-term traders. It may lead to a brief negative market reaction but, in the long term, good policy brings good results. Markets will ultimately be satisfied.

Today, Kobe Bryant is 41. Rick Springfield turns 70.

James M. Meyer, CFA 610-260-2220

Additional information is available upon request.
* – Boenning and Scattergood may act as principal in buying this stock from or selling it to the public.
# – The author of this report or accounts under his management at Tower Bridge Advisors owns this security.

Additional information on companies in this report is available on request. This report is not a complete analysis of every material fact representing company, industry, or security mentioned herein. This firm or its officers, stockholders, employees, and clients, in the normal course of business, may have or acquire a position including options, if any, in the securities mentioned. This communication shall not be deemed to constitute an offer, or solicitation on our part with respect to the sale or purchase of any securities. The information above has been obtained from sources believed reliable, but is not necessarily complete and is not guaranteed. This report is prepared for general information only.

Boenning & Scattergood, Inc. – Member FINRA / SIPC.

It does not have regard to the specific investment objectives, financial situation, or the particular needs of any specific person who may receive this report. Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed in this report and should understand that statements regarding future prospects may not be realized. Opinions are subject to change without notice.

Stocks gave back a bit of the gains achieved late last week as interest rates began to slip again.

There was no significant economic news. Interest rates have stabilized once again although they are not far from recent lows.

Speaking of interest rates and that over discussed 2-10 yield curve inversion that happened last week for about two hours, let me posit a question. What world would you rather live in: the one that has 2-year yields of 1.52% and 10-year yields of 1.55%, or the one that has 2-year yields of -0.90% (as in negative) and 10-year yields of -0.60%? The former has a spread of just a couple of percentage points and could invert at any moment. The latter has a positive spread of 30 basis points and has held firm. Of course, it wouldn’t take a rocket scientist to figure out that the former is the U.S. and the latter is Germany. I picked on Germany but I could have used Japan or almost any European nation other than the U.K. The realities are that we are not in a recession and there are precious few signals that a recession is imminent while Germany, Japan, and most of Europe are either flirting with recession, actually in recession, or growing just a smidge.

I am not trying to belittle the meaning of the yield curve. And I understand that leading economic indicators are pointing lower. Manufacturing activity in the U.S. has been weak for months. Housing has been spotty and auto sales lag behind strong numbers posted last year. Capital spending is still growing but corporations are confused by both the economic and political environments. Don’t look for any dramatic increases soon.

Washington isn’t helping with inconsistent messaging. On Sunday, President Trump sent his economic team out to the morning news talk shows to extol the strength of our economy. On Monday, rumors surfaced that the White House was planning to seek a payroll tax cut to buttress the economy. That rumor was denied. The President, personally, lashed out at Jerome Powell and suggested the economy needed a 100-basis point cut in the Fed funds rate plus more quantitative easing. Huh? If the economy was so great, why all the need for stimulus? On Tuesday, the White House confirmed that indeed it was talking about cutting the payroll tax among other steps to stimulate growth. Of course, all this comes after it had signed a spending bill that will create a deficit approaching $1.3 trillion for each of the next two years. Then, of course, there are the tariffs against Chinese imports due to start September 1. No wonder corporate executives don’t know what to do.

If the President is bad at messaging, the Fed may only be slightly better. Home, supposedly, to some of the world’s best economists, the Fed’s dot plots of future expectations released throughout the year show an FOMC that has persistently overestimated economic growth and overestimated future inflation. That has led to interest rates that were higher than necessary. The Fed rightfully cut rates in July and will almost certainly cut twice more this year. With that said, the notion of getting more in line with the rest of the world is preposterous if the rest of the world is executing bad policy. The lack of fiscal initiatives, especially in Europe, has forced central banks to do as much heavy lifting as possible to support economic growth. But interest rate policy alone is not very effective in that regard. Low rates can stimulate borrowing but only to a point. There are absolutely no signs that the negative interest rates we now see across Europe and Japan are stimulating a strong economic response. And making these rates even more negative doesn’t seem to work at all.

When you go shopping, how many times do you see something and say to yourself, “I wouldn’t want that if they paid me.”? Cutting the price alone won’t make the sale. People will pick and choose how they spend their money. Price is an important component but not the only one. That is not to say that cutting rates won’t help boost activity. The recent rate decreases in the U.S. are already leading to a sharp rise in mortgage refinance applications, for instance. But when rates go negative, an unnatural state is created. Lenders slow down lending even if borrowing demand increases. If banks can’t make a reasonable spread or profit, they will only loan to their best customers. Savers don’t know what to do. Banks are not yet charging individuals a negative rate, but they do charge fees. In theory, savers might respond by shifting money to riskier assets or spend it. The strength of European stock markets reflects some of that, but the investor class isn’t increasing spending enough to offset the impact of lost income on lower income savers. Low rates may entice more spending for some but rob others of needed interest income. Very simply, look at growth around the world. As rates have fallen steadily all along the curve this year, growth has slowed in almost every country. Whether the Fed is behind the curve or not is almost irrelevant to the facts presented globally that lower rates reflect an expansion of oversupply.

Money is a commodity just like oil or an airline seat. If the commodity is scarce, the price goes up. If there is too much supply, the price goes down. Look at the U.S. Prices are being raised where labor is the primary cost component. Restaurants are a good example. Food eaten away from home is seeing 2-3% price increases, but food eaten at home is barely increasing in price. At some point, this will push people to eat more meals in but that point hasn’t been reached yet. Rents are rising, an indication of demand overwhelming supply. Two other areas where prices continue to increase, hospital services and higher education, may be at tipping points. Health care inflation has been falling for some time from drugs to doctors’ fees. Hospitals will get in line soon under political pressure. Too many mediocre colleges charge virtually the same tuition as Harvard. Education can be valued by the present value increment its graduates earn versus a high school or community college diploma. Big data some day soon will calculate that value. Institutions where the present value doesn’t exceed four years of tuition will have to make changes or die.

As for money itself, the cost is represented by interest rates. When rates fall, there is too much money. Is there ever too much money? I would contend that when monetary velocity is near an all-time low, when hundreds of billions of bank deposits are sitting at the Federal Reserve earning a few basis points, and when the savings rate is the highest it has been in 20 years, except for a brief spike during the European debt crisis, then if there isn’t too much money, there is more than enough to satisfy existing demand. The obvious conclusions are:

  1. Adding more money alone won’t result in much more spending.
  2. Instead it will reduce monetary velocity further, lead to even lower interest rates, and increase savings.

The solution to oversupply isn’t more supply; it’s more demand. Demand is growing. The thought of tax cuts in a nation with $1+ trillion deficits, 2% growth, and near record low interest rates makes no sense. If there wasn’t going to be an election next year, we wouldn’t be hearing about this. Sure, cutting payroll taxes will increase demand. So will dropping $100 bills out of a helicopter. But there is an ultimate cost if all this money is borrowed. If you own a home free and clear and then take out a $400,000 mortgage, that may seem like free money today but some day you have to pay it back.

I will say this for a payroll tax. It is a much more effective tool to getting a short-term increase in demand. It is certainly going to be more effective than indexing capital gains to inflation, another thought being considered. In an election year, cutting taxes has an obvious appeal, especially when most voters have no clue what the deficit even means. The President might actually get more support from Democrats than conservative Republicans on this. Stranger things have happened but that doesn’t make the idea good policy. If there is any growth retardant out there today, it would be the impact on tariffs, a self-inflicted headwind.

As for markets, with daily incremental changes in interest rates getting a bit smaller, equity market volatility is declining. Low rates and decent earnings point to higher prices. But one has to be both selective, regarding stocks, and mindful of valuation. As the S&P 500 reaches toward 3000 again, it will face valuation headwinds unless you can make the case for higher than expected earnings. In addition, the lower levels of trade worldwide and the soft economies overseas continue to hurt multi-nationals, commodity producers, and the manufacturing sector. I would continue to avoid industries with a lot of storm clouds overhead unless you can see when the rain might stop.

Today, track star Usain Bolt is 33. Country singer Kacey Musgraves is 31. Speaking of country, Kenny Rogers is 81 today.

James M. Meyer, CFA 610-260-2220

Additional information is available upon request.
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It does not have regard to the specific investment objectives, financial situation, or the particular needs of any specific person who may receive this report. Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed in this report and should understand that statements regarding future prospects may not be realized. Opinions are subject to change without notice.

Stocks posted solid gains on Friday for the second day in a row as the brief 2-10 year Treasury yield inversion that lasted only a couple of hours faded and yields posted tentative gains along the curve.

Over the weekend, China preannounced a new lending structure that is a de facto cut in rates. That has pushed Chinese stocks higher and set up an opening rally around the world.

As noted last week, the move toward lower rates had begun to turn parabolic and was taking place at an unsustainable pace. Over the past few sessions, and continuing this morning, rates have started to bounce back. Whether, this is a short-term counter trend or a start of a V-shaped recovery is uncertain but bears close watching. Anyone who follows my two-day rule will be less bearish this morning. The rational support for that rule implies that a strong rally lasting more than a day is more than short covering by traders. It appears equity markets will open strong today. A key is whether the morning gains can be sustained. 

Normally, I don’t pay much attention to day-to-day movements but when volatility accelerates without a lot of net movement in prices, there is an obvious message. Usually, it involves a crosscurrent of factors. Over the past few weeks, the most obvious change has been the aforementioned sharp move down in interest rates all along the curve. That started August 1 when President Trump announced an escalation of trade tariffs against China starting September 1. While he moderated what he planned to introduce since, the escalation of tariff increases continues a pattern started last February. Whether all due to the tariffs or not, worldwide growth has slowed from a peak of well over 3% in the second quarter of 2018. Since almost 50% of worldwide growth comes from China and the U.S., the linkage between tariffs, reduced trade, and slower growth seems pretty direct and obvious. The tariffs might not be the only factor slowing growth worldwide but it appears to be the dominant force. 

As a result, excluding the impact last year of the Trump corporate tax cuts, profits have been flat for the past year and are expected to remain so at least through the current quarter. While analysts predict a reacceleration starting in the fourth quarter, those forecasts came out before the September 1 tariffs were announced. Mr. Trump continues to threaten more tariffs both against China and Europe. Threats alone may affect capital investment decisions but it is the actual implementation that affects growth. Given the election in the U.S. next year, one can only speculate on the future direction of tariffs. Logic might suggest less pressure over the next 12 months than over the past 12 months. Clearly, the President is concerned about rising talk of recession precipitated by the momentary inversion of the yield curve. Yesterday, he sent his economics spokespeople out onto the Sunday news talk shows to support the notion that our economy is strong and to poo-poo any notion of a possible recession before the election. 

In their favor, consumers continue to spend, not only here but around the globe. To the extent that there are recessionary winds in the air, they all center on manufacturing. With hindsight, inventories were too high at the end of 2018 and it takes time to work those down. Doing so precipitates a manufacturing slowdown. The imminent Brexit event has served to increase the stock piling of inventories. Assuming Brexit happens one way or the other this fall, that situation will self-correct rather quickly. 

While data last week showing sharp gains in retail sales support the White House theory that all is well, a coincident survey that showed a sharp slide in consumer confidence in July bears watching. If consumers show any reticence to spend in coming months, that could harden the notion that a global growth slowdown continues. Even assuming the consumer continues to spend, any reacceleration of growth will require some turn around in the manufacturing, capital spending, and commodities sectors. At the moment there are virtually no signs of any imminent turn. 

Trying to pull this all together, the notion of lower rates as a result of a weakening economy makes some sense. But the idea of a recession with consumer spending continue anywhere near the recent pace makes very little sense. Moreover, rates everywhere are unnaturally low. Short rates, usually dictated by central bank policy will remain near zero in parts of the world and very low in others. Banks that can lower rates are doing so to try and stimulate growth. But it is the mid-long end of the curve that defies rational explanation. In trading terms, negative rates can be explained. There are enough traders and speculators who believe rates are going even lower (and prices higher) to justify such moves. However, while they can be justified, the doesn’t mean they can be rationalized. Why anyone would want to buy a bond whose interest rate is so low that it can’t cover inflation over its lifetime makes very little sense. The extreme, negative rates, makes even less sense. Germany issues long bonds as zero coupon bonds. It may issue a long bond, therefore, at a price of over 105 euros and pay the bond off at maturity at 100. It may be a great deal for the German government but only a fool would lend money for 10 years at 105 hoping to get 100 back in a decade. The only way that works is if speculators are willing to bet on even lower rates ahead. They too will be fools if they hang on too long but they could win their gamble over the coming weeks or months. 

Thus, as I noted last week, the bond market is being irrational, a true sign of a bubble. Maybe the market last week set a bottom and has begun to unwind. It’s too soon to make that judgment but events of 2012 and 2016 when our 10-year bonds yielded under 1.40% at the extreme suggest that if last week wasn’t the bottom for rates, we probably aren’t far away. 

What does this all mean for stocks? In the short run, a rebound in rates will stop the rush of fast money into bonds and out of all other asset classes. That would be a positive for equities as we have seen over the past few trading sessions. Note, however, that if the market opens where futures imply, all that will have happened is that we will open about where we were 10-days ago. Stocks have spent several years trading primarily between 15 and 17 times forward earnings. Right now, they are close to 17 times. Thus, there is a valuation lid to the upside unless (1) earnings begin to reaccelerate, or (2) there is a true reduction in inflation expectations. Note that inflation data last week and over the past few months points to a slight acceleration in the pace of inflation. And, as noted earlier, earnings expectations are coming in a bit. Stocks could test the outer limits of their recent trading band and retest recent highs. A lot may depend the market’s reaction to Fed Chairman Jerome Powell’s speech on Friday. Note that the July 25-basis point cut happened the day before Trump announced another layer of Chinese tariffs. The September FOMC meeting will happen a couple of weeks after those tariffs are implemented. Trump’s anti-Fed rants are unlike to move policy. Look for hints Friday supporting another 25-basis point cut in September and possibly a third later this year. 

I would use any reasonable rally back toward old highs as an opportunity to rebalance, and an opportunity to shift from weak to strong within your portfolio. Looking ahead, I don’t want to be forced to guess how political decisions, e.g. tariffs, will impact the companies I am invested in if I can find solid growing companies that are less impacted by tariffs. With the S&P 500 still providing dividend yields in excess of the 10-year Treasury, I would emphasize companies with dividends of 2% or more that grow their payouts persistently in good times or bad. 

Today, Matthew Perry is 50. Bill Clinton turns 73. 

James M. Meyer, CFA 610-260-2220 

Additional information is available upon request.
* – Boenning and Scattergood may act as principal in buying this stock from or selling it to the public. 
# – The author of this report or accounts under his management at Tower Bridge Advisors owns this security. 

Additional information on companies in this report is available on request. This report is not a complete analysis of every material fact representing company, industry or security mentioned herein. This firm or its officers, stockholders, employees and clients, in the normal course of business, may have or acquire a position including options, if any, in the securities mentioned. This communication shall not be deemed to constitute an offer, or solicitation on our part with respect to the sale or purchase of any securities. The information above has been obtained from sources believed reliable, but is not necessarily complete and is not guaranteed. This report is prepared for general information only. 

Boenning & Scattergood, Inc. – Member FINRA / SIPC. 

It does not have regard to the specific investment objectives, financial situation or the particular needs of any specific person who may receive this report. Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed in this report and should understand that statements regarding future prospects may not be realized. Opinions are subject to change without notice. 

Summary: Bonds are in a bubble. There is no rational explanation for rates this far below the rate of inflation or for negative yields in Europe.

But when the bubble bursts is an open question. Until then, as bond prices rise, stocks are likely to fall further.

Stocks staged a rather tentative rally yesterday after a 3% decline Wednesday, when the 2-10 year Treasury yield curve briefly inverted, raising fears of a recession within the next two years.

The bond market has staged a huge rally this year with 10 year Treasury yields falling from 3.25% to just over 1.5%. Just this month, yields have fallen almost 40 basis points, a huge decline. When yields go down, bond prices go up. For traders and aggressive investors, that means that bonds have been just about the best large market opportunity over the past couple of months.

In normal times, stocks and bonds compete for investor dollars. That suggests they should stay in a near equilibrium. When bond prices rise (and yields go down), stocks should also rise as lower yields mean higher P/E ratios. Conversely, when bond prices fall (and rates rise), that would normally be a headwind for stocks.

But today isn’t normal. Since the July 31 FOMC meeting and the August 1 tweet from President Trump that tariffs would be increased on Chinese imports beginning on September 1, stocks have fallen by more than 5% and bonds have soared. What is happening is that momentum chasers are selling stocks to buy bonds. Some media sources claim this is a flight to safety. But while 10 and 30 year Treasuries may be safe from a principal standpoint, they move widely with changes in rates. These bonds are not being bought by long term investors trying to lock in 1.5% or 2.0% for 10 or 30 years respectively; they are being bought by traders who are betting that tomorrow someone will pay more for those bonds than they can get today.

The extreme is in Europe, where as much as half of sovereign debt now trades at negative interest rates. In Germany, 10 year Bunds trade at a rate of -0.60% and 30 year bonds trade at a yield of -0.20%. Seriously, would you pay $108 for a bond knowing that you will get $100 back in 10 years with no interest payments in between? I doubt it. But you might pay $108 if you were convinced that the price tomorrow would be $110.

This is what you call a bubble.

Bubble burst. When, we don’t know. It could be tomorrow or it could be a year from now. But there is no rational explanation to tell you why anyone would want to buy a bond at a negative interest rate or even at a rate so low that, adjusted for inflation, you pay nothing or even less.

In the short run, stocks will continue to drop until bond prices stop going up in a straight line. When might it end? In 2012 and again in 2016, the 10-year Treasury briefly traded between 1.3% and 1.4%. Inflation then was running under 2% and the long-term outlook was for inflation of about 2%, exactly the same as today. If you poll investors today, you will hardly find anyone who would suggest that the 10-year Treasury could trade at 3% or higher. Yet that is exactly where it was at the start of this year, just 8 short months ago.

When everyone is on the same side of the trade (in this case betting on lower rates), it won’t take long for that to be a losing trade. At some point, rational behavior will take over. But I can’t tell you when. Disruptive tweets don’t help. In the meantime, the path of least resistance for bonds is up and for stocks is down. However, when that turns, it could push rates back up as fast as they came down. Parabolic tops and bottoms are often V-shaped.

Yes, I know world growth is slowing and that may seem to be an ingredient for lower rates. But look at the data and not the headlines. June retail sales rose by 0.7%, a huge number. Weekly unemployment claims show few layoffs. The CPI this week was up 2.2% annualized. Mortgage refinancing applications surged. There are no signs of inflation in the current data.

As long term investors, we just have to wait this out. Emotional insanity doesn’t last all that long. At some point, and I mean within weeks, bonds will stop rising and stocks will regain footing.

If there is a negative for stocks, it’s valuation. Despite recent losses, stocks are merely approaching the midpoint of fair value. Since the start of 2018, stocks have traded between 2450 and 3000 on the S&P in round numbers. We are still a bit above the mean. Profits have been flat since the start of 2017 ex-the impact of Trump’s corporate tax cuts. I expect they will remain fairly flat over the next year, meaning stocks may well stay within the range for an extended period. A sharper than expected rate cut from the Fed or a tariff truce with China could ignite a big rally but without either, the short term likelihood is for stocks to drift lower until real bargains appear.

Today, Steve Carell is 57. Madonna turns 61.

James M. Meyer, CFA 610-260-2220

Additional information is available upon request.
* – Boenning and Scattergood may act as principal in buying this stock from or selling it to the public.
# – The author of this report or accounts under his management at Tower Bridge Advisors owns this security.

Additional information on companies in this report is available on request. This report is not a complete analysis of every material fact representing company, industry or security mentioned herein. This firm or its officers, stockholders, employees and clients, in the normal course of business, may have or acquire a position including options, if any, in the securities mentioned. This communication shall not be deemed to constitute an offer, or solicitation on our part with respect to the sale or purchase of any securities. The information above has been obtained from sources believed reliable, but is not necessarily complete and is not guaranteed. This report is prepared for general information only.

Boenning & Scattergood, Inc. – Member FINRA / SIPC.

It does not have regard to the specific investment objectives, financial situation or the particular needs of any specific person who may receive this report. Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed in this report and should understand that statements regarding future prospects may not be realized. Opinions are subject to change without notice.

Volatility continues. The market fell about 1.5% on Monday amid heightened trade fears and concerns about the growing demonstrations in Hong Kong.

Then yesterday morning, President Trump said he would defer some tariffs on consumer goods imported from China to December 1 to avoid price increases before Christmas. Stocks regained Monday’s losses. This morning, the 2-10 year Treasury yield curve inverted briefly and sellers returned. Futures point to losses at the open approaching 2%.

Volatility accompanies change. Change can be good or bad. At the moment, most of the visible change appears bad. German manufacturing is in recession and its exports are declining. China manufacturing activity is at its slowest pace in more than a decade. The trade/tariff war with the U.S. is squeezing growth. While its official Q2 growth was reported at 6.2%, no one believes it. As in the U.S., it is the consumer today that is keeping China out of recession. Over 30% of sovereign debt now sports negative yields. All the heavy lifting to try to support world economies is being borne by central banks. Thanks to Germany’s century long obsession with budgetary conservatism (it still feels the pain of massive devaluation after World War I a century later), European nations watch as it slips back into recession.

Just under 50% of world growth comes from the U.S. and China. Both nations are still growing and, despite the warnings of an inverted yield curve, recession doesn’t seem imminent in either nation. China’s central bank has been aggressively easing monetary policy for over a year, but there are limits how far it can go. Debt levels are rising. Letting the yuan weaken risks a flight of money out of the country. Uncertainties surrounding Hong Kong add to that risk. While the media talks of Chinese army intervention and even President Trump tweets about it, the Chinese know full well the repercussions should armed intervention lead to significant casualties. It still may happen but it is a last resort, not something imminent. It would be unwise to overstate the severity of what is going on in Hong Kong. I don’t mean to ignore the risks but until events force a flow of money out of Hong Kong to other nations like Singapore, we should probably view what is happening in Hong Kong more like the Occupy Wall Street movement of a few years ago.

Putting Hong Kong aside, the real worries the market faces are threats of looming recession (the yield curve inversion is just one more signal) and the threat of deflation. Let’s look at them separately starting with the risk of recession.

Our manufacturing sector may already be in or very close to recession. About 25% of the S&P 500 companies are now estimated to have down earnings over the next 12 months, a combination of weakness in the manufacturing sector, and recessions or near-recessions overseas. Of course, that means 3/4 of the companies are still projected to grow. Capital spending growth has slowed, mostly related to policy uncertainty, but it is still positive. Government spending is strong as are tax receipts. Government spending should grow about 4%. That leaves the consumer, who remains quite healthy. He is earning more money (adjusted for inflation), saving more and increasing spending at a 3%+ pace. Employment remains high and jobless claims are still near record lows. None of this suggests recession. However, while consumer confidence remains high, business confidence is fading fast. Part is the politics. Part is uncertainty overseas. Part is margin squeeze supported by higher taxes.

The President may proclaim that China and Mexico are paying the tariffs, but we all know that they are borne by producers, importers and retailers. Higher sales are not translating into higher margins. If employers get too fearful or see any actual sign of weakness, we may start to see a rise in unemployment claims. If I had to watch one economic indicator as a red flag warning sign of serious trouble ahead, I would watch unemployment claims. You don’t have to see a big increase to be worried. They tend to rise about 10% in the last months of economic growth and then spike during the actual recession, if one actually occurs. That means a 10% rise might be a false signal; that happens often without leading to recession. But this time around, given all the other negatively trending data including lower manufacturing output, weaker exports, the inverted yield curve, etc., I would be very cynical about a continued expansion if claims started to rise steadily.

I indicated earlier that central banks around the world are stepping up efforts to ease monetary conditions. But I should note that our Federal Reserve has made the least response in part because our economy to date has been growing at a very acceptable pace without any inflationary pressures. If the July rate cut put the Fed out in front, the reaction in the bond market would likely have been a steepening of the yield curve, not an inversion. I warned before the Fed meeting that we would have to watch the weeks that follow to determine whether the Fed’s moves were deemed to be sufficient or not. Markets have stated clearly that they were not. Of course, markets aren’t always right but neither is the Fed. In fact, if one looks back at almost every recession in the recent past, the Fed was always late to react. Markets are screaming for a 50-basis point rate cut at the September meeting. The Kansas City Fed holds its annual conclave that everyone watches at the end of August, and we should expect strong signals that suggest what the Fed will do in September, if not sooner. Once again, market reaction to the Fed statements will tell us if they are strong enough.

The other major fear overhanging markets is deflation. As a note continuously, the world is oversupplied. It is oversupplied because of the last recession and because there has been a surge of low cost manufacturing capacity in Asia, principally China. This appears everywhere. Commodity prices are in a downward trajectory with few exceptions. Since the threat of U.S. tariffs just a couple of weeks ago, iron ore prices in China have dropped by 20%. The last thing the world needs is more Chinese steel.

The June CPI came out this week and showed an annualized increase in prices, ex-food and energy of 2.2%, a sign that inflation isn’t completely dead. But if you look within the components, the following have risen by less than 1% year-over-year or declined: transportation services, medical care commodities, generic drugs, cars, commodities other than food and energy, home utility costs, apparel and food consumed at home. The only categories where prices rose by more than 2.2% were shelter, restaurants and medical care services. Indeed, only labor is in short supply. Wages are rising faster than inflation. Thus, services with a high labor component are seeing a bit of inflation, but nothing else.

This all paints a somewhat ominous picture. Growth is slowing with parts of the world already in recession. Prices are rising at an even slower pace and threaten to slip into deflation. What is needed, obviously, are stronger government actions to accelerate growth and stimulate confidence. Obviously, tariffs do just the opposite. I have no idea what enticed President Trump to delay some new Chinese tariffs until December. He had a pretty good idea when Christmas was when he suggested they would be instituted on September 1. Maybe it is simply the Trump method to set a stake in the ground and then pull back, a tactic we have seen often in the past year. What can boost the markets from here? Quite simply, more aggressive Federal Reserve policy, fewer tariffs or fiscal stimulus from around the world.

If recession does happen, and that remains a very big if, there are few signs that it should be a severe one for several reasons. Both banks and individuals are in fine shape. Low interest rates relieve many of possible surging debt service costs. Ultimately, a weak economy will bring proper reactions in the form of stimulative monetary and fiscal policy. Just to put an exclamation point on that statement, weekly mortgage application data released this morning show a sequential 37% spike in applications to refinance, a jump to the highest level since July 2016. Even mortgage applications to buy are 12% above year ago levels. As rates keep falling, refi activity will only accelerate. This is exactly what low rates are intended to do. Homeowners that refi can spend the savings elsewhere, save it or invest it in something like home improvement.

Thus, don’t label this economy dead quite yet. Just as markets overreacted to a modest delay in some tariffs yesterday, they are likely to overreact to a yield curve inversion today. The median time since World War II between the time of a yield curve inversion and the end of the bull market is about 11 months. And not every inversion signals a recession. Note that both the Fed and President Trump watch markets closely and both have tools to react.

But with that said, this is clearly evolving into a risk-off market. I think there is a much better chance that the next 10% move in the stock market is lower, not higher. For markets to move higher from here, bond yields have to stabilize and earnings expectations have to increase. With the bond market in a free fall that we haven’t seen for years, it is anyone’s guess where bottom might be for the 10-year Treasury yield. Rationally, a yield of 1.6%, less than anyone’s reading of inflation, is too low. Money for 10 years, adjusted for inflation, shouldn’t be free. Negative yields overseas are equally irrational. A Danish bank reportedly is offering mortgages at a negative yield. Don’t ask me to explain the rationale. That is what happens when a market goes into freefall and emotion begins to trump rational behavior. None of this means, however, that yields can’t still go lower. More important for stocks, however, is whether 2020 expected earnings have any chance of achieving the 5% growth that constitutes today’s consensus forecast. Clearly, if the economy weakens further, not only will that forecast prove wrong, it could be wrong by a wide margin.

A decline of 10-20% isn’t fun. It may not even occur. But as we learned as recently as this past fall, such declines can be reversed quickly. Long term investors don’t need to change asset allocations, but they should make sure that their equity positions are not higher than normal as a result of the 15-20% rise in the first seven months of this year. Just remember August-October is generally a very nervous time for equity investors while October-December is often a good time. Don’t overreact! But do pay attention and make appropriate changes as needed.

Today, Mila Kunis is 36. Halle Berry turns 53. Magic Johnson is 60. Steve Martin is 74.

James M. Meyer, CFA 610-260-2220

Additional information is available upon request.
* – Boenning and Scattergood may act as principal in buying this stock from or selling it to the public.
# – The author of this report or accounts under his management at Tower Bridge Advisors owns this security.

Additional information on companies in this report is available on request. This report is not a complete analysis of every material fact representing company, industry or security mentioned herein. This firm or its officers, stockholders, employees and clients, in the normal course of business, may have or acquire a position including options, if any, in the securities mentioned. This communication shall not be deemed to constitute an offer, or solicitation on our part with respect to the sale or purchase of any securities. The information above has been obtained from sources believed reliable, but is not necessarily complete and is not guaranteed. This report is prepared for general information only.

Boenning & Scattergood, Inc. – Member FINRA / SIPC.

It does not have regard to the specific investment objectives, financial situation or the particular needs of any specific person who may receive this report. Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed in this report and should understand that statements regarding future prospects may not be realized. Opinions are subject to change without notice.

Stocks sold off in the last half hour on Friday, bringing a very volatile week to a close.

For the week, the major averages were all down but gains mid-week muted the overall impact with losses generally totaling less than 1%.

This morning, demonstrators in Hong Kong have massed inside the airport effectively shutting it down. While the protests began about 10 weeks ago to protest attempts by Mainland China to pass laws allowing extradition of certain residents accused of crimes to the mainland, it is harder today to see what the precise goals of the protestors are after China suspended any attempt to pass such laws. Granted, suspension isn’t the same as actually taking the issue off the table entirely. If nothing else, the ongoing protests, which continue to be large, suggest both a distrust of the Chinese government to abide by its treaty with Great Britain to allow generally self-rule for 50 years, and a build-up of resentment to the Chinese government at the same time. While protestors complain that police reaction to the protests has become more violent, so far there have been no deaths and injuries have been minimal. That could change should China decide to bring in the military to crush the demonstrations, bringing back memories of the Tiananmen Square of 1989.

It appears far too early to make that leap from Tiananmen Square to the events of today. No one, including the Chinese government, wants to see anything that resembles those events. The Chinese government hopes that once schools reopen for fall semester, the size of the protests will shrink. So far, the protests have been dominated by youth and while support appears wide, it may not be universal. Residents of Hong Kong want to protect their freedom but want to avoid a strong military response. That’s a fine line to traverse and clearly shows in financial markets via heightened nervousness.

While the odds of an overwhelming military response may still be low, clearly risks have become more elevated in recent days and weeks. The White House has, to date, stayed out of the conflict, but rhetoric from our State Department is starting to get a bit stronger. None of this can help ease the path in trade negotiations between China and the U.S. Whereas six weeks ago, there was optimism that some first-step agreement between the two countries might come before the end of this year, today a majority no longer expects anything meaningful before next year’s Presidential election. President Trump has already promised 10% tariffs on the remaining $300 billion of Chinese exports to the U.S. China has declared it will no longer buy U.S. agricultural goods, and we responded in kind by not allowing licenses for U.S. companies to do business with Chinese telecom giant Huawei. It remains unclear how far each nation will go to increase pressure in the absence of progress in trade negotiations.

Clearly, for years, China has promised good behavior and then acted in a bad manner. It isn’t just trade. Bold steps to increase its influence in the South China Sea, for instance, is another example. The question, of course, is whether increased pressure from the U.S. will be enough to move China in the direction of better behavior before next year’s elections. Clearly, steps we have taken to date have hurt. No one believes China is growing its economy at a 6.2% annual rate as stated in the nation’s latest GDP release, but all believe it is still growing. In some ways, given that Chinese leadership isn’t bound by election cycles, it can take a longer view. But a slower growing economy could have adverse consequences of note, some very long term in nature.

All this plays into the worldwide deflation story as well. China has become the world’s incremental supplier and, because it sells its goods for less than most competition, it has been the primary deflationary force. As supply chains leave China, the internal appetite for Chinese manufactured steel, for instance, will be less, meaning even more steel will be dumped on world markets. The same can be said for all sorts of generic products from pants to TV sets. No wonder long-term bond rates and inflation expectations are headed in the direction of zero.

The evils of deflation are that if a consumer likes something, he can afford to wait until the product is really needed, knowing prices will fall in the interim. Non-luxury apparel is cheaper today than it was 10 years ago, but apparel sales are weak. Autos are cheaper. Yet auto sales are also stagnant. Price isn’t the only reason, but it is a contributing factor.

China isn’t the only place around the world where disruptive forces are active. Protests are increasing in Russia over a stagnant economy and worsening living conditions. Iran is, obviously, feeling the pressure of economic sanctions. Its oil exports are a fraction of what they were a year ago. Venezuela is rapidly becoming a nonentity, economically, on the world stage. Yet despite the absence of two major producers worldwide, oil prices are lower today than they were a year ago. Brexit will happen in just a few months and Britain still has no exit plan beyond a sharp separation from the EU, certain to cause serious disruption. Germany and Italy face political turmoil.

It’s no wonder the stock market isn’t more worried than it is. Despite all the events I just mentioned, U.S. growth continues, and the U.S. consumer remains willing to spend. Employment remains strong and maybe the best leading economic indicator, weekly jobless claims, remains near record low levels. The low interest rates, at least for now, supports stock prices. The 10-year Treasury yield is now below 1.7%. That is below the yield of the S&P 500 once again.

The risks for equity investors today are that a combination of overseas weakness, escalating tariffs and possible disruptions like, for instance, a worsening of the China protests, lead our economy into a recession that could cause earnings to fall faster than any rise in P/E ratios associated with lower interest rates. Worse, if deflation infects all economies, years of economic stagnation could follow.

How does one protect from these possibilities?

  1. Stay true to your asset allocation. Stocks are still up over 15% this year. That may require some rebalancing. Letting your equity allocation creep down a bit may give you more protection at the expense of losing opportunity gains should markets regain footing and march to new highs.
  2. Own companies with solid growth prospects even when the economy grows more slowly.
  3. Stay away from companies dependent on capital markets financing to support current operations.
  4. Own stocks that both pay good dividends (above the yield on 10-year Treasuries) and that will increase those dividends annually, even if there is a mild recession.
  5. Stay agile and don’t overreact.
  6. Remember that every action evokes a reaction. Too often, predictions are made that (1) bad news occurs and, at the same time, (2) there is no offsetting response. A slowing economy, for instance, pushes central banks to lower rates to stimulate future growth.

With all the unknowns in place, this is a hard market to predict. Volatility is generally high in times like these. But, like last week, volatility doesn’t necessarily mean sharp gains or losses. We are not in a recession and none seems imminent. Low interest rates are a positive for equity valuations. So far, Hong Kong bears watching but isn’t explosive. But that could change quickly. Stay nimble.

Today, actor Casey Affleck is 44. Jazz guitarist Pat Metheny turns 65.

James M. Meyer, CFA 610-260-2220

Additional information is available upon request.
* – Boenning and Scattergood may act as principal in buying this stock from or selling it to the public.
# – The author of this report or accounts under his management at Tower Bridge Advisors owns this security.

Additional information on companies in this report is available on request. This report is not a complete analysis of every material fact representing company, industry or security mentioned herein. This firm or its officers, stockholders, employees and clients, in the normal course of business, may have or acquire a position including options, if any, in the securities mentioned. This communication shall not be deemed to constitute an offer, or solicitation on our part with respect to the sale or purchase of any securities. The information above has been obtained from sources believed reliable, but is not necessarily complete and is not guaranteed. This report is prepared for general information only.

Boenning & Scattergood, Inc. – Member FINRA / SIPC.

It does not have regard to the specific investment objectives, financial situation or the particular needs of any specific person who may receive this report. Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed in this report and should understand that statements regarding future prospects may not be realized. Opinions are subject to change without notice.

For the second straight day, stocks advanced by more than 1%, more than wiping out the losses from Monday’s sharp decline.

With no new news regarding tariffs, trade, currency wars or the Fed, investors calmed down and resumed buying stocks. With bonds, even long-term bonds, generally yielding 2% or less, even income investors were gravitating to stocks.

Here are some of the facts we know:

  1. Growth is decelerating all around the world. In the U.S., leading economic indicators are falling, normally a precursor to recession.
  2. Long-term interest rates around the world are in freefall with only the U.S., the United Kingdom and China sporting positive interest rates all along the yield curve among the larger and developed markets.
  3. U.S. corporate profits are still rising but barely. Year-over-year dollar headwinds could allow profits to rise starting next quarter but that could be negated by threatened tariff increases.
  4. Tariffs already instituted over the past 18 months have resulted in a dramatic slowdown in trade worldwide. It has not, however, evolved into a major change in the balance of payments for the U.S. To the extent American companies have altered supply chains, for the most part manufacturing that has left China has gone elsewhere in Asia rather than return to the U.S.
  5. Consumers worldwide are still vibrant.
  6. So is the labor market. Unemployment is low as are the level of weekly jobless claims.
  7. Inflation expectations are falling. But interest rates are falling faster than inflation expectations. Today, the 10-year Treasury yield is very close to inflation expectations. The real cost of money is now negative.
  8. The lack of yield in the U.S. and negative yields around the world are enticing investors to take more risk. But there is little indication that the low rates here and the negative rates elsewhere are enticing people to spend more. Despite low rates, growth continues to decelerate.

Then there is what we don’t know:

  1. Will Trump actually implement tariffs against China on September 1? At the moment, most observers expect he will. Bilateral talks aren’t even expected until after September 1.
  2. Will the implementation of tariffs and the sharp recent decline in rates accelerate the move down in rates by the Federal Reserve, which has its next formal meeting in September? Markets, based on future expectations, suggest a full percentage point cut in the Federal Funds rate over the next year. Some are beginning to suggest the Fed Funds rate goes to zero even without an intervening recession. Why the Fed might do that with a growing economy is beyond my understanding, but that is the direction consensus opinion is developing.
  3. Sharply lower rates may induce a surge in mortgage refinancing, which will support growth, but they are unlikely to make major changes in other interest-sensitive markets like autos and retail due to factors not related to rates. New environmental rules in Europe will hurt 2020 sales and a modest change in credit card interest rates are unlikely to, by themselves, make a major change in retail spending.
  4. Perhaps the biggest unknown is the situation in Hong Kong. If the escalating protests evoke a violent response from Beijing that resembles Tiananmen Square, the reaction in financial markets could be sharp and severe. Depending on the severity of possible reactions, monies could leave both Hong Kong and mainland China. While President Trump has tried to stay out of the Hong Kong conflict, any violent reaction could force actions that further divide the two countries and would certainly place a large roadblock on any possible trade settlement. China has a bad set of choices. It can assert itself and crush demonstrations, but it can ill afford to see a subsequent significant flight of funds. I am not making any predictions; politics are beyond the scope of this letter. But the risks associated with a tough situation spinning out of control are real and large. At the moment, markets are not discounting problems but if they occur, the reaction would be very negative. Hopefully, the situation can be calmed down without confrontation. But this is more than a red herring risk.

While growth continues, earnings are still growing, and the outlook still suggests recession will be avoided. Risks have become more elevated, most specifically, the threat of deflation (too much supply!), Hong Kong and an escalating trade war. The problem of too much supply won’t be solved by enticing businesses to increase capital spending worldwide to add to oversupply. How do I know the world has too much capacity? Just look at price. At the moment in the U.S., the only significant categories where prices are rising faster than 2% are rents, hospital services and wages. And in all three cases, the rate of increase is falling. Commodity prices are falling everywhere. The greatest fear is that the whole world gravitates toward a Japanese-like economic pattern of near zero interest rates, rising savings and near zero growth until such time as inflation returns. Central bank policies that want to pump more money at ultra-low rates into the economic ecosphere simply serve to perpetuate the overcapacity and heighten the risk of deflation.

Look at the oil industry. Saudi Arabia and Russia are trying to find ways to restrict production in order to prop up prices. A far better economic solution, which may not be in the short-term interest of either nation, would be to let prices fall to a level that would stifle the drilling of new wells for a significant enough time to rebalance supply and demand. If production falls enough, prices could actually rise. But temporary artificial supply cuts don’t solve a long-term problem. Today, prices could fall below $40 per barrel and not create a shortage assuming Saudi Arabia and Russia produced at normal levels. Politics may not allow that to happen, but the upshot is that the world will remain oversupplied with oil for some time to come and it will lead to a gradual erosion in prices anyway.

So, what’s the solution?

Ken Rogoff and Carmen Reinhart wrote in an often quoted piece that it takes 10 years or so to recover from a financial crisis. The Great Recession was 10+ years ago. But their historical analysis doesn’t add in the immense capacity added by a surging China in the interim. That suggests 10 years might not be enough. As noted, the problem is not lack of demand but too much supply. Will the excess be absorbed in another year or two? Perhaps, but only if the world stops adding supply at a rate faster than the growth in demand. Central banks should get out of the game of promoting growth. They can affect the environment but they can’t, directly, create growth. The threat of deflation, accelerated by overly aggressive monetary policy, accelerates savings more than spending. Governments have to spend more, hopefully on infrastructure that promotes better productivity. Remember that workforce growth time productivity gains equal GDP growth. Our government has been talking about infrastructure spending for years without doing a thing. Unfortunately, there are no signs of any change.

As investors, the best answer is to remain in stocks that either grow fast enough to overcome deflationary forces or that pay and have the ability to raise dividends that exceed meaningfully the yield on 10-year Treasuries. A recession is a possibility but far from certain. Inflation is moving in the direction of deflation but isn’t there yet. Low interest rates keep P/E ratios high, but earnings have to hold for stock prices to benefit. The bottom line is that the consensus outlook hasn’t changed but risks are elevated. Volatility should stay above recent levels. Computer traders, as a result, create short term buying and selling opportunities. Markets with elevated volatility suggest change is in the wind. We have highlighted some of the possibilities. As events fall into place, for better or worse, we will have to be quick to react.

Today, Anna Kendrick is 34. Hoda Kolb turns 55. Designer Michael Kors is 60.

James M. Meyer, CFA 610-260-2220

Additional information is available upon request.
* – Boenning and Scattergood may act as principal in buying this stock from or selling it to the public.
# – The author of this report or accounts under his management at Tower Bridge Advisors owns this security.

Additional information on companies in this report is available on request. This report is not a complete analysis of every material fact representing company, industry or security mentioned herein. This firm or its officers, stockholders, employees and clients, in the normal course of business, may have or acquire a position including options, if any, in the securities mentioned. This communication shall not be deemed to constitute an offer, or solicitation on our part with respect to the sale or purchase of any securities. The information above has been obtained from sources believed reliable, but is not necessarily complete and is not guaranteed. This report is prepared for general information only.

Boenning & Scattergood, Inc. – Member FINRA / SIPC.

It does not have regard to the specific investment objectives, financial situation or the particular needs of any specific person who may receive this report. Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed in this report and should understand that statements regarding future prospects may not be realized. Opinions are subject to change without notice.

It has been a roller coaster week so far in the market with the Dow falling over 700 points on Monday before rallying 300 points yesterday.

The catalysts for this week’s volatility have been strong moves in currency markets set off by President Trump’s threat to impose 10% tariffs on $300 billion of Chinese goods on September 1. China, in response, let the yuan fall to over 7 to the dollar for first time in a decade. The White House responded by labeling China a currency manipulator. China since then has moved to stabilize the exchange ratio at about 7 calming markets for the moment.

Currency markets are by far the largest financial markets in the world. All financial markets are interconnected. Significant changes in any one has ripple effects everywhere. Given the sheer size of currency flows worldwide, even slight changes in exchange ratios can cause outsized movements across bond, stock, commodity and derivatives markets. That is what happened Monday. Yesterday witnessed a nervous recovery. Traders have no idea whether there will be a period of political calm ahead or whether the tit-for-tat war between the U.S. and China will escalate.

On the surface, a decline in the value of the yuan would seem to mitigate some of the economic pressures created by tariffs. A lowered value yuan reduces the pain of a 10% tariff. But that is just the narrow view. Many countries peg their currencies in some fashion to either the dollar or the yuan. Many issue dollar denominated debt. When the dollar gets more expensive, their debt obligations expand. Oil is priced worldwide in dollars. A strong dollar is offset by lower oil prices. Yesterday, as stocks rallied by more than 1%, energy stocks fell. The average oil and gas related stock is down close to 50% year-to-date in a stock market that, overall, is up 15-20%. The damage isn’t all currency related, but the pains of currency, oversupply and tariffs are overwhelming not only to oil and gas, but all commodities. The drop in commodity prices worldwide is reflected in negative interest rates around the globe.

All of this is unnatural. The borrower is supposed to pay the lender for use of the latter’s money, not the other way around. Commodities should trade in a range, not go into perpetual freefall. Tariffs are reducing demand and slowing trade in a world that was already oversupplied. While strength in the consumer sector is keeping most economies in a growth mode, eventually the headwinds just noted could erode consumer confidence and set off a true deflationary spiral.

At the moment, these are all ifs. They are not predictions. But an escalating trade war, or even the threats of more tariffs, ultimately could deflate most economies. President Trump’s economic agenda is built on America first. That is as it should be. Tariffs are his weapon of choice to pressure others to alter policies in a way that favors American commerce. He looks at the balance of trade as a key market of success. To him, a negative trade balance, all else being equal, implies something unfair within the trade rules that causes the imbalance. Others suggest that if we are the strongest trading partner, we will naturally have the greatest demand for imports. Indeed, our trade deficit tends to widen in good times and shrink in bad times. In addition, Mr. Trump is correct in noting that other countries impose greater tariffs on us that we do reciprocally. That is why, for instance, he periodically threatens tariffs against European auto exporters.

But whatever the reason, the clear fact is that tariffs stunt growth. Our growth has declined by about 1% over the past year as a result of tariffs implemented. That does not factor in future tariffs like the 10% expected to be levied on Chinese goods in September. More tariffs not only mean lower growth; they also mean lower prices and less inflation. American businesses have so much excess capacity and so little pricing power that very little of the tariffs imposed flow through to consumers through higher prices.

If there is “good news” in all this, it is that interest rates in our country are in free-fall. The 10-year Treasury yield is now below 1.7%. Low interest rates are a catalyst that promote more risk taking. In the stock market, that means higher P/E ratios. Thus, while earnings year-to-date are flat, stocks are up 15-20% because P/Es have risen as interest rates have fallen. Third quarter earnings are now forecasted to be flat again and new tariffs may lessen expected growth in the fourth quarter, particularly if tariffs are implemented.

Adjusting to all these changes implies elevated volatility. It also suggests that investors may choose to get as far away from the currency and tariff storms as they can. That means continuing to stay aware from commodity businesses, companies highly dependent on China or multinationals exposed to major changes in the value of the dollar. Falling P/E ratios favor growth stocks and falling interest rates put a floor under the prices of companies with high and growing dividends.

Clearly, markets near term will be highly dependent on the news flow. But the relative calm of yesterday may continue for a bit if the saber rattling slows down.

Today, Mike Trout turns 28. Charlize Theron is 44.

James M. Meyer, CFA 610-260-2220

Additional information is available upon request.
* – Boenning and Scattergood may act as principal in buying this stock from or selling it to the public.
# – The author of this report or accounts under his management at Tower Bridge Advisors owns this security.

Additional information on companies in this report is available on request. This report is not a complete analysis of every material fact representing company, industry or security mentioned herein. This firm or its officers, stockholders, employees and clients, in the normal course of business, may have or acquire a position including options, if any, in the securities mentioned. This communication shall not be deemed to constitute an offer, or solicitation on our part with respect to the sale or purchase of any securities. The information above has been obtained from sources believed reliable, but is not necessarily complete and is not guaranteed. This report is prepared for general information only.

Boenning & Scattergood, Inc. – Member FINRA / SIPC.

It does not have regard to the specific investment objectives, financial situation or the particular needs of any specific person who may receive this report. Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed in this report and should understand that statements regarding future prospects may not be realized. Opinions are subject to change without notice.

Stocks finished lower on Friday as traders continue to fret over President Trump’s threat to increase tariffs on an additional $300 billion of Chinese imports by 10%.

Overnight, the value of the Chinese yuan fell to a ratio of over 7 to the dollar for the first time in over a decade. As a result, equity markets worldwide accelerated their declines. Future markets point to losses of over 1% at the open.

Let’s start by reviewing last week’s chain of events. First, the Federal Reserve cut its key lending rate, the Federal Funds rate, by a quarter point on Wednesday. While markets reacted negatively immediately after the rate cut as Fed Chair Jerome Powell failed to promise additional cuts at future meetings, investors calmed down overnight and by mid-day Thursday, had recovered all the losses of Wednesday afternoon. But then around 2 pm, President Trump tweeted that he planned to increase tariffs on Chinese goods on September 1 since the Chinese were not moving quickly enough in his view toward a trade package he wanted. Moreover, China was not buying U.S. agricultural products in the quantities he thought they had committed to buy. Stocks fell immediately. Tariffs are a tax. They slow the pace of commerce and stifle growth. But by Friday, markets seemed to have calmed down. While markets finished lower for the second straight day, losses were pared in the afternoon and trading volumes slowed as one would expect for a summertime Friday.

But the currency moves over the weekend have set markets in motion again. There is no evidence yet that China intervened directly in the currency markets to force the yuan to fall against the dollar. Indeed, the natural reaction would be for the yuan to fall as the tariffs are aimed at hurting the Chinese economy. A weak economy leads to a weak currency as a counterbalance. The tariffs put China at a disadvantage; a weak currency would restore some of that disadvantage.

President Trump, even before last week’s threat to add more tariffs, has been complaining that many currencies around the world were weakening against the dollar and that was a headwind to U.S. growth overseas. A strong dollar or a weak yuan, euro, pound, etc. means that our exports become more expensive and imports to the U.S. would be cheaper. If we import more (at lower prices) and export less, that increases our balance of payment deficit. So does the fact that we are growing faster than most other nations. Faster growth means we import more and export less.

Anyone who has followed Trump’s economic logic knows (1) he wants a positive trade balance between the U.S. and every other nation if possible, and (2) he feels tariffs are his best weapon to achieve that. So far, that doesn’t appear to be working. He has actively imposed tariffs over the past two years and threatened many more. But our trade imbalance continues to increase despite the fact that we have become a much bigger exporter of energy resources.

As the old Chiffon margarine commercial said, “It’s not nice to fool Mother Nature!” Currency markets work like a balance scale. A weak currency allows economically disadvantaged nations to compete. Why don’t all countries, therefore, chase a weak currency policy? That’s a bit like asking why don’t all countries try to be weak competitively. It’s counterintuitive. Of course, the Treasury could interfere by buying or selling currencies to artificially change exchange rates but (a) that’s expensive and (b) such an effort cannot be sustained indefinitely.

Regardless of what I have just said, China, historically, has intervened to keep its own currency relatively stable on international markets. It did so principally by buying yuan. Letting the exchange rate fall to a level higher than 7 to the dollar would, in Chinese eyes, offset part or all of the economic impact of the proposed 10% tariffs. In theory, that could mean that U.S. importers would pay less for the goods we import and, even after tariffs are raised and passed through, at least in part, there would be no impact to the U.S. consumer. That doesn’t seem bad on the surface but that ignores the interlocking of all things economic and all financial markets. While the fall in the yuan may balance out pending tariffs, it means earnings of U.S. companies in China get translated back into fewer dollars. It means the price of oil and other commodities fall. It puts China at advantage against the rest of the world that isn’t in a tariff war with China. It puts China at an economic advantage against the rest of the world. Currency markets are far larger than bond or stock markets. Gains and losses in one affect what investors do in others. Getting back to the Mother Nature quote, we are now seeing the consequences of warm weather in so many different ways. Sharks are roaming beaches farther north. Mosquitos flourish. Some species become extinct. Currency markets work best when left alone.

Mr. Trump was tempted to intervene just a few weeks ago before a majority of advisors talked him out of it. I have no idea what his reaction to the weak yuan will be but, clearly, he won’t be happy. When he is mad, he is in danger of doing something impetuously and that is a heightened market fear this morning. Everyone expected the Chinese to retaliate against the threat of added tariffs. So far, the tariffs haven’t been implemented and China has not overtly interfered in currency markets. But if Trump implements the tariffs with promises of more to come, the Chinese don’t behave to his wishes and if both countries start to intervene in currency markets, no one can tell the actual outcome but all can conclude that the end result won’t be good for any financial market except possibly gold.

Tariff wars are more spats than wars. They don’t tend to be long lasting precisely because, in the end, they almost always do more harm than good. Bond yields are declining this morning once again as traders presume moves in currency and the threat of tariffs will result in lower economic growth. Thus, while lower rates could portend higher P/Es, they also mean lower earnings, particularly for multi-nationals. This morning, the President has already accused China of currency manipulation. That almost demands a response soon. This morning, his attention will be diverted to the twin mass shootings over the weekend, but he watches markets and won’t like what he sees. The problem is his next step is more likely to aggravate the situation than alleviate it.

We have gone more than 8 months without so much as a 5% correction. Stocks were already at the high end of their valuation range before the latest news hit. I suspect we are headed for at least a 5% correction here and it could be 10% or more before all is said and done depending on what further actions (and missteps) take place. I don’t think 10% tariffs on Chinese imports ends the economic recovery but it could leave the stock market in a bad mood for several weeks.

Today, Loni Anderson is 73. Maureen McCormick turns 63. Comedienne Selma Diamond is 99.

James M. Meyer, CFA 610-260-2220

Additional information is available upon request.
* – Boenning and Scattergood may act as principal in buying this stock from or selling it to the public.
# – The author of this report or accounts under his management at Tower Bridge Advisors owns this security.

Additional information on companies in this report is available on request. This report is not a complete analysis of every material fact representing company, industry or security mentioned herein. This firm or its officers, stockholders, employees and clients, in the normal course of business, may have or acquire a position including options, if any, in the securities mentioned. This communication shall not be deemed to constitute an offer, or solicitation on our part with respect to the sale or purchase of any securities. The information above has been obtained from sources believed reliable, but is not necessarily complete and is not guaranteed. This report is prepared for general information only.

Boenning & Scattergood, Inc. – Member FINRA / SIPC.

It does not have regard to the specific investment objectives, financial situation or the particular needs of any specific person who may receive this report. Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed in this report and should understand that statements regarding future prospects may not be realized. Opinions are subject to change without notice.

The Fed lowered interest rates 25-basis points on Wednesday as advertised.

In the subsequent press conference, Jerome Powell confused everyone about the FOMC’s future course and stocks fell by over 1%. Then yesterday, as the yield on 10-year Treasuries fell to 1.95%, stocks started to take off once again until President Trump threatened more tariffs. Low rates mean higher P/Es, which mean higher stock prices.

A lot of market pundits point to 1987, 1995 and 1998 as examples of when the Fed cut rates during relatively good times to maintain and extend an economic expansion.

Let’s look at each.

In 1987, the stock market soared and bond prices cratered steadily until the end of August when air started to leak out of the bubble. Then one Monday in late October, it burst as the Dow fell 22% in one day. These were days before complete automation. You actually had to call an order desk to execute an OTC order. By Tuesday morning, phones were ringing off the hook and no one answered. The Fed stepped in and provided liquidity including lowering rates. It was a brief but bold reaction to a sudden event. A year later, most of the losses had been recouped and markets continued on their merry way. There is virtually no correlation to today’s market. Yields today are low and headed lower. There is no panic in the equity markets. So let’s move on.

1995 is a better example. After several years of a strong economy and solid stock market, interest rates started to spike. Bond investors were getting killed. The stock market fell but most of the damage was in the bond market. The Fed stepped in to lower rates and try and bring calm to markets. It worked. The recovery resumed and the stock market went on to enjoy 4+ years of extended gains. Once again, however, we are comparing a reaction to higher rates and increases in inflation expectations to today’s world where inflation expectations have been consistently anchored at or slightly below 2% for some time. Let’s move on once more.

In 1998, the economy was performing fairly well, consistent with growth levels we see today. The stock market was becoming ever more bifurcated. Everything tech and internet related was hot. Smokestack America was to be avoided at all costs. Leaders sold for 10-12 times earnings. Second grade companies sold for less. Valuations were starting to get stretched. After a 20% correction, the Fed tapped the accelerator a bit, lowered rates some and extended the bull market and the internet bubble for another 18 months or so. In the spring of 2000, it finally burst and there was not much the Fed could do to stop a 40% bear market.

If this market resembles any of the above, it is 1998. But let’s look at the picture from a different viewpoint. The Fed is charged with maintaining price stability, which it equates with keeping inflation near 2%, and providing an interest rate framework that can foster growth. Some argue that the Fed tapped the brakes too hard last year with four rate increases slowing growth from 4% to 2%. One can argue that tariffs had at least something to do with that slowdown. Inflation remains missing in action. Too much supply means low prices. Recent GDP numbers show a decline in capex. That is what you get when supply is too big. Commodity prices are weak, another sign of excess supply. Natural gas prices are less than half of what they were last fall despite the fact that producers are flaring gas because of a lack of pipeline capacity.

There is also too much money. Central banks around the world, largely meaning the ECB and Bank of Japan, face lower growth mostly due to bad fiscal policy, excessive regulation and horrible demographic trends. Their response was to lower central bank rates to zero and flood the system with money.

The world’s problems today aren’t too little money; it’s too much capacity.

If you have a house with three kids and you have 5 gallons of milk in the refrigerator, are you going to buy more milk even if it’s $1 off?

Negative interest rates don’t create more spending; they create more confusion. They chase money overseas. They create hoarding. They don’t increase capex. Yes, they do move money into stock markets and other financial assets that benefit from lower rates but what comes next? Even more negative rates?

Our Fed watches what they are doing overseas and has decided they can’t keep rates at 2%+ while the rest of the world is at zero or below. It chose to chase bad policy! Inflation readings have actually been rising in recent months. The rate cuts weren’t needed to tweak inflation expectations. Growth is 2%+. They weren’t needed to increase growth.

The Fed gave in to markets that love lower rates because, at least in the short run, lower rates mean higher asset prices. I hope they didn’t give in to President Trump but his constant criticism can’t be 100% ignored.

What happens from here? If rates keep going lower at both ends of the curve, more cuts will follow. I don’t think we are headed to zero but negative rates around the world won’t last forever. When they revert to normal, which is something higher than the rate of inflation, asset values will subsequently fall. I am not advocating selling any financial assets today. As long as central banks want to ignite further gains, you don’t fight the Fed. But what the Fed and other central banks are doing today will bring the end point closer, not extend it out several years. Enjoy it now but realize that low rates carry a price long term. So does an accelerated buildup of sovereign debt.

President Trump wants lower rates, massive increases in spending and higher tariffs. He believes he can engineer an economy that will peak before next November’s election. Time will test his economic skill.

Today, actress Mary Louise Parker is 55.

James M. Meyer, CFA 610-260-2220

Additional information is available upon request.
* – Boenning and Scattergood may act as principal in buying this stock from or selling it to the public.
# – The author of this report or accounts under his management at Tower Bridge Advisors owns this security.

Additional information on companies in this report is available on request. This report is not a complete analysis of every material fact representing company, industry or security mentioned herein. This firm or its officers, stockholders, employees and clients, in the normal course of business, may have or acquire a position including options, if any, in the securities mentioned. This communication shall not be deemed to constitute an offer or solicitation on our part with respect to the sale or purchase of any securities. The information above has been obtained from sources believed reliable, but is not necessarily complete and is not guaranteed. This report is prepared for general information only.

Boenning & Scattergood, Inc. – Member FINRA / SIPC.

It does not have regard to the specific investment objectives, financial situation or the particular needs of any specific person who may receive this report. Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed in this report and should understand that statements regarding future prospects may not be realized. Opinions are subject to change without notice.

Stocks finished lower both on Friday and for all of last week.

Early strength, tied to hopes that the Fed next week would cut the Fed Funds rate by 50 basis points were squashed when the Fed officials who hinted at the possibility said such a discussion was only theoretical and didn’t apply to possible action at the upcoming FOMC meeting.

This week will be a big one for earnings, mostly concentrated tomorrow, Wednesday and Thursday.  133 S&P 500 companies are set to report this week including 10 components of the Dow Jones Industrial Average.   So far, about ¾ of the companies reporting have met or exceeded expectations.  While some feared that forward looking guidance might be somewhat dour given the recent slowdown in economic growth, that doesn’t appear to be the case so far.  The banks have pointed to consumer strength citing solid loan demand and very good credit card spending.

Tensions over the weekend in the waters of the Persian Gulf have put a bit of upward pressure on oil prices.  Forty years ago, the price would have spiked but today, world supplies are more geographically diversified and, to date, the actions, while an escalation of recent events, still haven’t closed the Strait of Hormoz and traffic is still pretty close to normal.  Obviously, Iran wants some relief from sanctions and is using provocation to get its way.  So far, it isn’t working.  At the moment, we don’t seem close to an event that would have significant economic impact (e.g. close the Strait entirely) but clearly this bears watching.

The other major theme overriding the market today is the continued worldwide growth slowdown and the efforts of central banks to combat that by further easing monetary policy.  The Fed and other central banks can’t force spending but, by making rates lower or funneling more money into market, they can make more spending appealing.  The risks, of course, are that all the easy money won’t stem the growth slowdown in which case a recession looms.  That, however, is a big risk.  When businesses hold sales, customers generally come and spend.  The only issue is how deep a discount might be necessary to clear inventory.

The other major open matter in Washington is the negotiation between Nancy Pelosi and Steven Mnuchin regarding Federal spending over the next two years combined with an agreement to raise the debt ceiling.  Congress goes into a six-week recess shortly.  The Treasury could run out of money without an ability to raise additional debt just about the time Congress comes back into session.  At the moment, it appears that both are confident that an agreement for a 2-year spending authorization can be passed.  However, similar to two years ago, the talk (few have seen any actual documents yet) seems to suggest another massive spending increase to make both sides happy.  The President wants more money for defense and border security; the Democrats want more money for their social agenda.  The easy way out, giving both sides what they want, has dangerous long term implications because of the accelerating deficit.  Even at current low interest rates, interest expense will soon exceed defense spending.  If rates rise, even a little bit, that could quickly get out of hand.  And Congress can’t legislate lower interest costs.  The monies to service the debt has to come from somewhere else.  Two years ago, President Trump threatened to veto the spending authorization bill but relented and signed it at the last minute. He vowed never to do that again.   Now, of course, he is potentially back in the same place.  So far, he has had little to say leaving it to Pelosi and Mnuchin to make a deal.  Pelosi is certain to face opposition from her progressive wing but not enough to scuttle the deal. Thus, as the week comes to an end, Mr. Trump is going to have to make a decision.  He could sign the bill saying he doesn’t really like it.  He could threaten a veto, send everyone into a tizzy before getting a very slightly better deal.  Or he could simply refuse to sign the bill.  Should that happen, the fall back is to go back to the limits set in 2011.  That would involve significant cuts to the planned level of spending both for defense and non-defense.  It would have no impact on entitlements.  At the moment the numbers being floated around suggest spending more than $300 billion about the austerity spending governed by the 2011 laws.  Many conservatives favor going back to those levels.  Certainly, from a debt management perspective, that make sense.  If, however, you want to look at near term GDP growth, $300 billion less spending would be a headwind to growth.

The probable outcome is for something in between.  How that evolves over the next 5 days will be crucial.  For markets, the resolution could be more impactful to markets than the corporate earnings reports.

Today, Prince George is 6.  Ezekiel Elliott is 24.  Don Henley is 72.  Danny Glover turns 73.  Finally, Alex Trebek turns 79.

James M. Meyer, CFA 610-260-2220

Additional information is available upon request.

* – Boenning and Scattergood may act as principal in buying this stock from or selling it to the public.

# – The author of this report or accounts under his management at Tower Bridge Advisors owns this security.

Additional information on companies in this report is available on request.  This report is not a complete analysis of every material fact representing company, industry or security mentioned herein.  This firm or its officers, stockholders, employees and clients, in the normal course of business, may have or acquire a position including options, if any, in the securities mentioned.  This communication shall not be deemed to constitute an offer, or solicitation on our part with respect to the sale or purchase of any securities.  The information above has been obtained from sources believed reliable, but is not necessarily complete and is not guaranteed.  This report is prepared for general information only.

Boenning & Scattergood, Inc. – Member FINRA / SIPC.

It does not have regard to the specific investment objectives, financial situation or the particular needs of any specific person who may receive this report.  Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed in this report and should understand that statements regarding future prospects may not be realized.  Opinions are subject to change without notice. 

Stocks managed to eke out a small gain after trading lower for much of the session.

With the next FOMC meeting less than two weeks away, the yield curve has flattened a bit reflecting investor optimism that lower rates could spur economic growth and a slight increase in the rate of inflation.

This week has been mostly about earnings.  What economic data we saw was mixed-to-negative.  The highlights were a decline in leading economic indicators, a harbinger of a slower economy ahead, and weaker than expected housing data. Those items are almost sure to reinforce the Fed’s likely decision to cut interest rates.  It is even possible that it could cut rates by 50 basis points instead of 25. That, however, is still a long shot. While it definitely would give the economy a shot in the arm and would be cheered by equity investors, it also could send an unintended message of excessive concern over the state of the economy.

As for earnings, most of the reports to date have come from banks. Generally, the numbers have matched expectations or even been a bit better.  The highlight was solid loan growth, a sure indication of a stable and slowly growing economy.  Bank stocks have performed decently over the past few months but have been consistent laggards over the past several years.  They are thought of as early cycle stocks, equities that outperform at a time when the central banks are stimulating aggressively to help lift an economy out of recession.

But a curious thing seems to be happening in this market.  Banks aren’t the only early cycle group coming alive.  A few homebuilders are at 52-week highs. While the performance of brick-and-mortar retailers is spotty, those that have solid growth are also doing well. Why are these stocks suddenly coming alive late in an economic cycle?

The answer may be that we are, in fact, entering a new cycle as the central banks once again start to ease in an effort to lift inflation and, secondarily, stimulate more economic growth.   We aren’t talking about fierce rate cutting or the massive purchase of bonds by the Fed in the open market.  We are talking about modest steps to reenergize an economy that was showing signs of old age.  Thus, in a sense, we are potentially entering a new phase of an aging bull market, one that will see some acceleration fed by lower rates.  That is exactly the catalyst that classic early cycle stocks need to reinvigorate themselves.  Will these stocks become true market leaders?  Maybe not.  But most sell at low P/E ratios, sport healthy dividends, and have improving balance sheets.  Many are actively buying back stock.  And a company can buy back a lot more stock when it sells at 8-10x earnings that when it sells at 20x or more.

Away from banks, a few key technology companies reported. One can hardly describe technology stock as cheap but when a company is able to beat expectations consistently, it usually attracts buyers. 

Overall, so far, earnings season is about as expected.   Companies are beating analyst forecasts by a few percentage points and look forward to the second half of the year with cautious optimism.  When the dust starts to settle a couple of weeks from now, what looked to be a down quarter going into earnings season may turn out to be flat or even up a tad.

The next two weeks will hold the key as the vast majority of S&P 500 companies report. The fact that there have been few big misses so far and few preannouncements may be a harbinger of better than expected results.

Today, former Starbucks Chairman Howard Schultz is 66.  Queen guitarist Brian May turns 72.

James M. Meyer, CFA 610-260-2220

Additional information is available upon request.

* – Boenning and Scattergood may act as principal in buying this stock from or selling it to the public.

# – The author of this report or accounts under his management at Tower Bridge Advisors owns this security.

Additional information on companies in this report is available on request.  This report is not a complete analysis of every material fact representing company, industry or security mentioned herein.  This firm or its officers, stockholders, employees and clients, in the normal course of business, may have or acquire a position including options, if any, in the securities mentioned.  This communication shall not be deemed to constitute an offer, or solicitation on our part with respect to the sale or purchase of any securities.  The information above has been obtained from sources believed reliable, but is not necessarily complete and is not guaranteed.  This report is prepared for general information only.

Boenning & Scattergood, Inc. – Member FINRA / SIPC.

It does not have regard to the specific investment objectives, financial situation or the particular needs of any specific person who may receive this report.  Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed in this report and should understand that statements regarding future prospects may not be realized.  Opinions are subject to change without notice. 

Stocks gave ground yesterday amid some profit taking. A sharp drop in energy prices nicked the oil sector

Late in the day, President Trump once again spoke of the possible need for further tariffs against the Chinese should trade talks fail to make progress.

The markets reacted much less harshly than they have in the past given Mr. Trump’s behavior pattern to pull back at the last minute.  But, if anything, he is unpredictable and a poker player can’t win by bluffing all the time.  Still, it is earnings season and with companies reporting decent results against a solid economic backdrop, the overall mood is still positive.

One big overtone of the past several years is populism.  It certainly has changed to political landscape.  Populists have either been elected or been a factor is many elections.  There is no better example of this than President Trump.  Populism draws ardent supporters.  Whatever you think if Mr. Trump personally, you can’t deny his ability to draw huge crowds.  But he isn’t alone.  Bernie Sanders, in the 2016 campaign, had equally ardent supporters.  Hilary Clinton’s failure to excite those of the left politically may have cost her the election. Today enthusiasm among progressives is split.  Some of that energy has been hijacked, at least for the moment, by “the squad”, for House newbies that have very progressive and controversial ideas.  They scream loudly and crudely sometimes.  So far, their appeal is narrow.  Moreover, it saps some of the energy from the main show, those running for President.  But over time, that will change and the energy will transfer to someone the squad endorses, or at least tolerates. We have already seen moments of emotional fire from Senators Elizabeth Warren and Kamala Harris.  It is way to early to see whether early energy can light a fire but if the Democrats are going to win, they are going to have to capture their share of populist energy.

Populism isn’t a left or right ideal.  It, as the word implies, represents ability it hear the people and offer then a better path forward. Often the promises don’t morph into reality.  Nations like Venezuela are prominent examples.  In many cases, the promises mix with corruption and greed and generate undesired result. Brazil and Argentina come to mind.

We see populism coming to the forefront in Great Britain. Theresa May came into office at a crisis moment.  The Brexit referendum had passed but it needed a leader to get it executed. She wasn’t up to the task. Now, the leading candidate to replace her is Boris Johnson, Britain’s version of a populist.  First he has to win his own party’s nod and then we will see if his charisma can get the job done.   France, in its last election, chose between a right wing extreme and a young outsider with his own brand of charisma, Emanuel Macron.  Mr. Macron lost his way, however, when he started to talk down to the populace.   He heard to boos and has begun to listen better but the jury is still out.

Mr. Trump, of course, represents a different and very unique version of populism.  He has populist policies that appeal beyond his base including more rational regulation, lower taxes, and a more disciplined approach to immigration but, to be polite, his execution is often crude and controversial.  That leaves the window open for Democrats but as recent French history shows, getting too extreme is a path to defeat.

Look, for instance, at the progressive rush to Medicare for all.   Joe Biden correctly points out that what sounds great is economically unfeasible.  Seniors currently covered by Medicare have been paying Medicare payroll taxes their whole lives.   Even assume private employers pay for a Medicare plan instead of private insurance in the future, how does one account for the millions who aren’t working for an employer who pays for benefits, aren’t poor enough for Medicaid, or aren’t old enough for Medicare?  Therein lies the flaw of many purely populist ideas.  The benefits are appealing and win votes but the execution is way too costly.  In the stock market, while the health care sector has lagged year-to-date, in good part due to the rhetoric surrounding the future of health care programs, for the most part, the threat of Medicare for all hasn’t had an overwhelming impact.  Mr. Biden’s idea to rework and improve Obamacare makes more sense and can be done in a way that allows the current system to sustain itself.  Yes, Republicans want to repeal and replace but that is all semantics.  Any result would be an alteration of what is already out there.  The real arguments won’t be about the label; but about the efficiency of a better plan.

That doesn’t mean the health care sector is off the hook.  Everyone is attacking drug pricing. Drug price inflation has been falling for years.  Generic prices have actually been in steady decline for much of this decade.  At some point, the government may get into the business of negotiating drug prices.  It actually does so today but not in a universal way.  But in the end, it will be market forces that win out. That is always the way.  Drug price inflation has been falling as co-pays rise and individuals become more invested in the economics of health care.  Put the incentives in the right place and market forces will generate the proper result every time.

As for earnings season, so far it is too early to make much of a conclusion.  More on that topic will come Friday.

Today, Luke Bryan is 43.  Angela Merkel is 64. Donald Sutherland turns 83.

James M. Meyer, CFA 610-260-2220

Additional information is available upon request.

* – Boenning and Scattergood may act as principal in buying this stock from or selling it to the public.

# – The author of this report or accounts under his management at Tower Bridge Advisors owns this security.

Additional information on companies in this report is available on request.  This report is not a complete analysis of every material fact representing company, industry or security mentioned herein.  This firm or its officers, stockholders, employees and clients, in the normal course of business, may have or acquire a position including options, if any, in the securities mentioned.  This communication shall not be deemed to constitute an offer, or solicitation on our part with respect to the sale or purchase of any securities.  The information above has been obtained from sources believed reliable, but is not necessarily complete and is not guaranteed.  This report is prepared for general information only.

Boenning & Scattergood, Inc. – Member FINRA / SIPC.

It does not have regard to the specific investment objectives, financial situation or the particular needs of any specific person who may receive this report.  Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed in this report and should understand that statements regarding future prospects may not be realized.  Opinions are subject to change without notice. 

Stocks continued to rally on Friday and most leading indices again closed at record high levels.

With long Treasury bond yield continuing to press higher, the 3-month to 10-year yield curve, which has been inverted for a few months, is very close to uninverting, perhaps even before the Federal Reserve lowers the Fed Funds rate by at least 25 basis points at the end of the month. 

The changing shape of the yield curve reflects (1) confidence that the Fed and other central banks will be easing monetary policy in the months ahead, and (2) that economic growth will reaccelerate in part due to easing financial conditions.

For stocks this is a potential double-edged sword.  The move back up in rates for 10-year Treasuries will push P/e ratios a bit lower.  However, if confidence in better earnings ahead improves, the offset would be enough to let stocks continue their run to record highs.  Obviously, earnings season, which begins this morning as Citigroup reports results, holds the key.  Management commentary regarding the outlook for the balance of the year will be key to sustaining the market’s current optimistic mood.

Some suggest that the market’s multiple could actually rise along with improved confidence despite any possible further rally in Treasury yields.  In the short run, emotion can trump rational behavior and, thus, anything is possible.  But as we have learned several times over the past couple of years, excessive optimism unsupported by reality leads to quick short-term declines.  I am not predicting that. But I think if stocks march much further into new high ground without accompanying fundamental support, the odds of a mild but sharp correction increase.

With those technical thoughts said, there are good reasons to be optimistic about the outlook for corporate earnings.   First, consumers are still in a good mood and spending money.  High debt loads and rising credit card debt do pinch some buyers, notably among millennials, but the data shows no serious threat to a solid spending environment.  Today and tomorrow is Amazon Prime Day(s) and I have little doubt that the numbers will show record spending, for instance.   Second, unemployment claims remain near record lows.  As long as people have jobs and they are secure in their employment, there is no good reason to expect spending growth to slow in any meaningful way.  Third, the recent drop in rates has begun to filter through to the housing market.  Demand is solid.  Indeed, what may be holding back home sales is a dearth of quality supply.  That have allowed both rents and sale prices to stay firm. While that is good for sellers, strong prices do keep some potential buyers out of the market.  Finally, the dollar, year-over-year, is about flat and, therefore, no longer an impediment to higher earnings.  Until now, the strong dollar has caused foreign earnings to appear lower when translated back into dollars.   That headwind disappears in the second half of 2019.  Lower Fed Funds rates could actually help to push the dollar slightly lower.

One group that could be particular beneficiaries of any move to economic acceleration and higher rates is the financial sector.  Banks struggle when rates fall, the yield curve flattens, and demand for loans wanes.  But loan demand has remained solid throughout the year.  If investors sense a better net interest margin ahead, banks could respond.  Investment banks would also gain as brokers earn more money on idle cash balances and margin loans.   Credit card companies would also earn higher rates.  If the economy remains solid, consumer credit losses would remain contained.  

The first half of 2019 was quite strong.  Part of the gains, of course, were a recovery of 2018 fourth quarter losses.  But still, with stocks now at record highs, there has been real forward progress.  Valuations are stretched, the one significant negative, but if earnings start to reaccelerate, that headwind may slow the pace of further progress but shouldn’t stop it altogether.

While financials may regain some solid footing, in mature bull markets, leadership rarely changes suddenly. That means, even with valuations high, that technology, communication services and consumer discretionary names should remain leaders.  Among other groups, companies that can match GDP growth on the top line and generate enough free cash to sustain and grow both dividends and share repurchases should continue to do well.

Today, Forest Whitaker is 58.  Arianna Huffington is 69.

James M. Meyer, CFA 610-260-2220

Additional information is available upon request.

* – Boenning and Scattergood may act as principal in buying this stock from or selling it to the public.

# – The author of this report or accounts under his management at Tower Bridge Advisors owns this security.

Additional information on companies in this report is available on request.  This report is not a complete analysis of every material fact representing company, industry or security mentioned herein.  This firm or its officers, stockholders, employees and clients, in the normal course of business, may have or acquire a position including options, if any, in the securities mentioned.  This communication shall not be deemed to constitute an offer, or solicitation on our part with respect to the sale or purchase of any securities.  The information above has been obtained from sources believed reliable, but is not necessarily complete and is not guaranteed.  This report is prepared for general information only.

Boenning & Scattergood, Inc. – Member FINRA / SIPC.

It does not have regard to the specific investment objectives, financial situation or the particular needs of any specific person who may receive this report.  Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed in this report and should understand that statements regarding future prospects may not be realized.  Opinions are subject to change without notice. 

Stocks finished mixed yesterday. The Dow Industrials set a new record high crossing the 27000 barrier for the first time.

On the flip side, the pharmaceutical stocks were lower as they may still have to lower drug prices to calm political pressure.

Away from healthcare, it was a quiet session.  Earnings season remains a week away.  Everyone is skeptical but the bar may have been lowered so far for most companies that exceeding expectations may not be a big hurdle.  Going forward, pressure from a strong dollar will dissipate in the second half of the year. 

Economic data of note did capture investor attention. Weekly jobless claims fell to just 209,000. There seems to be no sign that the labor market is slowing to a level that might threaten our economic recovery.  On the other hand, CPI numbers were a bit elevated.  Core CPI, less food and energy, rose 2.1% year-over-year.  Digging deeper into those numbers, shelter costs rose 3.5%. They comprise 42% of core CPI.  The biggest chunk of that number is what the government refers to as “imputed rent”, a measure of what the monthly occupancy cost of an owned house would be. The government considers the actual cost of a home as an investment, not an expense.  There are costs related to home ownership that are paid monthly including utilities, insurance, cable TV, etc.  But rather than use mortgage payments, which are fixed at the time of purchase for most of us, CPI includes a derived imputed rent that tries to replicate what the homeowner would be paying for his or her home if it was a rental property.   Don’t get too hung up on the details other than to note that housing related costs are running comfortably above the Fed inflation targets of 2% per year.

But with overall core CPI growing at 2.1% that implies that the other 58% of categories that combine with shelter to create the whole pie are delivering much lower inflation.  Indeed, if you do the math, the inflation rate for all core items excluding shelter is about 1.1%. That includes everything from medical expenses, to transportation to travel.

One can argue that there is a shortage of housing both rental properties and homes for sale.  As a result, inflation is real and above desired levels.  But for almost everything else, supply exceeds demand.  Car dealers are loaded with inventories while millennials like to trot around via an Uber.  Apparel prices have been trending down for a few years.  Electronics prices are driven down by technology advancements. Then there is the substitution effect.  If beef prices rise, consumers switch to pork, chicken or fish. 

A lot of the excess supply comes from overseas.  China created excess capacity long ago whether it be for base materials like steel or the capacity to make t-shirts.  Lowering interest rates might help goose demand for industries that rely on credit, like autos, but that isn’t going to change your appetite for going out to dinner.

Along with excess supply, we are learning to millennials in their 20s aren’t exactly the best managers of their own finances.  Between 2008 and 2012, 41% had credit cards.  That percentage is now 52%.  Their severe delinquency rate is over 8%, far higher than for any other age group.  In addition, many are saddled with student debt on top of their credit card debt.  That average interest rate on outstanding credit card balances is 17%.  Once one gets behind, catching up is hard.  Millennial net worth is significantly lower than for prior generations at the same age suggesting why sales of goods from homes to autos may be under continuing pressure.

Oversupply and some weak pockets of demand explain why Fed Chair Jerome Powell was so dovish in his presentations to Congress over the past two days.  The economy is still growing but shows signs of strain without any evidence of rising inflation.  Will one or two cuts do the trick?  Might Mr. Powell push for a 50-basis point cut at the end of July?  We will have to stay tuned.

In the meantime, markets seemed to be happy with his message. We now move on to earnings season where results may not be great but where expectations are extremely low.

Today, Richard Simmons is 71.  Bill Cosby turns 82.

James M. Meyer, CFA 610-260-2220

Additional information is available upon request.

* – Boenning and Scattergood may act as principal in buying this stock from or selling it to the public.

# – The author of this report or accounts under his management at Tower Bridge Advisors owns this security.

Additional information on companies in this report is available on request.  This report is not a complete analysis of every material fact representing company, industry or security mentioned herein.  This firm or its officers, stockholders, employees and clients, in the normal course of business, may have or acquire a position including options, if any, in the securities mentioned.  This communication shall not be deemed to constitute an offer, or solicitation on our part with respect to the sale or purchase of any securities.  The information above has been obtained from sources believed reliable, but is not necessarily complete and is not guaranteed.  This report is prepared for general information only.

Boenning & Scattergood, Inc. – Member FINRA / SIPC.

It does not have regard to the specific investment objectives, financial situation or the particular needs of any specific person who may receive this report.  Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed in this report and should understand that statements regarding future prospects may not be realized.  Opinions are subject to change without notice. 

After Friday’s strong employment report stocks fell as the likelihood of significant rate cuts later this year were diminished.

But the losses were cut by half or more at the end of a very slow trading day.

This morning, however, the downward response continues if futures are any indicator.  As we have noted numerous times, what drives equity markets are earnings and interest rates.  The inverse of a P/E ratio, or E/P is an earnings yield.  Since dividends are a direct function of earnings, an earnings yield is a reasonable proxy for a dividend yield which, in turn, competes with yields on other instruments such as bonds.  If interest rates fall, E/P should adjust downward in sympathy.  That means the inverse, or P/E will rise.

For the last five quarters, S&P 500 earnings have remained remarkably flat sequentially after a big jump in 2018 Q1 when the corporate tax cut took effect.  What gains came from higher productivity and expansionary fiscal policy were offset by higher tariffs and foreign currency translation losses. 

Now that the currency markets have flattened out since the spring of 2018, forex variations will have a much smaller impact on earnings going forward.  Earnings could begin to rise once again, particularly if interest rates stay low and the Fed cuts rates, as still expected, at the end of July.  But the rate of increase isn’t likely to be pronounced as most of the tariffs imposed by President Trump over the past year, and the retaliatory tariffs leveled by foreigners remain in place.

The number of Americans employed today is about 1.5% higher than a year ago. That suggests even a modest year-over-year gain in productivity of 1.0% would lead to an annualized rate of GDP growth of 2.5%.  But with tariff and political uncertainty slowing the rate of capex growth, modest sustained gains in productivity may be as much as one can hope for.  The semiconductor industry saw a sharp rise in inventory levels over the past three quarters, almost certainly as sign that prior optimism was excessive.  Semis go into a wide swath of products from smartphones to machine tools.  But a slowdown in demand, at least compared to prior expectations, suggests that tech spending growth has slowed. That is the part of investment spending that generates the greatest increase in productivity.  Thus, while productivity continues to improve, one should question whether recent gains are sustainable.

With currency impacts muted, and earnings gains likely to be modest, that leaves interest rate changes as the primary short term driver for stock prices.  Before going forward with this, let me suggest that if I have a choice between above average earnings growth accompanied by slightly elevated interest rates, or anemic earnings growth combined with low interest rates, I would take the former every time.  Why?  There are two reasons. First, over time, earnings rise persistently as our economy grows larger while interest rates move up and down around a center point for inflation which the Fed pegs at around 2%.  Second, I have a much easier time sensing the forward path for earnings than I do for interest rates.  Ask me to make an earnings forecast 12 months out and I can probably be accurate within 5-10% most of the time.  Ask me six months from now whether the 10-year Treasury yield is more likely to be 1.5% than 2.5% and I couldn’t make a super strong case for either.

Before Friday, markets were pricing in 2-4 cuts in the Federal Funds rate by the end of 2020.  Over the same span, earnings were likely to be up 5-8% according to forecasts.  With that said, future analyst forecasts for earnings tend to shift lower over time. Therefore, a more accurate prediction may be for earnings growth of 5% allowing for a few percentage points in variance either way. 

Thus, the major driver for stock prices is more likely to be changes in interest rates than it is major changes for projected earnings.  Indeed, virtually all of this year’s gains to date have related to changes in interest rates. The 10-year Treasury yield at the start of the year was about 3.25%.  Today, it is about 2.0%.

Let me give you a graphic reason how much that matters. Take company XYZ that traded at $100 per share at the start of the year with a $3.00 dividend, priced to yield 3%. XYZ, a blue chip company also is expected to increase earnings per share by about 5% to provide investors with a total return of 8%, very competitive with a competitive 10-year yield of 3.25%.  But with rates now lower by more than a percentage point, the total return for XYZ could be at least 100 basis points lower, maybe even the full 125 reflected in the decline in Treasury yields.   Assuming no change in the forecast of 5% earnings growth, the full impact of changing interest rates would be reflected through a lower dividend yield.   If XYZ were to be repriced to yield 1.75-2.00%, the stock price would rise to $150-170 per share.  Startling! 

Of course, if slower growth reduced future growth expectations, the full change wouldn’t be reflected via a change in dividend yield.  So, let’s add in a reduction in forecasted earnings from $5.00 to $4.80 and a 5% increase in the dividend rate.  If I do that, the math suggests a price of $120-130 per share.   That is still a healthy gain, and one that is all due to a combination of lower rates and higher dividends.  That is precisely what we have seen year-to-date.  It also explains why stocks that pay healthy growing dividends have done so well.  Witness utilities, REITs, and consumer staples.   But can this continue?

Again, it all comes down to interest rate projects. Fed Chair Jerome Powell will testify before Congress this Wednesday and Thursday. Wednesday will be the big day.  Is an interest rate increase of at least 25 basis points a virtual certainty come the next FOMC meeting at the end of July?  Probably given the persistence of inflation to stay well below 2% and the negative rates overseas.  But the more important question is what happens after July.  Mr. Powell is likely to disappoint anyone who wants to see a clear path to lower rates beyond (and that would include President Trump).   He will concede that inflation below 2% allows the Fed to be more expansionary and could set the table for further cuts.  But, for a man who always claims to be data dependent, he will not want to corner himself.  If he intends to set a message about September, the more likely forum would be the annual conclave of Fed leaders that the Kansas City Fed holds at the end of August.  Without a strong statement committing the Fed to lower rates, markets might sell off, but any overreading of Mr. Powell’s reticence to set out a long term plan would probably be misguided. 

Still, with so much good news priced in, stocks today carry some short term risk.  Fed policy is only one risk.  Any breakdown in US/China trade talks would be another.  That risk is far greater than the likelihood of an all encompassing new trade agreement.  The Iranian situation also poses risks if it leads to any sharp jump in the price of oil.  None of these will derail the economy growth glide path and none should lead to a major bear market.  Short term adjustments are normal. Earnings season begins in earnest next week.  After Mr. Powell’s comment this week, earnings will become the next big driver for stocks.

Today, Michael Weatherly is 50.   Kevin Bacon turns 60.  Anjelica Huston turns 67.

James M. Meyer, CFA 610-260-2220

Additional information is available upon request.

* – Boenning and Scattergood may act as principal in buying this stock from or selling it to the public.

# – The author of this report or accounts under his management at Tower Bridge Advisors owns this security.

Additional information on companies in this report is available on request.  This report is not a complete analysis of every material fact representing company, industry or security mentioned herein.  This firm or its officers, stockholders, employees and clients, in the normal course of business, may have or acquire a position including options, if any, in the securities mentioned.  This communication shall not be deemed to constitute an offer, or solicitation on our part with respect to the sale or purchase of any securities.  The information above has been obtained from sources believed reliable, but is not necessarily complete and is not guaranteed.  This report is prepared for general information only.

Boenning & Scattergood, Inc. – Member FINRA / SIPC.

It does not have regard to the specific investment objectives, financial situation or the particular needs of any specific person who may receive this report.  Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed in this report and should understand that statements regarding future prospects may not be realized.  Opinions are subject to change without notice. 

Stocks rose on Wednesday as rates remained weak.

But the big story today is the June employment report just released.

Let me start by restating one truism that we shouldn’t ignore.  The higher the net employment gain, the better it is for our economy. Period.   In June, 224,000 net new jobs were created.  After a May report in which the gain was only 75,000, this was an upside surprise.  So why are futures this morning moderately lower?  The obvious answer is that a stronger than expected economy would seem to lessen chances that the Federal Reserve will cut interest rates.   The market is pricing in 2-3 rate cuts over the balance of this year.  While a July cut is still a virtual certainty, future rate cuts would be less likely is the strength shown in June were to continue.

That, of course, is problematic.  The July report could show another strong increase or it could repeat a weak number like the one in May.  That is why Fed Chair Jerome Powell always reiterates that the market is data dependent and will consider every FOMC as a live meeting at which rates could go up or down.  While the stronger than expected June number suggests an economy that doesn’t need to be supported by multiple rate cuts, that could all change over time.

Imbedded within the employment report was an increase in average hourly wages of 0.2%, below the 0.3% estimate.  That continues to keep the focus on inflation which continues to run below the Fed’s 2.0% target. Wage acceleration is a key factor in any effort to raise the inflation rate. Thus, while the number of job increases may have exceeded expectations, the failure of wage growth to accelerate is a negative sign and one that will continue to make a July rate cuts an almost 100% certainty.

While the market’s initial reaction to the better than expected employment report was muted, it does suggest no dramatic change in course either for fiscal or monetary policy.  The Fed is still likely to cut at least once this year and 2-3 cuts are possible.  The 3-month gain in jobs of 174,000 does show deceleration and inflation does remain stubbornly too low.  In addition, the yield curve remains negative over a large part of the curve and rates in Europe keep falling.  Thus, a modest adjustment to market forecasts seems appropriate but a major change isn’t supported by today’s report. The next market mover will be earnings and reports will start coming in less than 2 weeks.

Today’s big birthday is Megan Rapinoe who turns 33 today.  I’m sure the birthday present she wants most is a victory for the U.S. Women’s team in the World Cup final on Sunday.

James M. Meyer, CFA 610-260-2220

Additional information is available upon request.

* – Boenning and Scattergood may act as principal in buying this stock from or selling it to the public.

# – The author of this report or accounts under his management at Tower Bridge Advisors owns this security.

Additional information on companies in this report is available on request.  This report is not a complete analysis of every material fact representing company, industry or security mentioned herein.  This firm or its officers, stockholders, employees and clients, in the normal course of business, may have or acquire a position including options, if any, in the securities mentioned.  This communication shall not be deemed to constitute an offer, or solicitation on our part with respect to the sale or purchase of any securities.  The information above has been obtained from sources believed reliable, but is not necessarily complete and is not guaranteed.  This report is prepared for general information only.

Boenning & Scattergood, Inc. – Member FINRA / SIPC.

It does not have regard to the specific investment objectives, financial situation or the particular needs of any specific person who may receive this report.  Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed in this report and should understand that statements regarding future prospects may not be realized.  Opinions are subject to change without notice. 

Stocks continued to chug along and now the Dow is within shouting distance of setting a new all-time high just as the S&P 500 did last week.

But all isn’t perfect. German ten-year bund yields fell below -30 basis points overnight and 10-year Treasury yields in the U.S. are down to 2.0% after reaching over 3.25% at the start of this year.

After a spike last year, our economy’s growth rate has once again receded to its 10-year trendline. For all the talk from supporters of tax cuts, enhanced fiscal spending and wider deficits, it doesn’t appear, at least at the moment, that their impact was sustained.  Sure, if Washington chooses to increase the deficit each year by $250 billion it could sustain a tailwind for short term growth.  But even the most avid supply sider would see the folly of expanding deficits each year at that pace.  The reality is that monetary velocity is slowing once again after briefly rallying off of multi-decade lows.

The culprit is over capacity. And I mean everywhere with the single exception of labor.  Our plants still run below 80% of capacity.  While China has slowed its pace of capacity additions, the expansion of production capability over the past decade continues to cast dark clouds all over the world.  President Trump tried, last year, to impose steel tariffs to keep China’s excesses from spilling over to our markets. But steel is a commodity and it will find a home somewhere at a price.  Thus, the early gains (from the perspective of U.S. steel manufacturers) from the tariffs quickly faded.  The President hoped other tariffs would serve to move production back to the U.S.  While he can point to anecdotal instances where that has happened, manufacturing output here is weakening and one of the economy’s current soft spots.  Indeed, since tariffs are a tax and non-productive, the impact of tariffs or even the threat of tariffs is simply to raise prices and reduce demand.  Lower demand at a time when capacity is in excess is a bad combination.

Tariffs alone are hardly the villain.  New fracking technology has led to a sharp increase in oil and gas production in the United States.  Even without adequate pipeline capacity to move all that can be produced to market, production is now back to record levels and rising rapidly.  The rise of alternative energy sources and slower growth worldwide are crimping demand. While prices may be elevated for the moment due to tensions near Iran, the near-to-long term outlook for oil prices is weak if demand cannot keep up with production growth. 

Warm weather has expanded crop production.  Perhaps heavy rains this spring will result in lower crop yields in 2019 in the U.S. but the damage has been done.  Commodity prices for agricultural products continue to be weak.

There is an oversupply of lumber, of semiconductors, of clothes, of smartphones, etc.

The end result of all this is lower inflation.   The Treasury, the Federal Reserve and other central banks have reacted by increasing the supply of money.  But instead of being spent, the excesses are being redeposited at central bank windows, at least here.  Banks can earn 2.35% today on their excess reserves, risk-free. To the extent that comes close to or even exceeds net interest margins, there is limited desire to lend.  Unless the Fed chooses to make it expensive for banks to redeposit funds, pouring more money into an economy that is awash with funds isn’t going to spur growth. 

One could argue that expanded fiscal policy might help. But here again it matters how the increased dollars are going to be spent.  If they simply fund an expansion of entitlements, that simply reshuffles money without any productive benefit.   Better infrastructure would lead to better productivity.  But Congress isn’t about to do that in front of an election and the current bifurcated Congress may not move forward after the election if the current makeup of government remains intact.  The reality is that Washington has been in economic gridlock since the passive of the tax bill in the fall of 2017 and there doesn’t seem to be much of a chance for change anytime soon.

That doesn’t mean the economy can’t grow.  It grew about 2% per year in the Obama years when gridlock was the normal state and it can continue to do so again.  But it is also clear that 2% growth isn’t going to allow inflation to rise back to 2%. Either the Fed has to accept a lower rate of inflation or its efforts to do some form of quantitative easing is going to have unintended consequences eventually.   Too much cheap money encourages dopey decisions.  In the early 2000s that meant too many homes got built leading to a collapse in financial markets when financially weak homeowners couldn’t service their mortgages.  Reality says every time may be similar but the facts are always different.  This time around, excess debt is held by sovereign governments and corporations.  Companies have been using “free” money to expand within markets already oversupplied, to fund acquisitions, often at inflated prices, and to buy back stock, often at high prices.  While the size of debt loads may not matter when interest rates are as low as they are, any increase in borrowing costs will pinch quickly. That is offered as one explanation as to why the economy slowed more than expected on the heels of four rate increases by the Federal Reserve last year. 

Sharply lower interest rates push holders of capital to take more risk since they cannot get desired returns when rates are too low.  In financial markets, that pushes money into the stock market, in particular to the high risk side of the market.  IPO booms often accompany times of capital excess and now appears to be one such time.  Is this a bubble?   Only history will tell us that but clearly a lot of companies that aren’t making money and have no prospect of making money any time soon are being rewarded with mind boggling valuations.  And more come to market each week.  This is a freight train that is going to go over the cliff.  I can’t tell you whether it will happen tomorrow or three years from tomorrow.

In 2000, leading analysts were building valuation models based on future expected cash flows that ignored early years of losses.  Today’s valuation models are different but they bear uncanny semblance.  Present value of future cash flow models depend on a subjective judgment of discount rate and terminal values.  Slight changes in either lead to major differences in target prices. As a stock goes up, often very sharply, a slight adjustment to either allows bulls to keep raising target prices.  Until, of course, one day it all falls apart and we learn yet again that the one constant is garbage-in, garbage-out.  

So, is the market overvalued today?   I think it is in parts.  Certainly the IPO market is frothy and I would label the prices of many of the hot tech names in sectors like cloud computer, collaborative software, and data analytics as extended, to be polite.  Consumer staples, REITs, utilities and pharma names are at high prices but if interest rates stay at or below present levels, these stocks can hold up.  However, some might say that is a big if. 

We had two valuation corrections last year.  Both lasted just a few weeks, were very sharp, but were not long lasting.  Within months, stocks recovered to old highs.  If the economy remains OK, risks or a debilitating bear market remain low.  But valuation matters.  The big boost this year-to-date has been entirely due to the sharp drop in interest rates.   As I noted at the beginning, the root of these low rates, weak inflation, isn’t about to change.  The Fed has little leverage to foster significant growth improvement by itself.  Governments around the world need to spend wisely.  Unfortunately, right now, the world outside of authoritarian states, have few strong leaders.  England has none.  Mrs. Merkel’s time in Germany is winding down.  Whatever your opinion of President Trump may be, there are few signs that he is going to get a fiscal game plan passed that will enhance economic productivity.  The Fed could help by sharply reducing the rate it pays on excess reserves. A high rate may have been justified during the early stages of recovery from the Great Recession but it is counterproductive today. 

With stocks now back to highs, the risks are rising. To move ahead further, either earnings prospects have to increase or interest rates have to fall further.  Stocks could get one more boost later this week if trade talks between the U.S. and China go well. Right now the most likely outcome is for smiles and a deferment of further tariff increases on our part.  But that is an expectation, not a guarantee.  Starting next week, the focus will go back to the economy and to second quarter earnings.  Neither looks all that buoyant at the moment.

Today, the Sixers’ J.J. Reddick is 35.

James M. Meyer, CFA 610-260-2220

Additional information is available upon request.

* – Boenning and Scattergood may act as principal in buying this stock from or selling it to the public.

# – The author of this report or accounts under his management at Tower Bridge Advisors owns this security.

Additional information on companies in this report is available on request.  This report is not a complete analysis of every material fact representing company, industry or security mentioned herein.  This firm or its officers, stockholders, employees and clients, in the normal course of business, may have or acquire a position including options, if any, in the securities mentioned.  This communication shall not be deemed to constitute an offer, or solicitation on our part with respect to the sale or purchase of any securities.  The information above has been obtained from sources believed reliable, but is not necessarily complete and is not guaranteed.  This report is prepared for general information only.

Boenning & Scattergood, Inc. – Member FINRA / SIPC.

It does not have regard to the specific investment objectives, financial situation or the particular needs of any specific person who may receive this report.  Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed in this report and should understand that statements regarding future prospects may not be realized.  Opinions are subject to change without notice. 

Stocks moved to new record high ground after the Federal Reserve strongly hinted that a rate cut would come at its July FOMC meeting.

Markets are pricing in at least one more rate hike before the end of 2019.

Normally, the Fed cuts rates to stimulate the economy.  That is a likely outcome of a rate cut in July.  But it isn’t normal behavior for the Fed to try and stimulate an economy growing at 2% or better in the 11th year of economic growth.  The Fed’s primary mandate is to maintain a stable pricing environment.  Many times the Fed has said that means a 2% inflation target.  Inflation has persistently been below 2% since the recovery began.   Over the past several months, the yield curve has started to invert. Today, the Fed Funds rate of approximately 2.35% is significantly higher that yields for bonds and notes issued by Treasury with maturities out past 10 years.  Moreover, the Fed continues to pay banks 2.35% on its excess reserves deposited at Federal Reserve Banks.  The incentive, therefore, today is for banks to earn 2.35% on deposits risk-free rather than lend the money out to any but its highest quality and largest customers.  The result is that monetary velocity, the rate at which money flows through the banking system, has reversed course and begun to head back down toward record low rates, hardly what the Fed want to see.

Lowering interest rates may stimulate animal spirits and increase loan demand.  The Fed could further accelerate demand if it cut the rates banks receive for excess reserves faster than the pace of any future rate cuts. If the challenge is to get banks to lend, paying them excessively to park money at a Federal Reserve bank would produce contrary results.

With all that said, reducing interest rates isn’t risk-free.  One reason the Fed and other central banks around the world are being forced into easier monetary policies is that governments are doing their fair share via fiscal policy.  The U.S. is more expansive that most.  In Europe, Germany is the 800-pound economic gorilla and the Germans have been reticent spending since its currency collapsed after World War I.  While fiscal prudence is an admirable trait, it could be counterproductive to the task of stimulating both growth and inflation. Central banks can reduce the cost of money but central banks can’t force spending directly.  Obviously, if you reduce the rate to borrow, especially if you lower it below the real cost of money, there will be increasing loan demand.  But the amount of debt, both sovereign and corporate, is at record levels and expanding at a healthy clip.  Advocates of all this borrowing suggest there is no problem if interest rates are low enough and attendant debt service costs are manageable.  That’s true, but only as long as interest rates stay low.   If they rise (and undoubtedly some day they will), the damage to the economy will be felt quickly.

Indeed, one can argue that the slowdown from 3%+ growth in mid-late 2018 to levels below 2% today in the U.S. and Europe may related directly to the four rate increases the Fed made last year.  With so much borrowing tied to variable rates, relatively modest changes may have an outsized impact economic activity.

Think about this.  A very modest 50 basis point increase in Fed Funds rates, which briefly pushed the 10-year Treasury yield up to 3.25% crushed the U.S. housing market, stopped auto sales in their tracks and rather quickly reduced real growth by a full percentage point or more.   Of course, monetary policy wasn’t the only factor.  The pace of fiscal expansion has slowed in recent months and President Trump’s tariff policies have negatively impacted growth rates as well.

I don’t want to sound overly negative.  There are many positive attributes of low interest rates for equity investors.  Lower rates mean the P/E ratio for stocks can move higher.  Indeed, the impact of the yield for 10-year Treasuries going from 3.25% to around 2.00% has had more to do with rising stock prices that any change in the earnings outlook.   But for stocks to continue their run past old record highs, rates have to continue to move lower or earnings growth must accelerate.  There are good reasons to believe earnings growth in the second half of 2019 will improve.  The dollar today is very close in value compared to a bread basket of foreign currencies to what it was a year ago.  Currency translation, therefore, should be a much smaller headwind for multi-nationals than it was in the first quarter of 2019 and it could even become a slight tailwind later in the year.  The U.S. consumer remains confident.  Layoffs are few and far between.   While manufacturing has weakened, it should recover if the pace of final sales continues strong.   There are prospects of some sort of pause in the trade war between the U.S. and China.  For now, the threat of tariffs against Mexico and Europe remain but there are no imminent tariffs scheduled to be implemented.

Along Wall Street, we often talk of risk-off and risk-on.  When times are gloomy, investors become risk averse.  With stocks back at record highs, this market is clearly risk-on.  Nowhere are those animal spirits more evident than in the new issue market where stocks are now selling for 10-50 times revenues (yes, I said revenues, not earnings).  A significant number of newly public companies have no earnings and no imminent prospects of making any money.   You can look back at history.  When this happens, it doesn’t continue forever.   No one, including myself, can tell you whether we are in the 7th, 8th, or 9th inning of this saga.   Leaving the party too soon may leave a lot of opportunity on the table. But leading too late can be very painful, not for every stock but certainly for those stocks that are in the hottest demand. 

I think we should remember last January and September.   In January 2018, stocks soared to new record highs only to face a 10% correction in just a few trading days in early-mid February.  Twice within a week the Dow lost over 1,000 points.  After recovering to record levels around Labor Day, equities went into another swoon that lasted to Christmas eve.  This time the decline was about 20%.  The good news is that in both cases, thanks to a strong economy and favorable interest rates, recovery was reasonably quick, both times within roughly 7 months.  Indeed, one can look at the market today and say it is up 15%+ year-to-date or that it is roughly unchanged from levels at the end of January 2018.

So, what are the conclusions we should reach?

  1. One may be able to argue that given current low interest rates stocks are fairly valued but clearly they aren’t cheap based on historic P/E ratios.
  2. The new issue market is heating up and that will draw in lots of speculators.  With rates so low, a lot of that speculative money will be borrowed money.  The next $50 move in any of these hot names could just as likely be up or down.  But real justifiable prices are generally well below today’s prices.  If you want to play in the IPO market, caveat emptor.
  3. Markets are pricing in a rate cut by the Fed in July and at least one more this year. They are pricing in some sort of tariff truce with China and Mexico.  It is assuming only limited military engagement in the Middle East.  I would suggest all these assumptions carry more than trivial risk.
  4. Managing investments is all about matching risks to reward opportunities.  You want to buy a stock when the 20%+ upside compares favorably to the 10% downside.  Stocks don’t move in a straight line. Today the market is celebrating new highs, waiting for a rate cut in July and hopeful that the tariff war with China is winding down.  It assumes government appropriations for fiscal 2019 will be enacted smoothly and the debt ceiling will be raised without commotion.  It has few current concerns.  Complacency is creeping in.  We know market mood swings can change overnight and when everyone decides to sell, there are few stabilizers.  Stocks fall rapidly.   I am not predicting a correction today, tomorrow, next week or next month.  But I have seen this happen too many times over the past 18 months to get too euphoric.   I am not a seller in long term portfolios but I am certainly not inclined to chase this market either.  Earnings season is just around the corner.  That could be a catalyst for the next move…in either direction.

Today, Prince William is 37.

James M. Meyer, CFA 610-260-2220

Additional information is available upon request.

* – Boenning and Scattergood may act as principal in buying this stock from or selling it to the public.

# – The author of this report or accounts under his management at Tower Bridge Advisors owns this security.

Additional information on companies in this report is available on request.  This report is not a complete analysis of every material fact representing company, industry or security mentioned herein.  This firm or its officers, stockholders, employees and clients, in the normal course of business, may have or acquire a position including options, if any, in the securities mentioned.  This communication shall not be deemed to constitute an offer, or solicitation on our part with respect to the sale or purchase of any securities.  The information above has been obtained from sources believed reliable, but is not necessarily complete and is not guaranteed.  This report is prepared for general information only.

Boenning & Scattergood, Inc. – Member FINRA / SIPC.

It does not have regard to the specific investment objectives, financial situation or the particular needs of any specific person who may receive this report.  Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed in this report and should understand that statements regarding future prospects may not be realized.  Opinions are subject to change without notice. 

Stocks staged a sharp rally yesterday after President Trump Tweeted that he would have an extended meeting with Chinese President Xi at the upcoming G-20 summit and that trade talks with China are resuming.

The move came in front of today’s conclusion of a two-day FOMC meeting.  Results will be released early afternoon with a press conference led by Fed Chairman Jerome Powell to follow.

We and others have been highlighting that the two binary events that can move markets over the short term are the success or lack thereof with trade negotiations with China and the path of future rate decisions from the Federal Reserve.  With the market now back with a percentage point of all-time highs, markets have spoken quite clearly that they now favor a favorable outcome from both events.  The Fed may not lower rates today; the markets put the odds of that happening at about 20-25%.  But markets do expect a strong signal that rates will likely be cut either in July or September unless there is a significant increase in the rate of inflation.   If rates are, in fact, cut today, the market will almost certainly extend yesterday’s rally in a meaningful way presuming that the Fed doesn’t overplay its hand and show serious concern that the economy is in danger of rolling over into recession.  I seriously doubt Mr. Powell would even hint at that. 

On the other hand, even though consensus says rates will be held steady but that a dovish statement would set the table for a rate cut as soon as the end of July, I am not so sure that markets would react positively to that outcome unless Mr. Powell was very emphatic calling for a July rate increase presuming no serious change in the data flow between now and then.   One could easily argue if a July rate cut was already baked in, why not simply do it now?  Does anyone really believe inflation is going to change suddenly in 6 weeks. Certainly, the President would like to see a cut now.  In fact, suggestions are already circulating that if the Fed doesn’t cut rates tomorrow, Mr. Trump might try and replace Mr. Powell as Fed Chair while leaving him on the Board.   Markets certainly would not like that outcome.  Even if you accept the conclusion that the Fed hiked rates once or twice too often last year, markets want to see the Fed remain independent.  They don’t want politicians dictating or influence monetary policy.

As for trade talks, Mr. Trump has proven adept in rattling sabers and then backing away in a way that has kept investor optimism (and the bull market) in tact.  Last night he started his formal campaign for reelection. Mr. Trump knows that an S&P well over 3000 will be a better stage to run on for reelection that an S&P well below 2500.  While he can’t fabricate economic growth single handedly, taking a less aggressive stance on tariffs and pushing for lower interest rates are two steps that will be highly stimulative to markets.

But with that said, after yesterday’s rally, an awful lot of good news is now priced in.  Markets are once again believing that a tariff war with China has peaked. There may not be a formal agreement at the G-20 meeting but one is probably not so far away.  At least that is today’s consensus.  As for interest rates, it seems only a question of when the Fed will lower rates, not if.   The problem is that the market now leaves little room for disappointment.  The last summit with North Korean Leader Kim Jong Un was unsuccessful, to be polite.   Iran tensions are rising and while neither side wants conflict, neither side is in a rush to back down either.   The risks that one side or the other might step over the line are rising.   Trade talks will China simply might not find the necessary common ground to satisfy Trump or his supporters. 

Remember that I described today’s FOMC meeting and the G-20 summit as binary events.  Either the Fed lowers rates (a big plus for markets) or it doesn’t.  Even if Mr. Powell sounds very dovish at the post-meeting press conference, there is nothing he can say to guarantee a rate cut in July.  As noted earlier, if July were a certainty, why not just do it now?   As for the meeting with Trump and Xi, while both respect each other, they have conflicting agendas, conflicting forms of government, conflicting time horizons, and conflicting strategies.  Trump could be tempted to sign something that gives lip service to problems like intellectual property theft but the whole world would quickly see through a paper tiger agreement.  Thus, if he doesn’t get what he wants, there is a real chance that he comes home empty handed and elevates tariffs.  Markets are clearly not ready for that.

After today’s meeting, one of the two binary events will be history.  We will know pretty clearly where the Fed stands and markets will make a very quick adjustment.  It will be another week plus before we know what the G-20 might bring.   While the air of optimism pervades today, that could quickly change over the next 10 days.  I, for one, am not going to be a hero, particularly with markets rather fully priced.   In the end, earnings matter and we will see second quarter results shortly beginning in mid-July.  Until then, the Fed and China are the focus.  After those events, however, markets will remind us that earnings matter.  

Today, Boris Johnson is 55.  Paula Abdul turns 57.  Kathleen Turner is 65.  

James M. Meyer, CFA 610-260-2220

Additional information is available upon request.

* – Boenning and Scattergood may act as principal in buying this stock from or selling it to the public.

# – The author of this report or accounts under his management at Tower Bridge Advisors owns this security.

Additional information on companies in this report is available on request.  This report is not a complete analysis of every material fact representing company, industry or security mentioned herein.  This firm or its officers, stockholders, employees and clients, in the normal course of business, may have or acquire a position including options, if any, in the securities mentioned.  This communication shall not be deemed to constitute an offer, or solicitation on our part with respect to the sale or purchase of any securities.  The information above has been obtained from sources believed reliable, but is not necessarily complete and is not guaranteed.  This report is prepared for general information only.

Boenning & Scattergood, Inc. – Member FINRA / SIPC.

It does not have regard to the specific investment objectives, financial situation or the particular needs of any specific person who may receive this report.  Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed in this report and should understand that statements regarding future prospects may not be realized.  Opinions are subject to change without notice. 

Stocks fell modestly on Friday ending a rather tranquil week following sharp gains the week before and a prior 6-week stretch of losses.

Once again, there was little economic news.  Most of the economic data last week highlighted the slow pace of inflation.

For the next couple of weeks we are likely to get much in the way of new economic and corporate data.  The two pending market moving events are this week’s FOMC meeting and the G-20 summit at the end of the month where Presidents Trump and Xi could meet to discuss trade.  At the moment, the consensus view is that the Fed will keep interest rates where they are for now but will hint of a possible cut between now and the September meeting if inflationary pressures stay muted and the short end of the yield curve stays inverted.  Likewise, the consensus is that Trump and Xi will meet and come to no conclusion regarding trade and tariffs but they will both express optimism that a deal in the not to far distant future is achievable.  Both of these can be seen as binary events.  Either they stay true to consensus or any deviation brings about a meaningful market reaction.  Those reactions can go in either direction.  A Fed Funds rate cut this week, done to ensure a continuation of the record-long recovery would be well received.  Conversely, no change in rates and no post-meeting statement hinting at a possible cut over the next 90 days would almost certainly lead to a market correction of some size. 

As for trade, no deal is near.  That may not stop Mr. Trump from voicing optimism.  He certainly views the stock market as the scorecard for his economic policies.  He knows the markets want closure to the tariff issues. While he will almost certainly not be able to deliver a comprehensive plan this month, talks of progress may be enough to placate investors.

Also, later this month, Democrats will begin a series of internal debates among the 24 announced Democratic candidates.  Actually, only 20 will debate on stage but no one really cares now about the 4 with the lowest polling positions.  Given that each will have no more than 5 minutes to speak, none are going to use the debate stage to get too deep into policy initiatives.  Nonetheless, an obvious general theme is already taking shape.  Most want to roll back at least part of the corporate tax cut initiated last week.  Most espouse some form of expanded infrastructure spending.  Virtually all want government to take an expanded role spending more money to help middle and low income America.  At this point in time, markets are not too focused on the various platforms of individual candidates.  Clearly, markets would have a tough time accepting The New Green Deal or Democratic Socialism.  We live in a capitalist society where the private sector owns or controls most of the productive assets.  That has been the case throughout our history.  Some Democrats suggest a variety of socialism might need our needs better.  But I doubt our nation, soon approaching its 250th anniversary, wants to solve whatever problems face us but tearing apart the capitalist backbone and replace it with significant state ownership of productive assets in banking and healthcare.  So, while the media and Republicans will pounce on some of the more extreme positions laid out by progressive Democrats, this isn’t where we are headed and markets understand that. 

Clearly, it is possible that the activist wing of the Democratic Party can capture a majority of primary voters and pick a candidate farther left than I suggest.  But if that happened, history would suggest that such a move would be political suicide. Extreme candidates on either side of the aisle have a long history of getting trounced in the general election.  Of course, there is always a first time but, for now, markets are not even remotely pricing in such an event.   Even should a very progressive President get elected getting majorities in both chambers of Congress to pass appropriate legislation would be extremely difficult.  Just look at recent past.  President Obama got one signature piece of legislation passed, the Affordable Care Act.  And a decade later, our health care system is still standing and companies within the health care sector are still thriving.   The only other major legislative piece, Dodd-Frank, would have been passed in some form as an aftermath of the financial crisis under any administration although it may have looked much different under Republican leadership.  As for Trump, his signature legislation, of course, was his bill that reduced the corporate tax rate to 21%.  It may still be too soon to judge the long term impact of the law.  What we do know is that corporate cash flows have increased markedly but corporate investment spending, after a brief spike, has settled back down to normal levels and GDP growth is only marginally higher than it was before the tax cut became law. 

In sum, monetary policy, demographics, technology advances, and modest improvements in productivity have more to do, long term, with economic growth than the actions of any President.

If fiscal policy’s role in our economy is perpetually overstated, with growth settling into a 2-3% range (probably toward the lower end of that range), and with inflation dormant, what should investors do?  First, we should note that while fiscal policy’s impact on the overall economy may be overstated, its impact on individual sectors can be significant.  Clearly, for instance, the ability of commercial and investment banks to take risk and use maximum leverage has be altered dramatically since the financial crisis.  Tariffs and the threat of tariffs have slowed trade between China and the U.S.  The government is pounding on drug pricing.  The generic drug industry has been in a tailspin for almost a decade with no sign of abatement.  One of Wall Street’s old saws says, “Don’t fight the Fed”.  I would argue “Don’t fight the White House” deserves equal consideration. 

Thus, we all need to monitor our portfolios continuously to make sure our companies aren’t in the cross hairs of government. But with that obvious exception, buying great companies that can grow revenues in line with nominal GDP (i.e. +4-5%) or better, that generate free cash flow to buy back 2-4% of shares outstanding, and pay a dividend that provides a meaningful yield should be a wonderful long term strategy.  Companies that have less control of their own destiny may entail more risk. Energy companies, for instance, can’t control the price of oil.  Multinationals can’t control the value of the dollar.  Right now, doing business with the Chinese offers elevated risk.  While tensions could ease at any time, they are unlikely to disappear as long as China provides the biggest economic threat to U.S. leadership.

Finding great companies isn’t all that difficult.  In sports, we pick athletes to all-star teams and most of the picks are obvious.  We do have to be careful that we don’t pick great companies with a backward looking lens.  Barron’s this week highlights its all-star team of best managements.  How many do you own?  You don’t want to own them at any price but it is a good place to start if you want to build a shopping list for the next correction.

Today, Venus Williams is 39. Barry Manilow turns 76.

James M. Meyer, CFA 610-260-2220

Additional information is available upon request.

* – Boenning and Scattergood may act as principal in buying this stock from or selling it to the public.

# – The author of this report or accounts under his management at Tower Bridge Advisors owns this security.

Additional information on companies in this report is available on request.  This report is not a complete analysis of every material fact representing company, industry or security mentioned herein.  This firm or its officers, stockholders, employees and clients, in the normal course of business, may have or acquire a position including options, if any, in the securities mentioned.  This communication shall not be deemed to constitute an offer, or solicitation on our part with respect to the sale or purchase of any securities.  The information above has been obtained from sources believed reliable, but is not necessarily complete and is not guaranteed.  This report is prepared for general information only.

Boenning & Scattergood, Inc. – Member FINRA / SIPC.

It does not have regard to the specific investment objectives, financial situation or the particular needs of any specific person who may receive this report.  Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed in this report and should understand that statements regarding future prospects may not be realized.  Opinions are subject to change without notice. 

Yesterday, stocks halted a two-day losing streak. A late afternoon rally helped shares finish near their best levels of the session.

Attacks against tankers in the Persian Gulf helped to lift the price of oil stocks which have been in steep decline lately.  The bond market was fairly quiet and both the economic and corporate calendars were light.  Inflation data this week generally reconfirmed that inflation continues to run slightly below Fed target rates.  While softness in recent economic data and low inflation could be the catalyst for a Fed rate cut announcement next week, the more likely outcome would be for the Fed to hold rates steady while voicing concern that continued softness could justify a rate cut at either the next meeting at the end of July or the following meeting in mid-September.  

The FOMC meeting next week will come in front of the G-20 meeting where Presidents Trump and Xi could meet to discuss trade and tariffs.  It isn’t the Fed’s job to predict whether or not tariffs will be implemented and, even should that happen, their impact will depend on the extent that we place higher tariffs on Chinese imports.  The Fed reacts to market forces. Tariffs are just one.  At the moment they seem important.  But how they flow through to consumers via higher prices, and the impact they may have on overall demand in the U.S. is conjectural at the present time.  Thus, there are fairly good arguments to wait until July (or later) to take actual action while, at the same time, letting investors know that the Fed is watchful and concerned about recent economic softness.

As I have been noting, with stocks now close to levels first reached nearly a year and a half ago and revisited both last fall and this spring, for prices to move meaningfully to new highs, investors either have to presume that interest rates will continue to fall (along with inflation expectations) or the outlook for corporate earnings will have to improve above current consensus for next year.  Upcoming second quarter earnings could give stocks a lift if results are favorable.  In addition, consensus expectations will move up or down with changing values in the dollar.  At current levels, the translation impact of foreign earnings will have a much less dramatic impact than they did during the first half of 2019.

Three macro issues currently dominate the market:

  1. Fed policy changes
  2. Tariffs
  3. The 2020 election.

Fed Policy:  I just spoke to that point and little additional comment is necessary.  Fed Chairman Jerome Powell has said repeatedly that he is data dependent.  One can fuss about recent trends but there doesn’t appear to be a dramatic move in the economy in either direction.  With hindsight, the Fed in late 2018 was probably too concerned with rising inflation prospects and a good case can be made that one or both of the second half rate increases were not needed.  If the yield curve at the short end remains inverted through the summer, a least one rate cut would become likely.  But I don’t see Fed action materially changing the economic needle any time soon.  Growth is falling back toward its normalized 2% path it has been on since the recession. One time items, like changes in tax rate, a sharp change in the value of the dollar, or expanding fiscal policy clearly can raise or lower the rate of growth over a relatively short period.  But there aren’t a lot of economic imbalances in the system. So Fed policy changes should be subtle and their impact modest over the next 12 months.

Tariffs:  The President believes strongly that tariffs or the mere threat of tariffs gives him substantial leverage.  Sometimes the threat is enough.  He clearly got Mexico to at least state that it would work toward slowing the flow of migrants to our border while under threat of tariffs.  We will know better in coming months whether that promise can be fulfilled.  China is likely to be a bigger and more lasting economic threat.  Some tariffs are already in place.  Both Trump and Xi proclaim great respect and a working relationship with each other but, to date, there has been little concrete progress toward improving treatment of intellectual property and allowing American companies easier access to Chinese markets.  Most likely, progress will come in stages.   China needs to have open world markets for its exports and U.S. businesses want access to the world’s second largest marketplace.  Economic opportunity is the greatest catalyst to promote cooperation and find common ground.   It won’t be easy.  Both sides will be resistant to change.  But, over time, there should be erratic movement in the right direction.

2020 Elections:  Democrats haven’t even had their first debate among themselves and there are 24 candidates to choose from including centrists and far left progressives.   Ignoring personalities and social agendas, the investor class worries about earnings and interest rates.  At this point, we hear many more sound bites than facts.  It should quite obvious that the more extreme options are hardly likely to become law but any movement toward greater government control, and more taxes may unnerve markets sporadically over the next 12 months.  Any real movement, however, is likely to await the real campaign after both conventions and after we know the actual nominees.  Fringe freshman members of the House may make firebrand speeches but they won’t be the candidates.  Ultimately the election will focus on a few key states like Pennsylvania, Michigan, Ohio and Florida none of which will likely embrace extreme changes from current policy.   Thus, for now, I think the election impact is still not front and center although a larger threat over the next 12-18 months.

The bottom line is that there is little reason to expect stocks to break out from current levels any time soon unless (1) the Fed takes a materially more dovish stance than currently expected (e.g. cuts rates next week and suggests one or two more cuts could come soon), or big tariff news, good or bad, is announced.

Today, President Trump is 73.  Boy George is 58.  Do you think they ever celebrated together?

James M. Meyer, CFA 610-260-2220

Additional information is available upon request.

* – Boenning and Scattergood may act as principal in buying this stock from or selling it to the public.

# – The author of this report or accounts under his management at Tower Bridge Advisors owns this security.

Additional information on companies in this report is available on request.  This report is not a complete analysis of every material fact representing company, industry or security mentioned herein.  This firm or its officers, stockholders, employees and clients, in the normal course of business, may have or acquire a position including options, if any, in the securities mentioned.  This communication shall not be deemed to constitute an offer, or solicitation on our part with respect to the sale or purchase of any securities.  The information above has been obtained from sources believed reliable, but is not necessarily complete and is not guaranteed.  This report is prepared for general information only.

Boenning & Scattergood, Inc. – Member FINRA / SIPC.

It does not have regard to the specific investment objectives, financial situation or the particular needs of any specific person who may receive this report.  Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed in this report and should understand that statements regarding future prospects may not be realized.  Opinions are subject to change without notice. 

The Dow’s six session winning streak ended yesterday as a solid early morning rally faded.

With that said, the pace of the rally simply wasn’t sustainable without a strong uptick in economic data. The only major release yesterday, a modest and expected rise in producer prices for May, wasn’t market moving in either direction. As noted Monday, with stocks now back near all-time highs once again, equities need a catalyst that would either push interest rates down further or earnings expectations higher.

While markets are pricing in at least two rate cuts of 25 basis points each between now and the end of the year, that isn’t a forgone conclusion.  There is a good argument against any cuts in an environment that seems to indicate growth of about 2% can be sustained for some period of time.  Why create stimulus in a growing economy?  Why not save the stimulus fire power until a more crucial time?  And why cut rates, a tactic to stimulate growth, while continuing to slowly reduce the size of the Federal Reserve balance sheet, a negative to growth?

The Fed has two mandates, one to maintain price stability and the other to stimulate economic growth.  Both are to be done in concert.  With that said, the Fed toolkit is more effective as a method to control price stability than as a weapon to raise growth levels.  Prices are a function of supply and demand.  The Fed, in conjunction with the Treasury, can clearly have a giant impact on the supply and cost of money.  While its policies don’t impact demand quite as much as supply, the Fed’s weapons to fight inflation and deflation are stronger than anything Congress or the White House have.  That is not to say that fiscal policy can’t be overly stimulative or constraining.  But government spending represents well under a quarter of GDP and that includes state and local governments as well as Federal spending.

As for managing growth, by making the cost of borrowing higher or lower, the Fed can affect demand but it is only one factor in the supply/demand equation. The Fed can’t create jobs.  It only has an indirect effect on the mood of consumers.  It clearly can affect industries, like housing, that are heavily dependent on the cost to borrow, but it has a much smaller impact on whether I buy a new summer wardrobe or not.  Of course, maintaining price stability, in and of itself, has an impact on demand and confidence.  Deflation precipitates hoarding and lowers spending.  Why buy today when it will be cheaper tomorrow.  On the flip side, hyper inflation reduces any incentive to save unless interest rates are kept above the rate of inflation.

Assuming the Fed isn’t too far off base in is effects to anchor short term interest rates, other economic forces take over and growth generally continues based on population growth and some normalized level of productivity gains.  Right now, there is a growing debate whether the Fed, after four rate increases last year, did indeed get too far off center and ending up creating market distortions.  The centerpiece of that possible argument is the inverted yield curve in the 0-5-year maturity range.  The yield for the shortest duration assets is tied directly to the Fed Funds rate, currently centered around 2.4%.  But the market has now priced 2-year Treasury yields under 1.9%.  In normal markets, yields are higher as maturities get longer for obvious reasons.  When, however, they invert as I just showed for the 0-2 year range they both send a message that the Fed is out of step and they begin to have a real economic impact.  Saving rises because of the relative attraction of money market and CD rates to other alternatives.  A 2.25% return, versus inflation of well under 2% provides real value with almost no risk.  Second, banks borrow short and lend long.  When the yield curve inverts, spreads narrow and banks become more reticent lenders.   While the inversion this time around has only been for a couple of months, the impact so far has been relatively modest.  However, if one looks at monetary velocity, the rate at which money turns over, it bottomed last year and was on a steady path up until the yield curves began to invest.  Then velocity stopped improving and it has started to edge back down once again.  A monetarist view of GDP is money supply times the rate money turns over (velocity).  If money simply sits and is never spent, there wouldn’t be any economic activity.  Thus, all other things being equal, the Fed wants to see a healthy velocity of money.  As long as rates are inverted, that won’t happen.

An obvious additional question is why did rates invert?  And the obvious answer this time around is that inflation simply hasn’t appeared.  Tariffs, a tax on imports, was supposed by many to be inflationary.  But overseas supplies have absorbed a healthy percentage of the cost of tariffs to date and little has been passed on to consumers so far. That might change if the rate of tariffs were to be increased further.  It was also assumed that as the unemployment rate fell, the pace of wage increases would rise.  That has happened but at a very slow pace.  And attendant improvements in productivity have offset the impact of higher wages.  While it is theoretically obvious that at some point labor shortages could become severe enough that productivity gains alone won’t be enough of an offset, we don’t seem to be at that point yet.  Moreover, recent monthly employment gains have slowed suggesting the point where wage pressures increase could be further out than expected.

Thus, next week, when the FOMC meets once again, the argument to possibly cut rates isn’t about sustaining growth.  It is about giving the market a stronger push to help raise the level of inflation toward the Fed’s 2% target.  While the Fed, economists and Wall Street focus on real rates of growth, in our everyday lives we live in a world of nominal GDP.  When a company reports sales most of the time, we don’t know how much was volume and how much was price.  When we receive a pay check, it is in nominal dollars; there is no adjustment for inflation.  Thus, if real GDP growth falls from 3% to 2% and inflation falls from 2% to 1.5%, the combination is more substantial than one might think.  Nominal GDP growth goes from 5% to 3.5%.  When sales grow 5%, companies have some wiggle room to improve margins or to invest a bet more for the future.  But a 30% decline in the growth rate, nominally, clearly forces companies to pay more attention to every penny spent.  That is part of the reason that investment spending growth has slowed.

So, will the Fed cut next week?  Markets suggest that is a strong possibility but not a certainty.  The Fed tends to be cautious.  Do they wait for more data and wait to its next meeting at the end of July?  It could.  Does relentless pressure from President Trump challenge Fed independence and cause it to hold off as a result?  It may but I think the Fed wants to act independently.  If the FOMC feels a rate cut today makes sense, I think it will do so regardless of pressure one way or another from the White House.

Clearly, it appears in hindsight that 2-3 increases last year might have been better than 4.  Clearly how President Trump proceeds with tariffs against China will impact both growth rates and prices.  Jerome Powell, the Fed President, is a businessman, not an economist.  He isn’t blind to the world or to markets.  He communicates regularly with business and Congress.  He isn’t afraid to change directions if necessary.  If rates rose too far or too fast last year and need adjusting, he will do that.  Would waiting another six weeks matter?

The message of this past December and January are construction.  Clearly markets responded very sharply against the December hike.  Mr. Powell got the message and made it clear within a couple of weeks that no further rate increases were forthcoming. Markets reversed their September to December slide and, by late April, were back at all-time high levels.  Should the Fed fail to cut rates next week, markets are likely to react negatively, probably not as vociferously as it did in December but still sending a loud message. If the reaction is more severe than expected, Mr. Powell has time to send an early clue that he hears markets and will respond in July.  If markets fall but in an orderly fashion or simply stay relatively flat, he might wait past July.  By markets, I mean both the equity and bond markets.  Clearly, if the shape of the yield curve becomes more inverted, that would generate a stronger post-meeting response. 

The bottom line is that this Fed is going to get it right.  The only question is whether it will happen now or a couple of months from now.  It is also possible that the Fed waits, economic data starts to improve noticeably, and the Fed can wait indefinitely to move rates.  That is an argument for waiting until July or later.  The key, though, for long term investors, is that this Fed isn’t going to stubbornly fight the markets. Rather it will stay in step.  It won’t react to weekly or monthly market gyrations unless they become extreme but it will stay in synch over the coming months and even years.  That should give investors comfort recognizing the obvious near term risks associated with next week’s FOMC meeting.

Since there are no real significant birthdays of note today, I want to acknowledge two who were born on this date. George H.W. Bush would have been 95 today.  Anne Frank was born 90 years ago today.

James M. Meyer, CFA 610-260-2220

Additional information is available upon request.

* – Boenning and Scattergood may act as principal in buying this stock from or selling it to the public.

# – The author of this report or accounts under his management at Tower Bridge Advisors owns this security.

Additional information on companies in this report is available on request.  This report is not a complete analysis of every material fact representing company, industry or security mentioned herein.  This firm or its officers, stockholders, employees and clients, in the normal course of business, may have or acquire a position including options, if any, in the securities mentioned.  This communication shall not be deemed to constitute an offer, or solicitation on our part with respect to the sale or purchase of any securities.  The information above has been obtained from sources believed reliable, but is not necessarily complete and is not guaranteed.  This report is prepared for general information only.

Boenning & Scattergood, Inc. – Member FINRA / SIPC.

It does not have regard to the specific investment objectives, financial situation or the particular needs of any specific person who may receive this report.  Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed in this report and should understand that statements regarding future prospects may not be realized.  Opinions are subject to change without notice. 

Last week, stocks rose all five days and the Dow was up 5% for the week.

Before starting this morning, I want to thank my colleagues for pitching in so admirably during my vacation.  Before switching back to the markets, I want to make one comment on infrastructure.  Anyone who has traveled overseas knows that the gap between our roads, airports and rail systems compared with those of other nations, both developed and developing, has been widening.  It is a tragic commentary to note that as the wealthiest nation on earth and with all the road and airport taxes we pay, the United States has to lag so far behind. Finger pointing won’t do any good; everyone in Washington is to blame.  Economically, poor infrastructure hurts productivity.   I guess the only conclusion I should make is that our government has become increasingly bifurcated over the last two decades.  As a result, little gets done beyond the minimum.   If we don’t work to stay first class, we will lose our leadership.  The only way that will happen is for all sides to work to find common ground.   Infrastructure is only one example.  We obviously need improvement in health care and education as well where we are also falling behind.  This is not a problem Democrats or Republicans can fix alone.

Enough of my soap box talk.  Back to the markets.  The first week I was gone, it couldn’t have been bleaker.  Economic data was poor, bond yields fell sharply precipitating a fall in stock prices.  Washington went on the attack against the FANG companies.  German manufacturing data was scary.  Trump wanted to place tariffs on Mexican imports of as much as 25%.

But a week isn’t enough to make a trend.  Last week, stocks rose all five days and the Dow was up 5% for the week.  The economic data didn’t get any better.  But Fed speakers strongly hinted at a rate cut next week at its FOMC meeting with perhaps another one or two to come later this year.  At least that is the message of the bond market where 2-year Treasury yields fell to below 1.8%.  Friday’s weaker than expected employment report initially pushed stocks down in pre-market trading but they then rallied as investors determined that the weak data reinforced the likelihood of a rate cut next week.  We should always remember that stocks and bonds compete for investor dollars.  When bond yields fall, stocks become relatively more attractive.

There are two reasons for a Fed rate cut.  The first is to stimulate the economy enough to maintain a 10-year economic recovery.  The other is juice an economy in or falling into a recession.  So far, there is little economic data to show a recession is imminent.  Unemployment claims haven’t hooked up.  Home building permits are rising and they should rise further as mortgage rates decline.  Consumer confidence remains near record levels.  Falling gasoline prices will help put more discretionary dollars into pockets.  While the short end of the yield curve has inverted for several weeks, the 2-10 year Treasury yield spread has widened a touch, an indication, I believe, that markets believe that we are not near a recession and that a near term rate cut or two will insure continuation of our expansion.

The fly in the ointment, so to speak, has been the threats of tariffs, most recently against the Mexicans and China.  Late Friday, Mr. Trump removed the tariffs threat against Mexico.  According to Washington, the threat led to a major effort by Mexico to help stem the flow of illegal migrants across our southern border.  According to skeptics, all the agreement did was memorialize agreements between the two nations earlier this year.  Whoever you choose to believe is largely irrelevant.  What is important economically is that the tariffs aren’t going to happen, at least for now. 

The economic problem related to Trump’s repeated threats, some implemented and some not, is that it creates constant confusion and uncertainty.  Mr. Trump, who likes to disrupt to his advantage, may not always realize the second derivative implications of delayed spending activity.  A key driver for sustained economic growth of 3%, 4% or more that Republicans have been speaking about since the tax cuts were announced, has been a slow but steady gain in productivity.  Some of that relates to technological advances that come from Silicon Valley, not Washington.  Some of that relates to greater cash flow as a result of lower taxes.  But recent trends in capital spending have begun to weaken.  How much of that relates to a weaker economic outlook and how much relates to political uncertainty is open to debate.  Suffice it to say, however, that capex growth is beginning to soften and if that trend sustains, then productivity advances will be tougher to achieve.   Without sustained productivity growth of 2-3%, our growth rates will revert to those of the Obama Administration.  From a stock market perspective, that may not be so bad.  Earnings growth may be a bit less that previously forecasted but lower inflation and interest rates will be a healthy offset.

With stocks now within 2.5% of their all-time highs, and likely to open higher this morning with the Mexican tariff dispute solved for the moment, the question becomes what drives stocks higher from here.  As is normal in volatile times, stock performance has varied greatly from sector to sector.  Leaders one month can quickly fall out of favor the next and visa versa.  With that said, steady staple stocks and high dividend payers have been recent leaders due mostly to lower interest rates.   The weakest sectors have been commodities including energy, victims of weak pricing.   Unless interest rates have much further downside, it would seem the leadership may rotate again.  If we don’t go into a recession and business confidence rises with a more accommodative Fed, then tech may resume leadership. 

For now, if you missed last week’s sharp rally, it is probably not a time to be very aggressive.  One characteristic of a market and economy in transition is heightened volatility without much change in value.  As Jim Vogt noted last week, that is exactly where we have been.  Tops have been defined by peaks in January and September 2018, April 2019 and highs today.  Lows were defined by the Christmas Eve bottom.  Without a breakout to noticeable new highs, I think the safest bet is to presume that the 18 month trading rates stays intact. 

Today, Kate Upton is 27. Prince Philip turns 98.

James M. Meyer, CFA 610-260-2220

Additional information is available upon request.

* – Boenning and Scattergood may act as principal in buying this stock from or selling it to the public.

# – The author of this report or accounts under his management at Tower Bridge Advisors owns this security.

Additional information on companies in this report is available on request.  This report is not a complete analysis of every material fact representing company, industry or security mentioned herein.  This firm or its officers, stockholders, employees and clients, in the normal course of business, may have or acquire a position including options, if any, in the securities mentioned.  This communication shall not be deemed to constitute an offer, or solicitation on our part with respect to the sale or purchase of any securities.  The information above has been obtained from sources believed reliable, but is not necessarily complete and is not guaranteed.  This report is prepared for general information only.

Boenning & Scattergood, Inc. – Member FINRA / SIPC.

It does not have regard to the specific investment objectives, financial situation or the particular needs of any specific person who may receive this report.  Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed in this report and should understand that statements regarding future prospects may not be realized.  Opinions are subject to change without notice. 

Stocks fell sharply yesterday with all leading averages falling more than a full percentage point.

Most of the damage came early amid new trade fears and some elevated concerns about Brexit.   But markets stopped falling by midday and actually rallied a bit into the close. 

Futures are higher this morning suggesting that without further news today, the losses can be contained.  While the Dow is on pace for its fifth straight weekly decline, the cumulative losses over that period total less than 5% although clearly losses were higher for companies directly impacted by trade fears or the Huawei controversy.

In times of limited corporate or economic news, markets have a habit of overreacting.  Another way to say this is that markets tend to either fear the worst or submit to unbridled optimism.  What we do know is that the U.S. is raising some tariffs on Chinese imports.  What we don’t know is what the next step will be.  Will more tariffs come in 90 days?  Will the threatened next wave of tariffs be postponed?  We have been hearing of auto tariffs for over a year and none have been implemented to date, for instance. Some tariffs aimed at Canada and Mexico may even be reduced soon.  The obvious answers to these questions are that we don’t know.  But that doesn’t mean markets won’t price in future expectations.  Markets often forget that one action usually begets a reaction.  For instance, should Mr. Trump implement tariffs on all Chinese imports, markets would almost certainly fall sharply.  Our economic growth rate would fall.  The odds of a recession might increase.  As we all know, Mr. Trump likes to keep score. He views the world in terms of wins and losses.  While tariffs might increase his bargaining leverage, they certainly would increase America’s short term economic pain.  Tariffs are already unpopular for voters and opinions would turn even more negative should tariffs be placed on popular consumer items. And none of this presumes all retaliatory steps by the Chinese.  Therefore, will Trump raise tariffs again in 90 days.   Probably not.  He might defer them.  He certainly views the threat of another wave of tariffs as a bargaining chip.  He expects to meet President Xi in late June.  The outcome of those talks may be the key to the next step forward.

With all that said, the odds of an all-encompassing deal with China that helps our balance of trade, commits China to policing intellectual property theft, and removes all existing tariffs is unlikely.  Since both Trump and Xi view the world in an “I win, you lose” fashion, a deal that allows both sides to claim victory at the same time will be a hard one to achieve.  It took many months to modernize NAFTA without meaningful changes.  What we are seeking with China is a wholesale change in its behavior without any major concessions on our part.

While we can conjecture all we want, over the next several weeks, to and including the late June G-20 talks, ebbs and flows in trade talks are likely to be front page news and market moving.   But unless the overall economic outlook changes materially, market changes are likely to be contained.   When the S&P 500 crossed 2900 in April, it reached its outer band in terms of valuation.   Said differently the 25% rally from Christmas to the end of April basically took away most bargains. Thus, we have a buyer strike in May.  There are always reasons to sell; markets move up when there is some urgency to buy.  With valuation removed, growth showing signs of slowing, and trade tensions rising, the path of least resistance is lower.  That can all change if prices fall too much, if growth reaccelerates, or trade tensions ease.

Moving to Britain, overnight Prime Minister Theresa May announced she would resign on June 7.  All the leading candidates to succeed her are Brexiteers.  With that said, the EU is not in a mood to renegotiate the deal made with Ms. May.  That doesn’t mean there could be a few tweaks but a broad change in Britain’s favor is unlikely.   What does change is the odds of a hard exit come October should the new PM not have the strength to develop a coalition to support a compromise deal.   Ms. May clearly lacked the political power to build any sort of compromise.  The British pound had fallen for 14 straight days in anticipation of her resignation and increased odds of a hard Brexit.  Now all await her successor and any possible change in course of action before the new October Brexit deadline.  While Brexit won’t have the economic impact of a trade truce with China, it is another modest negative to add to those already in place.

As the negatives pile up, it is easy to get too nervous.  Adjusting to modestly slower growth is fine but a modest slowdown in growth isn’t a repeat of 2008.  One of the hallmarks of true financial collapses like 2008 is that they stay in our brain for a very long time.  Your parents and grandparents still behave will thoughts of the Great Depression in the backs of their mind.  Caution is good but excessive worry is not.  The economy is somewhat like a rolling hillside.  They are uphills and downhills but nothing threatening to stop the journey.  Mid-course corrections happen as a matter of course.  Yes, there exists the possibility of an all-out trade war but it would seem, at least to me, somewhat illogical 12-18 months before a Presidential election.  If Mr. Trump wants to play serious hardball, that should be a second term action.  Even then, a President who views the stock market as his scorecard, isn’t likely to create a recession where none exists.  Thus, markets might drift lower into earnings season but any serious decline approaching 10% in total should bring bargain hunters back.  Low interest rates also push investors toward bonds.  One reason safe stocks like utilities, REITs, and consumer staples are acting so well despite valuations that seem excessive based on history that that low bond yields are driving income seekers to these stocks. That isn’t likely to change until rates start moving back up.

The stocks getting hurt the worst and those with strongest ties to China.  Obviously, news headlines will be most meaningful to them.  Some are even approaching bargain levels although it still may be early to step in.  Nibbling might be a better course.  In the meantime, stay calm, set your shopping list, and don’t worry about easing in as stocks climb a wall of worry.  We are not in for a repeat of 2008. 

Today, Patti La Belle is 75.  Bob Dylan turns 78.

James M. Meyer, CFA 610-260-2220

Additional information is available upon request.

* – Boenning and Scattergood may act as principal in buying this stock from or selling it to the public.

# – The author of this report or accounts under his management at Tower Bridge Advisors owns this security.

Additional information on companies in this report is available on request.  This report is not a complete analysis of every material fact representing company, industry or security mentioned herein.  This firm or its officers, stockholders, employees and clients, in the normal course of business, may have or acquire a position including options, if any, in the securities mentioned.  This communication shall not be deemed to constitute an offer, or solicitation on our part with respect to the sale or purchase of any securities.  The information above has been obtained from sources believed reliable, but is not necessarily complete and is not guaranteed.  This report is prepared for general information only.

Boenning & Scattergood, Inc. – Member FINRA / SIPC.

It does not have regard to the specific investment objectives, financial situation or the particular needs of any specific person who may receive this report.  Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed in this report and should understand that statements regarding future prospects may not be realized.  Opinions are subject to change without notice. 

Stocks closed up Friday on the heels of a strong employment report and a 50-year low in unemployment.

The economy continues to hum along with little inflation. But, alas, if only the economic data was the driver of stock prices.  When things look like they can’t go wrong, look to Washington to throw a fly in the ointment. 

One characteristic of President Trump to that he likes to pivot in unexpected ways keeping everyone off balance.  He particularly chooses to do so when he his being beaten up on a particular issue, in this case the aftermath of the Mueller report and the repeated efforts of Democrats in the House of Representatives to call current and former members of his administration to testify.  In the President’s mind, he feels vindicated by the report, at least to the extent that there isn’t enough in it to warrant further action.  He, therefore, wants the House to drop the subject and move on.  That apparently isn’t going to happen without a fight.  So, to turn the attention away from the Mueller report, the President has shifted gears. With the withdrawal of both Stephen Moore and Herman Cain as nominees to the Federal Reserve board, he is beginning to float names of other candidates.  He is stepping up the pressure to cut interest rates even though he has no power to get that done and probably won’t sway the FOMC to do so.  Indeed, the next meeting isn’t for another six weeks and it is highly unlikely, based on current information, that the Fed will move then. 

Overseas, North Korea has resumed missile testing but not nuclear weapons.  The President, not wanting to lose the sense of progress there after suggesting that he has made the world safer after earlier talks, is willing to give North Korea a pass, at least for now.

That leads to trade talks.  Mr. Trump has often described himself as a proponent of tariffs as a weapon to get what he wants on the trade front.  While he often has stated that he and President Xi of China have a great relationship and talks with China have been proceeding, over the weekend, Mr. Trump stated that he wants to raise tariffs on goods now subject to a 10% tariff to 25% on Friday and he suggested that without further and speedier progress he just might slap 25% tariffs on everything China exports to the U.S. shortly.

This tactic is classic Trump.  The Chinese clearly will not take this well.  Just a few days ago it was hoped that talks could wrap up soon with a Trump-Xi signing of an agreement happening perhaps as early as late May.   But clearly, the agreement that seems to be evolving was going to be weaker than Trump could accept politically.  The threat to raise tariffs immediately is a step to increase the heat on China to take seriously the enforcement mechanisms to get a deal through Congress.

Many have suggested that Trump will take almost any deal just to have one, and would claim it is the best deal ever with China.  But, while that may be politically acceptable short term, it is unlikely that conservative Republicans in the Senate, much less Democrats, are going to support a weak agreement.  Mr. Trump’s comments say, loud and clear, that if there is going to be an agreement, China must respect intellectual property, stop hacking and stealing, and allow American companies to do business in China in much the same way Chinese companies do business here.  

Will the tariffs happen?  Five days is still a long time but unless China responds with anything other than anger, the odds suggest the tariffs will be put into place and it will clearly add urgency to the negotiations.  As for Wall Street, clearly this is a kick in the head, at least for the short term.   Companies are not going to be able to adjust supply chains in five days.  How long these tariffs stay in place, assuming they are implemented, is anyone’s guess.  It clearly depends on the Chinese reaction. China could walk away from the negotiating table, address talks with new urgency, or anything in between.  The reality is that, after initial anger, China is going to have to take the U.S. stance that enforcement mechanisms need to be stronger seriously. The only question is how long will it take for them to come to that realization.

Futures are down sharply in the early going by 1-2%.  That is hardly a big dip given recent advances. We have noted many times lately that stocks are ripe for a correction and today’s news is clearly a catalyst.  This could be a one-day hiccup or the beginning of something larger.  While several leading averages, like the S&P 500 and the NASDAQ Composite have been setting record highs recently, the Dow hasn’t and the Dow Transportation index has been conspicuously weak.   “Sell in May and go away” is an old saying on Wall Street and not always right.  But clearly, after gains of almost 25% from the December lows, some sort of correction, even a small one, seems in order.   We will know a lot more about the status of trade talks in a few days.  In the meantime, I don’t think this morning’s apparent weakness is the buying opportunity.  Give this at least a few days to play out.

Today, George Clooney is 58.  Bob Seger is 74.  Willie Mays turns 88.

James M. Meyer, CFA 610-260-2220

Additional information is available upon request.

* – Boenning and Scattergood may act as principal in buying this stock from or selling it to the public.

# – The author of this report or accounts under his management at Tower Bridge Advisors owns this security.

Additional information on companies in this report is available on request.  This report is not a complete analysis of every material fact representing company, industry or security mentioned herein.  This firm or its officers, stockholders, employees and clients, in the normal course of business, may have or acquire a position including options, if any, in the securities mentioned.  This communication shall not be deemed to constitute an offer, or solicitation on our part with respect to the sale or purchase of any securities.  The information above has been obtained from sources believed reliable, but is not necessarily complete and is not guaranteed.  This report is prepared for general information only.

Boenning & Scattergood, Inc. – Member FINRA / SIPC.

It does not have regard to the specific investment objectives, financial situation or the particular needs of any specific person who may receive this report.  Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed in this report and should understand that statements regarding future prospects may not be realized.  Opinions are subject to change without notice. 

Stocks moved higher again on Friday.

But elsewhere, stocks show signs that the momentum that propelled stocks back close to their historic highs may be running out of gas just as we approach the heart of earnings season. 

Obviously, a major deviation in earnings versus expectations could drive stock prices higher or lower but we don’t see that happening.  Rather, with stocks now selling for about 17 times forward earnings, they appear fully priced.  Fully priced doesn’t mean overpriced but there are few bargains left.  That’s what a 20% rally from recent lows will do.

So, what makes stocks move higher from here?  The obvious answers are some combination of higher earnings, lower interest rates or a weaker dollar.  I will deal with the last one first.  Current values fluctuate as the relative performance of various large economies differ from expectations.  The current expectations that are imbedded in current currency values are for 2-3% growth in the U.S., about 6% growth in China, and very little growth in Europe and Japan.   Couple these with interest rates near zero in Europe and Japan, and you derive a pattern that shows the dollar trading in a narrow range against competitive currencies as it has been doing for almost the last year.   At this point in time, I see no change in that picture.  Late last year and early this year, there were concerns that slowing growth could be a precursor to negative growth in many developed economies.  Logic suggested that growth slowing to a new sustainable level was the most likely outcome but emotions overtook logic while growth was slowing.  Fears ignited that recession wasn’t far away.  Yield curves inverted, at least along the short end of the curve amid confusion about central bank interest rate policy.

But those fears have now subsided.  Growth appears to have stabilized.  There are even signs, both in China and the U.S., that some pickup could actually be in order.   Interest rates remain low but have bounced a bit in recent weeks, still well below fall 2018 levels.   Earnings in the first quarter are still going to be flat or down slightly but that is almost all due to year-over-year strength in the dollar that will dissipate as we move further into the year.   Our 2019 estimate for S&P 500 earnings of about $170 is virtually unchanged from last fall.

What has changed, and probably the biggest catalyst behind the stock movements of the past several months is the outlook for interest rates and inflation.  As the 10-year Treasury yield crossed 3% late last year, estimates of 3.0-3.5% within 12 months were common.  But now as the 10-year Treasury yield stabilizes in the 2.5-2.6% range, 3.0% seems a bit far away.  In addition, the 3-month to 10-year spread, which briefly turned negative, is now positive once again and the 2-10 year spread is back to 20 basis points at the high end of the range over the past six months.  Fears of a recession within the next 12 months have faded.  Certainly, there are economists who always have a recession in their forecast 1-2 years out but I would counter that predicting the economy 2 years out is about a simply as predicting weather two years hence.  Anyone suggesting recession in the not too fare distant future needs to demonstrate why a rather well balanced world economy is going to become imbalanced.

That doesn’t mean stock markets can’t get ahead of themselves leading to a bear market within an economy that is still growing.  We saw this in both 1987 and 2000.  In both cases, an overly exuberant IPO market was the catalyst.   Today, at least we are having a robust IPO market but, for now, exuberant isn’t a word I would use to describe it.  But clearly, that segment of the market bears watching particularly as the very large offering of Uber approaches.  Note that isn’t usually the public offering of real high profile names that signals an end to a bull run.  Rather it is the second derivative follow-ons of overvalued second and third generation wannabes that signal too much hype and precipitate a large correction.  That could be months or years away.  Or it could never happen if the IPO market never reaches a supercharged state.

With that said, stock prices are a function of supply and demand.  IPOs provide more supply.  More supply without more demand would mean lower prices, all other factors being equal.  Also note that a company’s IPO may only be the tip of the iceberg.  Most offerings involved a relatively small number of shares.  The real bulk of increased supply comes when a lockup period ends, usually within 3-6 months of the actual IPO.  The lock up period is that interval after the IPO when insiders, both management and early private investors, are forbidden from selling stock.  Once the lockup periods end and selling begins, there is often pressure on a company’s stock price.

Obviously, for every seller there has to be a buyer.  Often funds to buy come through sales of other stocks.  Therefore, in a high volume IPO environment, buyers will have to sell other stocks to raise many to buy the new names investors find attractive.  If you recall the Internet bubble of the late 90s, tech stocks rocketed higher while much of the rest of the market marked time. 

Today, it is much too early to suggest a recurrence.  We have only had a handful of high profile IPOs to date and few of any size have gotten past their lockup periods yet.   Over the past several years, a catalyst for higher stock prices have been elevated levels of share repurchases.  Many companies continue to fund repurchases through rising free cash flow.  Others, which had borrowed money to fund their buying have slowed the pace of repurchases.  Fewer repurchases and the specter of more new stock flowing out of the IPO market suggest less positive momentum ahead for the overall market. 

With all this said, the primary catalyst for rising stock prices is earnings growth.  After a flat-to-down first quarter, we expect solid 5-10% earnings growth over the rest of 2019.  Next year earnings could be close to $180 for the S&P which would price the market at 16 times forward earnings, close to historic norms. But with interest rates well below historic averages, modest further upside is possible.

The net is that stocks can move higher over the next 12-18 months but at nowhere near the pace of the first three months of this year.  With interest rates likely to stay low, money could flow from bonds to stocks, helping to offset the headwinds of added IPO-related supply.  Slow growth implies some volatility and leaves open the possibility/probability of a 5-10% correction at any time.  Such corrections, if they occur, would represent the best buy opportunities from here.  Earnings season, now upon us, also creates opportunities when investors overreact to slight quarterly earnings shortfalls.

Today, Jack Nicholson turns 82.

James M. Meyer, CFA 610-260-2220

Additional information is available upon request.

* – Boenning and Scattergood may act as principal in buying this stock from or selling it to the public.

# – The author of this report or accounts under his management at Tower Bridge Advisors owns this security.

Additional information on companies in this report is available on request.  This report is not a complete analysis of every material fact representing company, industry or security mentioned herein.  This firm or its officers, stockholders, employees and clients, in the normal course of business, may have or acquire a position including options, if any, in the securities mentioned.  This communication shall not be deemed to constitute an offer, or solicitation on our part with respect to the sale or purchase of any securities.  The information above has been obtained from sources believed reliable, but is not necessarily complete and is not guaranteed.  This report is prepared for general information only.

Boenning & Scattergood, Inc. – Member FINRA / SIPC.

It does not have regard to the specific investment objectives, financial situation or the particular needs of any specific person who may receive this report.  Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed in this report and should understand that statements regarding future prospects may not be realized.  Opinions are subject to change without notice. 

Stocks fell yesterday. While the media blamed it on jitters over possible weak first quarter earnings, the more likely reason was simply profit taking.

First quarter earnings season gets started tomorrow as three major banks are due to report results in the morning.  The flattened yield curve and lower rates will be a headwind to traditional banking while the strong dollar will hurt international results. 

On the other hand, a strong stock market will benefit those banks heavily involved in the securities business.  Traditionally, however, the banks have not been a good barometer for how the rest of earnings season will look like.  The volume growth of commercial and industrial loans may give us some hint of activity but things like loan loss reserve changes and net interest margins are simply not very applicable to other business segments.

In general, economic activity was solid in Q1 but not spectacular.  The surge in consumer spending during Christmas season abated a bit.  Tax refunds are lagging behind last year even though total taxes paid on 2018 earnings are likely to be fairly flat or down slightly from 2017 before the tax cuts.  Higher incomes will push taxes higher as will the lack of deductibility of state and local taxes for those living in high tax states.  But the reason refunds are down is because businesses under withheld last year leading to a bit more money in consumer hands in 2018 and less in the way of refunds (or higher April 15 tax payments) this spring.   While some will see some noticeable benefit from the tax cuts, most of the advantage went to corporations and not individuals.  The largest beneficiaries will be those who used to itemize but can now take advantage of the enlarged standard deduction.  Generally, these will be families that don’t own their own home (i.e. renters) who don’t have large medical expenses or charitable contributions to itemize.

Away from the consumer, inventories swelled at year end.  Businesses reacted to rising sentiment late in 2018 and got a bit too exuberant.  That additional inventory appears to have hit certain industries harder than others.  The semiconductor industry is a case in point.  It may take another 3-6 months for inventories to normalize.  Another industry taking it on the chin in Q1 is agriculture.  A combination of high inventories, courtesy of the Chinese tariffs, and terrible weather have ravaged farm incomes.  The flooding in the Midwest will delay spring plantings at a minimum.  Some acreage may never get planted at all this spring.  That could inflate prices later this year but it won’t look pretty over the next several months.

But not all is doom and gloom. The recent drop in interest rates is bound to help the housing and auto industries. While the decline came too late to help first quarter earnings, traffic and orders are picking up.  Since investors look ahead, they will forgive weak Q1 earnings for the promise of better and brighter days to come.

Another area of strength is software, particular for cloud, customer service and cyber applications.   We are in a transformative period where the cloud is replacing on-site data centers, where customers are becoming more and more mobile, where phones are the go-to device for computing rather than the laptop or desktop, where multimedia is replacing text, and where digital wallets are supplanting paper money.  All those transformations are enabled by software.

Then there are the worlds where change is so vast and rapid that the evolution is more opaque that transparent.  Social media has changed all of us.  But it is still evolving.  Privacy is a huge issue today but it is only one of many.   Social media allows all of us to live within protected silos. We shut out what we don’t want to see.  Thus, it allows us to communicate but we communicate selectively.  For advertisers, and therefore, for the social media platforms, this is an advantage.  But it is also changing our ways of life in ways we don’t yet completely understand.  Its role, for instance, in shaping politics is still evolving.  Candidates use it to reach target audiences but those wishing to interfere also use social media to distort and twist truths.  How to regulate this world remains a mystery and could ultimately affect the profitability of the platforms.

Another area where the future is opaque is healthcare.  There is no question that more and more healthcare is needed and medical advances will allow us to live longer.  But what can we afford?  The number of nursing home beds over the next decade will probably be cut in half despite rapid growth of those over 80 years old.  Why?  Because nursing homes are expensive and much of the care provided there today will be provided in home or at other sites in the future to save money.  Left unchecked, entitlements and interest costs will soon consume over 50% of the Federal budget.   States now outsource Medicaid.  Drug pricing is under attack.  While lower drug prices are clearly a plus for consumers, drugs are far less than one-fifth of total health care costs.   The cost of hospital care is a far larger piece of the pie.  Thus, while technological advancement and new drugs will continue to lift earnings for part of the health care segment, pressure on pricing, and the need to move patients to the point of most cost-effective care will impact that industry for a very long time.

Back to Q1, this should be the weakest quarter for earnings in 2019, a combination of low GDP growth impacted by tariffs, weather and a government shutdown, as well as the strength in the dollar.  The year-over-year increase in the value of the dollar will fall sharply over the next two quarters will GDP growth should improve, partly in conjunction with lower interest rates.   On one hand, everyone knows Q1 earnings growth will be tough to achieve.  That should be priced in to stocks already.  On the other hand, the sharp rally in the first quarter suggests that for stocks to move higher from here, forward looking statements have to be quite optimistic.   That becomes a bit iffy given that issues like tariffs and Brexit remain unresolved. 

Thus, look for a mixed quarter and a bumpy stock market over the next 2-3 weeks.  Some backing and filling, after recent gains, would be a healthy outcome.

Today, Steven Seagal is 67.  John Madden turns 83.

James M. Meyer, CFA 610-260-2220

Additional information is available upon request.

* – Boenning and Scattergood may act as principal in buying this stock from or selling it to the public.

# – The author of this report or accounts under his management at Tower Bridge Advisors owns this security.

Additional information on companies in this report is available on request.  This report is not a complete analysis of every material fact representing company, industry or security mentioned herein.  This firm or its officers, stockholders, employees and clients, in the normal course of business, may have or acquire a position including options, if any, in the securities mentioned.  This communication shall not be deemed to constitute an offer, or solicitation on our part with respect to the sale or purchase of any securities.  The information above has been obtained from sources believed reliable, but is not necessarily complete and is not guaranteed.  This report is prepared for general information only.

Boenning & Scattergood, Inc. – Member FINRA / SIPC.

It does not have regard to the specific investment objectives, financial situation or the particular needs of any specific person who may receive this report.  Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed in this report and should understand that statements regarding future prospects may not be realized.  Opinions are subject to change without notice. 

Stocks continued to rise on Friday after an almost perfect employment report showed healthy growth in jobs.

The report also showed a steady rise in wages that will raise real income without threatening overall inflation.   On the trade front, negotiations with China continue without an imminent conclusion.

Over the weekend, Bridgewater Associates Chairman Ray Dalio was all over the news programs and on Sixty Minutes talking about the dangers of income inequality specifically pointing to the lack of quality education, particularly in inner city schools.  While we have heard that before, the conversation took on added meaning after he pledged to donate $100 million to the State of Connecticut to help improve its education product.

The Dalio argument melts into the evolving debate both within the Democratic Party as it begins the process to find its nominee for President in 2020, and the larger debate that will evolve during the Presidential race.  Progressives within the Democratic Party are trying to use shock treatment with manifestos like the New Green Deal wrapped in labels like Socialism.

Democracy, socialism and capitalism are three words we are going to hear a lot about over the next two years.  Modern democracy, as we know it today, was literally a creation of our own founding fathers who created a government of the people, by the people, and for the people.   It was built from the ground up.  There was no founding monarch and no legacy base.  The creation of an executive, legislative and judicial branch of government balanced by an attempt to equal weight the powers of each was a new invention.  While it has been tested many times, after over 240 years, it seems to be working rather well.

The U.S. Constitution rather precisely laid out the role of the Federal government.  That role was limited to tasks that were beyond the scope of states (e.g. national defense) or not conducive to private enterprise (e.g. the court system).  In today’s world, activities are separated into three silos.  The biggest is the private sector and in a democracy built of a capitalist base, the profit motive is the biggest motivator, the driver of almost all activity.  Whether it be making widgets, selling them, or inventing a better widget, the profit motive is the driver.  There are many keys to success in such a world including access to capital and intellectual capabilities plus the entrepreneurial energy of corporate leadership.  Since there is clearly a boundary line between fair and unfair competition, government has a role to ensure that the foxes don’t have freedom to do whatever they please in the chicken coop.  Conservatives typically want less regulation and liberals want more.

Socialism removes much of the profit incentive and redistributes assets from the successful and rich to those less successful and less wealthy.   Without the profit incentive, however, innovation lags as does growth.  Name one major innovation of the last 100 years developed either within a socialist system or under a dictatorship.  For socialism to succeed in the effort to grow and develop new and better resources, some incentive is needed to replace the profit motive.

Let me get more specific.  Growth, as I often note, is a function of population growth and productivity.   While, in economic terms, productivity is measured as the output per manhour, it becomes harder to define in a world less based on manufacturing and more based on services.   Obviously, replacing 50 workers with robots to achieve the same level of production is productive and is easy to measure.  But what about the benefits of a new highway that both shortens commuting time and, as a second derivative, allows new communities to be built nearby.  The opening of a connector bridge between I-95 and the Pennsylvania Turnpike shortens the trip between Philadelphia and New York by 20 minutes or more than 15%.  That’s productive.

On the other hand, look at the proposal of Cory Booker to have the government buy a bond annually for everyone born to a family below a certain income level and finance that with higher taxes on the wealthy.  That is simply a transfer payment.  It is no different than many of the entitlement programs in place.   I am not making any judgment whether that is a good or bad proposal. What I am saying is that, by itself, it isn’t productive.

Which gets me back to Ray Dalio and the need for better education.  History has shown time and time again that once income disparity gets too great, it can lead to ultimate chaos. It could be seen in the decline and fall of the Roman Empire, the French revolution, the rise of Communism, or Venezuela.   More than 25 years ago, I was in South Africa right before Nelson Mandela was to become President.  While one could revel in the fall of apartheid, one also could see reason to be very pessimistic about South Africa’s ultimate future.  An entire generation of black youth was uneducated and living in slums like Soweto.  25 years hence, the leaders of the nation would emerge from this uneducated base.   Today’s problems in South Africa are totally a result of the lack of any education a quarter of a century ago.

In our nation, Presidents serve 4 or 8 year terms.  Fixing education isn’t a 4 or 8 year solution.  In our world today, the rich have an alternative to inadequate public education.  They send their kids to private schools.  The middle class also have alternatives. They move to better school districts. What is left is the poor underbelly.  States often lack the political will to support this class and it gets left further behind.  

All I am doing here is identifying the problem.  Ray Dalio is going a step further. He is trying to find a solution.  Better books, more computers, and better training for tomorrow’s job skill set are steps in the right direction.  Cities are trying to do some of that with charter schools.  The point is that if the underbelly gets hopelessly behind, the risk of unintended consequences rises.

Foundations fill a gap here as well.  Foundations fill the gaps that private enterprise and government leave behind.  For instance, there is little profit incentive to treat malaria and, since most of those who die from the disease do so in the poorest nations, governments don’t spend the money to find the cures.   Many foundations today, see the gaps in education and are trying to step in.

Unlike transfer payments, which are not productive in an economic sense, clearly having a broader base of educated workers is productive.  In a world where better artificial intelligence will progressive replace the simplest remaining tasks done by humans (e.g. kiosks replacing order takers in fast food restaurants), humans will have to raise their skill levels to become incrementally productive.

This whole subject is going to be the core of the national debate over the next 18 months.  Some of those that have are more willing to share than others but, after 240+ years of capitalism and democracy, I doubt only a vocal minority of Americans want a pure socialist world where government manages banks, healthcare, and all higher education.  Conversely, there are some, but less than a majority, who simply want little or no tax, less government interference, and a sharp reduction in entitlements.   Most are somewhere in between.  Finding that center point is what the election of 2020 is going to be about.  It is a healthy debate.  Hopefully, it won’t be entirely overshadowed by derisive name calling and the elevated nastiness that many fear.  Markets won’t be immune to the discussion.  Markets are clearly on the side that says, where government is concerned, less is more.  Since markets vote for policy over personality, they are generally happy with President Trump so far.  But note that they were happy with President Obama as well.  

Bottom line, it will be a fascinating 18 months to come.   My only ending political comment is that if either side gets too far from the middle, they invite disaster.   So far, the biggest noise makers within the Democratic Party have been on the far left.  But just because they make the most early noise, don’t think they will still have everyone’s favor a year from now.  I suspect between now and next summer at least a half dozen Democrats will rise to the top and like Humpty Dumpty will have a big fall.  History is strongly in my favor on that call.

Today, Robin Wright is 52.  John Schneider, one of the “Dukes of Hazzard” is 58.

James M. Meyer, CFA 610-260-2220

Additional information is available upon request.

* – Boenning and Scattergood may act as principal in buying this stock from or selling it to the public.

# – The author of this report or accounts under his management at Tower Bridge Advisors owns this security.

Additional information on companies in this report is available on request.  This report is not a complete analysis of every material fact representing company, industry or security mentioned herein.  This firm or its officers, stockholders, employees and clients, in the normal course of business, may have or acquire a position including options, if any, in the securities mentioned.  This communication shall not be deemed to constitute an offer, or solicitation on our part with respect to the sale or purchase of any securities.  The information above has been obtained from sources believed reliable, but is not necessarily complete and is not guaranteed.  This report is prepared for general information only.

Boenning & Scattergood, Inc. – Member FINRA / SIPC.

It does not have regard to the specific investment objectives, financial situation or the particular needs of any specific person who may receive this report.  Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed in this report and should understand that statements regarding future prospects may not be realized.  Opinions are subject to change without notice. 

Stocks closed mixed once again yesterday.

While the Dow Jones Industrials posted nice gains, the S&P 500 rose just 0.2% and the NASDAQ Composite was down slightly.  

Most of the leading averages have now recovered to within 2% of their all-time highs.  While they could all make a run to new records over the next couple of weeks, their success will depend on the outcome of trade talks with China and investor reaction to first quarter earnings.

While we all know that the economy slowed through much of the first quarter and international companies will feel the impact of a strong dollar on earnings, it is hard to make the case that much negative news is built into a market that is up close to 15% since the start of the year.  While most companies have fiscal years ending in December and report at the end of calendar quarters, there are more than a handful of companies that report on off months.  Those, for instance, with quarters ending in February have already reported and investors have voted with mixed reactions.  Others missed and saw their share prices drop sharply.   We expect the same behavior beginning as the major banks report at the end of next week.  There will be winners and losers plus a lot of companies that report within the range of expectations.  But as noted above, the recent rally has placed the margin of error on the downside meaning that understanding how the weakness in Q1 could hurt earnings, any miss or lowering of estimates will put any company reporting disappointments in the penalty box.

Today, there will be two pieces of news to digest.   First, since this is the first Friday of the month, is the March employment report.  We are looking at two numbers.  First, of course, is the total number of new employees.  After February’s dismal performance, one could fear a repeat.  Any number of net jobs created materially below 100,000 would create shivers in the market.  On the flip side, gains over 100,000 would be taken in stride, even outsized gains beyond expectations of 150,000-175,000 new jobs created.  The second is the gain in wages.  We want wages gains to be robust but not too robust.  Any acute acceleration in the rate of wage increases will spook markets that the Fed might consider raising interest rates.

But the Fed doesn’t rely on any one data point.  At the moment, it is no mood to do anything.  And, frankly, there is no reason why it should.  The economic growth outlook is for real growth in excess of 2% this year (some hope for well in excess) with inflation about 2%, more if you include food and energy, less if you just look at the core rate.  The Fed, having lived through several years of inflation a bit below 2%, is more than willing to live with some inflation, using whatever measure one chooses, a bit above 2%.  A bit above doesn’t mean 3% or 4%.  It means something less than 2.5%. 

If I were a Fed Governor (and no one asked me; it appears Herman Cain and Steve Moore are first on the list), I would sit back and do absolutely nothing right now.    An economy growing too fast risks lighting the fires of inflation.  An economy growing too slow risks setting off recession.  Right now we are spectacularly in between which is precisely what markets are approaching all-time highs.   From a Fed standpoint, it is a perfect world.  Yes, the Fed probably got too aggressive last fall and it has spent the last six months walking back that hawkish stance.   Are rate a quarter point too low or high today?  Really?  Is there anyone who can tell precisely, within 25 basis points the perfect rate?  I doubt it.  But what I do know is that we are living in an economy growing 2%+ with an inflation rate of 2%-.  That is as close to perfection as possible.  Putting all politics and rhetoric aside, the primary drivers of growth are population and productivity.  Our population growth isn’t accelerating and, if we make immigration more difficult, the outlook isn’t positive.  As for productivity, getting to 2% in an economy dominated by services, is going to be difficult, especially when investment spending is constrained by all the uncertainties related to trade, Brexit, and the overall political environment.

We might learn more about trade soon.   Chinese Vice Premier Liu He and President Trump met last night. Mr. Liu has to present any agreement back to Chinese leadership.  Hopefully, something can be signed by this summer’s G-20 meeting.  At the moment, the key issues are enforcement and the status of existing U.S. tariffs.   Clearly, markets are poised for an agreement and any breakdown in talks will set off a correction.  Conversely, any success could spark a rally to or through previous highs.  But I suspect some degree of success is already priced in and any blow-off rally should probably be sold.  A 17x multiple on forward earnings takes us to just under 2900 on the S&P 500.  That is almost precisely where we are today, suggesting stocks are fairly priced right here.  Said in a different way, don’t expect the salad days of Q1 to continue unabated.  As noted, Q1 earnings reports could be a catalyst for a bit of uneven trading, up on days when key companies report favorable results and down on days when they don’t.   Markets never move in a straight line forever and they certainly don’t move up or down by 10-15% per quarter.  Look at the last six months in context.  Q1 gains pretty much offset the losses of last year’s fourth quarter.  Call if relatively even since September despite an overall rise in earnings and a decline in interest rates.   But for those Q1 gains to continue, at least at the same pace, expectations have to rise. That probably is more than one could ask for.

Therefore, the obvious strategy is to sell what is fully priced relative to rational expectations and to buy what gets beaten down to the extreme during earnings season.  Longer term, with no recession in sight, the key is to stay to one’s asset allocation and stay focused on companies that can continue to grow is a slow growth economy.

Today, Pharrell Williams is 46.

James M. Meyer, CFA 610-260-2220

Additional information is available upon request.

* – Boenning and Scattergood may act as principal in buying this stock from or selling it to the public.

# – The author of this report or accounts under his management at Tower Bridge Advisors owns this security.

Additional information on companies in this report is available on request.  This report is not a complete analysis of every material fact representing company, industry or security mentioned herein.  This firm or its officers, stockholders, employees and clients, in the normal course of business, may have or acquire a position including options, if any, in the securities mentioned.  This communication shall not be deemed to constitute an offer, or solicitation on our part with respect to the sale or purchase of any securities.  The information above has been obtained from sources believed reliable, but is not necessarily complete and is not guaranteed.  This report is prepared for general information only.

Boenning & Scattergood, Inc. – Member FINRA / SIPC.

It does not have regard to the specific investment objectives, financial situation or the particular needs of any specific person who may receive this report.  Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed in this report and should understand that statements regarding future prospects may not be realized.  Opinions are subject to change without notice. 

Stocks fell for the 5th straight session on Friday although they finished well off their lows.

Friday was the 11th straight decline for the Dow Transports, an indication that slower growth in the U.S. is worrying investors.

Yesterday, March 10, was the 19th anniversary of the peak of the dot.com bubble all the way back in 2000.  On that date, the NASDAQ closed above 5000. Over the next two years, the index fell by almost 80%. As Warren Buffet often quotes, you don’t know who is swimming naked until the tide goes out.  We certainly learned to separate fact from fantasy right after the millennium. 

Saturday, March 9, on the other hand, was the 10th anniversary of the stock market’s bottom during the Great Recession.  The S&P 500 over the past decade has risen from its 666 low of that date to a high around Labor Day of a bit over 2900.   Back then, there was talk of nationalizing the banking industry and putting other controls on big businesses.  From those calls came Dodd-Frank which has clearly changed the face of the banking industry and insulated it from some of the more egregious risky behavior evidenced at the time by names like Lehman Brothers.  As we enter the 2020 campaign season some of the more progressive Democratic candidates are making calls for even more stringent controls not only of banks but of all industry.  But while these voices at the moment may be among the loudest, they don’t necessarily reflect a majority consensus of where America is or should be headed.   For almost 250 years, America has grown into the world’s economic leader based on a combination of capitalism and democracy.   Unregulated capitalism is subject to abuse.  When the abuses become excessive, there have been times when the subsequent reactions overreached.  During the Trump administration some of the more aggressive regulatory efforts have been softened.  Clearly, the 2020 election will, in part, be a mandate as to whether regulation has gone too far, or not far enough.

While the rhetoric will heat up over the next 18 months, little is likely to change in the interim.  Financial markets react to facts not media hype.   While the recent correction might be construed as a statement on the weakening growth rates both here and abroad, the most obvious explanation is simply that markets move up almost 20% from late December lows and a correction necessary to reestablish bargains that would attract new money was long overdue.  There was nothing in last week’s correction that could be interpreted as disorderly.  At the same time, the extended decline in the Transports points to a fundamental slowing of fundamentals punctuated by the very small employment gains in February reported on Friday.

Looking forward, the elation felt after the tax cuts of 2018 has now worn off.  Growth in the U.S. is back to levels seen consistently after the Great Recession, perhaps a touch higher.  Productivity gains have improved a bit but should settle back down toward 1.0-1.5% in coming quarters as U.S. growth rates moderate.  Combined with the likely growth of the work force of about 1% in 2019, the combination suggests that 2% overall GDP growth is a fair expectation.  The Trump administration would like to suggest, particularly in front of election season, that it has changed the basic underpinnings of our economy enough to permanently raise economic growth rates.  But given demographic constraints, a slowdown in net immigration, and difficulty in sustaining elevated productivity gains in a largely service-oriented economy, that doesn’t appear to be the case.  None of this suggests that any economic damage has been done.  There is no reason to expect sustained growth of less than 2%.  Moreover, with labor force growth likely to moderate going forward, inflationary pressures will remain very modest.  The bottom line is 2% growth, plus or minus plus inflation likely to remain below 2% is a pretty good long term backdrop for stocks.  Grown will be a bit below historic norms, mostly due to the laws of large numbers.  But inflation will also be well below post-World War II averages.  Combined, the two should lead to a typical 7-9% growth in the fundamental value of equities. Offsets to lower earnings growth will be high free cash flows, better dividends, and more share repurchases.

Overseas, the picture has some similarities (e.g. worsening demographics) suggesting worldwide growth should continue to moderate over the years.   With our growth being above average, one result is a rising U.S. trade deficit despite efforts of the Trump administration to alter that outcome.  Indeed, evidence seems to indicate that tariffs have only worsened the trade picture.  Retaliatory tariffs on U.S. agricultural exports have more than offset the reduction of U.S. imports of key products like steel and semiconductors.  With that said, part of the cause of last week’s losses, apparent difficulties getting to the finish line in Chinese tariff talks, will continue to weigh on markets until forward progress is restored.  The good news is that resolution is almost imperative for both China and the U.S.   Indeed, reform of trade practices sought by the U.S. may actually strengthen China’s standing on the world economic stage in the long run.   The trick now is to reach an agreement that allows both sides to create victory.   That should happen before mid-year. 

When markets correct, investor worries start to rise.  With that said, there is no obvious reason today to become more worried.  Bond prices and yields remain in a tight range.  Lower mortgage rates should help housing and auto sales in 2019.   Consumer spending growth has moderated a bit but individuals are saving a lot; their buying capacity is actually growing.   Tariffs and politics always create some tension but it is hard to see problems escalating.

The obvious exception to the last statement would be if some of the policies of the progressive left become the core of the Democratic platform of 2020.  But there are already indications that isn’t going to happen so quickly.  Take single-payer health care.  There have already been early steps taken within the House at the subcommittee level to proceed down that path but those steps ran into a brick wall when the subject of cost arose.  Today, employers foot the vast majority of the cost of healthcare and our tax system allows that to happen without saddling individuals with a large tax burden.   If the U.S. were to simply offer Medicare for all, clearly, it would have to charge everyone a premium in the form of a tax similar to today’s Medicare tax to pay for it.  That means substituting a tax on every working person for the insurance premiums now paid by employers for the most part.   Making that transition work is a hurdle no one has come close to solving yet.  It’s easy to build a platform of multiple benefits, such as single payer healthcare, but anyone who has taken Accounting 1 knows, for every debit there is any offsetting credit.   In English, every benefit has a cost.  Thus, we will hear many times over the next 18 months wish lists of new benefits.  But many of these suggestions will quickly disintegrate without cogent plans to pay the costs.   That doesn’t mean however, that some progressive candidates won’t quickly whip up emotional support among the young, poor and most liberal among us.  Some ideas will get more traction than others and could send some fear into markets.  But it will still be the political center that selects the next President and no one should lose sight of that.

As for now, we are in that mid-quarter vacuum of data.  Earnings season is over and it is still too early in March for any company to alter Q1 outlooks.  Economic data for February is largely out already.  Thus, other news events, like tariff talks, can take on outsized importance for the next few weeks. Also recognize that after this week, companies start to shut down stock repurchase programs until after Q1 earnings are released.  Thus, markets can do a bit of a dance on eggshells for a couple of weeks until we get into earnings season. That could add some volatility but I don’t see any sharp change in direction.

Today, 76er General Manger Elton Brand turns 40.

James M. Meyer, CFA 610-260-2220

Additional information is available upon request.

* – Boenning and Scattergood may act as principal in buying this stock from or selling it to the public.

# – The author of this report or accounts under his management at Tower Bridge Advisors owns this security.

Additional information on companies in this report is available on request.  This report is not a complete analysis of every material fact representing company, industry or security mentioned herein.  This firm or its officers, stockholders, employees and clients, in the normal course of business, may have or acquire a position including options, if any, in the securities mentioned.  This communication shall not be deemed to constitute an offer, or solicitation on our part with respect to the sale or purchase of any securities.  The information above has been obtained from sources believed reliable, but is not necessarily complete and is not guaranteed.  This report is prepared for general information only.

Boenning & Scattergood, Inc. – Member FINRA / SIPC.

It does not have regard to the specific investment objectives, financial situation or the particular needs of any specific person who may receive this report.  Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed in this report and should understand that statements regarding future prospects may not be realized.  Opinions are subject to change without notice. 

Stocks fell for the fourth straight session after a gloomy European economic forecast from the ECB led to a more dovish stance by the central bank.

As we have all been expecting and witnessing, growth around the world, including the U.S. has slowed noticeably from its pace of just a few months ago.   Part of that is political uncertainty, particularly in Europe.  Part relates to the added cost of doing business as a result of tariffs imposed around the world, precipitated by President Trump’s efforts to level the playing field.

The immediate impact of the ECB announcements yesterday on our economy are (1) that it should reinforce the stance from the Federal Reserve to leave our short term interest rates alone until at least the second half of 2019, if not longer, and (2) further strengthening of the dollar as the differential between our growth rate and those of the rest of the developed world widen.   This will have a particularly negative impact on earnings of U.S. multinational companies who will be hurt by both weaker growth overseas and the negative translation impact of expressing foreign earnings in U.S. dollars.

The moves by the ECB also resulted in lower rates in our market, a benefit to borrowers but a negative to lenders.  Notably, the yield curve didn’t change its shape noticeably.  The bond market is still calling for a slow growth environment without much inflation.  The odds of recession haven’t changed.  

Also yesterday, fourth quarter productivity data came out showing a net increase of just under 2%.  Combined with a growth rate of the work force of about 1.5% (depending on whether you believe the payroll or household survey data more), this still suggests overall growth of something close to 3%.  However, with inventories building and our economy decelerating, it would be logical to expect productivity in the first half of 2019 to slip back toward 1% or so.  All this coincides with our thoughts that the first half of 2019 may be the lowest for growth in some time. But there are reasons to expect improvement thereafter, particularly if tariff pressures can be reduced.  In addition, to the prospect of lower tariffs, lower interest rates should be a positive influence on interest sensitive industries like housing, autos and retail.  Spring selling season for housing is just getting underway and, despite some poor housing data for the late fall and winter, there are some signs of life over the past 4 weeks or so.

Lastly, this morning’s employment report for February will only add to the confusion.  Just 20,000 new jobs were added last month, well below January’s gain of 311,000 jobs.  I wouldn’t put too much emphasis, however, on the sharp decline since numbers for both January and February were almost certainly distorted by the government shutdown in January.  To the extent some government workers took temporary jobs in January and left them in February, that would increase the January number and decrease the February total.  Given the volatility of the monthly employment statistics under normal conditions, I always suggest looking at a rolling 3-month average.  That number, 186,000 net new jobs was very close to the consensus estimate for February of a bit over 180,000 new jobs.  I would also note that despite the meager gain in new jobs in February, the unemployment rate fell from 4.0% to 3.8%.  Finally, the impact of higher wages was evident in the report.  Wages rose by 4% annualized in the month, the highest rate of increase since the recession.  However, coupled with a 1.9% gain in productivity, the net impact is just about 2%, right on with the Fed target for inflation.  With all this said, and given the negative tone in the marketplace this week, the low number will be fodder for sellers of equities this morning.

Of course, stocks look ahead.  The current economic malaise should largely be priced in assuming no meaningful further deterioration is about to take place.  Stocks rose almost 20% from their lows Christmas Eve to their recent highs last week.  Some retracement is to be expected.  So far, that has been orderly.    But with that said, and as we saw last year both in February and the late fall, selling pressure can escalate quickly.   Sudden drops have become almost a norm and any downturn has to be respected.  In addition, as we move into mid-March, soon most corporations will have to cease stock buyback programs until their first quarter earnings are released in April.  How important is that?  In the fourth quarter, corporations spent more money repurchasing stock than they spent on investments within their business.   Most stock repurchases are concentrated in 8 months, excluding the 30 days each quarter in front of earnings.   In December, not only did the lack of repurchases rob markets of buying power in a tailspin, but tax selling and hedge fund liquidations added fuel to the downturn.  This time there will not be any tax selling and only minimal need for hedge funds to fund liquidation requests.  Thus, there shouldn’t be outsized selling pressure.  That doesn’t mean stocks are immune to a decline larger than 10% but it shortens the odds.   If you are nervous near term, watch the VIX measure of volatility.  If it remains below 20, any correction should be orderly, maybe in the range of 5-8%.  But if downside pressure mounts and the VIX rises higher, a 10%+ retreat could occur leading to some chatter that a full retracement toward the December lows is possible.

As readers of these letters know, I have pegged fair value very close to where we are today.  That means stocks at the moment are not at compelling cheap prices although they aren’t very expensive either.  But since everyone likes a bargain, one could see some further downside before any correction runs its course.   With four down days in a row, it is time to be a bit more defensive than offensive.   In good markets, the last hour or so is a trader’s friend.  In weak markets, the opposite is true.   Be careful of morning rallies without any follow through.  My sense is that first quarter earnings will not be all that surprising but I don’t expect many companies to beat forecasts and raise full year guidance very much.  As has been the case so many times, the more likely pattern is that the average company with beat existing first quarter estimates by a small amount followed by management commentary that will tone down future expectations.  In the end, I don’t expect much change in overall 2019 estimates.

All this suggests we are at the beginning of an orderly correction, one that will reestablish some bargain prices needed to bring in new buyers.  Fundamentally, the overriding concern is the outcome to trade talks, first with China and perhaps later with Europe concerning possible tariffs on automobiles.   It now appears that the China talks will drag on a bit longer than one might have hoped a week or two ago.  The key is the enforcement mechanisms to will protect any concessions China makes relative to respecting intellectual property rights and reducing forced technology transfers.   While all economies around the world have felt the impact of tariffs instigated by U.S. policy, no country has felt the impact more than China.  But that doesn’t mean China is ready to roll over and comply fully with developed world norms.  Presidents Trump and Xi are both headstrong rulers who want to be able to claim victory with any agreement.  Finding the right balance to let both “win” isn’t simple.

In the meantime, now is the moment to build your shopping list and perhaps weed out the investments that aren’t meeting expectations.  Stocks are only about 2% below recent highs.  Raising a little cash now for better bargains later isn’t a crazy idea.  With that said, corrections are a normal part of a market’s breathing process.  There are moments, in the best of times, when stocks simply are fully priced.  Retailers have sales a few times a year and so should the stock market.  Don’t overread any correction even if we have a day or two with losses of 2% or more.  There isn’t a recession looming a month or two down the road and markets aren’t overheated.  It’s just a continuation of a nice pattern of two steps forward, one step back.

Today, Lester Holt turns 60.  Monkees drummer Micky Dolenz turns 74.

James M. Meyer, CFA 610-260-2220

Additional information is available upon request.

* – Boenning and Scattergood may act as principal in buying this stock from or selling it to the public.

# – The author of this report or accounts under his management at Tower Bridge Advisors owns this security.

Additional information on companies in this report is available on request.  This report is not a complete analysis of every material fact representing company, industry or security mentioned herein.  This firm or its officers, stockholders, employees and clients, in the normal course of business, may have or acquire a position including options, if any, in the securities mentioned.  This communication shall not be deemed to constitute an offer, or solicitation on our part with respect to the sale or purchase of any securities.  The information above has been obtained from sources believed reliable, but is not necessarily complete and is not guaranteed.  This report is prepared for general information only.

Boenning & Scattergood, Inc. – Member FINRA / SIPC.

It does not have regard to the specific investment objectives, financial situation or the particular needs of any specific person who may receive this report.  Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed in this report and should understand that statements regarding future prospects may not be realized.  Opinions are subject to change without notice. 

Stocks finished modestly lower after the worst down session in several weeks on Monday.

There was nothing sinister to trigger the weakness, just some profit taking after a two-month run up.

This morning’s ADP forecast of a bit over 180,000 new jobs created in February adds one more data point to a set that now indicates a measurable slowing in the rate of growth that probably began late last year and continues through the first quarter to date.   What we see is not a sign of something diabolical.  There is no recession in sight; just a simple slowing in the rate of growth. 

Internationally, the slowdown is more noticeable in a lot of countries.  Japan has probably slipped back into recession.  Its demographics are so bad that staying out of recession is considered a victory.  China’s growth has slowed over the past year and U.S. tariffs certainly haven’t helped.  But the Chinese government has taken bold and massive stimulative steps that should keep growth well over 5%.  Thus, while China’s growth is the lowest in several decades, it still is higher than almost anywhere else in the world.   Europe teeters with recession.  That too is partly a function of demographics but political uncertainties in France, Germany, Italy and Spain are all contributing factors.  Brexit looks likely to be delayed but kicking the can down the road, while avoiding a hard exit, isn’t a solution.  The U.K. will hold a series of votes this month that most likely will move closer to a solution without invoking either a hard exit or a call for a new referendum.   Look for a modified exit in the second quarter, one that will cause a bit of pain but will be seen my most as a victory.

Getting back to the U.S., to understand today’s economic picture, one has to look back to the passage of the new tax law in the fall of 2017.  Many companies reacted by paying one-time bonuses.  Others doubled up payments in late 2017 to gain some tax advantages.  As a result, many workers started 2018 with some extra cash in their pockets, money they freely spent in early 2018.  By the second quarter, growth had exceeded 4% and optimists within the administration were calling for a sustained period of 3-4% growth as far out as one could forecast.  But, alas, that wasn’t to be.  Just as “cash for clunkers” and first-time home buyer tax credits pulled demand forward when desperately needed during the depths of the recession, in the end there is a dead zone created once the demand is filled.   To some extent, especially, when looking at numbers on a year-over-year basis, that is where we sit today.  The U.S. consumer is still spending but not with the same enthusiasm as six months ago. 

It would be a mistake to overread the slowdown.  Not long ago, economists of leading investment banks were tripping over each other to see how low they could take forecasts for growth in the second half of 2019.  Some were down to as low as 1%.   But it now seems likely that growth could well hit bottom in the first half of this year.  The government shutdown and tariffs certainly haven’t helped.  I would like to think the tariff problems will soon go away but if President Trump succeeds (at least in his own mind) of reaching an agreement with China on trade and intellectual property, he might believe that the use of tariffs was the weapon that got the other side to agree.  He has before him a Commerce Department proposal to raise tariffs on European car imports.   Hardly anyone in the business world, including U.S. auto makers, believes imposing tariffs on European cars is a good idea.  But Trump loves tariffs as a weapon and, therefore, to conclude tariffs will disappear overnight may be excessively optimistic.  With that said, U.S. auto imports from Europe comprise a very small part of our economy and tariffs probably won’t move the economic needle much if imposed.

We have seen an interesting pattern in retail over the past few months.  Low end retailer have reported very strong results, even better than expected.  But fashion and high end retailers have generally missed forecasts.  This includes virtually all the department store chains.  Gasoline prices are started to edge up again adding a bit more pinch to the retail pocketbook.   On the other hand, tax refunds, which were lagging early on, seem to be coming in fairly level with last year erasing one major fear.   In total, retail is OK.  It is growing at a tepid pace.  Online remains strong while in-store sales remain spotty, stronger at the low end, with department stores bearing most of the negative weight.  To a large extent, this is self-inflicted as few have developed a true omni-channel presence that can compete.

Housing is also showing some hints of sunlight.  While starts have been down this winter, the spring selling season is off to an OK start, not great but not horrendous either.  It has become a buyer’s market.  Priced right, inventory sells.  But sellers have to accept that buyers are not going to chase.  Those who price homes based on wishful thinking will get little or no attention.  But rising household formations, flat pricing and lower mortgage rates suggest a second half of 2019 significantly better than the last six months.  

At the core of our economy there are a record number of jobs and productivity is slowly rising.  That can sustain 2-3% growth.  In the short run, that may not show on the top line as a bit of excess inventory has built up through the end of last year that needs to be burned off.  That should happen during the first half of 2019.   Thus, the combination of less cash in the pockets of many (fewer bonuses and perhaps smaller tax refunds for those in high tax states), and inventory liquidation could lead to growth of less than 2% in the first half of the year followed by better comparisons in the second half.

Tying this back to the stock market, equities are now priced at about 16.5x forward estimated earnings, a bit higher than normal but not out of line given low inflation expectations and interest rates.   I would label it fairly priced.   Given a recovery of almost 20% since Christmas Eve, some pause might be expected.   If any further first half softness causes further moderation of earnings forecasts, then a pullback of something on the order of 5% wouldn’t be surprising.  But if the second half of the year shows stability or even signs of slight improvement, then stocks could make a run toward 2900-3000 before the year is over.  I wouldn’t recommend chasing stocks here but having a shopping list ready for a modest pullback makes sense.

Today, Phillies pitcher Jake Arietta is 32.  Shaquille O’Neal turns 46. 

James M. Meyer, CFA 610-260-2220

Additional information is available upon request.

* – Boenning and Scattergood may act as principal in buying this stock from or selling it to the public.

# – The author of this report or accounts under his management at Tower Bridge Advisors owns this security.

Additional information on companies in this report is available on request.  This report is not a complete analysis of every material fact representing company, industry or security mentioned herein.  This firm or its officers, stockholders, employees and clients, in the normal course of business, may have or acquire a position including options, if any, in the securities mentioned.  This communication shall not be deemed to constitute an offer, or solicitation on our part with respect to the sale or purchase of any securities.  The information above has been obtained from sources believed reliable, but is not necessarily complete and is not guaranteed.  This report is prepared for general information only.

Boenning & Scattergood, Inc. – Member FINRA / SIPC.

It does not have regard to the specific investment objectives, financial situation or the particular needs of any specific person who may receive this report.  Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed in this report and should understand that statements regarding future prospects may not be realized.  Opinions are subject to change without notice. 

After persistent gains, stock gave back some yesterday as investors finally started to focus on a steady stream of worse than expected economic news both in the U.S. and abroad.

Weekly unemployment claims have begun to gradually increase.  Although still low, they indicate some corporate reticence to hire and maybe even some moves to right size companies. 

Manufacturing survey data indicates continued growth but at ever slower rates.  Retail sales, as reported by the government were abysmal in December.  Many think the data will ultimately be revised but, again, there is a new trend in place. 

Overseas, the trends are worse. Germany, France and Italy are nearing recession levels. Chinese growth is showing some signs of stability but at a lower level than previously expected.  Japan is back in recession.  There have been at least three causes:

  1. Less expansive monetary policy throughout most of the developed world
  2. The impact of U.S. tariffs on trade.
  3. Political uncertainties (e.g. Brexit)

Markets have been encouraged by prospects that U.S. tariffs against China will not be increased further, at least for a few months.  But the prospects of another round of auto tariffs once again raised uncertainty.

But with all the clouds suddenly appearing, perhaps the biggest pending storm is early indication that tax refunds in the U.S. are down almost 9% versus last year.

Let me go back a bit over a year when the IRS was adjusting withholding tables to account for the new tax law. While the law was primarily a tax cut for corporations, proponents extolled the benefits to individuals as well.  Along this line, if employees didn’t adjust their exemptions with employers, the percentage of income withheld declined.  The good news is that this provided more cash in the pockets of workers in 2018.  The early boost helped to allow GDP growth of over 4% in the second quarter of 2018.    But the bad news is that all this is coming home to roost now.  Not only are refunds likely to decline but a significant percentage or workers are going to be socked with a significant tax bill instead of the usual refund.

Employees can begin to file returns in early February and refunds are just beginning to be dispersed. The government shutdown has the IRS a bit behind in processing refunds.   If one expects refund, there is an incentive to file early. Those expected to pay on April 15 have the incentive to wait.   While tax refunds aren’t “income” in the same sense of wages, many families count on them to repay credit card debt or to fund special projects. 

We won’t see the impact fully until we start to see economic data for February and March.  Maybe as more returns are filed, the refunds will come closer to matching 2018 levels.  But so far that doesn’t seem to be the case.  Those hit hardest will most likely be workers in high tax states that will have sharply lower deductions this year.  A few, that can benefit from the higher standard deduction will be smiling. But overall, this may be the most important economic factor to consider over the next several months.  Weak refunds and less spending are clearly a toxic combination.  Combined with the impact on earnings from weaker operations overseas and the impact of a strong dollar, this is a bad near term set-up.

Technically, stocks are quite overbought after the strong January-February rally.  Bargains have disappeared.  If there was a lesson from 2018, it is that stocks rise gradually and fall suddenly.  I have no idea what the trigger for a correction might be.  It might be delayed as the China tariff talks resolved.  But it is a time to make sure that your asset allocation is set properly.  A combination of slower growth, more tariffs and lower tax refunds suggest a correction could happen sooner rather than later.

Today, Drew Barrymore is 44.  Julius Erving turns 69.

James M. Meyer, CFA 610-260-2220

Additional information is available upon request.

* – Boenning and Scattergood may act as principal in buying this stock from or selling it to the public.

# – The author of this report or accounts under his management at Tower Bridge Advisors owns this security.

Additional information on companies in this report is available on request.  This report is not a complete analysis of every material fact representing company, industry or security mentioned herein.  This firm or its officers, stockholders, employees and clients, in the normal course of business, may have or acquire a position including options, if any, in the securities mentioned.  This communication shall not be deemed to constitute an offer, or solicitation on our part with respect to the sale or purchase of any securities.  The information above has been obtained from sources believed reliable, but is not necessarily complete and is not guaranteed.  This report is prepared for general information only.

Boenning & Scattergood, Inc. – Member FINRA / SIPC.

It does not have regard to the specific investment objectives, financial situation or the particular needs of any specific person who may receive this report.  Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed in this report and should understand that statements regarding future prospects may not be realized.  Opinions are subject to change without notice. 

Stocks finished mixed yesterday after a rocky start.

Government retail sales figures for December were substantially worse than expected. 

While some suspected that the data was corrupted somehow by the government shutdown, the reality appears to be that consumers are notably less confident today than they were two months ago prior to Christmas.  Perhaps the government shutdown and negative press has had more of an emotional impact than some perceive.   Weekly unemployment claims have been rising as well.  While still close to historic lows, they represent an important factor to watch.  We are not yet seeing any sign of material layoffs but any indicator that suggests less job security is worrisome.

Nonetheless, stocks quickly rallied off their early morning lows yesterday.   The government data wasn’t the only news affecting investors.  It appears likely that President Trump will accept the compromise reached in Congress and sign legislation today that will prevent another government shutdown.  Of course, the President always wants the last word and his last word this time is likely to be a declaration of a State of Emergency that will allow him to move funds, mostly from the Defense budget, to build his wall to a greater extent.  The move is certain to be challenged both in Congress and in the courts.  Claimants will include those harmed by the absence of Federal funding diverted from the Defense budget as well as landowners where the additional wall construction will take place.  The issue may still be tied up in the courts at the time of the 2020 election.

The other big news story currently occupying investor minds is the trade negotiations with China. Treasury Secretary Mnuchin yesterday tweeted that progress is being made, whatever that may mean. But investors jumped on the news anyway and pushed prices higher in the afternoon.  While all this has been happening, bond prices have been trading in a narrow range and the 2-10 yield spread has been persistently stable within a 14-18 basis point range.  The dollar as also remained within a tight band.

Investors are also getting used to the idea that earnings are likely to fall in the first quarter largely due to currency related headwinds.  By the end of March, this will be old news and the worst of the headwinds will be behind us.

On the surface, that might suggest that bright sunshine is about to appear providing an opportunity to extend the 2019 rally.   But stocks look forward for guidance.  The real question is after the government shutdown is averted and after trade talks are resolved, hopefully in a positive manner, what news is likely to lift stock prices that have already returned to historic norms?  Indeed, that’s the key question.

The current reality is that growth rates are shrinking around the world.  Europe is on the brink of recession.  Japan may already be there.  There are two culprits.  First, while central banks are mostly behaving in an accommodative fashion, several, notably the Federal Reserve, are less accommodative than they were in the past. The Fed over the past few months has stepped back from somewhat hawkish rhetoric but it is still less accommodative than it was when interest rates were near zero.  Europe, likewise, is no longer cutting rates and it has set a timetable to stop buying bonds.  Key rates overseas remain close to zero.  But politics get in the way.  Brexit is one fear.  Macron and Merkel are increasingly unpopular with their electorates and are being forced to lean left. Spain and Italy now face similar assaults from their extremes.

Back home, investors have largely chalked off the Green New Deal as extremely hyperbole but the decision by Amazon to abandon its initiative to build a second headquarters in New York City is testimony that protests from the left have an impact.   Many who don’t like Donald Trump note his persistent distortion of the facts.  But the left does exactly the same.  There was never going to be a $3 billion handout to Amazon but, in the end, the incentives that could have reached $3 billion were apparently a key component in the decision by Amazon to build in Long Island City. While it is proper for Amazon to seek economic benefit for itself based on its ability to create 25,000 high paying local jobs, if there were messages within the failed venture, two stand out.  First, any large company like Amazon that is going to make a decision that has both broad economic and political implications better understand both and not rely just on the former.   Second, extremists always shout louder than the center.  That allows the extremists often the opportunity to set the agenda over the muffled protests from the middle.  In the case of Amazon, that scuttled the deal.   In 2020, should Democrats nominate a candidate too far left for the quiet center to accept, they will learn the consequences in the voting booth.

Ultimately, looking forward, with central banks largely in a neutral state, if there is going to be an end to the deceleration process it will either come from natural forces, including an expansion in the labor force and further improvements in productivity, or from a more business friendly political environment.  Corporate managements have proven adept at winding their way through the barriers imposed by both politics and policy but fewer barriers make like easier. Currency headwinds will dissipate but not disappear in the second half of 2019.  But with equities now near fair value, further gains won’t be quite so easily attained as they have been year-to-date.

Matt Groening, the genius behind “The Simpsons”, turns 64 today.

James M. Meyer, CFA 610-260-2220

Additional information is available upon request.

* – Boenning and Scattergood may act as principal in buying this stock from or selling it to the public.

# – The author of this report or accounts under his management at Tower Bridge Advisors owns this security.

Additional information on companies in this report is available on request.  This report is not a complete analysis of every material fact representing company, industry or security mentioned herein.  This firm or its officers, stockholders, employees and clients, in the normal course of business, may have or acquire a position including options, if any, in the securities mentioned.  This communication shall not be deemed to constitute an offer, or solicitation on our part with respect to the sale or purchase of any securities.  The information above has been obtained from sources believed reliable, but is not necessarily complete and is not guaranteed.  This report is prepared for general information only.

Boenning & Scattergood, Inc. – Member FINRA / SIPC.

It does not have regard to the specific investment objectives, financial situation or the particular needs of any specific person who may receive this report.  Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed in this report and should understand that statements regarding future prospects may not be realized.  Opinions are subject to change without notice. 

Stocks soared yesterday after reports that Senate and House conferees reached an agreement to avoid a government shutdown.

In addition, there were also stories suggesting that trade negotiations with China were progressing to the point that the U.S. might defer extending tariffs on March 1.

Details of the agreement to fund all the remaining government agencies still aren’t available but it appears that it includes some funding for border wall security.  With all the hyperbole about building a wall along a large part of the Mexican border, to date all that has happened is that part of the existing barrier has been rebuilt or upgraded.  The agreement appears to provide funding to extend the wall for about a cumulative total of a bit more than 50 miles at specified locations.  Sounds like a reasonable compromise.  Of course, the President has to sign on and has expressed doubts.   Never one to let anyone else have the last word, he threatens to try and tweak the bill but the obvious danger is that reopening it might mean it can’t be resolved before a weekend deadline.  While several of his conservative media acolytes like Sean Hannity and Ann Coulter disparaged the agreement, this time around, the damage to Trump himself, should he choose to walk away from an agreement reached by both Republican and Democratic leadership, is probably too severe for him to attempt such action.  In Florida, signs are already up to expect road closures starting Friday for the President’s four-day holiday retreat.   He won’t be coming until a deal is signed.

Away from the politics, it will be worth noting how expensive the deal might become after 535 members of Congress try to add their own personal goodies. These bills have a way of inflating the deficit, one that doesn’t need any additional inflating.  As always, the devil is always in the details.

As for the China trade/tariff talks, once again the short term economic pain to both countries created by extended tariffs is something each is incented to avoid.  While tough talk and posturing could take negotiations down to the last minute, the Trump administration is starting to see that unilateral actions don’t always work.  Backing out of the Trans Pacific Partnership almost immediately upon taking office has led to a series of bilateral and sectional trade pacts that (1) leave the U.S. out, and (2) enhance China’s presence along the Pacific rim.  So far, the only agreement we have reached is with South Korea. Even the revised NAFTA agreement is in some political jeopardy.

It is obvious why stocks would rise if two apparent storm clouds, a possible new government shutdown and increased tariffs on Chinese imports, start to disappear. But be careful buying into strength created by these two events. Our economy is still growing at an ever slower rate.  That will be apparent when first quarter GDP is reported this spring.  Economies in Europe are at the edge of recession and also show further deceleration ahead.  China is also in a growth slowdown.  Resolving the U.S. government funding issues and deferring additional tariffs on Chinese imports, isn’t going to change any of those dynamics.  Granted they may not get worse but stocks today are back to fair value if not a little bit ahead.  Instinct is to buy on good news but the real news that should shape the stock market in the months ahead is any sign of economic stabilization or re-acceleration.  Right now, there are virtually no such signs either here or abroad.  Without any hint that the deceleration process is ending, it would be hard to sustain the January-February gains.  

Just because stocks are near fair value doesn’t mean they can’t become overvalued again as they were in early 2018 and again in late summer.  But as we learned last February and October, getting out at the top requires exquisite timing.  Of course, every stock must be judged on its own.  With that said, few are cheap today.  Those that are down are down for a reason.  Many now are starting to trade above historic valuation ranges again.  Not all, but some.  Pay attention and don’t be afraid to take any further good news on the trade front to lighten up on stocks that might become extended on further rallies.

Today, Peter Gabriel is 68.  Jerry Springer turns 74.

James M. Meyer, CFA 610-260-2220

Additional information is available upon request.

* – Boenning and Scattergood may act as principal in buying this stock from or selling it to the public.

# – The author of this report or accounts under his management at Tower Bridge Advisors owns this security.

Additional information on companies in this report is available on request.  This report is not a complete analysis of every material fact representing company, industry or security mentioned herein.  This firm or its officers, stockholders, employees and clients, in the normal course of business, may have or acquire a position including options, if any, in the securities mentioned.  This communication shall not be deemed to constitute an offer, or solicitation on our part with respect to the sale or purchase of any securities.  The information above has been obtained from sources believed reliable, but is not necessarily complete and is not guaranteed.  This report is prepared for general information only.

Boenning & Scattergood, Inc. – Member FINRA / SIPC.

It does not have regard to the specific investment objectives, financial situation or the particular needs of any specific person who may receive this report.  Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed in this report and should understand that statements regarding future prospects may not be realized.  Opinions are subject to change without notice. 

Stocks fell once again on Friday although they cut losses significantly by the close.

With earnings season winding down, news that move markets will come from a different direction. 

The U.S. economic data to be released in February isn’t likely to change the market’s course.   Most of the big numbers relating to January are already out and have generally been positive, especially the second straight month showing employment gains of over 300,000.  European data is weaker but, unless that is a sudden deceleration or acceleration, there shouldn’t be a sudden change in financial prices.

With that said, there are several key events to watch.  The first is the Chinese trade talks.  Last week, when snags appeared, stock prices wobbled.  This morning, on news Secretary Mnuchin is headed to China for more talks, there is a slight improvement.  No doubt, these discussions will continue, with ups and downs, all the way to the March 1 deadline when tariffs will be raised from 10% to 25% on about half the goods we import from China unless either an agreement is reached or President Trump extends the deadline.  Both China and Trump want an agreement, but we are not prepared to sign one without any substance relating to the protection of intellectual property or allowing greater access for American companies in China.  Obviously, there would be a modest-to-moderate short term cost associated with higher tariffs, a cost investors won’t like given an economic cycle beginning to show its age.

The second short term event to watch is the pending government shutdown should negotiations fail to reach a compromise by Friday.  Over the weekend, talks again stalled over wall funding and the need for additional beds to support detainees.  These kinds of talks always go down to the wire and, given the deadline is midnight Friday, it would be no surprise for them to carry over through this coming weekend.  Neither side wants to see another shutdown.  President Trump would probably get the most blame if it happened. The President appears ready to declare a national crisis that allows him to defer funds from elsewhere in the budget but that would almost certainly be subject to both court and legislative challenges that he stands a significant chance of losing.  If there are other alternatives available to him, none have surfaced so far.  The impact of a second shutdown wouldn’t be severe economically, but it would be painful emotionally.  Unpaid Federal workers, just getting back on their feet from the first shutdown, would likely not be a forgiving a second time around.

A third issue, one that doesn’t reach a deadline until the end of March, is Brexit.  Clearly the Brits down like th original compromise deal the May administration reached with the EU.  The EU says it won’t compromise further but a hard Brexit would be painful to all, especially Britain’s largest trading partners, Ireland, Germany, France and Italy.  This too is likely to go down to the wire with emotional ebbs and flows that will impact financial markets.

While all this is happening, talk rises of a so-called earnings recession, i.e. two or more quarters of down earnings.  This is something we flagged many months ago as a possibility based on only a modest slowdown in the U.S. GDP growth rate.  The possibility has increased slightly as European economies have softened a bit faster than previously expected and first half GDP gets affected by at least on U.S. government shutdown.  The biggest culprit, however, is the strong dollar.  Year-Over-year differences in the value of the dollar will be most severe now through April after which they will moderate quickly.  The impact on reported earnings will be most severe in the first quarter and I would not be surprised to see reported earnings down during the March quarter.

But the picture becomes much less severe each passing quarter.  The year-over-year change in the dollar index goes from 6%+ in Q1 to less than 2% in the second half of the year assuming the dollar remains near current levels.   Meanwhile lower inflation and falling interest rates could help interest sensitive industries like housing and autos to stage some recovery after Q1.   Also, energy prices have bounced back a bit reducing fears of a sudden fall off in drilling activity this year.  In fact, once new pipeline capacity is opening later in 2019, production in key basins should reaccelerate.  Thus, after Q1 the earnings picture should improve.

One other event last week was the announcement by Rep. Alexandria Osacio-Cortez and Senator Ed Markey of a Green New Deal, a roadmap quickly endorsed by many leading Democrats including some already declared for President.  Most in the business community scoffed at the plan as a progressive pipe dream.   President Trump campaigned on a program to “Make America Great Again”. The details included a corporate tax cut, less regulation, a more conservative Supreme Court and, tougher immigration including the building of a wall along our Southern border.  Whether one agrees with Trump or not, he campaigned on a list of achievable objectives and, over the first two years, made significant strides to get them accomplished.

The Green New Deal is a pipe dream.  It is aspirational.  Idealistically, it may have a point to make.  But it can’t become a serious campaign platform without a sensible way to execute it.   No one argues conceptionally with the ideal of a good paying job, proper housing and affordable health care for everyone.  Few argue of a dream of a society with no carbon footprint. But even with a 70% tax cut on millionaires and billionaires, this isn’t a goal that can be achieved economically. Instead what the plan does is excite a progressive base that gives no thought to the cost of reaching their ideals while striking fear in others that view economic chaos not knowing what might be tried.  Both the Democrats and the Republicans have to spend more time and energy trying to win the center and less time pandering to their respective bases.  Obviously, we are barely into the 2020 campaign season, a time when Democrats do have to talk to the base more than the center.  But if they spend the next 15-18 months publishing Green New Deals and derivatives, they will lose the center before the real campaign even starts.  The Democrats have a lot of reasons to believe they can defeat Mr. Trump in 2020.  But a march to socialist nirvana is probably not the best approach.  If the ultimate nominee starts too far left, those of us in the political middle will become disenfranchised and distrustful of any attempt to move to the center.

So far, the 2020 campaign has no impact on financial markets.  But if you remember some recent elections in places like France, Italy, Germany and Brazil, extremist platforms, whether they be left or right, can create havoc in financial markets during campaign season.  We can scoff for now, but how the Democratic race for President plays out will start to have meaning a year from now.  It isn’t today’s issue, but it is one to watch.

Today, Jennifer Aniston turns 50.  Sheryl Crow is 56.  Jeb Bush turns 65.

James M. Meyer, CFA 610-260-2220

Additional information is available upon request.

* – Boenning and Scattergood may act as principal in buying this stock from or selling it to the public.

# – The author of this report or accounts under his management at Tower Bridge Advisors owns this security.

Additional information on companies in this report is available on request.  This report is not a complete analysis of every material fact representing company, industry or security mentioned herein.  This firm or its officers, stockholders, employees and clients, in the normal course of business, may have or acquire a position including options, if any, in the securities mentioned.  This communication shall not be deemed to constitute an offer, or solicitation on our part with respect to the sale or purchase of any securities.  The information above has been obtained from sources believed reliable, but is not necessarily complete and is not guaranteed.  This report is prepared for general information only.

Boenning & Scattergood, Inc. – Member FINRA / SIPC. It does not have regard to the specific investment objectives, financial situation or the particular needs of any specific person who may receive this report.  Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed in this report and should understand that statements regarding future prospects may not be realized.  Opinions are subject to c

Stocks fell sharply yesterday morning for a combination of reasons.

Stocks fell sharply yesterday morning on a combination of weak economic data from Europe and reports that Presidents Trump and Xi no longer plan to meet before March 1 to stave off imposition of higher tariffs on Chinese exports to the U.S.  The next scheduled time the two will be together is at the June G-20 meeting although, obviously, nothing prevents them from meeting sooner.

At the moment a full blown trade deal between China and the U.S. is unlikely any time soon. The two nations remain far apart on key issues of how to enforce violations related to intellectual property or how to open up Chinese markets to American companies.  But a full blown deal isn’t necessary to get Trump to delay the imposition of higher tariffs if there is some progress on top of Chinese promises to import more American oil, soybeans and beef.

The decline yesterday, which was cut in half by the market’s close, was orderly but it served as two separate reminders.  First, after almost 6 straight weeks of gains, investors had to be reminded that valuation matters once again. Stocks had returned to fair value quickly and were no longer bargains. That doesn’t mean they had gotten overpriced to any significant degree but they certainly weren’t cheap any longer.  A little correction would make prices attractive once again.  Second, the vast majority of observers believed that Mr. Trump wouldn’t choose to impose higher tariffs after just going through a government shutdown.  He may still come to an eleventh hour agreement. That has certainly been the case before.  But one can’t take that for granted. And lest anyone forget, we are less than two weeks away from another possible government shutdown. Yes, Mr. Trump could declare a national emergency to allow him to commandeer funds from the military or some other source within the government to fund his wall demands but that is a dicey moved filled with political risk.  The odds that such a move could withstand Congressional or legal challenges are not good and, for that reason, the President would likely go that route only as a last resort.

For better or worse, Mr. Trump is going to have to find a path to be able to work with the Democratic House.  Down the road are next year’s budget requests and the need to raise the debt ceiling.  For both sides to behave like stubborn mules not only creates gridlock but also unwanted events like government shutdowns.  It is easy to say that moderation on both sides is needed but, so far, no one has found a solution.   Some in Congress are hopeful they can reach an agreement before February 15 but there is no assurance that President Trump will sign on. 

February is one of the least important months economically and earnings season is fast winding down.   In that vacuum of news comes the tariff talks, funding the government, progress or lack thereof on Brexit (whose deadline is March 29), and a whole slew of other geopolitical concerns around the world.

On top of all this is fear of an earnings recession.  That is far different from an economic recession. What is happening now is similar to 2015 when an even stronger dollar than we see today, along we oil prices falling to near $30 per barrel, sent earnings of multinational and energy companies tumbling and left the stock market negative for most of the year.  Back then, the year-over-year change in the dollar reached as much as 20%.  This time around the maximum change in the dollar weighted index is about 6% and will impact earnings for the first 4-5 months of 2019.  Oil prices are down again this year versus a year earlier but, once again, the rate of decline is nowhere near the extremes of 2015.  Rig counts fell 60-70% back then. Today, they have barely fallen.  Thus, while dollar weakness combined with a slowdown in growth rates could lead to flat or even slightly lower year-over-year earnings in the first quarter, unless the dollar surges from here, the likelihood and earnings comparisons stay negative in the second half of 2019 are relatively modest.  That, of course, presumes that Mr.

Trump doesn’t further inflame a trade war.

Given that none will be settled this week and the likelihood is that none will be settled next week either, the headlines we will be reading over the next few weeks doesn’t look very heartening.  Even if one problem gets solved (e.g. funding the government), the next one looms closer.  None of these will have a dramatic impact on earnings, dividends or interest rates, but all impact the psyche.  It is one reason February can often be a time of uncertainty in the financial markets.  Lest we forget, last year was a vivid example.   We also should remind ourselves that market emotions can changed suddenly.   Look at last October, November and December for proof.  Values today are sound.  There is no need to do anything suddenly.  Markets are not overpriced. But six weeks of steady rises can build in a sense of complacency that can, and should, be erased with a day or two like yesterday.  

One should also pay some attention to my two-day rule.  The trend is still up until there are two consecutive days of meaningful declines.  Yesterday was one.  We will see if today is the second.

Today, composer John Williams is 87.

James M. Meyer, CFA 610-260-2220

Additional information is available upon request.

* – Boenning and Scattergood may act as principal in buying this stock from or selling it to the public.

# – The author of this report or accounts under his management at Tower Bridge Advisors owns this security.

Additional information on companies in this report is available on request.  This report is not a complete analysis of every material fact representing company, industry or security mentioned herein.  This firm or its officers, stockholders, employees and clients, in the normal course of business, may have or acquire a position including options, if any, in the securities mentioned.  This communication shall not be deemed to constitute an offer, or solicitation on our part with respect to the sale or purchase of any securities.  The information above has been obtained from sources believed reliable, but is not necessarily complete and is not guaranteed.  This report is prepared for general information only.

Boenning & Scattergood, Inc. – Member FINRA / SIPC. It does not have regard to the specific investment objectives, financial situation or the particular needs of any specific person who may receive this report.  Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed in this report and should understand that statements regarding future pros

Stocks were mixed yesterday, a relatively light day for earnings.

The bond market has stayed within a relatively tight range all week while the dollar has inched higher. 

The big political news comes from Venezuela where the U.S. and other countries are backing the head of the country’s legislature, Juan Guaido, as its new head of state given the allegedly fraudulent reelection of Nicolas Maduro.  But Maduro still controls the military and has no intention of stepping down.  Why this matters to us economically is that Venezuela is still a reasonably sized producer of crude oil.  Moreover, the crude it produces, gunky and heavy, is precisely what about 5 Gulf Coast refineries need to make diesel and jet fuel.  

There is more to the tale than that.  While Venezuela ships heavy crude to our refineries, we ship naphtha to them which is used to cut the viscosity of their oil so that it can be processed and shipped.  Several years ago, as Venezuela was spiraling into despair, Russia, through a state controlled oil company invested money in Venezuela and now owns about half of its national oil company.  Should the U.S. impose sanctions on Venezuela, certainly quite possible, it would set off a worldwide chain reaction creating some degree of turmoil. Venezuelan oil production has fallen so far, that additional declines wouldn’t necessarily be that meaningful.  But the impact on specific fuels in specific markets, like diesel and jet fuel in this hemisphere, would be meaningful.   It would also impact Russia.  Given our government’s love/hate relation with the Russians, that raises further questions.  So far, this isn’t all that meaningful but it bears watching.  It certainly beats talking about the government shutdown. 

The World Economic Forum is now ending in Davos, Switzerland. This conclave brings together world business, political and academic leaders every January.   This year, they walked in bearing a collective sour and apprehensive mood.   The weak stock market, volatile currency markets, slowdown in China, and decelerating economic growth worldwide had many participants issuing dire warnings looking forward even knowing that the most recent economic data was pretty good.   Last year, everyone came to Davos brimming with optimism. Quite often, it appears to be a contrary indicator.   Morgan Stanley CEO, James Gorman probably stated it best when he likened Davos to an echo chamber where everyone’s concerns and warnings bounced off the proverbial walls into the minds of each participant.  It was hard to stay optimistic with all the fears in place.

Of course, there are always concerns.  This year’s range from tariffs to China, to the long term impact (if any) of the U.S. government shutdown to the rise of populism.   But if one could summarize what is changing moods, I would focus on two words, bifurcation and empathy.   In the U.S. we see the bifurcation full blast in the current battle between Donald Trump and Nancy Pelosi over the wall.  Neither is giving an inch.  Neither is willing to listen to the other side.  Neither seemingly cares much about the impact on millions of lives.  And for what?  A couple of hundred miles of wall isn’t going to make a difference.  It won’t stop drug flow and it won’t stop bad guys from coming into the country.  $5.7 billion, the cost of the wall additions, is a pittance compared to the costs to many who have to work (or aren’t allowed to work) without getting paid.  

It isn’t just the shutdown, which will end in due course with all the government workers getting paid anyway.  It is almost like the center disappearing and everyone moving left or right.  It isn’t just here.  Former fringe elements are becoming real political forces in Italy, Germany, France and Spain. The U.K. is being torn by how to separate itself from the rest of the Continent.  In South America, countries lurch from extreme left to extreme right with no pathway yet to success.  France went from a near Socialist to a pragmatic businessman and now we have yellow-vested protestors on the streets.

This is all a result of income inequality.  The halves are flourishing, generally in control, and don’t see what the problem is. The half-nots are frustrated and lashing out.  We see it in areas other than income.  Me Too, and Black Lives Matter are further evidence.   So far, the world doesn’t seem to be able to find a middle ground.  There may not be any for a while.  The mood is sour.

Bifurcation, this widening of divides, is the first word.  The second is empathy.  No one showed the lack of empathy more in the last 24 hours than Commerce Secretary Wilbur Ross who said yesterday that he didn’t understand the plight of unpaid Federal workers. They could all go to a bank and get loans against future pay checks.  Even if that were 100% true, it is the type of totally uncompassionate statement that we have had to endure (from all sides!) over the past few years.

As a result, investors are tired, frustrated and worried.   On the other hand, consumers, at least in the U.S. are working, feel secure in their jobs and spending freely.  We just completed the best Christmas season in years. Restaurants are busy.   Apparel is hot again.  What isn’t hot is investment.  It isn’t just businesses that are apprehensive, partly due to the mood, partly due to policy uncertainties, and partly due to fears of slower growth.   It is individuals.  Big ticket items like houses and cars aren’t big sellers.   Millennials want to rent as long as they can whereas Boomers wanted to buy as soon as they could afford to.  City dwellers would rather Uber than own a car.  Some of this may be uncertainty and mood.  Some may be the burden of student loans.  Whichever doesn’t matter.

So what do we do as investors?  As I have said many times, investors buy earnings and interest rates. They don’t buy moods, politics and bifurcation.   Stocks are holding up pretty well against an onslaught of pretty lousy headline news.  As noted previously, a lot of clouds will likely dissipate within the next 60 days or so.  Brexit will come to pass one way or another by springtime.  The tariff issues with China will be clarified for better or worse.  The government will reopen.  The Fed will stay largely in the background.  One rate increase of not this year isn’t going to be an economic game breaker.   Markets could retest their December lows but a full retest to below 2400 isn’t likely.  Investors aren’t as overleveraged today, this isn’t the time of year anymore for hedge fund liquidations, and earnings are still pretty good.  Valuations are fair.  Could markets slide 5% or so?  Of course!  But that would only create buying opportunities.

Stocks today are neither cheap nor expensive in the aggregate but there are plenty of bargains.   Look carefully, be disciplined about prices, don’t chase, and you will find them.  Don’t let the political mood sour your investment focus. But stay aware should changes have economic consequences.

Today, Alicia Keys is 37.

James M. Meyer, CFA 610-260-2220

Additional information is available upon request.

* – Boenning and Scattergood may act as principal in buying this stock from or selling it to the public.

# – The author of this report or accounts under his management at Tower Bridge Advisors owns this security.

Additional information on companies in this report is available on request.  This report is not a complete analysis of every material fact representing company, industry or security mentioned herein.  This firm or its officers, stockholders, employees and clients, in the normal course of business, may have or acquire a position including options, if any, in the securities mentioned.  This communication shall not be deemed to constitute an offer, or solicitation on our part with respect to the sale or purchase of any securities.  The information above has been obtained from sources believed reliable, but is not necessarily complete and is not guaranteed.  This report is prepared for general information only.

Boenning & Scattergood, Inc. – Member FINRA / SIPC.

It does not have regard to the specific investment objectives, financial situation or the particular needs of any specific person who may receive this report.  Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed in this report and should understand that statements regarding future prospects may not be realized.  Opinions are subject to change without notice. 

Stocks fell yesterday reversing Friday’s gains.

There is a very high profile World Economic Forum going on in Davos, Switzerland this week.  CNBC is giving it non-stop coverage. 

Last year, just as the tax cuts were going into effect, almost everyone was optimistic. Stocks followed a decent fourth quarter run with a spectacular January.  Of course, we all know what followed, a sharp correction in February featuring two sessions where the Dow dropped by more than 1000 points. 

This year seems quite different. There are many fewer economic tailwinds.  The tax cut is now a year old and will no longer provide a year-over-year bump to earnings.   Brexit is less than 90 days away without a solution.  Workers in yellow vests are creating havoc in France and echo effects throughout Europe.  The ECB has slowed quantitative easing while the Fed is raising interest rates here. China’s growth is declining.   Tariffs are now in place and Mr. Trump threatens to raise them further should China not support better protection for intellectual property.  Sovereign debt levels are exploding as nations around the world try to stimulate growth to extend the economic upcycle.

Many leading voices from the investment world from Seth Klarman to Ray Dalio (Google these names if you don’t know who they are) are voicing concerns and rightfully so.  No one, including the two names just mentioned, can tell us when they will start to spoil the party.  Inflation and interest rates remain very low and earnings continue to grow.  The decline in stock prices in 2018 has moved valuations back to levels one can call fair.  Valuation per se is no longer an issue.  

I have often said that recessions occur as a result of economic imbalances.  At this very moment, I don’t see any.  It is unlikely they will occur this year.   The yield curve still hasn’t inverted although it is hovering between 15 and 20 basis points from being dead flat.  Low inflation is keeping cost in check.  GDP growth is slowing around the world but is still expected to be over 3%.  However, with that said, there is an obvious air of concern, not only in Davos, but all over the world.

I will cite four areas of concern that bear watching:

  1. The amount of sovereign debt outstanding.
  2. The economic future of China
  3. The rise of populism
  4. President Trump.

Sovereign Debt – What is happening in this country is also happening worldwide.  Debt-to-GDP ratios are exploding. While low interest rates make the cost to service debt tolerable, the burden increases as rates slowly rise from near zero and entitlements, contracted by law, expand at an accelerated base now that many baby boomers have reached 65.   For a decade low interest rates plus declines in defense spending, have offset the burden of rising debt.  But now defense spending is up, entitlement costs are accelerating, and deficits are exploding under a leader, Mr. Trump, who has never feared the use of debt or high leverage.  The problem of too much leverage is never apparent until it is too late.  Simple math suggests one percentage point of increase interest cost on $20 trillion in debt is $200 billion of additional expense per year.  Either that gets added to a deficit already over $1 trillion per year or it must be offset by cost cuts elsewhere. The only elsewhere is entitlement costs.

China – For decades, China has growth at 7-10% per year as it emerged from the Mao era.  But now the laws of large numbers are catching up.  China’s government is doing all it can to stimulate growth including tax cuts and easy money. But all that is doing is borrowing from tomorrow to sustain growth today.  It is a losing battle. China wants to accelerate the transition from a manufacturing and infrastructure economy to one built upon the consumer, like the U.S.   But growth is still slowing and will likely continue to slow in future years.

Populism – There is a long history of what happens to economies after income inequality reaches extremes. In France, a business-friendly pragmatist replaced an unpopular socialist who promised good things but got swallowed by France’s bureaucracy.  But his tax policies, favoring business and the wealthy, have backfired and led to a storm of protests.   France’s democracy today is built on our model.  It was our greatest ally in the Revolutionary war.   There are a lot of people who treat the gilets jaune movement as a precursor of what to expect around the world.  Maybe it won’t erupt here in the same way. But we have already seen contagion from Europe in other ways.  After the migration from the Middle East and Africa swamped Europe two years ago and the election of Donald Trump, with his base of populist support, we have reacted here with a big fight over a wall separating Mexico from the U.S. While some still see immigration as an American ideal, many see it as a threat to our safety.  The normal left-right immigration fight is the threat of migrants stealing our jobs versus the land of opportunity.  Not so today.  With unemployment close below 4%, this time the argument is a combination of safety and preserving the existing American heritage versus those who view America as a land of opportunity for all.  As the current government shutdown shows, this is a battle likely to escalate before any solution can be reached.

President Trump – Without getting into politics, the economic concern about Trump centers on the impulsive nature of his decision making process.  The most recent example, although not economically significant, was his decision to pull all 2,000 American troops out of Syria ASAP.   The decision was apparently made without input from the military, his security team, or the Defense Department.  For weeks now, others have had to backtrack from that decision.  The current concern is about tariffs.  These are taxes.  Despite Mr. Trump’s assertion that China is paying us billions, the entire burden is being paid by U.S. importers.   It is hard to plan without some confidence of ongoing business rules of the road.  As a result, investment spending is under pressure.

All of these concerns are real.  None overwhelm us today.  All could become major factors tomorrow.  Perhaps all the concerns are overblown and none will create a storm.  With all that said, in the short run, earnings reports and forecasts for 2019 will dominate.  Early results have been good and managements are cautiously confident.  Short term, that should rule and we continue to believe 2019 can be a good year for stocks. But the concerns of Davos are not about to fade.  The end cycle euphoria that sometimes occurs isn’t likely to evidence itself this time around.  Perhaps that is healthy.  Moral:  watch to numbers; earnings and interest rates are the driver of stock prices.  But don’t lose sight of the four issues described above.   Some may fade but others will get more worrisome.  They matter.

Today Mariska Hargitay is 55. Airline pilot Chelsey “Sully” Sullenberger is 67.

James M. Meyer, CFA 610-260-2220

Additional information is available upon request.

* – Boenning and Scattergood may act as principal in buying this stock from or selling it to the public.

# – The author of this report or accounts under his management at Tower Bridge Advisors owns this security.

Additional information on companies in this report is available on request.  This report is not a complete analysis of every material fact representing company, industry or security mentioned herein.  This firm or its officers, stockholders, employees and clients, in the normal course of business, may have or acquire a position including options, if any, in the securities mentioned.  This communication shall not be deemed to constitute an offer, or solicitation on our part with respect to the sale or purchase of any securities.  The information above has been obtained from sources believed reliable, but is not necessarily complete and is not guaranteed.  This report is prepared for general information only.

Boenning & Scattergood, Inc. – Member FINRA / SIPC.

It does not have regard to the specific investment objectives, financial situation or the particular needs of any specific person who may receive this report.  Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed in this report and should understand that statements regarding future prospects may not be realized.  Opinions are subject to change without notice. 

Stocks continued to rally yesterday despite mixed earnings reports and continued negative noise from Washington regarding the government shutdown.

While many in Congress claim to be frustrated no one yet has found a key to get President Trump and Speaker Pelosi to the negotiating table. 

Evidently the pressure to date hasn’t been severe enough to either.  That will likely change sooner rather than later.  While the direct economic impact will be fairly modest, if the shutdown lasts a lot longer, everything from public stock and bond offerings, small business loans, drug approvals and permitting needed to open or expand businesses will be impacted in a significant way.  If there is a glimmer of hope, pressure builds daily.  Elected officials are never immune to constituent outrage.  We are probably at the point where no one wins; there are only going to be losers.  That ultimately threatens every incumbent and they know that.   Financial markets haven’t shown any negative reaction yet.  When they do, expect the shutdown to come to an end quickly.

On December 20, prominent hedge fund manager David Tepper told CNBC that the Federal Reserve had taken away the Fed put on the market.  In English, he meant that the backstop of ultra-low interest rates was gone.   The resultant tailwind was no more.   While his point was spot on, his public statement to that effect was a bit late.  From the moment Jerome Powell became Chairman of the Federal Reserve, he made it pretty clear that as long as economic growth was solid, he was planning to restore interest rates to a neutral state via steady quarterly increases in rates.  There were four such increases last year.   In early October and again in December, both times accompanying rate hikes, Mr. Powell hinted that it was possible the Fed could even raise rates a bit past neutral if it felt the need to keep a lid on inflation.  Both times he said that, markets were spooked.  The equity markets declined sharply in October after leading averages set record highs in September.  A brief relief rally took place in November but markets soon headed lower again and accelerated after Mr. Powell’s remarks in December.  The final straw was a 2%+ move lower in a holiday shortened session on Christmas Eve.  After that, Mr. Powell adopted a more conciliatory tone.  While he had mentioned all along that actions at each FOMC meeting would be dependent on the data and evidence of the moment, he began to emphasize that the Fed had reached the bottom end of the range of normal and no further increases were required at the moment.  While the Fed still penciled in two more increases in 2019, he indicated that after four in 2018, it might be prudent to pause and see how the data flowed in, especially given the total absence of inflationary pressures to date and the reduction in inflation expectations through the fall. Stocks started to rally and have been on a steady upswing although the pace of improvement was certainly more moderate than the sickening declines of December.   Today, markets are now back close to fair value based on historic norms.  Traders should be at least aware that both the February and October declines came suddenly and both followed strong previous months. 

In that regard, look at the market action this week of companies that have reported results so far.  The banks have mostly all rallied on rather tepid results.  In general, loan demand has been good but trading has been poor. Earnings generally matched or beat expectations but revenue performance was mixed.  Bank stocks got creamed from September through December in expectations of slower growth, weak trading, and a flattening yield curve.  While results weren’t great, they were better than feared. Thus, the pop this week.  Note that even with the gains, most bank stocks are still 10-20% or more below their 52-week highs.  It isn’t just the banks.

Which brings me to my last topic for the morning and week.  Late cycle.   The most common phrase I hear almost daily is that our economic is late cycle. What does late cycle mean?  Let me take a stab.  To do so, I will define the economy in four phase; early cycle, mature cycle, late cycle and recession.  I don’t think I need to spend any time defining a recession.  That’s when the economy declines for at least two quarters.  We clearly aren’t there.

Early cycle, when the economy escapes from a recession (or depression) is characterized by tons of added liquidity by central banks, low interest rates meant to goose demand, and a catch-up period when consumers gain the wherewithal to buy what they forsook during the recession.  It is also a period characterized by sharp jumps in productivity.  Companies don’t add workers until they are sure the economy is on solid footing. Thus, existing workers work a bit harder until new workers are added.  This phase generally lasts a relatively brief period of time, perhaps 1-2 years on average.  If the recession was serious enough, it might last a bit longer.

The next phase, the mature cycle phase, is when everything is generally humming along in a balanced fashion.  Growth fluctuates but not by a serious amount.  It generally follows a path defined by labor force growth rates and sustainable gains in productivity.  In this phase, government policy is generally neutral.  Inflation is tame.  While it isn’t trivial to keep everything in relative balance, during this phase, the tweaks needed by central banks are relatively modest.   I suspect we are in this phase today.   It took the Federal Reserve a bit longer than normal to allow interest rates to normalize but every recovery doesn’t follow a financial crisis as severe as 2008.  Perhaps the penalty for the Fed being late and having to catch up was a modest market decline in 2018 and an economy that got a little bit ahead of itself at the same time.  Easy money also allowed some degree of speculation to creep in late in 2017 as stocks move toward 20x forward earnings and the buzzword at every cocktail party was bitcoin.

But that euphoria burned itself out before it became supercharged.  This was not the Internet bubble redux.  Which leads me to the last phase, late cycle.   In my head, late cycle is when serious imbalances start to appear.  In the stock market, there is an IPO boom where half-baked ideas have to opportunity to go public.  In housing, it is like 2005 when one out over every two homes sold was sold to a non-occupant.  It’s the Internet bubble.  In 2007, it was credit default derivatives and collateralized mortgage pools.  In 1987, it was portfolio insurance. 

We saw whiffs of this in 2017.  The aforementioned bitcoin bubble was one piece of evidence.  The emergence of dozens of so-called unicorns, private companies with valuations of tens of billions was another.  Some of this crept into the stock market but the decline of 2018 snuffed it out.   Some of the unicorns were exposed as unsuccessful businesses.  A few turned out to be outright frauds.   But there real good news is that a modest correction in valuation in 2018 coupled with a Federal Reserve that did its job means that we remain in the mature cycle of the economic expansion with no obvious end in sight.   The Fed neither has to raise interest rates to squelch inflation nor step on the accelerator to stimulate growth.   Washington doesn’t have to do anything.  Maybe it is so dysfunctional that it can’t anyway!

None of this means that we are problem free.  Debt levels of corporations below the Fortune 100 are worrisome.  Our budget deficits keep rising. Together with rising mandated entitlements, that will lead to a serious problem before too long.  Europe, gripped with Brexit, gilets jaune, and other populist movements, is struggle to stay out of recession. Chinese growth is slowing.   But to me, late cycle is the end, the last step before recession.   I don’t think we are there. Rather I think market forces and the Fed saved us from approaching that stage.  Perhaps, as 2019 begins, markets are seeing what I am seeing and the fears that so dominated December rightfully have faded.  We are back to fair value.  It isn’t time to be complacent.  But it isn’t time to panic either.

Today, Kevin Costner is 64.  On this date, in 1882, A. A. Milne was born.  In his honor, today is Winnie the Pooh Day.

James M. Meyer, CFA 610-260-2220

Additional information is available upon request.

* – Boenning and Scattergood may act as principal in buying this stock from or selling it to the public.

# – The author of this report or accounts under his management at Tower Bridge Advisors owns this security.

Additional information on companies in this report is available on request.  This report is not a complete analysis of every material fact representing company, industry or security mentioned herein.  This firm or its officers, stockholders, employees and clients, in the normal course of business, may have or acquire a position including options, if any, in the securities mentioned.  This communication shall not be deemed to constitute an offer, or solicitation on our part with respect to the sale or purchase of any securities.  The information above has been obtained from sources believed reliable, but is not necessarily complete and is not guaranteed.  This report is prepared for general information only.

Boenning & Scattergood, Inc. – Member FINRA / SIPC.

It does not have regard to the specific investment objectives, financial situation or the particular needs of any specific person who may receive this report.  Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed in this report and should understand that statements regarding future prospects may not be realized.  Opinions are subject to change without notice. 

Although stocks closed mixed to slightly lower on Friday, last week was a good one for equities.

Last week was the third up week in a row as investor confidence snapped back a bit from December’s sharp downturn.

Now we enter earnings season.  A few high-profile companies that report on off quarters have already guided toward a slower economy.  Others have preannounced weaker than expected results.  Last week, the big department store chains suggested that Q4 profits would miss expectations. While sales were generally OK, more promotional activity was apparently required.  But the woes of the department stores didn’t mean bad times for all.  Leisure and athletic apparel remain hot and the company, which sells primarily through its own stores and distribution channels, has been control of prices and margins than the department stores have selling national brands subject to lots of promotional activity.

Elsewhere, Chinese trade data over the weekend point to a dramatic slowing there.  China is unique among major countries in that government reported data is very circumspect.   Hard numbers, including trade figures, which the government either doesn’t report or can’t be fudged easily suggest that the industrial complex within China is experienced a significant slowdown.  While the consumer doesn’t appear to be impacted as heavily, clearly there must be some echo effect from a slowing infrastructure building.   Futures are off close to 1% in premarket activity representing fear that a Chinese slowdown will spread worldwide.  Both the U.S. and China suggest trade negotiations are going well.  China has already lowered some tariffs and agreed to buy more goods from the U.S.  Given the growing anger over the government shutdown in this country, the Trump administration would love a “win” to regain some popular support.  A deal with China that at least suggests steps to respect intellectual property and the allow greater access to Chinese markets for foreign companies would be such a win.  As we know, even a small step in the right direction will be trumpeted as a victory by both sides.  Markets certainly would like such news.

Stocks have risen about 10% from the Christmas Eve lows.  On a historic basis, assuming growth of 0-5% in earnings per share in 2019, they still remain on the cheap side of average.  That, of course, presumes that profits can stay flat or rise a little bit.  On the plus side, no one is forecasting a recession in the U.S. this year and the outlook for the rest of the world is for slow but positive growth.   Relatively low commodity costs relief one possible price pressure.  Strong cash flows are feeding ongoing stock repurchase programs that, by themselves, might add 2-3% to earnings per share in 2019.  But there are negatives as well.  Decelerating growth suggests some inventory liquidation might be necessary.  We are already seeing that in markets from oil to semiconductors.   Wages are rising at a slowly accelerating pace.   So far, those increases have been offset by improving productivity.  The dollar’s strength in 2018 will be a significant headwind for international earnings through the first two quarters of 2019.  In a few cases, for companies with over 50% of sales overseas, could see negative reported earnings in the first half of the year.   And, of course, there are the unknowns related to policy, notably tariffs.   Add all this together, and it appears that earnings can continue to grow, but significant growth will be a struggle especially early in the year when the year-over-year hit from currency translation is most severe.  

Analysts have been bringing down estimates over the past couple of months.  They certainly aren’t blind to market action and commentary from companies that have recently reported. But history shows that analysts often underestimate the impact of economic change.  In other words, they don’t revise up fast enough as times improve and they don’t revise down fast enough when headwinds start to appear.  I suspect this will the earnings season that will see the sharpest downward revisions.  In fact, if several of the headwinds now facing the market, from tariffs to a strong dollar, subside later in the year, it is quite possible that worries today will force analysts to overcompensate and lower forecasts a bit too far.  Perhaps this is the primary reason that I expect markets to be relatively bumpy early in 2019 and more positive later in the year. 

Beyond the first quarter, my greatest concerns are unforced errors from Washington.  The current government shutdown may foreshadow these concerns.  By itself, the shutdown won’t move the economic needle much although certain companies could see a meaningful short term impact.   We are used to gridlock; we saw it for the last six years of the Obama administration.  But there are significant events still ahead of us that could create obstacles that impact markets.  The debt ceiling will have to be raised.  In the recent past, this has become a political tool that has upset markets.  The fiscal 2020 budget process is another hurdle. The current shutdown relates to a 2019 funding process gone astray over $5 billion in funding for a barrier across our southern border.  We may not have heard the last about tariffs.   In essence, gridlock would be fine as long as Washington does nothing further to upside economic growth.  But as we see almost daily, when it comes to behavior in our capital, the past is no longer much of a guideline for future performance.  If there is any good news from this, I believe now that workers have not gotten paid, law makers on both sides of the aisle will come under increasing pressure to act.  I won’t begin to suggest the compromise other than it will be economically irrelevant per se.  But the distaste that is sure to survive the current shutdown may give both parties and the President food for thought before they try brinksmanship again any time soon. 

Today, LL Cool J is 51.  Faye Dunaway turns 78. Singer Jack Jones is 81.

James M. Meyer, CFA 610-260-2220

Additional information is available upon request.

* – Boenning and Scattergood may act as principal in buying this stock from or selling it to the public.

# – The author of this report or accounts under his management at Tower Bridge Advisors owns this security.

Additional information on companies in this report is available on request.  This report is not a complete analysis of every material fact representing company, industry or security mentioned herein.  This firm or its officers, stockholders, employees and clients, in the normal course of business, may have or acquire a position including options, if any, in the securities mentioned.  This communication shall not be deemed to constitute an offer, or solicitation on our part with respect to the sale or purchase of any securities.  The information above has been obtained from sources believed reliable, but is not necessarily complete and is not guaranteed.  This report is prepared for general information only.

Boenning & Scattergood, Inc. – Member FINRA / SIPC.

It does not have regard to the specific investment objectives, financial situation or the particular needs of any specific person who may receive this report.  Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed in this report and should understand that statements regarding future prospects may not be realized.  Opinions are subject to change without notice. 

Stocks rose a bit over 1% last week, but that hardly tells the tale.

On Thursday, stocks fell by about 2.5%.  That sent shockwaves through the market as concerns rose that weakness in China, spurred in part by the tariff wars would set off a worldwide economic downturn. 

Then on Friday, the monthly employment report showed gains much higher than expected.  Later the same morning Federal Reserve Chairman Jerome Powell said the Board was listening to the angst of the market and was watching data closely for any sign of economic weakness. Suddenly there was a 180-degree mood swing send stocks up over 3% for the day and, as mentioned, a bit over 1% for the weak. 

Volatility without directly is emblematic of change. For the past few months, after setting new record highs in the early fall, stocks fell from peak to trough by about 20%.  Those who want to be precise can argue whether what we just lived through was a bear market or not but it had all the characteristics of one.  Certain well over 50% of the stocks in the S&P 500 fell more than 20% from their highs.  Almost 80% were down 10% or more.   We have labeled this a valuation correction against an overlay of slowing growth.  Friday’s employment report clearly suggests that if the economy is slowing, it isn’t slowing all that much.  So much market commentary over the past few months has centered on the Federal Reserve and its policy to tighten monetary policy to withdraw the so-called Fed put, that extra boost provided by low cost money and excess liquidity, and let markets guide the economy without any help or hinderance from central banks.  Of course, the U.S. doesn’t work in a vacuum.  Central banks all over the world are still largely behaving in an accommodative manner.  Thus, if the Fed gets or remains too aggressive in its move toward neutral it runs the risk of helping to push the dollar even higher than it is now.  That would dampen demand for exports while reducing the prices of imports and basic commodities serving to slow economic growth and lower inflation.  Indeed, over the past few months, that is exactly what has happened.

With that said, Mr. Powell and the Fed have not changed policies. But what they have done, and what proved to be an accelerant to the market on Friday, is that it improved its messaging.  The old message, the one the markets didn’t like was that the Fed though it might need to increase short term rates a few more times in 2019 to get to neutral but the timing of such moves would be dependent on the economic data at each FOMC meeting. The new messaging was that data dependence would trump any inclination to raise rates if growth was slowing and inflation contained.  Both messages, essentially say the same thing.  There is still an argument where neutral is, whether it be close to the current 2.25-2.50% or a bit higher, perhaps closer to 3%.  Despite the strong employment report on Friday, virtually everyone agrees that U.S. GDP is slower today than it was in the second quarter when it moved above 4% briefly.  But it is still a very healthy 2.5% or better.  Forecasts for later in 2019 vary.  Some say it may slip below 1.5% while others feel it could stay above 2%.   I’m not sure anyone can make a more compelling case for 1.5% or 2.0%.  We’ll just have to wait and see.  Certainly, the first half of 2018 saw some pent up spending that was waiting for the implementation of the new tax law.  That’s now history.  And one has to recognize the fear that exists that an economy slowing down may not stabilize until it turns negative.   But, as I noted Friday, with consumers spending as much as they are while still being able to save, and gainfully employed, it is hard to see what will frighten them to spend less per capita than they are spending today.

Thus, we are at a crossroads:

  1. Growth is slowing from 4%+ to something less.  We believe 1.5-2.5% is sustainable and a reasonable predictive range.
  2. The short end of the yield curve has flattened.  Rates from 30 days to 5 years are all now in the 2.4-2.5% range.  But while the yield curve has flattened, it hasn’t inverted.  10-year Treasuries are still above 2.6%.
  3. The 2.6% 10-year rate is down from 3.25% in late summer.  Inflation expectations are down as well.  Dollar strength continues to put downward pressure on inflation.
  4. Forward P/Es for stocks have fallen from 19x in late January to 15 today. That means that stocks were priced about 20% above historic norms at the start of the year and close to or slightly below historic norms today.
  5. Global growth is slowing but no major country is currently in recession.  
  6. Earnings of U.S. companies, especially multi-nationals will have a hard time beating estimates of 4-7% growth in the first half of the year in large part due to the strength in the dollar.
  7. While recent signs suggest that China and the U.S. could reach some sort of trade deal or at least a tariff truce by the March deadline, threats of higher tariffs still loom over both countries.
  8. The Fed is probably transitioning from a policy of raising rates 25 basis points every 3 months while reducing its balance sheet by $50 billion per month, to a slower pace of monetary tightening.

There are other issues like Brexit and the U.S. government shutdown that could cause short term volatility. But Brexit will be solved one way or the other by March and the government will be open soon despite Trump threats to keep it closes for weeks, months or years.  By the end of this week, 40 million Americans won’t be receiving food stamps and by the end of January, it will be clear that tax refunds will be deferred should the government remain shut.  That simply isn’t going to happen.  I have no idea how the stalemate will be broken but it will and this will become one more noise factor in our rear view mirror before long.   Indeed, what the market determined on Friday, is that the Fed is now yesterday’s news.  Think about it.  The Fed isn’t going to raise rates in all likelihood for at least another six months.  Depending on market volatility, it could even slow the runoff of its balance sheet; it certainly won’t accelerate it.

The biggest near term hurdle is Q4 earnings season.  In all likelihood, the earnings themselves will be pretty much in line or slightly ahead of forecasts.  The key will be forward looking guidance.  I suspect analysts have been trying to get out in front of this and have lowered 2019 estimates going into the reporting season.  But they still might have a way to go.  Indeed, it is quite possible that managements and analysts, being as nervous as they are right now, will even overshoot to the downside. Another way of saying this is that after earnings season is over, estimates for 2019 will be down to or even below what they should be barring either a recession that I don’t see or some major external event, such as elevated tariffs, that currently aren’t built into earnings models.

If you add all this together, the confluence of short term events may be the perfect set up for a reasonably good stock market in 2019 after we get through earnings season. The economy is still growing, inflation expectations are low and so are interest rates, and stocks are reasonably valued if not slightly undervalued.   Given the starting point, gains in 2019 of 10%+ are achievable.

Today, Jeremy Renner is 48.  Nicolas Cage is 55.  Katie Couric turns 62.

James M. Meyer, CFA 610-260-2220

Additional information is available upon request.

* – Boenning and Scattergood may act as principal in buying this stock from or selling it to the public.

# – The author of this report or accounts under his management at Tower Bridge Advisors owns this security.

Additional information on companies in this report is available on request.  This report is not a complete analysis of every material fact representing company, industry or security mentioned herein.  This firm or its officers, stockholders, employees and clients, in the normal course of business, may have or acquire a position including options, if any, in the securities mentioned.  This communication shall not be deemed to constitute an offer, or solicitation on our part with respect to the sale or purchase of any securities.  The information above has been obtained from sources believed reliable, but is not necessarily complete and is not guaranteed.  This report is prepared for general information only.

Boenning & Scattergood, Inc. – Member FINRA / SIPC.

It does not have regard to the specific investment objectives, financial situation or the particular needs of any specific person who may receive this report.  Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed in this report and should understand that statements regarding future prospects may not be realized.  Opinions are subject to change without notice. 

Stocks rose about 1% on Monday with almost all the gains happening in the last 5 minutes.

That volatile end to the session put an exclamation point to a very volatile week. 

This morning futures are down about 1.5% in the early going, partly erasing that last 5-minute surge and partly due to some weak Chinese manufacturing data which, frankly, won’t make any dent in anyone’s 2019 GDP forecast for the United States.  I want to take another look at 2019 starting with what I believe is the consensus view going into the year. Right now, the general opinion is that 2018 ended on a high note.  Christmas retail sales rose about 5%, 3% or so in stores, and 19% online.   Manufacturing activity in the U.S. slowed a bit but is still growing.  Car sales have flattened out and are expected to remain near current levels going into next year.  Investment spending has also flattened in Q4, based on durable goods orders, somewhat disappointing but totally explainable by confusion in Washington.  Housing will start the new year on a low note but demographics and recent declines in mortgage rates offer some hope that when spring selling season begins after the Super Bowl, the surprise could actually be to the upside.   Overseas, the outlook for Europe is barely positive, about in line with long term expectations, and Japan appears likely to slip back into recession thanks to terrible demographic trends that remain in place.  China will grow more slowly and there is some risk that excess capacity, a surge in empty newly built apartments, and an increasing reliance on the use of debt could cause 2019 to be worse than current consensus expectations.  At the same time, a surge in government-back stimulus might support growing consumer demand.

Against this backdrop, a new chapter begins in Washington as Democrats take over control of the House.  That means they now control the agenda.  Nothing happens without House and Senate agreement which means Nancy Pelosi and Mitch McConnell either find common ground or things grind to a halt. The first test will come this week as both sides sit down with President Trump to negotiate the end of a partial government shutdown.  The focal point is Trump’s demand for $5 billion to finance further development of a wall along our Southern border.  The $5 billion is chump change in the whole scheme of things.  To put that number into perspective, added interest expense alone, a result of more borrowing at higher rates, will add well over $100 billion per year to our deficit.   Entitlement increases already mandated by law will add tens of billions of dollars more.  Thus, the $5 billion is the subject of a political fight, not an economic one.

It won’t be the last battle either.   Expanding deficits are going to become a growing concern.  In 2019, Congress will be forced to increase the debt ceiling.  A little over five years ago, the Tea Party (now represented by the Freedom Caucus of conservative House Republicans) almost created a default situation and did precipitate a move to lower the debt rating on U.S. bonds by Standard and Poor’s.  Thus, the current fight is a small skirmish no matter how you look at it.  Yes, it is currently being blown out of proportion by the media, common practice today.  But its resolution will be looked at as a harbinger of what lies ahead.  If all the parties can’t solve a $5 billion squabble without creating chaos, what is going to happen down the road when a real problem arises?  Thus, in theory, markets shouldn’t pay any attention to a $5 billion fight.  But it takes on more meaning, and therefore affects markets more, when it becomes a roadmap for future fights.

Let me take this a step further.  Republicans (and President Trump) want more border security, tougher immigration standards, increased military spending, and modest spending savings across other discretionary parts of the budget.   The President has shown no inclination to deal with the expansion of entitlements except for some very small modifications around the edges (e.g. food stamp eligibility). The net is that, despite stated desires for fiscal conservatism, Republicans want to spend more mixed in with a few high profile efforts to save to emphasize a false fiscal conservatism.  Democrats, meanwhile, will focus on trying to reinvigorate ObamaCare in some way, expanding coverage to more Americans. They also want infrastructure spending to increase although, to date, they have shown evidence how they would pay for that.  Entitlements are also off the table for Democrats.  Add the interest and entitlement spending increases and the risks rise that Federal spending will get even more out of control in 2019, a risk I am not sure has been considered properly by markets quite yet.

If you put the desires of both parties and the President together, you find very little common ground.  Yes, there will be some small deal making along the lines of “you give me a little and I will give you a little back”. But without some demonstrated way to pay for new programs, what gets passed will be little or none.  That means debt and deficits will surprise to the upside. That is expansionary in the short term at least until the debt service burden becomes overwhelming.

I don’t think, however, that happens in 2019.  Few argue that growth will slow in 2019 from a 3%+ rate in 2018.  Optimists hope that 2.5%+ can be sustained but that appears difficult with flat auto sales, a slight decline in housing, and only modest increases in investment spending.  But, at the same time, it is hard to get too pessimistic.  Housing was down in 2018 and could actually recover a bit this year, a combination of good demographics (household formation growth is strong) and lower mortgage rates.  Consumers continue to both spend at healthy levels and save, a great combination.  While employment growth will likely fall from the 175,000-200,000 pace of 2018, growth can fall to 100,000-125,000 and still allow the unemployment rate to fall.  It would also allow productivity to rise keeping growth above 2%.

Corporate profits should grow again in 2018 but at a more normal mid-single digit pace, in line with the growth in nominal GDP.  Stock buybacks will help earnings per share to grow faster but the strong dollar will be a headwind for multi-nationals.  The net result should be a modest increase in reported eps for the year with most of the growth coming in the back half of the year when currency headwinds subside.   As for interest rates, the 10-year Treasury spent virtually all of 2018 in a 2.50-3.25% range.  With inflation still comfortably below 2%, I think that range will still be in effect in 2019 suggesting normalized P/Es of 15x trailing earnings and 15.5-16.0x forward earnings should be there center point for stock prices. Hence my 2850-2900 target range for the S&P 500.  Given that the 2018 Q4 correction has put us below fair value to start the year, I would expect equities to gain 10%+ by year end although still failing to regain September 2018 record highs. 

Of course, there are always wild cards.  Some are unpredictable and others I could list, like war, are red herring risks that always exist but appear highly unlikely.

With that said, here are some that are real.

  1. Tariffs/Trade – Markets can quickly absorb a U.S. effort to expand existing tariffs on Chinese imports to 25% but markets have not factored in any impact of either going higher than 25% or expanding the tariffs to all Chinese imports.   Tariffs on imported European cars would probably have very modest impact on U.S. GDP but would be meaningful to nations like Germany. 
  2. A debt ceiling debate that gets out of control  – We have seen this happen before and, therefore, it is a risk worth mentioning.  It is important to note that no one, the President, Republicans or Democrats, win if such a debate creates market chaos.  All sides would lose big time.
  3. Who will be the Democratic nominee? –  We won’t know that answer in 2019 but the key players probably will be identified.  The big question is whether Democrats move left, as they often do during the primaries, and lean toward a charismatic progressive or whether any middle of the road candidate that has appeal to the political center can emerge.  As the House races in the mid-term elections showed, Mr. Trump’s appeal beyond his base is limited.  But if Democrats select a very progressive candidate replete with lots of spending ideas and higher taxes, Mr. Trump, or whoever runs as a Republican, will look a lot more appealing to the center.  As all elections show, Americans tend to vote with their wallets.  While Mr. Trump stirs the pot a lot and angers many, equity investors like the mix of lower taxes and less regulation.  Any serious fears that corporate taxes will return to 35% won’t sit well with Wall Street.
  4. Donald Trump – While I don’t expect anything beyond tariffs will have a measurable economic impact, his habit of starting with extreme requests and then walking back toward a compromise always offers the threat of short term volatility.   The other obvious Trump related issue that can’t be ignored is the Mueller investigation.  It is highly likely that Mr. Mueller will issue a report this year which may or may not be a final report.  That could set into motion a whole range of possible outcomes beyond the scope of this letter.  Mr. Trump is also likely to replace key departed personnel, like James Mattis and John Kelly, with people less likely to challenge Mr. Trump’s wishes.  He cherishes loyalty above all else and wants to surround himself with as many of his own acolytes as he can.  Certainly, some decisions, like the abrupt desire to recall all troops from Syria, can still be challenged and cause modest change.   Because most important economic decisions require Congressional action, equity investors should be less threatened.  But they aren’t immune.  For instance, Mr. Trump has threatened to seal the southern border if he doesn’t get his wall funding.  I am not sure that could be done but, clearly, he can affect some short term chaos.

If we add all this together, 2019 is actually shaping up to be a pretty decent year and maybe even a better than decent year for stocks. Given the heightened volatility in recent weeks and the need for some further earnings adjustments, which should happen after Q4 results come in beginning in a couple of weeks, 2019 may get off to a somewhat rocky start. But unlike 2018, when valuations were stretched as the year started, this year valuations are relatively cheap.  Assuming no recession, nothing matters more than valuation.  As we get passed the first few months, when Brexit is resolved one way or the other, tariff concerns become less fuzzy, and we all get to see whether Trump and Pelosi can find any common ground at all, clouds should give way to some sunshine.

Today, Kate Bosworth is 35.  Cuba Gooding, Jr. turns 50.

James M. Meyer, CFA 610-260-2220

Additional information is available upon request.

* – Boenning and Scattergood may act as principal in buying this stock from or selling it to the public.

# – The author of this report or accounts under his management at Tower Bridge Advisors owns this security.

Additional information on companies in this report is available on request.  This report is not a complete analysis of every material fact representing company, industry or security mentioned herein.  This firm or its officers, stockholders, employees and clients, in the normal course of business, may have or acquire a position including options, if any, in the securities mentioned.  This communication shall not be deemed to constitute an offer, or solicitation on our part with respect to the sale or purchase of any securities.  The information above has been obtained from sources believed reliable, but is not necessarily complete and is not guaranteed.  This report is prepared for general information only.

Boenning & Scattergood, Inc. – Member FINRA / SIPC.

It does not have regard to the specific investment objectives, financial situation or the particular needs of any specific person who may receive this report.  Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed in this report and should understand that statements regarding future prospects may not be realized.  Opinions are subject to change without notice. 

If I told you last week, when the Dow fell over 1500 points, that this week would be more volatile… Would you have believed me?

If I told you that the worst Christmas Eve ever would be followed by the biggest rally in Dow points ever followed by the biggest market reversal in 10 years would you have believed me?  And we still have two days to go before the end of the year, two days when many traders will be on vacation or will have closed their books for the year.  Hang on to your hats.

If you read the Wall Street Journal or listen to CNBC you will be offered a whole slate of fundamental explanations.  You have heard the litany ad nauseum.  The Fed.  Trump. Tariffs. Global uncertainty. Brexit.  The list seems endless. 

But stop and take a breath.  Our economy is growing 2.5-3.0%.  We just finished the best Christmas season in five years.  Tax refunds in Q1 will be higher than in the recent past.  Consumers are both spending and saving, about as good as it gets.  Europe is slowing but the demographics tell you Europe is destined for years to come to have GDP growth close to 1% plus or minus.  Japan is back in recession.  Again, demographics is the villain.  Without huge government stimulus or massive improvements in productivity, Japan’s GDP is going to decline.  That doesn’t mean, however, that GDP per capita is in permanent decline.   China is slowing.  It is convenient to blame tariffs but China is running into two problems; the law of large numbers and demographics.  China’s one child policy combined with no safety net for the elderly is starting to become a more dominating factor. The government has been using debt to stimulate the economy but that can’t go on forever.

So, what are the problems?  As I see it looking ahead, not behind, there are two significant issues.   One, market liquidity, has been a topic of increasing focus lately.   When markets start to fall, many investors hunker down.  Not the algorithmic traders, however.  For them, volatility is the fuel that ignites opportunity.  Every firm that relies on computers to find anomalies that give them better odds of success, springs into overdrive.  The problem is that the patterns they each find turn out to be the same or similar.  As a result, they are all buying at the same time and selling at the same time.  Fewer participants all leaning in the same direction brings chaos.  Thus, what happens is exactly what you have been witnessing the past two weeks, violent swings up and down with most of the violence happening during the last hour.  The supporters of algorithmic trading like to say that the volume they add provides liquidity as if volume and liquidity are synonyms.  That is clearly not true.  Liquidity comes from the number of participants more than from the volume of trading.  Clearly, rising liquidity chases many investors away.  You only have to look at the massive amount of mutual fund selling that has been happening in December to see my point. 

But since computers and passive investors don’t rely on fundamentals to any great extent, the volatility they add doesn’t change ultimate values.  What is does is extend the overshoot in either direction.  That is why I suggest to identify those stocks you want to buy and begin to nibble as they fall to your buy points.  I realize that, emotionally, it is hard to buy into a market falling 2-4% per hour. That is why you simply can’t be a hero and identify the bottom.

Look at where we are at the moment.  Stocks were down about 20% at Monday’s close.  Stocks of smaller companies or high beta (meaning volatile) names were down more.  Rallies on Wednesday and yesterday recovered about 6%.  Fair value based on 15.5-16.0 times next year’s estimated earnings is somewhere around 2650 for the S&P 500.   In September, the S&P was about 300 points or more than 10% over fair value.  At Monday’s close, they were about 300 points or a little over 10% below fair value.

Now, with two good days in a row (my simplistic 2-day rule), it appears the worst of the storm is over.  The S&P, around 2500 is still moderately below fair value.  That doesn’t mean every stock is cheap.  But it does mean there are some good bargains still out there.

There are three ways to go:

  1. The most conservative is to find companies with solid growing dividends yield at least as much as 10-year Treasuries (now about 2.8%) that have conservative balance sheets and are selling below historic norms. i.e. they are cheaper than normal.
  2. You can focus more on earnings than dividends.  Find companies capable of achieving 10%+ growth next year regardless of our economy’s rate of growth.  Again, make sure these names have strong managements and good balance sheets.  Of course, valuation matters.
  3. Take some of your cash reserves and try and hit a home run or two.  Look for names really beaten up over the past few months and take a shot recognizing that these will all have warts that could turn into cancers.  What earnings power will GE have left after selling enough assets to get its balance sheet back in shape.  Answer that question right and you could make a lot of money.  Get it wrong and you lose a lot.  Oil prices have gone from over $70 per barrel to close to $40.  OPEC cuts start in January and the growth of U.S. production will slow if prices stay low for long.  Some oil stocks are down 50% or more since September.  If prices rebound, these will be winners.  Again, take one or two shots here; don’t speculate with all your cash reserves.

I noted earlier that there were two problems I see looking ahead.  Liquidity was just one.  The other is debt.  U.S. households today have levels of debt-to-GDP about in line with what they were in 2007.  That isn’t all that comforting, but it isn’t all that alarming either.  Unemployment is really low and, with lower interest rates today, the cost of debt service isn’t overbearing.  Financial institutions have brought down the ratio of debt-to-GDP significantly.  Credit Dodd-Frank for that.  However, non-financial corporate debt has risen from 75.9% at the end of 2017 to 92.3% today. Much of the incremental borrowing has been to support share buybacks or large acquisitions.  Low interest rates have buried the problem so far but if rates rise and debt service coverage decreases, the troubles start.  Much of the post-recession debt is BBB rated.  If conditions tighten and debt service coverage decreases, as much as a trillion dollars of BBB debt could sink to junk status.  What that will do is explode credit spreads meaning the cost to borrow for the vast number of U.S. companies will go much higher.  You can figure out the consequences from there.

The same problem exists at the government level.  Debt-to-GDP was 58% in 2007.  It is now over 86%.  This doesn’t take into account off-balance sheet obligations like future pension payments.  Problems associated with a rise in debt have been masked so far by two factors. First and foremost, low interest rates have contained the debt service obligations. Second, under President Obama, defense spending as a percentage of GDP declined significantly.  But now defense spending is rising, entitlement spending continues to grow and interest rates are increasing.  The U.S. had to raise $1.3 trillion of new debt in 2018 and to that total you have to add the $400 billion reduction to the Fed’s balance sheet.  In 2019, according to current plans, the Fed will reduce its balance sheet by another $600 billion while Treasury will have to add another $1+ trillion in new borrowings.  You can do the math.  $3 trillion of new debt at 2.5% adds $75 billion to the deficit.  A half a percentage point of incremental interest on $16 trillion of existing debt adds another $80 billion.  That’s over $150 billion of added government expense in just two years.  Eventually, deficits will matter.  When is the obvious question.  The only thing I know is that when happens, it is going to be nasty.

But when isn’t tomorrow.  Right now, there are signs that the headwinds of angst are coming to an end.  That doesn’t mean clear sailing.  Trump can upset the apple cart at any time with a tariff statement or whatever.  Brexit fears could ignite selling although I don’t want to overstate the impact of a hard Brexit on most U.S. companies.   Most importantly, even after two very strong sessions, valuation is on your side for now.  With that said, think of 2700 as the red line in the sand.   Once you cross it, valuation is no longer a tailwind.  That’s less than 10% from where we sit today.  If I presume 2020 earnings of $180 for the S&P 500 and a normal 15.5 p/e, a logical target for the end of 2019 is about 2800.  If stocks rally above that level in 2019 (and they could without a recession), then it will be time to take some money off the table.  Thus, we can develop a simple macro rule for now.  Assuming on recession, below 2700, stocks are attractive.  Above 2800 they become unattractive. 

Today, John Legend is 39.  Denzel Washington turns 63.  Maggie Smith is 83.

James M. Meyer, CFA 610-260-2220

Additional information is available upon request.

* – Boenning and Scattergood may act as principal in buying this stock from or selling it to the public.

# – The author of this report or accounts under his management at Tower Bridge Advisors owns this security.

Additional information on companies in this report is available on request.  This report is not a complete analysis of every material fact representing company, industry or security mentioned herein.  This firm or its officers, stockholders, employees and clients, in the normal course of business, may have or acquire a position including options, if any, in the securities mentioned.  This communication shall not be deemed to constitute an offer, or solicitation on our part with respect to the sale or purchase of any securities.  The information above has been obtained from sources believed reliable, but is not necessarily complete and is not guaranteed.  This report is prepared for general information only.

Boenning & Scattergood, Inc. – Member FINRA / SIPC.

It does not have regard to the specific investment objectives, financial situation or the particular needs of any specific person who may receive this report.  Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed in this report and should understand that statements regarding future prospects may not be realized.  Opinions are subject to change without notice. 

This is a valuation correction, not a response to a weaker than expected economy.

Stocks are now valued below historic norms.  No one knows whether the next 5% is up or down but valuation is now on your side.  Unless there is a pending recession hidden by any data we can find, equities should offer above average returns over the next year plus.

Stocks got slammed once again on Monday is holiday-shortened session dropping close to 3%.  If there was any solace, the stocks that did the worst on Monday were the names that had held up the best in the recent correction, namely consumer staples, drug stocks, REITs and utilities.  An old saw on Wall Street says that the bear ultimately gnaws everyone in the end.  The best performers get beaten up last.  Maybe, therefore, that is a sign that the worst is just about over.

If I had to characterized the almost 20% correction between Labor Day and today, I would say most of it related to valuation.  The economy continues to perform strongly.  And while the market decline is prejudicing opinions to suggest that some economic evil lurks just past the horizon, there is almost nothing in the economic data of the last four months to suggest that growth this year or next year is going to be any different that what was forecasted on Labor Day.  We all know now and knew then that earnings per share growth, which has averaged close to 20% this year, would fall significantly next year once the tax cuts were anniversaried.  

Tariffs?  While President Trump repeatedly threatens to raise tariffs on European cars and Chinese goods, nothing has changed much over the past four months and the odds of a massive increase in tariffs pending is about the same today as it was then. 

The yield curve?  Some feared inversion, a signal of a pending recession.  But while the 2-10-year spread narrowed at one point to just under 10 basis points, it is back up to almost 20 basis points this morning.  It was about 25 basis points in September. Thus, despite all the noise and chatter you hear in the media, the bond market is not signaling recession.  If it is signaling anything, the decline in the yield on 10-year Treasuries of close to 50 basis points to (1) a flight to safety in a sharp market decline, a very natural occurrence and (2) a moderate decline in inflation expectations.  The latter should be good news. 

How about the Fed?   I would contend that the Fed has done exactly what everyone expected four months ago; it increased rates 25 basis points in December and suggested future rate increases would be data dependent.  The December forecasts for 2018 moderated just a bit and so did expectations of future rate increases.  

How about Europe?  Europe is slowing about as expected.  Brexit is proving to be a bit more complicated that one might have hoped four months ago but there are still three months to come to some reasonable conclusion.

How about the mid-term elections?  The general consensus was that Republicans might gain a seat or two in the Senate and lose control of the House.  That is exactly what happened.  While there may be a lot of investigations and noise that which rankle a lot of liberal and conservative feathers in the months ahead, from the stock market’s point of view, little is likely to happen.

Trump?  Some may view him as a bit more volatile and unpredictable.  His rants against the Fed can’t help but the Fed has made it clear that it isn’t allowing political noise to affect its actions.   That may not be 100% true but it seems to be pretty close.   Washington turmoil can’t do much to placate investor fears but no one can argue with any relevant data that what is taking place in the economy is having much economic impact.  According to Mastercard, retail sales from November 1 to December 24 (ex-cars) were up 5.1%, the best performance in six years.  In-store sales were up 3%; a year ago some speculated they would never rise again.  87% of sales were done at retail.  Online sales rose 19%.  Will they slow next year?  I don’t know how anyone can speculate.  What I can suggest is that lower gas prices and expected higher tax refunds should keep sales strong at least through the first several months of 2019.

There must be some negative surprises.  What were they?  I would argue that investment spending is less than what was expected 4-6 months ago.  Tariff fears and Washington uncertainty are probably the culprits. Oil prices have collapsed over the past three months.  That helps energy consumers but it demolishes an industry still reeling from a price collapse a little over two years ago.  Housing had been soft going into the fall but the pace of decline accelerated as mortgage rates rose.  But with rates now declining and input costs, notably lumber, declining, it is possible that the important spring selling season might see some signs of improvement.

GDP rose over 4% in the second quarter and over 3% in the third quarter.  According to surveys, Q4 looks on track to rise about 2.5%.   None of this synchs with a stock market down 19% from its late summer peak.

So, let’s look at where we are today.  As of Monday’s close, stocks were at 14.5x trailing earnings and about 14.0x forward estimates, about one multiple point below historic norms.  Adjusted for the recent inclusion of REITs into the index, maybe the gap today is 1.5 multiple points meaning the S&P 500 at about 2350 should be valued at closer to 2600 based on historic norms.  At its peak it got a bit over 2900.  Should it still fall a bit more, it could get a far below fair value as it got above fair value in February or late summer.

But if one steps back and tries to filter out all the noise, all the insanity of Washington, all the fears you hear 24/7 on CNBC, etc. I come up with the following.   Stocks generally rise about 5-6% plus the rate of inflation, or about 7-9% per year.  For some time, I warned that, because the market had been overvalued, future expected equity returns would be less than historic norms.  Now, with stocks somewhat undervalued, I would argue that forward-looking returns will be greater than historic norms using today as a starting point, perhaps something closer to 9-10% per year.

There are some caveats to this thesis (there are always caveats!).  First, with volatility far above normal levels, I have no idea whether the next 1000 Dow points are up or down.  Heck, the Dow could move 1000 points in a day.   Second, I am presupposing no major economic disruption.  I remind everyone that economic recoveries don’t die of old age; they die of imbalances and bad policy. An escalating trade war would be an example of bad policy but I am not predicting that and I don’t think the market is either.  Some want to point to the recent 25 basis point rate increase by the Fed as bad policy.  Time will tell whether that is true or not.  Certainly, raising rates in such a negative market environment had an undesired short term effect but that could get erased quickly with any change in sentiment.  But if inflation is somewhere a bit under 2%, a Fed funds rate of 2.25-2.50% can hardly be described as a sign of extremely tight policy.   If markets don’t stabilize very soon, the Fed could slow the pace it is shrinking its balance sheet.  If it slowed that from $50 billion per month to a lower number, stocks would rally immediately.  One problem prognosticators have is that they don’t look ahead more than 1 move.  Despite some who say the Fed is blind, it isn’t and, if necessary, it will react. 

All this, says today is a better time to buy than to sell.  Liquidity always dries up at year end and that accentuates market moves.  In a down market, it stokes fear.  Good investors have to control emotions.  We made not get the whole September-December decline back quickly but, if no recession is pending, 12 months from now one should be handsomely rewarded for purchases made today.  To be sure, there are risks; there always are.  Tariffs and Trump-related uncertainties are two.   Analysts still have to adjust 2019 estimates down a bit but not nearly as much as some suggest.  Right now, the mood is to sell the rallies.  That will work until it doesn’t.  My two-day rule comes into play here.  Most rallies recently could be measured in hours.  The first thing one wants to see is a market that finishes a session at a high.  Then next day follow through is needed.  After a 19% decline, missing the first 3-4% isn’t going to be life threatening to your portfolio. But get your shopping list ready.  December 26 offers great bargains in retail stores.  It may offer great bargains in the stock market as well.

Today, Jared Leto is 46.

James M. Meyer, CFA 610-260-2220

Additional information is available upon request.

* – Boenning and Scattergood may act as principal in buying this stock from or selling it to the public.

# – The author of this report or accounts under his management at Tower Bridge Advisors owns this security.

Additional information on companies in this report is available on request.  This report is not a complete analysis of every material fact representing company, industry or security mentioned herein.  This firm or its officers, stockholders, employees and clients, in the normal course of business, may have or acquire a position including options, if any, in the securities mentioned.  This communication shall not be deemed to constitute an offer, or solicitation on our part with respect to the sale or purchase of any securities.  The information above has been obtained from sources believed reliable, but is not necessarily complete and is not guaranteed.  This report is prepared for general information only.

Boenning & Scattergood, Inc. – Member FINRA / SIPC.

It does not have regard to the specific investment objectives, financial situation or the particular needs of any specific person who may receive this report.  Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed in this report and should understand that statements regarding future prospects may not be realized.  Opinions are subject to change without notice. 

Stocks continued to fall again on Friday. By now you have probably seen the statistics.

Depending on which average you look at, last week was the worst for stocks since the bottoms in August 2011 or November 2008 during the Great Recession.

But unlike 2011, at the peak of the European debt crisis, or 2008, when we were in the depths of the Great Recession, one cannot look at the economic data for an answer to what might be causing the decline in stock prices. One also can’t look around the world. While other markets were down 1-3%, most related to selling in our markets, declines elsewhere were nowhere near the 7-8% declines in our markets. It wasn’t just stocks. Oil has been in free-fall for almost two months dropping over 40% over that period.

So, what is the cause? Actually, it appears to be a confluence of causes.

  1. When selling began in October, stocks were overvalued by historic standards. To some extent, therefore, this began as a valuation correction.
  2. Computer and algorithmic traders feed on heightened volatility. As volatility increase, computer selling increases as well.
  3. As declines persisted and escalated, weaker equity holders capitulated and sold. Net withdrawals from actively managed mutual funds have totaled in excess of $50 billion over the past two weeks.
  4. Margin debt, at least at the start of the decline was high. As selling led to larger declines, margin calls have escalated forcing even more selling.
  5. Lower prices have led to increased tax-loss selling.
  6. Events in Washington added to the turmoil and uncertainty. These include a partial government shutdown, the resignation of James Mattis, the sudden withdrawal of troops from Syria, and other signs of unrest, chaos and uncertainty within the Executive Branch. While none of these events individually have significant economic consequences that should disrupt markets, the accelerating flow of bad news doesn’t inspire confidence.
  7. The Federal Reserve’s messaging of its shift toward a slower pace of future rate increases has been poor, to say the least. With that said, the Fed news is now in the rear view mirror. Barring outright collapse in financial markets, the Fed isn’t going to alter the near term future.

With all this said, the economy continues to hum along. Third quarter growth was well above 3%. While non-defense related durable goods orders have slowed along with economic uncertainty, strong final demand will ultimately lead to a rebound in spending. Another industry that has slipped lately in housing. Demographics, high employment and a strong economy suggest that demand for housing is still there. But prices need to come down a bit after several years of above average increases, and mortgage rate increases have put pressure on buyers. With that said, recent declines in long term bond yields are likely to bring mortgage rates back down. Housing starts in October rose contrary to expectations and that was before mortgage rates started to fall. At the moment, home sales are low seasonally and won’t pick up again until February. But if mortgage rates stay low and lumber prices remain under pressure, we could see a surprising rebound in housing.

At the start of the market decline, there was a lot of focus on yield curve inversion. While there has been some flattening of the curve in the 2-5-year range, the yield on 2-year Treasuries has actually declined since the most recent FOMC announced Fed Funds rate increase and the spread between 2 and 10-year bond yields has moved back up to 14-15 basis points, a signal that bond markets don’t see an imminent recession.

Over the weekend, Treasury Secretary Stephen Mnuchin tweeted that he spoke to heads of the largest banks and wanted to assure everyone that the banks had no liquidity problems. Sources also said that President Trump was considering firing Federal Reserve head Jerome Powell. If these two steps were designed to show that government had the backs of equity investors, the outcome was just the opposite. First, Mr. Trump can only fire Mr. Powell for cause. Since there clearly isn’t any other than the President’s disagreement over the last rate increase, Mr. Trump has backed off that position. As for the Mnuchin statement, since no one thought that the recent decline had anything to do with bank liquidity, a lot of people in the financial world are puzzled as to what precipitated the statement. Follow up conversations with media confirm that Mr. Mnuchin made calls as part of routine policy but liquidity was hardly the primary conversation. At any rate, his tweet is just one more example of how Washington unpredictability can exacerbate nervous markets.

Today is a half day for investors as markets close at 1 pm. Many European markets will be closed Wednesday for an extended Christmas holiday. Many hedge funds and U.S. trades will be winding down between now and year end. Normally, that suggests like volume with some momentum to the upside as tax-selling comes to an end and investors position optimistically for the next year. But 2018 is far from normal. What is logical to expect today is more volatility although volume will be lighter than last week when volume set multi-year highs. Futures were higher very early on, then fell the equivalent of 200 points before rebounding slightly. Any large buy or sell program today could overwhelm markets temporarily. That is a risk, not an expectation.

Here’s the reality. Stocks today sell at a P/E ratio below historic norms both related to recent or expected earnings. In other words, based on history, stocks are cheaper than normal even assuming conservative forward-looking earnings assumptions. Interest rates remain low by historic standards. The combination of low interest rates (and therefore low expected bond returns barring a sudden further drop in bond yields) and low P/Es suggest stocks should become the preferred investment once markets calm down. But, no one can tell exactly when calm will be restored. With that said, declines like we saw last week don’t often repeat themselves. Stocks are way oversold. Just a rebound to declining 50-day trend lines would mean a rally of 5-10%. Selling rallies rather than buying the dips is the normal order in bear markets and it appears that we are in one now. Markets could be forecasting a recession in late 2019-2020 or they could be dead wrong. We don’t know. A reasonable prediction is for slowing economic growth both here and around the world but slower growth isn’t the definition of recession. If growth simply slows and stabilizes at 1-3%, stocks will rebound strongly over the next year. By strongly, I mean year-over-year returns from here will be double digit.

There isn’t going to be a recession if employment stays near record levels and consumers keep spending. If one looks at Main Street and not Wall Street, there are no signs whatsoever to suggest the consumer is frightened or going into a cocoon. I don’t see anything in natural economic order that would cause a sudden change in behavior. The risk, in my mind lies in Washington behavior. A heightened trade war that increases tariffs massively would be an example. Even more discord between Democrats and Republicans probably won’t rise to a level that will undermine economic confidence but I can’t say that with any degree of certainty. The Fed isn’t likely to be the villain. It is done raising rates for now and, as New York Fed President John Williams noted last week, it will be very responsive to markets going forward. It isn’t chasing a preordained policy on autopilot as some suggest. Brexit could cause some noise but, whatever happens, it will be history before mid-year. Logically, there is every reason to expect stocks to rally soon, perhaps after Q4 earnings season. Emotionally, the mood of the moment is as sour as it can be. But times of peak fear are often the best buying opportunities. With that said, I don’t think we will reach true bottom until the past leaders, namely the FANG stocks, find a bottom. The good news is that process is well along.

Today, author Stephanie Meyer is 45. Ricky Martin is 47. Since I never publish on Christmas Day, I thought it might be interesting to note who was born on Christmas. The list includes Canadian Prime Minister Justin Trudeau, singer Jimmy Buffett, actress Sissy Spacek, Rod Serling of Twilight Zone fame, and film legend Humphrey Bogart.

James M. Meyer, CFA 610-260-2220

Additional information is available upon request.

  • – Boenning and Scattergood may act as principal in buying this stock from or selling it to the public.

– The author of this report or accounts under his management at Tower Bridge Advisors owns this security.

Additional information on companies in this report is available on request. This report is not a complete analysis of every material fact representing company, industry or security mentioned herein. This firm or its officers, stockholders, employees and clients, in the normal course of business, may have or acquire a position including options, if any, in the securities mentioned. This communication shall not be deemed to constitute an offer, or solicitation on our part with respect to the sale or purchase of any securities. The information above has been obtained from sources believed reliable, but is not necessarily complete and is not guaranteed. This report is prepared for general information only.

Boenning & Scattergood, Inc. – Member FINRA / SIPC.

It does not have regard to the specific investment objectives, financial situation or the particular needs of any specific person who may receive this report. Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed in this report and should understand that statements regarding future prospects may not be realized. Opinions are subject to change without notice.

Once again markets were highly volatile yesterday with the Dow swinging well over 500 points before finishing with a slight gain.

 A 7% decline in oil prices weighed on that sector and the entire market. As we have been warning, volatile has risen in front of the FOMC rate decision. That decision will be announced at 2pm today and I can almost guarantee, heightened volatility after the fact no matter what the Fed decides to do.

While most of the focus this week has been on interest rates and today’s pending rate decision, the Fed has another important tool it uses to control interest rates and contain inflation. Through the purchase, sale and liquidation of government debt, the Fed can activity control the amount of liquidity in the U.S. financial system. Before and during the Great Recession, the Federal Reserve banks held less than $1 trillion of assets, mostly Treasury securities and some agency debt. When the apex of that recession hit in September 2008, the Fed stepped in and quickly expanded its balance sheet to $2.5 trillion at a time when commercial paper markets literally dried up, Fannie Mae and Freddie Mac were taken over by the Federal government, Lehman Brothers failed, Merrill Lynch collapsed along with associated mortgage backed derivatives. Clearly, that injection of liquidity prevented a complete collapse of our financial system. Even as a recovery began, it was the Fed’s decision that the recovery was so fragile that had to inject more liquidity into markets as Europe faced the prospect of sovereign defaults in Greece and elsewhere. By the time quantitative easing (QE) ended in 2014, the Federal Reserve’s balance sheet had swollen to about $4.5 trillion. Finally, at the start of 2018, the Fed thought our economy and financial markets were stable enough to begin the process of reducing its balance sheet back to a more desired level. This year it will liquidate about $400 billion and next year the current plan is to reduce the balance sheet by an additional $50 billion each month or a total of $600 billion. Thus, over a two-year period, the Fed will have reduced its balance sheet by about $1 trillion meaning that it will have withdrawn that same amount of liquidity from our financial system.

When QE began, the idea of adding liquidity was to stimulate the flow of money once again. In theory, the banks through which the liquidity was channeled would help to circulate funds through the general economy and stimulate lending activity and economic growth. One measure of the success of this plan is to look at the turnover rate of money or velocity. Although it rose from 1.71 to 1.74 from the second quarter of 2009 at the bottom of the recession to the third quarter of 2010, soon thereafter it began to fall. Since the government began measuring velocity in the late 1950s, the lowest it had ever gotten was 1.65 in 1964. It matched that level of the end of 2011 ultimately reaching a record low of 1.43 in late 2017.

What does this all mean? It means the money the Fed injected to stimulate activity and growth wasn’t doing what was intended. Instead the excess liquidity just sat there. Well, it didn’t just sit there; it was invested. In simple terms, the liquidity went into the financial markets, not the commercial markets. It created more demand for investment and raised the value of all assets. Long term bond yields fell below 1.5%. Stocks rose to 19x forward earnings. Home prices rose faster than inflation. Oil recovered from near $30 per barrel to more than double that.

That has all changed this year as the Fed began to reduce its balance sheet and remove liquidity from the market. But since very little of the liquidity the Fed provided went into the general economy, there has been relatively little impact on general economic activity from the withdrawal of liquidity other than in those industries highly dependent on debt financing. Instead, the impact has been felt in financial markets. As inflated prices return toward normal, we have seen interest rates rise, equity P/E ratios fall and real estate values drop.

The Federal Reserve has stated a game plan of normalizing rates as well as the size of its balance sheet. The two, raising rates and reducing the size of its balance sheet, work in tandem. Both serve to slow the pace of economic growth and keep inflation under control. The trick is to slow, not stop growth. As the excess liquidity is withdrawn and, as noted above, most of it is coming from financial markets, volatility has risen. Volatility had been in steady decline from the 2009 bear market end until the very beginning of this year. But it has started to rise again and should continue to rise as the Fed continues to pull money out of markets. The 50-week average for the VIX volatility index bottomed around 11 in late January and now stands at over 16. The extremes of the past few weeks may not be sustained for much longer but the calm markets of 2017 are probably not going to return either.

The fact that securities transaction costs and bid-asked spreads have narrowed to less than a penny has taken away all inducement for market makers to carry any inventory. Volatility raises the animal spirits for algorithmic traders, particularly is relatively small markets like oil where prices have declined more than 6% per day four times over the past month.

At the moment, the volatility has been to the downside and we all feel the pain. But even in bear markets, there can be and almost certainly will be violent bursts to the upside.

What conclusions does all this lead to?

  1. Given all inflation indicators right now show a deceleration in the rate of price increases or an acceleration in price declines, there is risk that the Fed might be close to overplaying its hand. It seems logical to me that the risks of not raising rates today and letting inflation get out of hand are much less than the possibility of creating more downside fear over the short run. With that said, one quarter point change in interest rates isn’t likely to be the event that separates slow growth from an outright recession.
  2. Heightened volatility doesn’t mean prices have to drop. Volatility works in both directions. We have made the case that fair value for the S&P 500, assuming earnings rise less than 2% next year, is around 2700 based both on historic norms and the relation of stocks to high grade junk bond valuations.
  3. With that said, in the short run, emotions dominate rational behavior. If markets were overvalued by 5-10% earlier in 2018, they can become undervalued by the same amount. That suggests risk to the downside of 2400-2450. That isn’t a prediction. It is a statement highlighting what we believe the risk might be today. If stocks are going to trade between 2400 and 2900 for the S&P 500, then when the average is closer to the lower end of the range, the risk/reward ratio rises.
  4. If we are getting back toward normal and given recent volatility, it would make sense for the Fed to slow or even stop the pace of future rate increases as well as the pace of balance sheet liquidation. If I were a voting member of the Fed, after today I would say let’s stop and assess for the next six months unless we see data suggesting a broad acceleration in inflation. Moreover, I would slow the pace of balance sheet sales hoping for a more normalized rate of volatility.
  5. Just because an asset is cheap doesn’t mean it won’t get cheaper. The way to deal with this is to identify what you want to buy, what is an attractive entry point, noting that when everyone is in a mood to sell you can get your best bargains, and nibble slowly. If your stock keeps going down, add a little more. If your target price proves to be too low, you will miss an opportunity but, in all likelihood, you will pick up some bargains and miss some others. Don’t buy anything based on price alone. In this kind of market, only buy companies you really want to own.
  6. Finally, don’t let your emotions get the better of you. If you buy stocks of great companies at bargain prices (i.e. below fair value) you will be a winner every time in the end. Market bottoms end when weak hands capitulate.

I have no idea what markets will do later today or tomorrow after the Fed rate decision but I expect a lot of volatility for the rest of this week related both to the Fed decision and options expirations on Friday. They then should start to calm down. Given most markets are oversold on a short term basis, we just might see a healthy rally between now and the end of the year. Don’t get suckered in. We are in a decelerating economy where stocks sell at a very modest discount to fair value. That discount can be wiped out quickly with any steep rally. Rather than trying to guess the market, probably an impossibility, identify stocks of great companies you want to own at really attractive prices. Also look at your asset allocation. A sharp drop in equities relative to fixed income may mean stocks are the better bargain at the present time.

Today, Jake, Gyllenhaal is 38. Alyssa Milano is 46. Cicely Tyson turns 94. We’ll miss you, Penny Marshall.

James M. Meyer, CFA 610-260-2220

Additional information is available upon request.

– Boenning and Scattergood may act as principal in buying this stock from or selling it to the public.

– The author of this report or accounts under his management at Tower Bridge Advisors owns this security.

Additional information on companies in this report is available on request. This report is not a complete analysis of every material fact representing company, industry or security mentioned herein. This firm or its officers, stockholders, employees and clients, in the normal course of business, may have or acquire a position including options, if any, in the securities mentioned. This communication shall not be deemed to constitute an offer, or solicitation on our part with respect to the sale or purchase of any securities. The information above has been obtained from sources believed reliable, but is not necessarily complete and is not guaranteed. This report is prepared for general information only.

Boenning & Scattergood, Inc. – Member FINRA / SIPC.

It does not have regard to the specific investment objectives, financial situation or the particular needs of any specific person who may receive this report. Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed in this report and should understand that statements regarding future prospects may not be realized. Opinions are subject to change without notice.

Stocks fell sharply on Friday after a report out of China pointed to slowing retail sales.

When the market closed, the leading averages were right at their 52-week closing lows. Futures this morning point to a lower opening, more on momentum and sour sentiment than on any sign of fundamental weakness. 

We have had multiple retests of the2580-2600 region in the S&P 500. Whether that range will hold one more time is up for debate.  Any breakdown below that level could be harsh but there are more reasons to believe a bottom is near at hand than not.  While the economy is definitely slowing, there are no signs yet of a pending recession.  I say that often and the retort is that economies can go from good to bad surprisingly quickly. But even accepting that statement as true, there are always early warning signs of economic deterioration. Right now, most of the apparent slowing is overseas.  It is tempting to think that overseas weakness will spread here but one should note that our trade activity is a much smaller percentage of GDP than for almost any other major nation.  While we do still import oil, we produce most of our own food and, net, we are now close to energy self-sufficiency.  Most of what we import relates to the fact that the related goods can be made more cheaply in a foreign country.  And if the country of manufacture runs into problems, in most cases it isn’t all that difficult to move to a supplier in another land.

Where economic weakness or other geopolitical concerns overseas comes into play concerns demand for our exports.  We are major exporters of aviation and defense equipment, for instance. We also sell products, like drugs, for which American companies are the primary worldwide supplier.  Finally, we sell more food to the rest of the world than any other nation.  While demand may vary slightly from year-to-year, price is more important than volume.  Price depends somewhat on economic demand but the bigger factor is whether which determines crop size.  When crops are larger than expected, weaker prices often result.  But prices don’t always move together.  This year, beef prices are up but hog prices are down. Such disparity is more common than not.

Thus, we are relatively insulated from weakness overseas as long as the weakness isn’t extreme.  A strong dollar translates foreign activity back into fewer dollars and hurts earnings of multinational companies but the pace of activity, measured in physical volume remains solid.

If weakness overseas isn’t providing the wakeup call that an economic slowdown is near, one must look for other signs.  About the only domestic sector in actual decline is housing. The culprits there are rising interest rates combined with above average price increases since the Great Recession. Over the past 2-3 years, the pace of price increases has started to decrease starting with some high profile markets, like New York City, and gradually spreading to most of the nation’s hottest markets like California, both North and South, andSeattle.  Price is always the mechanism to restore balance.  Unlike the period leading up to the Great Recession when one of every two homes was sold to anon-occupant, this time around, there is very little speculation going on.  People who are buying homes today are doing so for life style reasons, not economic. In many markets, rents are rising faster than home prices, a sign some rebalancing is taking place. The rate of new household formations today equals or exceeds the pace of homebuilding. Inventories are tight.  What is inhibiting growth at the moment is cost, not demand.  That should be self-correction with a major downturn. 

Another major market that is now flat after growing at a sustained pace is the auto market.  For several years post the Great Recession, demand was aided by a bit of catch up. Once job seekers found employment, they started to buy cars again.  But as more millennials moved to urban centers, they had less need for cars.  From a profit standpoint, the auto companies continue to do well because of a mix shift from conventional cars to SUVs and trucks.  That won’t last forever but as millennials start families and move to suburbs that require two or more cars per family, demand should reaccelerate. Over time, the impact of ride sharing and Uber will take some toll on demand but those forms of transportation are more urban-centric.

Away from cars and houses, demand seems strong.  Consumers are both buying and saving more, an almost perfect combination. Credit card usage is rising.  This promises to be a good Christmas.  Manufacturing continues to be strong.  Some suggest the benefit from the tax cuts will only be a one-time event. While the year-over-year impact of the tax cut on corporate earnings will result in much smaller growth comparisons beginning with the first quarter of 2019, the incremental cash available for corporate investment or for incremental dividends or share repurchases will continue to be elevated versus historic norms.  With stocks theoretically prices to a present value of future cash flows, the rise in dividend payments approaching 10% year-over-year provides the best basis for a solid floor for stock prices.  With the 10-year Treasury now yielding less than 2.9% and the S&P 500 yielding about 1.9%, any persistent growth of dividend payments in excess of 5%, let alone 8-9%, should make stocks very competitive versus bonds.  Indeed, one can construct a very diversified portfolio of high quality stocks paying 3% or more with annual dividend increases.  Ultimately, it will be valuation that helps a market find a floor in a non-recessionary environment, even one in which sentiment is as weak as it is today.

None of this precludes further near term downside.  We have a big Fed meeting this week that could prove disappointing if the Fed raises rates and hints too strongly of several more rate increases to come in 2019.  While almost everyone expects the Fed to say it is data dependent regarding future rate increases, any hints that it still believes that neutral is farther away than 2.5% than most investors believe could set off more selling.  PresidentTrump threatens to shut down the government Saturday if Congress doesn’t give him $5 billion in wall funding.  It almost certainly won’t unless he gives the center and left a lot of concessions.  Normally, a short-term government shutdown doesn’t spook markets much but with sentiment as bad as it is now, this time could be different. There is also a big option expiration at the end of this week to throw into the mix.  Therefore, as I have been noting recently, this should be a very volatile week. 

At the end of 2018, I noted we were living in the best of times but before long, the good news of earnings momentum and tax cuts would be history making the second half of 2018 tougher than the first.  Valuations were becoming stretched. That became crystal clear in February.  Indeed, for most of 2018, the story of the equity market was a reduction of P/E ratios to a more historic norm as interest rates were rising toward neutral.  2019 could turn out to be the exact opposite.   P/Es are now normal to slightly below normal. Any further market weakness will make valuations more enticing.  Sentiment, which was near euphoric a year ago, is now as bad as it has been since 2015-2016 and approaching levels last seen in the European debt crisis of 2010-2011.  Earnings continue to rise but the pace in the first half of 2019 will slow to low single digits and could even be negative for multi-nationals due to the strong dollar.  But Fed policy,Brexit and trade should become smaller issues after the first quarter.  Assuming the dollar stays relatively close to where it is today, currency headwinds will lessen in the second half of the year. 2019 is shaping up to be a bumpy ride early and a rather pleasant one later in the year.

There are two storm clouds to watch for, however. The first is trade. All the above presumes no all-out trade war withChina in 2019.  There are a lot of words to describe Mr. Trump’s policies and actions. Subtle isn’t one of them.  While hitting hard can be good, it can have bad consequences as well.   Second, isMr. Trump himself.  With the House now under Democratic control, the actions of the Trump administration are going to face heightened scrutiny.  Disregarding any talk of impeachment, the administration will be taken to task many times over the next two years.  In the 1970s, scrutiny by Congress and the media ultimately brought down the Nixon administration.  In no way, am I suggesting the same will happen this time around.  But I am suggesting that these investigations have the potential to undermine smooth government and souring American confidence.  That isn’t a prediction but it is a statement of a possible storm cloud to watch for.  All the investigations to date have come during a period of a Republican-controlled Congress.  Actions and reactions going forward are hard to predict and, therefore, increase uncertainty.  But until there is a trade war or a negative economic reaction to any political misdeeds, I will label the two more red herring risks than substantial concerns.

Today, Chase Utley is 40.  Pope Francis is 82.

James M. Meyer, CFA 610-260-2220

Additional information is available upon request.

* – Boenning and Scattergood may act as principal in buying this stock from or selling it to the public.

# – The author of this report or accounts under his management at Tower Bridge Advisors owns this security.

Additional information on companies in this report is available on request.  This report is not a complete analysis of every material fact representing company, industry or security mentioned herein.  This firm or its officers, stockholders, employees and clients, in the normal course of business, may have or acquire a position including options, if any, in the securities mentioned.  This communication shall not be deemed to constitute an offer, or solicitation on our part with respect to the sale or purchase of any securities. The information above has been obtained from sources believed reliable, but is not necessarily complete and is not guaranteed.  This report is prepared for general information only.

Boenning & Scattergood, Inc. – Member FINRA / SIPC.

It does not have regard to the specific investment objectives, financial situation or the particular needs of any specific person who may receive this report.  Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed in this report and should understand that statements regarding future prospects may not be realized. Opinions are subject to change without notice. 

Expect more volatility next week around the FOMC rate announcement and the big quarterly options and futures expirations next Friday.

 Investment sentiment is extremely low, often a precursor to a bottom.  Bottoms can be hard to time precisely but with stocks now fairly valued or modestly undervalued, it may be time to start nibbling.

Stocks have been mixed for the past two days.  Strength continues within the defensive stocks while energy and financial names continue to be very weak performers.  Tax selling serves to accentuate the downward moves in some of the names at or near 52-week lows.

Overnight, weak retail trade data out of China sent Asian stocks down and that weakness has spread first across Europe and then to our pre-markets.  In early going, it appears equities are likely to open down about 1% while bond yields are down one or two basis points.  But the big action is likely to come next week associated with the FOMC meeting that concludes on Wednesday and the big quarterly option exploration that comes on Friday.   Given recent volatility and the possibility that leveraged bets can make up for some of 2018’s losses, one should expect heavy option action this cycle.  The major put-call action on the broad market seems focused around the 2600 level on the S&P 500, about 2% below last night’s close.  I have never been able to understand market action immediately after a Fed rate announcement.  Whatever bets traders make in front of the news need to get quickly unwound, win or lose, right afterwards.  Thus, all I can speculate is that next Wednesday and Thursday are also certain to be volatile with high volume.  But once the Fed does its thing, whether it raises rates or not, the result will quickly get baked into stock prices and traders will look forward, not backwards.

If one looks at the Fed Futures market, there is about an 80% chance that rates will be raised 25 basis points next week.  The obvious conclusion is that there is a 20% chance it does nothing.  Absolutely no one believes there will be a rate increase higher than 25 basis points and no one believes the Fed will cut rates.  Obviously, by Wednesday afternoon, whatever the Fed does, there will be certainty.  The 80% probability embedded in prices will be adjusted up immediately to 100% or adjusted down to zero.  While it is possible the Fed will hike rates 25 basis points and stick to its September tone strongly suggesting 3 or more rate increases next year, recent statements by a wide variety of Federal Reserve officials point to a significant moderation of tone.  This time around, if there is a 25-basis point rate increase, it will be accompanied by statements suggesting any future increase will be subject to market conditions at the time of subsequent FOMC meetings.  The media and investors can twist whatever words come out of Chairman Powell’s mouth at the post-meeting press conference to be more dovish or hawkish than I just noted but the conclusion everyone should reach is that every Fed meeting going forward is active and any rate decision will be based on the circumstances at the time of the meeting.  

Markets today expect no further rate increases until the fall of 2019 at the earliest.  Given early signs of economic deceleration in the U.S. and more obvious signs overseas, that appears to be a reasonable assessment.   Mr. Power is a pragmatic Fed leader with a business, not an economic, background.  Ask him what he might do in 12 months and he will say every time that it depends on conditions 12 months from now.  He might say, all things being equal that he would like to raise rates 1 or 2 more times if the economy is strong enough but that isn’t a prediction of future rate hikes.  We can dissect every nuanced word, but the stark reality is that whatever the Fed does on Wednesday is the last action it will take regarding rates for many months. 

The Fed is also in the process of reducing the size of its balance sheet.  It will reduce it by about 10% in 2018 and could reduce it another 15% in 2019 again subject to market conditions.  Recent heightened volatility in all financial markets point to some increased stress at least compared to recent periods of excess liquidity.  The Fed has to be mindful that it doesn’t overplay its hand and remove too much liquidity from jittery markets.  No doubt the question will be raised at Mr. Powell’s post-meeting press conference and he will respond yet again that market conditions will help to dictate speed at which the Fed reduces the size of its balance sheet.

Perhaps lost in the news flow overnight and apprehension about the reaction to the pending FOMC meeting, China cut auto tariffs, a clear sign that it wants to move forward toward a peaceful resolution of the trade conflict. Since China didn’t start the battle, however, it will be up to President Trump whether steps taken going forward are sufficient to defuse to war.  With that said, Trump, a true Narcissist if there ever was one, wants to be loved.  An escalated trade war won’t raise his popularity with anyone, except possibly Peter Navarro.  Thus, the odds still favor peace more than war.

Last week, according to Lipper surveys, Americans withdrew $46 billion from equity funds and $13 billion from fixed income funds.  Investor sentiment surveys are now at their most negative levels in years.  It is hard to find anyone who wants to buy securities in front of next week’s expected volatility.  It is hard to find anyone who wants to but securities in front of next week’s expected volatility.  Institutions are making extended leveraged bets, probably more to the negative side.   But extended market declines require more than simple fear or negative sentiment.   While data overseas points to slowing in many markets, consumer spending is solid, employment growth continues, inflation remains in check and manufacturing activity continues to expand.  Leading indicators are still rising.  Unemployment claims last week fell sharply.   We are probably headed for a period of slower growth but for a full blown bear market to happen, the odds of recession have to increase significantly.  So far, any such signs are few and far between.  Investor sentiment can swing from very positive to very negative and back again quickly.   I am not forecasting a switch per se.  That would almost certainly be hazardous to my health.  Maybe we still face on of those sharp blowoffs so characteristic of market bottoms.  Or maybe we just move sideways in a volatile fashion as we have for some weeks until the selling exhausts itself.   Either way, barring a sudden change in economic circumstances, the rolling correction of 2018 appears to be in its 7th or 8th inning, if not later.   One doesn’t have to be a hero and dive into a shallow pool from 30 feet.  One can nibble at bargains and add on further dips or on subsequent recoveries.  Stocks are not supercheap but that are, at least in our estimation, now below fair value.  In some sectors, they are well below fair value.  Don’t guess the bottom.  Instead, isolate a bargain or two and start nibbling between now and year end.   Conservative investors may want to wait for the outcome of the Fed meeting and options expiration but the time to buy is when stocks are cheap, not when they are expensive.

Former Brazilian President Dilma Rousseff is 71 today.

James M. Meyer, CFA 610-260-2220

Additional information is available upon request.

* – Boenning and Scattergood may act as principal in buying this stock from or selling it to the public.

# – The author of this report or accounts under his management at Tower Bridge Advisors owns this security.

Additional information on companies in this report is available on request.  This report is not a complete analysis of every material fact representing company, industry or security mentioned herein.  This firm or its officers, stockholders, employees and clients, in the normal course of business, may have or acquire a position including options, if any, in the securities mentioned.  This communication shall not be deemed to constitute an offer, or solicitation on our part with respect to the sale or purchase of any securities.  The information above has been obtained from sources believed reliable, but is not necessarily complete and is not guaranteed.  This report is prepared for general information only.

Boenning & Scattergood, Inc. – Member FINRA / SIPC.

It does not have regard to the specific investment objectives, financial situation or the particular needs of any specific person who may receive this report.  Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed in this report and should understand that statements regarding future prospects may not be realized.  Opinions are subject to change without notice. 

It’s been a wild week on Wall Street, even by recent standards.

By 11am yesterday, the Dow had dropped almost 1600 points in about 1 ½ trading sessions. Then it rallied into the close reducing yesterday’s losses to less than 80 points.  The NASDAQ Composite actually closed higher.

What causes such volatility?  The question itself denotes uncertainty.  It is also important to note that while the volatility causes a lot of angst, the moves have been largely directionless with stocks still within a trading range since Labor Day.  Today’s labor report isn’t going to be very helpful for those trying to decipher whether the U.S. economy is weakening and, if so, by how much.  Non-farm employment growth of 155,000 was modestly below expectations but not by enough to matter.  Construction labor growth was subdued, probably weather related.  The unemployment rate remained at 3.7% and wage growth year-over-year was 3.1% as predicted.  Given that productivity growth remains above 1%, the real impact of higher wages won’t move the overall inflation number far from the Federal Reserve’s 2% target.  The net of all this is that the expectation that the Fed will raise rates on December 19 in less than two weeks with rise from the 70-80% range it has been in. The economy is clearly strong enough to sustain one more rate increase.

However, based on recent statements from Fed officials, including Chairman Jerome Powell, subsequent increases will be data dependent.  Bond markets, which have risen sharply over the past week, have pretty much priced out any further rate increases. The stock market, judging from recent weakness, still frets that more than one increase is coming next year.   I believe the general consensus within the Fed is that one or more may be necessary next year but that judgment can be deferred at least until March. By then the impact of 4 increases in 2018 will have begun to work their way through the economy.

The overall big fear of the moment and the greatest cause of uncertainty I alluded to above, is whether we are simply set to grow at a slower pace or whether we are beginning the process of going from robust growth to recession.   There are certainly early indicators of a slowing economy.  The stock and bond markets themselves are leading indicators.  Housing starts have started to decline.  Auto sales have plateaued.   Commodity prices are weakening, particularly oil. That may help that part of the economy that consumes oil and other commodities but it will reduce investment spending among independent oil companies if prices fall any further below $50 WTI and stay there for any length of time.  There is a big OPEC meeting set to conclude this morning.  At the moment, it appears OPEC plus Russia have agreed to production cuts of close to 1.3 mm barrels per day.  Add in an announced Canadian cutback of close to 300,000 barrels per day and one can see how inventories of crude, now close to 40 mm barrels worldwide, will begin to come down.  That should stabilize crude prices.  Add the OPEC announcement to a benign labor report this morning and perhaps some near term calm can be restored to markets.

Finally, one can add in a tweet from President Trump this morning that said trade talks with China are going well.  I suspect that is code to say the asset of Huawei’s CFO last week isn’t stopping negotiations. Whatever the President might say in a one-line tweet to try and calm markets, trade negotiations with China are going to take a very long time and any comment this morning, while psychologically helpful to markets, has no real meaning.

Getting back to the market’s uncertainty, times of transition always bring with them an enlarged list of worries.  Before addressing some of them, let me reiterate one point emphatically.  Economic growth cycles don’t die of old age. They die when imbalances occur.  Too much debt, overuse of toxic derivatives, and sloppy banking practices led to a financial crisis that caused the Great Recession of 2007-2009.  Excessive exuberance surrounding Internet stocks caused a stock market bubble in 2000.  Ditto 1987.    Double digit inflation forced the Fed to step on the brakes hard in 1980 causing back-to-back recessions.

One can argue that at the start of 2018, markets were a bit overly enthusiastic. Corporate profits were about to rise by more than 20% courtesy of a huge corporate tax cut.  Stocks reached 18-19x estimated 2018 earnings, about 20% above historic norms.  You can do the math; in 2018 20% growth in earnings has been offset by a repricing of assets back toward historic norms.  We can look at this in another way.  Stocks, bonds, and other financial assets became overpriced as central banks flooded markets with excess liquidity and priced credit below the rate of inflation.  As a result, asset prices became artificially inflated.  As rates have moved toward normal and the Fed gradually reduces the size of its balance sheet, asset prices also move toward normal.

I can’t say the process is over, but it should be close.  Whether a December rate hike, virtually certain after today’s labor report barring an unexpected collapse in financial markets over the next ten days, more Fed officials believe we will be close to a neutral interest rate.  Note that if no further increase happens in 2019, the Fed will still be tightening via the planned reduction of its balance sheet by $600 billion.  If I had to guess right now, and it would only be a guess, I would expect 0-2 further rate increases next year.  Zero would be operative if the rate of economic slowdown intensifies.  Two could happen if growth remains about 2.5% and wage increases accelerate from the current pace.

Gradually, the uncertainties are unwinding.  Oil markets should find some price stability in the $45-60 range.   The Fed will almost certainly take a more dovish tone at its next meeting.  World economies are slowing and the pace of deceleration is an obvious concern.  But unlike 2007 when ticking time bombs, like the collapse and bankruptcies of sub-prime mortgage lenders were taking place and the use of CMOs and related derivatives were exploding, I don’t see anything similar this time around.

Rather, I believe we have been in a rolling bear market where over half of the S&P 500 is now 20% or more below recent highs. The declines started in the second half of 2017 when retail stocks collapsed.  Auto and housing stocks started to fall early this year as interest rates started to rise.  Banks quickly followed.  Industrials fell as tariff fears rose.  Oil stocks collapsed this fall as oil prices tanked. One can argue whether or not the process is complete (we never seem to know exactly until after the fact). But barring a recession, most of the damage appears to have been done and most stocks are now at or below historically normal P/E ratios.  Perhaps the last shoe to drop is a resetting of 2019 profit expectations to account for slightly lower growth expectations and very strong currency headwinds in the first half of 2019.

Thus, my conclusion is that we are well along in the process of resetting expectations to (1) normalized interest rates and central bank policy, and (2) more modest growth ahead.   All this week and last week, investors were fixated on the possibility or even the likelihood of an inverted yield curve.   While it has been flattening for several months, the 2-10-year Treasury or, more important, the 3 month-to-10-year Treasury spread do not appear ready to invert.  Moreover, while credit spreads have widened a bit, there have not blown out the way one would expect if a recession was pending.    While I don’t rule out a recession, I think the odds are far greater that we are simply transitioning to a period of slower growth.  The transition requires some adjustments and the markets have been making them since February.   I believe we are much closer to the end than the beginning.  If there is “bad” news, I think it is that markets have gone from overvalued to fairly valued.  If 2700-2800 in the S&P 500 is an expected normal value, we effectively are at the bottom end of that range right now.  That limits both the upside and downside. I still see a market struggling for a couple more months before resuming an upward path in line with historic growth, i.e. rising 5-10% per year including dividends.  All this presupposes no major escalation of a tariff trade war with either China or Europe.

 

Today, Terrell Owens is 44.  Larry Bird turns 61.

 

 

James M. Meyer, CFA 610-260-2220

 

Additional information is available upon request.

* – Boenning and Scattergood may act as principal in buying this stock from or selling it to the public.

# – The author of this report or accounts under his management at Tower Bridge Advisors owns this security.

 

Additional information on companies in this report is available on request.  This report is not a complete analysis of every material fact representing company, industry or security mentioned herein.  This firm or its officers, stockholders, employees and clients, in the normal course of business, may have or acquire a position including options, if any, in the securities mentioned.  This communication shall not be deemed to constitute an offer, or solicitation on our part with respect to the sale or purchase of any securities.  The information above has been obtained from sources believed reliable, but is not necessarily complete and is not guaranteed.  This report is prepared for general information only.

 

Boenning & Scattergood, Inc. – Member FINRA / SIPC.

 

It does not have regard to the specific investment objectives, financial situation or the particular needs of any specific person who may receive this report.  Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed in this report and should understand that statements regarding future prospects may not be realized.  Opinions are subject to change without notice.

The G-20 summit this weekend is a binary event for financial markets

Either Trump and Xi reach a temporary truce and start negotiations sending stocks higher, or the trade war escalates and market move lower, perhaps to a new correction low.   The odds favor the former but the risks of the latter aren’t trivial.

After a very tough Thanksgiving week with stocks down about 4%, markets have turned around this week on the heels of strong Black Friday and Cyber Monday retail sales.  Markets are also anticipating that the Trump/Xi meeting scheduled during this week’s G-20 meeting will result is a less combative tariff/trade environment.

As I have outlined before, there are three major events happening between now and mid-September. For markets, the most important one is the G-20 meeting.  The consensus expectation is that Trump and Xi will meet on friendly terms and exit with a handshake and a commitment to work together to solve trade and other issues.  Depending on whether anything of substance happens during their talks, Trump may or may not go forward with a plan to raise tariffs on approximately $200 billion of goods in January. The extremes that any actual substantive agreement will emerge or that Trump will be so dissatisfied that he will announce 10-25% tariffs on everything China exports to the U.S. appear to be low.  The least likely outcome is anything resembling a formal agreement.

Remember that the big issue revolves around forcing China to respect intellectual property.  The country has been stealing it in some manner for decades.  The country has very ambitious growth goals between now and 2025 and the easiest way to get there is to piggyback on the intelligence of others.  President Trump looks at the world as a zero sum game.  Every dollar that flows to China or is used to buy Chinese goods is a dollar not spent on U.S. products.  It’s. “I win; you lose”.  There isn’t a world where everyone wins.

We also know the following about Trump.   He has a huge ego and likes world leaders to stroke it.  Xi knows this and persistently tries to make Trump feel that he is China’s greatest ally.  Trump likes strong leaders whether they be Xi, Putin or even Kim Jong Un.   But, at the same time, he’s not completely blinded.  He knows China has been abusing our intellectual property for decades.  Ending those abuses are a key part of his agenda. Trump keeps score.  He wants to fulfill all his campaign promises.  He isn’t so naïve to believe China will suddenly fall in line with policies of the developed world but he needs to show movement in that direction.  Xi’s job is to allow the perception of progress to happen while still being able to do business the Chinese way as much as possible.

It took almost two years to get a NAFTA rewrite done and it is still a work in progress.  A Chinese agreement will be a lot more complex.  Robert Lighthizer, our trade representative, is a no nonsense guy.  No one is going to stroke his ego.  With that said, the NAFTA rewrite isn’t a bold change from the original plan.  It is merely an update.   Any China deal will be much more complex and will take at least most of 2019 to solve.  The issue for markets is how much hubris will markets have to deal with before there is any agreement.   We all know Trump’s strategy by now.  He starts with fire and brimstone, pauses with a smile or two, restarts to war of words, and backs away again. This week, he was talking tough promising tariffs on everything if China didn’t capitulate by this weekend.

As I noted above, the most likely outcome is for a handshake and genuine cooperation to move talks forward.  But if Xi overplays his hand and doesn’t offer to put any serious discussion of intellectual property or open markets on the table, Trump could easily leave Buenos Aires angry and start up the fire and brimstone speech again promising tariffs of 25% on $200 billion of goods in January with more to come.

The reason that isn’t the consensus outcome is because Trump looks at the stock market as a barometer of the economic success of his administration. Right now, the market doesn’t look so hot.  His response is to lash out at the Federal Reserve for raising interest rates.  But unlike how he tries to sway the American public on issues like immigration, financial markets react to facts and forecasts.   Markets now are in decline because they perceive growth decelerating and inflationary pressures rising.   Adding an escalating trade war to that mix will only send the market lower.  But, and this is a minority view, he could wake up Sunday and go back toward fury if he feels he isn’t getting to first base with Xi knowing that he still has time to pull back from the brink between now and January when the next installment of tariffs would be set to go into effect.

One should remember that recent multi-national conferences haven’t gone all that well for Trump who has become more isolated from world leaders.  The recent NATO meeting and the World War I remembrance are to recent examples.  Each time he comes home mad, he reacts.  Thus, this week’s G-20 meeting is a binary event for markets.  Either he makes temporary peace with Xi and markets react positively or he comes home mad and markets move lower.  Investors can gamble on the outcome or they can standstill and react to the outcome.  Against that backdrop, remember that we are in a decelerating phase of our economy with a strong dollar backdrop, both unfavorable for stocks. With that said, one could make a case that by now, markets have priced in some degree of deceleration next year, long term interest rates have stopped going up, and a slower growth rate could push the dollar lower.

The other two events coming soon, the OPEC meeting next weekend, and the FOMC meeting in mid-December, seem to have become less important.  Virtually everyone now expects OPEC to pull back on production after having raised it anticipating U.S. sanctions on Iran that never happened.  OPEC wants to stabilize oil prices near the current $50 level.  With that said, as U.S. oil production increases, OPEC has less control over oil.  From now on, market forces will dictate oil prices more and more.  The world knows where there is enough oil to meet demand.   Price trumps output.  By that I mean, Saudi Arabia or Russia can’t adjust output enough to compensate for a 20%+ drop in oil prices.  As for U.S. producers, with prices now near $50 at key shipping points and prices closer to $40 at the Permian wellheads, there is bound to be less drilling in the months ahead.  Slower production growth will stabilize prices and probably even move them up a bit between now and Memorial Day.  Indeed, if you look at the last 5 years or so, there seems to be a ceiling near $75 WTI and a floor of about $40.  Movements above and below those levels aren’t sustainable. High prices invite too much production and low prices will halt new investment.

The last event, the FOMC meeting, will almost certainly seen the Fed raise interest rates by 25 basis points. The only way that won’t happen is if Trump leaves the G-20 meeting promising massive new tariffs sending financial markets into a tailspin.   But, at the same time, the Fed is likely to emphasize that, going forward, any further increases will be data dependent. That doesn’t mean that there won’t be any.  The Fed will watch carefully for rising inflationary pressures and be quick to raise rates further if those pressures rise or if growth accelerates to unsustainable levels.   Similar remarks have been made by various Fed officials this week and such an outcome is probably baked into stock and bond prices today.  10-year Treasuries are very stable at the moment around 3.05%, down about 20 basis points from a recent peak.  Perhaps the most important remaining input for the Fed before its mid-December meeting is the December 7th release of November employment data. The Fed will be watching both the size of the job growth and wage inflation data.

Thus, the next few days are key to the market’s near term performance.  Either trade becomes front and center with greater confrontation between China and the U.S., or everyone exiting smiling and the pressures recede, at least for now.  This weekend’s meeting is a binary event.  Either this week’s rally gets extended or quickly erased.  We will know soon.   Regardless, stocks at the moment trade slightly below fair value.  That means I wouldn’t be real enthusiastic to buy a post G-20 rally but would look at my shopping list if the market takes another leg lower should Trump come home mad.

Today, Jon Stewart is 56.  Singer Randy Newman is 75.

 

James M. Meyer, CFA 610-260-2220

 

Additional information is available upon request.

* – Boenning and Scattergood may act as principal in buying this stock from or selling it to the public.

# – The author of this report or accounts under his management at Tower Bridge Advisors owns this security.

Additional information on companies in this report is available on request.  This report is not a complete analysis of every material fact representing company, industry or security mentioned herein.  This firm or its officers, stockholders, employees and clients, in the normal course of business, may have or acquire a position including options, if any, in the securities mentioned.  This communication shall not be deemed to constitute an offer, or solicitation on our part with respect to the sale or purchase of any securities.  The information above has been obtained from sources believed reliable, but is not necessarily complete and is not guaranteed.  This report is prepared for general information only.

Boenning & Scattergood, Inc. – Member FINRA / SIPC.

It does not have regard to the specific investment objectives, financial situation or the particular needs of any specific person who may receive this report.  Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed in this report and should understand that statements regarding future prospects may not be realized.  Opinions are subject to change without notice.

Economists adjust forecasts for 2019

As more and more economists adjust forecasts for 2019 and point to rapid deceleration, we believe the correction may be near its final phase. Assuming U.S. growth slows to a level below 2% by the second half of 2019, favorable interest rate and currency trends will stabilize or even improve corporate earnings.  We in the early days of an economic slowdown and not a recession presuming there is no further meaningful escalation of trade wars.

Stocks fell again on Friday as equities lost 4-5% in value last week.  Investors are increasingly concerned with forward looking growth in the U.S., as they should be.  We have been highlighting not only the pending slower pace of growth into 2019, but the impact, in the first half of next year, from the falling dollar.  On top of this news, the big additional factor has been a sharp drop in oil prices over the past month.  While President Trump has been pushing for lower oil prices, the sharpness of the decline has rattled investors and added uncertainty to the marketplace.  With housing, autos and semiconductors in decline, the addition of another declining sector certainly weakens the economic outlook further.

With all that said, there are still few signs that we are headed for a recession.  Consumer demand remains strong, productivity has been increasing slowly, inflation is contained and the number of workers is at record levels.  But it is becoming increasingly clear that the energy provided to our economy from tax cuts and expanded fiscal spending don’t seem to be enduring.  The threats and imposition of tariffs meant to provide more balanced trading relationships between the United States and our key trading partners so far has borne little fruit.  Investment spending grew well under a 1% annual rate in the third quarter and the sharp decline in oil prices almost certainly means capital spending in the oil sector, a key market for investment spending will begin to decline very soon.  Watch closely the change in rig count published weekly.   They declined two weeks ago.  One week isn’t a trend but all trends have to start somewhere.   While the U.S. government may be tempted to expand fiscal spending further to support economic growth, the rapid increase in annual deficits, that will continue for several years barring efforts to rein in entitlements, probably limits what can be done responsibly.

President Trump looks at financial markets as a barometer to measure his economic performance.   While he denied, via Twitter, that he was dissatisfied with Treasury Secretary Steven Mnuchin’s performance, he appears set to make him a scapegoat for the market’s decline.  Perhaps his dissatisfaction with the weak stock market will impact how he approaches the G-20 meeting later this week.  One doesn’t have to be a rocket scientist to know that any belligerent statement regarding possible future tariffs, particularly against China, will push stocks down further. While he will waive that stick (Mr. Trump seems averse to using carrots), he has been trying hard to make nice to China in recent weeks suggesting that, at a minimum, he will give the Chinese some slack to begin negotiations rather than bludgeon them further with more tariffs.  But when two strongmen like Trump and Xi get together and at least one (and maybe both) look at the world in an “I win, you lose” vision, plans going in may not match the reaction going out.   Thus, while logic suggests some degree of near-term tranquility, at least in relation to trade, nothing is certainty until the meetings are over and everyone returns home.

Besides oil, the other big concern has been the Fed.  Fed Chairman, Jerome Powell, will speak a couple more times before the mid-December FOMC meeting.  He isn’t likely to tip his hand but he might change his tone.  Indeed, other Fed officials have been doing that for him.  While odds still strongly favor a quarter point rate increase in the Fed Funds rate in two weeks, the Fed is likely to acknowledge the economic weakness beginning and will state unequivocally that any future increases will be predicated on maintaining economic strength while being mindful of inflation.  Two months ago, many economists were forecasting growth in the second half of 2019 of 2.5-3.0%.  Now there are some predicting second half growth of less than 1.5%.  I suspect, when the smoke clears, numbers will come somewhere in between.  If growth deceleration picks up steam, long term interest rates will fall and the dollar will weaken.  This assumes no further acceleration of trade wars.  The weaker growth will be accompanied by a slower pace of employment growth and decreasing inflationary pressures.  If the dollar starts to weaken over the course of the next few months, then earnings in the second half of 2019 could actually accelerate after flattening, or even falling, in the first half of the year.

Finally, let me look back at oil.  While global demand may be slowing slightly, the real reason for the sudden drop in oil prices is a surge in supply as U.S. production accelerated and both Saudi Arabia and Russia increased production in front of supposedly pending Iranian sanctions.  When President Trump pulled the plug on those sanctions, prices collapsed.  They are normally weak in the fall, a combination of weak seasonal demand and refineries going offline for maintenance.  Thus, the sharp increase in supply against weak seasonal demand ignited the sharp selloff.  Next week OPEC meets and will likely agree to pull back production to levels that existed before Mr. Trump threatened sanctions on Iran.  Will that be enough to stop the slide?  Most say no but it will certainly help.  What is clear today is that the U.S. is the new marginal producer.  Unlike Russia and Saudi Arabia, which can turn production on or off on command of its national leaders, production in the U.S. is dictated by supply and demand.  If prices fall through the $50s and into the $30s, we will get a repeat of 2015 and 23016 when rig counts fell by almost 80%.  The excesses aren’t as great this time around, OPEC will cut its production sooner, and the U.S. might yet impose sanctions of some kind on Iran.  But, in the short term, the path of least resistance is still lower although there may be some short-term firming around the OPEC meeting.  Note, however, that oil prices have a strong seasonal component and it is rare for prices on Memorial Day to be lower than they were the previous Thanksgiving.  Therefore, expect some firming by spring although the weaker pricing environment probably means the rebound both in profits and investment spending within the energy sector will be less than what one would have predicted two months ago.

Markets remain dominated by institutional investors.  Many are hedge funds whose performance year ends in a month. Right now, that month matters to many portfolio managers.  They want to be where the momentum is.  Over $1 trillion has come out of yesterday’s momentum names. What seems to have been working best has been defensive issues from consumer staples to utilities.  Now these stocks are overpriced, at least the ones, that have had the most positive momentum.  The real winners of 2019 probably lie in between, companies that can continue to grow earnings in a decelerating economy but whose share price hasn’t become swollen by the swing in momentum from super growth to dividend-supported value.

I think it is important to note that the correction we are in has gone a long way to discounting a very tough first half of 2019, one with rapidly decelerating growth in the U.S. combined with very negative currency impact on international earnings.  By the second half of next year, however, assuming the predictions of decelerating growth evolve as predicted, the environment should change for the better even if growth is below 2% assuming a more favorable currency and interest rate environment. There is a temptation, as markets reach bottom, to get excessively gloomy.  Indeed, that is what makes bottoms.  Right now, markets are probing for a bottom. We might even need a cathartic 1-2 day blowoff decline of scary proportions built on a spike in volume.  It happens that way more often than not but it isn’t a prerequisite for a bottom.  Indeed, we came close to that last week and that could have been the bottom.  A rally today wouldn’t prove that but a sustained rally all week might.   In any case, I think we are close to the low for this correction.  If it hasn’t already happened, I think it will occur between now and mid-December.

Today, Tina Turner is 79.

 

James M. Meyer, CFA 610-260-2220

 

Additional information is available upon request.

* – Boenning and Scattergood may act as principal in buying this stock from or selling it to the public.

# – The author of this report or accounts under his management at Tower Bridge Advisors owns this security.

 

Additional information on companies in this report is available on request.  This report is not a complete analysis of every material fact representing company, industry or security mentioned herein.  This firm or its officers, stockholders, employees and clients, in the normal course of business, may have or acquire a position including options, if any, in the securities mentioned.  This communication shall not be deemed to constitute an offer, or solicitation on our part with respect to the sale or purchase of any securities.  The information above has been obtained from sources believed reliable, but is not necessarily complete and is not guaranteed.  This report is prepared for general information only.

 

Boenning & Scattergood, Inc. – Member FINRA / SIPC.

 

It does not have regard to the specific investment objectives, financial situation or the particular needs of any specific person who may receive this report.  Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed in this report and should understand that statements regarding future prospects may not be realized.  Opinions are subject to change without notice.

Stock prices are all about earnings, interest rates and the dollar.

The cause of the October/November decline is a significant reduction in forward looking earnings expectations tied to both slower future growth and a strong dollar. If the peak stress is to be in early 2019, stocks, which look ahead, may be near the end of their correction.

Stocks fell sharply yesterday extending their down day losses to almost 4%.  The selling accelerated after President Trump strongly expressed support for Saudi Arabia, a signal markets took to mean that any production cut announced by OPEC at its December 6 meeting will be less than previously expected.  As a result, oil prices tumbled and turned the energy sector into the worst performing sector in yesterday’s market.

With the U.S. now exporting more than 3 million barrels of oil per day as the largest producer of oil in the world and likely to increase next year as new pipeline capacity comes on stream connecting key fields to the Gulf Coast shipping ports, it could well be that low prices are more destructive to our economy than productive.  Yes, low prices provide some benefit to consumers and industries dependent on energy input.

In that regard, a new report out this morning showed durable goods orders, ex-defense and aircraft were flat in October after posting small declines in August and September.  One of the keys supporters of the Trump tax cuts suggested was that a large corporate tax cut would provide capital to support a surge in investment spending.  While spending did accelerate in the first half of 2018, it appears to have slowed markedly since mid-summer.  Part of the early year strength was energy related as oil companies sharply expanded production. In fact, production rose so fast that it outstripped to ability of existing pipelines to move product to appropriate markets.  While spending for new pipelines has accelerated, drilling for new oil in areas where pipeline capacity was insufficient slowed.  Now, as the industry can look forward to mid-2019 when new pipelines will be coming on, collapsing prices may give drillers pause relative to starting new wells.

The supply/demand imbalance that has caused the sharp drop in oil prices is almost all due to an expansion in supply.  Even with some slowing in worldwide economic growth rates, expanding economies in China, India and other emerging markets is keeping demand buoyant.  But with the expansion of production in the U.S. and the decision by President Trump to delay sanctions on Iran just as it was pressuring Saudi Arabia and Russia to increase production to offset the impact of sanctions, has led to a sharp drop in prices.   While Mr. Trump’s decision to stand by Saudi Arabia 100% may reduce the size of the production cut planned in December, the Saudis and the Russians are highly dependent on the cash flow from oil sales.  There is no way that a modest increase in supply will offset a 25%+ decrease in the price of a barrel of oil.  Prices are normally weakest at this time of year anyway after refineries go down in the fall for maintenance and inventories of crude build up.  Saudi may lessen the planned supply cut in December but, as P.T. Barnum said, once fooled, shame on you; twice fooled, shame on me.  Mohammed bin Salman may owe a bit of gratitude to President Trump but just as Mr. Trump persistently puts America first, he must put Saudi first.  A further collapse in oil prices is not in his interest.  As noted above, I’m not confident it is in our interest either.  A good part of the profit recession of 2015 related to a lack of spending and income in the U.S. oil patch.

Getting back to the market as a whole, I want to start by reiterating that stock prices are almost entirely a function of earnings, interest rates and the value of the dollar.   Earnings continue to grow but it is clear that growth rates are decelerating.   Moreover, while U.S. GDP appears to be on a path to slow to 2-3% next year from 3%+ this year and a peak of 4.2% in the second quarter, earnings growth next year could almost disappear entirely in the first half for companies that do a lot of business overseas.   In the first and second quarters of 2019, the year-over-year increase in the value of the dollar will approach 10%. That isn’t as extreme at the 20%+ hit in 2015 that caused an actual profits recession, but it is of sufficient scope to keep the rate of earnings increase to low single digits.   Obviously, if the dollar rises further, it will become more of a headwind.  But rising currency values make our goods more attractive to others and raise the price of imports.  Currencies serve to correct worldwide economic imbalances.  If the U.S. is growing much faster than everyone else, a rising dollar will serve to reduce that discrepancy as we export some of our growth to the benefit of others. Thus, over time, one should expect the pace of increases in the value of the dollar to slow or even reverse.  For equity investors, that suggests the peak year-over-year headwind should be in the first half of 2019.  Since stocks reflect perceived economic circumstances 6-9 months ahead, the correction of October/November should be discounting that fact right now.

Next, let’s look at interest rates.  Today, the 10-year Treasury yields a tad over 3.05%, about 20 basis points below recent peaks.  As growth forecasts slow and inflationary pressures recede, yields should stabilize or even decline.  The Fed is searching for the neutral Fed Funds rate that neither gooses the economic nor impedes growth.  It feels 3-4% growth is beyond what our economy can sustain without forcing prices higher.  Sustainable growth is closer to 2%.   The question today is whether the Fed needs to do any more to move growth lower.   Fiscal stimulus passed in 2017 and 2018 will still be flowing through the economy in 2019.  But the tax cut benefits will begin to abate and the impact of tariffs will hurt. They serve as a tax lowering demand and squeezing margins.  Tariff uncertainty is also a major factor curtailing investment spending.  Without an acceleration in investment spending, it is unlikely that we will experience a durable lift to productivity, an essential to keeping growth elevated above 2%.

Putting all this together, we face very slow profit growth in 2019, with modest changes to the value of the dollar and the course of interest rates.  The Fed will almost certainly raise rates 25 basis points in December but will show increased uncertainty over the need for many further increases.   If, as many economists predict, we are already on a glide path to 2% growth, there may not be a need for any further increases.  The next possible increase would be in March.  If not then, it could be delayed until June.   The data between now and then will dictate the Fed’s actions.

I think markets today are not fussing any more about the Fed.  They remain nervous that Trump could decide to go all in on tariffs in January if talks with China late next week go badly.  But such a move would have grave economic consequences for our own economy over the short term and would almost certainly lead to another significant leg down in stock prices.  Mr. Trump has said repeatedly that he regards the stock market as a barometer of his administration’s economic success.  He almost certainly doesn’t want to be the cause of a further decline of 10% or more.   Moreover, if he puts tariffs on all Chinese goods and China doesn’t flinch, what’s his next step?  He may not have thought that through but I am sure many of his advisors have.  He may have to take bolder action some day but my guess (and it can only be a guess given Mr. Trump’s volatility) is that he will stand pat for a while and let negotiations move forward.  We will know more within a couple of weeks.   If that proves accurate, within 3 weeks, markets will have a lot more certainty regarding the path of tariffs, oil prices, and interest rates.

But the reason stocks are weak today is really all about earnings.  Estimates coming out of the summer were for growth of 10%+ next year and now it looks like something less than 5% is more likely with negative growth in the first half of 2019 possible for most multi-national companies.  That is the biggest cause for the decline we are experiencing.  In the stock market, it isn’t about GDP; it’s about EPS (earnings per share).

We have done the exercises several times in recent weeks that suggest fair value for the S&P 500 is somewhere in the 2700-2800 range.  At 2900+, the late summer highs, stocks were overpriced.  Today, with the S&P at 2641, they are modestly underpriced.  Stocks can remain overvalued or undervalued for a considerable length of time but they eventually correct to the mean.   There has been a lot of technical damage to this market and one should tread carefully.  Today, there is a full day of trading but volume should dry up this afternoon at traders head off for Thanksgiving.  Friday is a half day due to the holiday.  With very light volume likely, I wouldn’t expect as much volatility but one never knows when emotions run high.  Traders are looking for a capitulation flush where stocks drop even more sharply than the last couple of days on very high volume.  That doesn’t mean it has to end that way.  But given recent behavior, the mood is no longer buy the dips; it’s sell the rallies. That will probably happen until there is that cathartic flush or traders are convinced that a successful retest of the October/November lows has occurred.  With all that technical mumbo jumbo aside, what long term investors need to keep in mind are two thoughts.  First, markets that are now below fair value have less long term risk than buoyant markets far above fair value.  Second, if you believe in asset allocation, slowly you might put fresh money into stocks, not bonds to compensate for the recent decline in equity prices.  That may be hard to do but today you would be a buyer at much more favorable prices than you were two months ago.

Today, Michael Strahan is 47.  Goldie Hawn turns 73.

 

James M. Meyer, CFA 610-260-2220

 

Additional information is available upon request.

* – Boenning and Scattergood may act as principal in buying this stock from or selling it to the public.

# – The author of this report or accounts under his management at Tower Bridge Advisors owns this security.

 

Additional information on companies in this report is available on request.  This report is not a complete analysis of every material fact representing company, industry or security mentioned herein.  This firm or its officers, stockholders, employees and clients, in the normal course of business, may have or acquire a position including options, if any, in the securities mentioned.  This communication shall not be deemed to constitute an offer, or solicitation on our part with respect to the sale or purchase of any securities.  The information above has been obtained from sources believed reliable, but is not necessarily complete and is not guaranteed.  This report is prepared for general information only.

 

Boenning & Scattergood, Inc. – Member FINRA / SIPC.

 

It does not have regard to the specific investment objectives, financial situation or the particular needs of any specific person who may receive this report.  Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed in this report and should understand that statements regarding future prospects may not be realized.  Opinions are subject to change without notice.

Storm clouds remain and investors continue to be nervous.

But the skies should gradually clear next year if trade wars don’t intensify.  

Stocks continued to rally on Friday but the rally wasn’t wide spread and it faded in the end.  Barring any sudden positive news, one should expect a choppy market this holiday week in advance of the G-20 summit next weekend at which time Presidents Trump and Xi are scheduled to meet and, hopefully, set the stage for trade negotiations.  But both are headstrong leaders and either, upset at not getting their way, could back out setting the stage for a destructive trade war.  Wall Street is still betting that some accommodation, which may simply mean the deferral of trade hostilities, will happen. Xi doesn’t need to help slow Chinese growth further while Trump, who looks at the stock market as a scorecard for his economic program, doesn’t want to see another sharp drop toward bear market levels.

With that said, Wall Street remains nervous.

  1. Corporate eruptions have bond investors on edge. Credit spreads have begun to widen and risks are clearly rising even as the economy continues on a 3% growth pace.
  2. Trade frictions will remain elevated at least until the G-20 meeting.
  3. Oil prices have dropped sharply as Trump hoodwinked the Saudis into expanding production as we was making deals to ease possible sanctions on Iranian oil. Now the Saudis promise to go to the December 6 OPEC meeting and push for a production cut.  Our relations with China, Iran, Saudi Arabia and Europe continue to deteriorate.  That may not prove harmful economically but it certainly won’t be good.
  4. The Federal Reserve is likely to increase short term interest rates on December 13 unless the unemployment rate jumps with the November employment report or some other economic indicators show a sharp deceleration in our economy between now and then. That is unlikely. While we expect the Fed to acknowledge some slowdown in growth at the meeting, traders will remain nervous that future rate cuts may force economic growth to decline more than expected.
  5. The strong dollar almost guarantees international revenues and earnings, expressed in dollars, will decline in the first half of 2019.

So what’s the good news?  Actually, there is quite a bit.

  1. There is no significant reason to expect an economic slowdown to morph into a recession. Employment and productivity are still growing. Confidence remains high. While the short term lifts of corporate tax hikes and expansionary fiscal spending elevated growth from 2% to 4%, as those forces recede, the logical expectation is that growth returns to 2% or a bit better, not zero.
  2. Less growth reduces inflationary pressures. If productivity can grow 1.5% or so, input costs, including wages, can grow 3.5% and still leave inflation close to the Fed’s 2% target.
  3. The dollar won’t rise indefinitely. We expect maximum year-over-year strength to begin to dwindle in the second half of 2019.
  4. Trade wars are destructive and won’t continue indefinitely. It is entirely possible that trade war fears are at a peak right now.
  5. Despite worries that the Fed will move rates up too far, too fast, without inflation data to support a quarter point rate increase each quarter, we would expect the pace of rate increases to slow in 2019.

As we have noted often over the past two weeks, we believe current prices are close to fair value which suggests stock prices should rise gradually with rising earnings over the next year or more.  While reported earnings may be flat in the first half of 2019 if the dollar remains strong, companies who primarily do business in the U.S. will continue to grow.  Beyond midyear, corporate earnings growth should spread to most companies.  If stocks look 60-9 months ahead, markets today should be anticipating the worst, i.e. a slowdown in growth and flattening corporate profits in the first half of 2019.  But as the clouds clear and markets start to look further out, the bull market will resume and stocks could move higher.  If there are no new tariffs in early 2019 and the Fed can convince markets any future rate increases in 2019 will be data dependent, we believe a nice year end rally could ensue.

Today, Ryan Howard is 39.   Jodie Foster is 56.  Meg Ryan is 57.  Allison Janney turns 59.  Larry King is 85.

 

James M. Meyer, CFA 610-260-2220

 

Additional information is available upon request.

* – Boenning and Scattergood may act as principal in buying this stock from or selling it to the public.

# – The author of this report or accounts under his management at Tower Bridge Advisors owns this security.

Additional information on companies in this report is available on request.  This report is not a complete analysis of every material fact representing company, industry or security mentioned herein.  This firm or its officers, stockholders, employees and clients, in the normal course of business, may have or acquire a position including options, if any, in the securities mentioned.  This communication shall not be deemed to constitute an offer, or solicitation on our part with respect to the sale or purchase of any securities.  The information above has been obtained from sources believed reliable, but is not necessarily complete and is not guaranteed.  This report is prepared for general information only.

Boenning & Scattergood, Inc. – Member FINRA / SIPC.

It does not have regard to the specific investment objectives, financial situation or the particular needs of any specific person who may receive this report.  Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed in this report and should understand that statements regarding future prospects may not be realized.  Opinions are subject to change without notice.

After the recent sharp correction, markets are in no man’s land with not enough momentum to go much higher and no real rational reason to resume the recent correction. 

Until the G-20 meeting at the end of November, stocks could move in a choppy sideways pattern.

 Stocks were mixed yesterday, a day after a huge post-election rally and a day during which the Federal Reserve held interest rates steady and offered no further future guidance beyond what it already offered.  The post-meeting statement was virtually identical to the September statement except for an acknowledgement that capital spending grew more slowly in the third quarter. Stocks fell around the world overnight and futures point to a lower open this morning.

With the rally this week, stocks have now recovered about half of October’s losses.  From here, I expect the going will get a little tougher.  Over the next couple of weeks, there aren’t any obvious catalysts to push stocks up further other than seasonal trends.   We went into Q3 earnings season with some optimism that strong growth would stop the early October slide.  But while the numbers reported generally met or exceeded expectations, forward looking guidance was mixed at best and there were signs worldwide that growth rates were slowing.

Very few market observers see a recession in 2019.   Asked, many will offer the notion that a recession is a real possibility for 2020 but recessions don’t just happen out of the blue. The come about because of some economic imbalance.  The notion is offered that it will be the Federal Reserve that will create the recession by hiking interest rates too far too fast trying to stop a phantom inflation that doesn’t exist.  But that conclusion is based on a set of assumptions that stretches at least my imagination.  It presumes that Federal Reserve Chairman Jerome Powell will set, or perhaps more appropriately has set, a path of steady Fed Funds rate increases that will take the rate to something close to 3.5%, a number that would not only slow a robust economy but turn it negative.   That assumption presumes that Powell isn’t a pragmatic banker with a long business history but a stubborn ideologue.   Of course, that flies in the face of all past reality which suggests that he will be very data dependent.

The Fed’s primary mission is to maintain a stable currency.  That means keeping inflation in check.  To most Fed observers, that means inflation of about 2%, just about where it is today.  To be sure, there are pressures that have to be monitored that could push inflation higher.  With a 3.7% unemployment rate and wages rising 3.1% year-over-year, the Fed doesn’t want to relax as inflationary pressures increase.  But the most recent wage data actually shows month-over-month increases closer to 2%.  Crude oil prices in recent weeks have fallen 20% from their peak and other commodity prices are falling.  Productivity, the counterbalance to rising input costs, has started to rise.  On its present path, the Fed has been raising rates 25 basis points every quarter.  One can’t argue that such a pace has slowed the economy to date.  To the extent there has been any slowing, trade tariffs and related uncertainties would appear to be a larger influence.  I think the Fed will stay on its present course at least into mid-2019.  If there is no measurable change in inflationary pressure, it could skip a quarter and monitor the economy.  But if wages are rising at a faster pace, say 3.5-4.0% and growth holds well over 3%, then more increases will be forthcoming.  Conversely, if inflation stays tepid and economic growth slips below 3%, one should argue for at least a temporary end to rate increases.

Thus, in reality, there are almost no signs of a recession.  Sure, there will be one somewhere in the futures but not to the visible horizon.  That doesn’t mean, however, that equity markets are destined to rise indefinitely.  Indeed, there are many headwinds we face, some that could disappear soon and others that could pick up steam.

  1. Tariffs – Perhaps the biggest near term question is whether President Trump will implement more tariffs against China in January. The optimists will say that his bark is often harsher than his bite, that he will back away and let negotiations begin after he meets with President Xi of China at the end of November. But that requires Xi to acknowledge the need to allow a discussion of intellectual property rights.   There is little question that under his leadership, China has taken a backward step when it comes to economic fair play.  If Xi doesn’t want to meet Trump in the middle, Trump won’t hesitate to take a tougher stance.
  2. Slower growth – We may not see a recession near at hand but we don’t see 4% growth sustained either. Furthermore, growth in Europe and China are slowing. Europe has to deal with a central bank likely to be less accommodating, the conclusion of Brexit, and uncertainty in Italy.  China’s debt burden is beginning to look like a house of cards.  Slower growth often brings with it inventory liquidation.
  3. Dollar strength – Although our economy is slowing, it will still grow faster than economies in most other developed nations. We also will have higher interest rates.  While I am not a particularly good forecaster of currency, faster growth and higher rates are the key ingredients to a stronger currency.  Even if the dollar merely holds where it is today, the year-over-year strength in the dollar will cause a decline of as much as 10% in foreign earnings of U.S. companies expressed in dollar terms during the first half of 2019.
  4. Decelerating earnings growth – While the impact of the tax cuts are already factored into stock prices, the above factors may not be totally discounted. Standard forecasts still predict earnings growth of close to 10% next year. About 2% of that comes from share repurchases.  But if our economy grows at a nominal rate (before taking inflation into account) of 5% and the dollar weighs on international earnings, the only way to get to 8% growth before the impact of share repurchases is for profit margins to rise.  That seems a stretch in a decelerating economy.  I think a number closer to 2-3% is likely.

Putting all this together, it would appear fair value for stocks is pretty close to today’s prices.  If we are around fair value, then the risk of a 10% decline or a 10% rise is about the same.   Said in a different way, should the market rise toward 3000 on the S&P 500 by year end, as some predict, I would suggest taking some profits.  If stocks reverse and resume their correction, I would be a buyer on the dip.  Right now, especially after a very strong last two weeks, I would probably sit on my hands and do nothing.  Over the next few weeks, I would expect some backing and filling distilling both the effects of the October correction and the sharp snapback of the last week.  Key near term events to watch are the G-20 meeting at the end of November and coming inflation data.  Retailers will be reporting third quarter earnings but they aren’t all that important.  Q4 is the key and managments at this point in time can only speculate.  How do they know what I am going to buy for Christmas if I don’t know myself?

Today, former Eagle quarterback Sam Bradford is 31.  David Muir is 45.

James M. Meyer, CFA 610-260-2220

Additional information is available upon request.

* – Boenning and Scattergood may act as principal in buying this stock from or selling it to the public.

# – The author of this report or accounts under his management at Tower Bridge Advisors owns this security.

Additional information on companies in this report is available on request.  This report is not a complete analysis of every material fact representing company, industry or security mentioned herein.  This firm or its officers, stockholders, employees and clients, in the normal course of business, may have or acquire a position including options, if any, in the securities mentioned.  This communication shall not be deemed to constitute an offer, or solicitation on our part with respect to the sale or purchase of any securities.  The information above has been obtained from sources believed reliable, but is not necessarily complete and is not guaranteed.  This report is prepared for general information only.

Boenning & Scattergood, Inc. – Member FINRA / SIPC.

It does not have regard to the specific investment objectives, financial situation or the particular needs of any specific person who may receive this report.  Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed in this report and should understand that statements regarding future prospects may not be realized.  Opinions are subject to change without notice.

Election Day turned out as expected. Trump’s base gave him greater control of the Senate but Suburban America turned the House Democratic.

While there are open questions, don’t expect much from Congress.  The attention now turns to tomorrow’s FOMC meeting.

Stocks continued their recovery from the October swoon yesterday as investors focused on the mid-term elections.  The outcome, a split decision with the Republicans gaining seats in the Senate and Democrats wresting control in the House, seemed to satisfy the majority as futures point to another positive opening today.

While the headline results were just about in line with consensus there were some nuanced outcomes that bear mentioning.  It appears the power of President Trump, the campaigner, were reinforced by this election.  His focus was on retaining the Senate and he campaigned hard for a lot of Republicans headed for tight races.  Much of his attention was concentrated on races involving Democrat incumbents in Red states running for reelection.  While there are still three undecided Senate races (all of which are leaning Republican at the moment), it appears likely that the Republicans can gain as many as three seats.  If that stands up, the Senator with the most to lose could be moderate Susan Collins of Maine.  She was often the swing vote in tight contests.  With a larger Republican majority loyal to Trump, her power to be the pivotal decision maker could be reduced.  What all this means is that the ability to get more conservative judges appointed will increase.  Should another Supreme Court seat open up in the next two years, it would appear to be certain that another very conservative person would be seated without nearly as much to do as we just witnessed with the Kavanaugh confirmation hearings.

While Republicans can bask over the Senate victories, the House pivoted the other way.  At the moment, with about a dozen races still outstanding, it would appear that the Democrats will control at least 225 seats and take over control.   Unlike in the Clinton years, when there were many Blue Dog conservative Democrats in the House, the make up this time is almost 100% liberal.  Thus, at least between now and 2020, the odds of more tax cuts or the ability to make last year’s tax package permanent have been sharply reduced.  Total repeal of Obamacare is also highly unlikely.

There remain a lot of open ended questions that could be resolved fairly quickly in 2019.

  • Will there be any hint of cooperation between a Democratic-led House and President Trump? –  Perhaps a lot will settled early when the House picks a Speaker.  Nancy Pelosi, of course, wants to return to that role and she has promised to try and work with the President to find common ground.  While she is effective as a leader and has a strong base of popular support, there is also vocal opposition.   If House leadership decides to spend a lot of energy investigating Trump or doing other things deemed obstructionist, such efforts could backfire if not grounded in a very strong factual base.  The elections yesterday clearly demonstrate just how divided America is and the divisions are about equal in size.  There is a small centrist base that actually likes many of Trump’s policies but don’t like him personally. That is the core Democrats want to attract in 2020 if they have any hope of unseating Trump.   Should the House show that under Democratic leadership nothing gets done except investigations intended to placate a liberal base, the centrist core will abandon them in 2020.  There are, actually, a lot of issues where some compromises can be achieved:
    • Infrastructure – The issue isn’t the need; it’s how to pay for those needs.
    • Drug pricing – Both the White House and Democrats supports Federal efforts to rein in drug price inflation.
    • Regulating Social Media – Again, both sides see abuses. What can be done and what should be done remain open questions.
    • Immigration – Republican voters labeled this their single biggest issues. Democrats understand a desire for strong borders and tighter control but they would like to see a little more empathy. That includes a path to citizenship for Dreamers. There was an apparent agreement at one time to allow the Dreamers a path in exchange for funding for a wall along our Southern border.  That just might come to fruition in this coming Congress.
    • Spending control – While Democrats have a wish list of social spending programs, they won’t get anywhere, at least for the next two years. The first fiscal fight of note will be the extension of the debt ceiling, which was suspended until March 2019 so as not to interfere with the election.  Democrats are certain to try and bargain for something in return for extending it while Republicans are going to say what all incumbent parties say, i.e. the debt ceiling debate shouldn’t be politicized.  Perhaps this debate, more than any other, will show what power to persuade the Democrats actually have for the next two years.
  • Foreign affairs – While it might appear that the House would have little control over foreign affairs, fiscal matters begin there. Without funding, even the White House has limited options.
  • Debt and Deficits – While Democrats are often pictured as big spenders and Republicans portrayed as conservatives, the truth is that everyone wants to spend and few want to pay fully for what they spend. That produces trillion dollar sized deficits. The President, the House’s Freedom Caucus, and at least a few members of the Senate, profess some degree of fiscal discipline.   The danger is that the sum of all these don’t add up to a majority.   Escalating spending might help GDP growth in the short run but too much debt eventually leads to catastrophe.
  • The Presidential Tweets – It isn’t like Mr. Trump to act conciliatory when he is mad.  Will he use his bully pulpit to pressure House leadership to act as he wants?  Almost certainly, the answer to that is yes.  But unlike on The Apprentice, he can’t fire anyone in the House.  Will his tweets be part of a successful negotiation or will it further split the nation apart?  The answer could be yes to both.

With all that said, the likely legislative path for the next two years will be gridlock.  Yesterday can also be seen as the preamble to the 2020 elections.   One can look at that in two lights.   Favoring the Republican side, Democrats have a long history of overplaying their hand. The shift in the House was largely a response from suburban districts that were repulsed by Trump’s behavior more than his policies.   State by state, red or blue, Democrats picked up House seats in big city suburbs.  Those areas are and will be the party’s strength over the next two years.  While these districts have been leaning left for many years, they are not populated with a majority that favor a far left economic agenda.    On the other hand, rural districts were decidedly pro-Trump.  If anything, the elections show that he expanded his base.   What we learned about 2020 is that the election is likely to be decided by a few key states, Florida, where it appears Republicans won narrow victories in both the Governor and Senate races, and in a swath of the country from Pennsylvania to Minnesota where Trump surprised everyone in 2016.  There the message for Republicans wasn’t quite as strong last night.  They lost many House races in districts Trump won in 2016.  These states, Pennsylvania, Wisconsin, Ohio, Michigan and Minnesota, plus Florida, will be the true battleground for 2020.

Elections are not the only story this week.  The Federal Reserve’s open market committee meets today and tomorrow.  No one expects any action but there will be a lot of focus on Chairman Powell’s post-meeting remarks.  Given recent economic strength, I doubt he will be ambiguous about a December rate hike although there are a few, including President Trump, who would like to see some equivocation.  Instead, there will be a lot of questions trying to see if Powell will move from his stance that the course of rate increases is to get to about 3% (i.e. four more rate increases over the next year) with a possibility of a few more should the economy stay strong accompanied by slowly rising inflationary pressures.  Mr. Powell could well stay pat with his prior stance, which spooked markets in October while emphasizing his willingness to adjust policy to the data.  Said slightly differently, I would expect Mr. Powell to be a bit more dovish in tone without changing his basic plan of attack.  All markets really want or have any reason to expect is just that; a willingness to let the data create the path and not some preordained road map.

In sum, this is an important week but it is not over.  The elections sealed the deal of a split Congress, one that is likely to do very little over the next two years but one that will play a big role in how the 2020 Presidential campaign will play out.  Democrats need both a candidate and a message. At the moment, they have neither but there is a long time between now and November 2020.  The second, and perhaps to markets, the more important will be the comments tomorrow from Mr. Powell.  As long as growth is above 3%, unemployment is low, and inflationary pressures are rising, he is likely to keep on course to raise rates at least 3-4 more times.  He is likely to say that while, at the same time, noting that the Fed is always data dependent and will adjust along the way to economic circumstances. This morning markets will celebrate a bit.  Whether that celebration lasts beyond tomorrow morning will hinge a lot on what Mr. Powell has to say.

Today, Emma Stone turns 30. Ethan Hawke is 48.  Sally Field is 72.

 

James M. Meyer, CFA 610-260-2220

 

Additional information is available upon request.

* – Boenning and Scattergood may act as principal in buying this stock from or selling it to the public.

# – The author of this report or accounts under his management at Tower Bridge Advisors owns this security.

Additional information on companies in this report is available on request.  This report is not a complete analysis of every material fact representing company, industry or security mentioned herein.  This firm or its officers, stockholders, employees and clients, in the normal course of business, may have or acquire a position including options, if any, in the securities mentioned.  This communication shall not be deemed to constitute an offer, or solicitation on our part with respect to the sale or purchase of any securities.  The information above has been obtained from sources believed reliable, but is not necessarily complete and is not guaranteed.  This report is prepared for general information only.

Boenning & Scattergood, Inc. – Member FINRA / SIPC.

It does not have regard to the specific investment objectives, financial situation or the particular needs of any specific person who may receive this report.  Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed in this report and should understand that statements regarding future prospects may not be realized.  Opinions are subject to change without notice.

Stocks fell on Friday but almost all the decline was due to investor disappointment with the company’s December quarter outlook.

The employment report for October was very strong with about 250,00 new jobs created and the unemployment rate remaining at 3.7%.  Wages rose by more than 3% year-over-year but month-to-month the gain was much closer to 2%. There doesn’t seem to be much acceleration in wage growth according to Friday’s data.  If there is one fly in the ointment, the large number of new jobs created suggests that productivity growth remains muted.  Perhaps, in part, that is due to the retirement of skilled baby boomers while the latest new hires are probably much less skilled.  The better part of the young labor pool was hired long ago.  Thus, any future gains in production are going to have to be derivatives of technology and automation. There are few signs of accelerated spending in that regard.

With the early October economic data now behind us and most of the earnings reports now out, we should be entering a more quiet market backdrop.  Obviously, the volatility generated in October acts as a bit of a coiled spring and it will take time for that to unwind.  Normally, the fourth quarter is one that treats equity investors well as everyone looks with optimism toward the next year.  Tomorrow, of course, is Election Day and the outcome has suffocated almost all other news in recent days.   At the moment, according to the most respected polling data, Republicans should retain the Senate with a very slight majority.  They could pick up a seat or two; a lot depends on turnout.  Similarly, the odds seem to favor Democrats narrowly winning enough seats to take control of the House.  Once again, turnout will be the deciding factor in many of the elections.   Should that be the outcome, the conventional wisdom is for two years of gridlock to ensue.   A lot will depend on whether House Democratic leadership has any interest in finding common ground with the President. Cynics will say no but, in front of a 2020 Presidential race, perhaps making an effort will be worth something.  The picture won’t change if the Democrats win both chambers.   Should Republicans keep control of both, the odds for some economically important legislation rise but only slightly.  The biggest hurdle will be the desire of a significant number of conservative Republicans to show budget restraint, especially in light of predicted $1+ trillion deficits looming annually.   Proposals for a 10% middle class tax cut or a big infrastructure bill, therefore, won’t see the light of day unless proponents find a way to pay for them.  In Washington, spending is the easy part.  Paying the bill is harder.  With just enough true conservatives still left in both the House and Senate, it would seem likely that little will come out of Congress over the next two years regardless of the outcome.  Obviously, I am ignoring the range of possible non-economic issues but these won’t have a major impact on the stock market.

We will also find out fairly soon, which of Mr. Trump’s recently proposed actions were true commitments and which were political rhetoric.   I doubt, for instance, that 15,000+ troops will spend much time at our Southern border given that they would be legally constrained to support details.  As mentioned above, a 10% middle class tax cut depends on how it is paid for.  Should Democrats win the House and the Chairmanship of the Ways and Means Committee change, the odds of any further tax cuts become more remote.   We will see soon how other proposals made in recent weeks become either reality or fade away.   Once the dust settles, the economic focus will turn to two things; Christmas season and Chinese tariffs.  Once again, with Mr. Trump, watch the actions and not the verbal threats.  Market observers still believe the odds that 25% tariffs will go into effect January 1 against China are still less than 50:50. The odds that they will impact all consumer imports as well are even smaller.  But oddsmakers don’t make policy; the President does. There, at least, will be talks between Trump and Xi in late November at the G-20 and Mr. Trump could give China temporary reprieve if it states a willingness to open talks. Remember that he gave North Korea a pass if it engaged in discussions about nuclear disarmament.  So far, there has been some behind the scenes talk but little substantive action.  The same is true with the EU.  Promises of 25% tariffs on cars was pulled back after Trump met with top ECB officials.  So far, nothing new has evolved and the tariffs remain on hold. This week, we are set to see new sanctions on Iran but, for now, the President is giving several nations the ability to continue buying Iranian oil.  Sanctions won’t be very tough with so many waivers.  Many in business hope the same happens with China, that the promise of talks, regardless of how fruitful they are in the short run, will stop further tariff implementation.  Should that be the case, stocks could rally strongly into the end of the year.  Should Mr. Trump, however, surprise us all and reiterate his tough stance after the meeting and promise to move forward on tariffs, it could be another rough patch.

Looking further ahead, the most important economic questions surround interest rates and economic growth. Obviously, the two are intertwined.  Many, indeed most, expect growth to gradually fall from the 4% level of Q2 to something under 3% by the second half of 2019.  Supply siders believe growth can still remain at 3% or even higher.  Most, however, believe growth rates will gradually fall toward 2.5% or lower unless there is a significant step up in productivity and sustained high levels of capital investment.  Interest rates will clearly mirror which path the economy takes.  Faster growth invites higher inflation and interest rates.  If growth falls back toward 2.5%, inflation expectations could stay muted and bond yields might stay close to where they are today.

Thus, over the next two months, a lot more questions will get answered.  We should expect clarity on tariffs, for better or worse.  The strength of the Christmas season should set the stage for growth early in 2019 and the near term trend for interest rates.  With the election behind us within a day or two, the attendant uncertainties will be answered. That is not to say that our lives will be worry free.  We should see wholesale changes in a cabinet that has seen more than a fair share of changes so far.  It is quite possible after the election that we will hear Robert Mueller’s report.  Who wins the House could determine the path the conclusions of that report take.   The debt ceiling was suspended until March 2019 and our gross debt by then will approach $22 trillion.  If Democrats will the House, leadership will make demands to allow the debt ceiling to be increased.   Finally, a strong dollar is going to play havoc with international earnings at least through the first half of 2019.  Somehow, no one has renamed Wall Street Easy Street.

However, in the short run, meaning between now and year end, assuming trade threats don’t get worse, a strong Christmas season and the end of campaign rhetoric should enable stocks to enjoy their usual year end rally.  With that said, I think we are now going to find ourselves locked in a trading range with the end of September/early October highs representing the top of the range and last Monday’s lows the bottom.  A trade agreement or at least trade peace with China could allow stocks to move to new highs.  Conversely, higher interest rates or ratcheting up the trade war could lead to new lows below the bottom of the range.  Both, at the moment, are not consensus views. Therefore, I think the most likely outcome is for stocks to drift upward toward the top of the range.  If they get there, we will reassess at that time.

Today Odell Beckham Jr. is 25.  Tatum O’Neal is 54.  Tilda Swinton is 57.  Kris Jenner turns 62.   I’d like to be a fly on the wall if these four got together to celebrate!

 

James M. Meyer, CFA 610-260-2220

 

Additional information is available upon request.

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# – The author of this report or accounts under his management at Tower Bridge Advisors owns this security.

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It does not have regard to the specific investment objectives, financial situation or the particular needs of any specific person who may receive this report.  Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed in this report and should understand that statements regarding future prospects may not be realized.  Opinions are subject to change without notice.

In the week before elections, let us take much of President Trump’s new initiatives with some skepticism

Renewed talk of trade negotiations with China is good but until China decides that Intellectual Property rights are part of that discussion, the stalemate remains.  We will be better able to separate reality from political hype next week after the elections are over.

Stocks rose again yesterday as the trade differences between China and the U.S. seemed to moderate. Futures point to an even stronger open after a Bloomberg report quoted administration insiders saying they were working to draw up a draft of an agreement in front of the anticipated Trump-Xi meeting at the G-20 summit at the end of November.  Talking is good and the market’s instant response is as expected.  But until China is willing to make a discussion of Intellectual Property (IP) rights part of the discussion, nothing fundamentally changes.

With that said, the Trump pattern has to warn of dire consequences right up to the eleventh hour.  He did that with Canada before a new treaty was signed.  He did that with Europe promising 25% tariffs on cars shipped to the U.S. before backing off after meeting with ECB head Junker.  He threatened to blow up North Korea before agreeing to meet with Kim Jong Un.   In addition, it is the week before mid-term elections.  Therefore, everything said must be taken into context.  This week he has threatened to unilaterally revoke birthright citizenship, to send up to 15,000 soldiers to our southern border to stop a caravan that may never actually reach our border, to cut middle class taxes by 10%, and now to come to a trade agreement quickly with the Chinese.  Next week, we can begin to separate fiction from reality.

I think the real news for the markets is that the correction is officially over, at least for now.  Interest markets have stabilized, earnings reports continue good, and the heightened fears caused by the sudden market drop are disappearing.  That doesn’t mean the correction had no message nor does it mean that the entire loss will be recovered overnight.  Granted, if there is a pending treaty with China and all tariffs are revoked on both sides, we could see a blowoff bullish spike to new highs.  But again, let’s look at the China/U.S. trade dispute next week after elections to separate hype from reality.  If Mr. Trump decides to back away from tariffs without any concession on IP rights from the Chinese, that would be almost shocking and would undermine his entire game plan.  I have to believe the odds of that happening are pretty small suggesting the shoe is really in Xi’s court and not in Washington.  We can draw up all the trade agreements we want.  Until IP rights are part of the discussion, there are no grounds for negotiation.  One outcome, perhaps a likely one, is for Xi to put IP rights up for discussion without making or even suggesting any actual change in policy.  That could give Trump the room to loosen tensions just as he did with Junker over car tariffs.  There hasn’t been substantive progress with Europe yet and it will take quite a while longer for negotiations with China to reach resolution.

But perhaps the biggest point to note is that, to date, the tariffs actually in place have made relatively little difference to our overall economy.  Yes, some companies and some industries have experienced headwinds as a result.  But put that in context.  Earnings in Q3 rose close to 25% including the costs of whatever tariffs are now in place.   That suggests a conclusion that if tariffs haven’t been a substantive headwind so far, simply stepping away from instituting additional tariffs in January or beyond will have fewer economic consequences than market psychology changes might suggest.

Conclusion:  always respect the market dynamics.  As is always true at the end of corrections, there is usually a 100% mood swing, one that could carry through to Election Day and beyond.  I think the only eventuality that will change the mood is a Democratic sweep of both the Senate and the House, an outcome most suggest is highly unlikely.  But, at the same time, this brief (in time) feeling of euphoria will fade.  The market is telling us:

  1. The bull market is aging.
  2. The fear of higher inflation and higher interest rates is probably more substantial than the fear of disinflation and lower rates.
  3. GDP growth rates probably peaked in the second quarter.
  4. Stocks were fully priced and needed occasional corrections to attract new buyers.
  5. When growth fades, more companies run into difficulties. We are seeing more stories of broken companies than we have seen for some years. Kraft Heinz last night was the most recent example.
  6. There is a difference between growth at a reasonable price and growth at any price.

Finally, today is the day of the monthly payroll report.   250,000 new jobs were created in October.  The unemployment rate stayed at 3.7% and month-over-month increases in wages were 2.2%. The report was solid and there were limited signs of rising inflationary pressure.  All good.  If there was a negative takeaway, it would be that it has going to be hard to expand productivity if our economy keeps adding 250,000 jobs each month.  To sustain growth well above 2.5%, productivity has to increase beyond where it is today.   So far, there are no signs that is happening.  Therefore, look for growth in the second half of 2019 to fall to or below 2.5%.  If we get there with tame inflation, I would take that combination gladly.

Today, Nelly is 44.  David Schwimmer is 52.

James M. Meyer, CFA 610-260-2220

 

Additional information is available upon request.

* – Boenning and Scattergood may act as principal in buying this stock from or selling it to the public.

# – The author of this report or accounts under his management at Tower Bridge Advisors owns this security.

 

Additional information on companies in this report is available on request.  This report is not a complete analysis of every material fact representing company, industry or security mentioned herein.  This firm or its officers, stockholders, employees and clients, in the normal course of business, may have or acquire a position including options, if any, in the securities mentioned.  This communication shall not be deemed to constitute an offer, or solicitation on our part with respect to the sale or purchase of any securities.  The information above has been obtained from sources believed reliable, but is not necessarily complete and is not guaranteed.  This report is prepared for general information only.

Boenning & Scattergood, Inc. – Member FINRA / SIPC.

It does not have regard to the specific investment objectives, financial situation or the particular needs of any specific person who may receive this report.  Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed in this report and should understand that statements regarding future prospects may not be realized.  Opinions are subject to change without notice.

Stocks staged a strong rally yesterday as investors went bargain hunting

But we have seen sharp one-day rallies within significant market corrections.   When selling pressure evaporated midday yesterday, buyers stepped in.  Today, we will see if that rally is enduring.

I would be foolish to say in a declarative way that the market has found the bottom or what level will constitute bottom.   But I think I have a sense for what fair value might be.  The current estimate for S&P 500 earnings for 2019 is close to $170 but I think that is probably a bit high.  The recent dollar strength is going to be a headwind to earnings at least through mid-2019 assuming it doesn’t escalate further from here.  Thus, I am going to use $165 as an estimate for valuation purposes.   If I assume the Fed will normalize rates in 2019, then using a normal P/E, based on over 75 years of history, of forward earnings estimates of 15 shouldn’t lead me to far astray in an attempt to calculate fair value.   15 times $165 is 2475 or about 7% below current levels.

But there are reasons to believe that calculation may be a bit too severe.  According to data we used from S&P Capital IQ, stocks currently sell at 18.6x estimate earnings as determined a mean but only 15.4 using a median.  What causes the difference?  There are 48 stocks in the average that now sell at 30x or more times 2019 estimated earnings.  You know some of them including Amazon and Netflix.   But you would probably be surprised to learn that 23 or the 48 stocks are REITs.   REITs are valued based, not on earnings, but on funds from operations (FFO).  By law they must distribute 90% of their income to protect their tax-free status.  Most pay out a high percentage of FFO.  Simply said, earnings per share are a meaningless valuation tool when it comes to REITs due to the impact of very high non-cash expenses (e.g. depreciation).   If I use historic data to come up with an average multiple of 15, I need to adjust for the fact that there are now 32 REITs in the S&P 500 versus none in 2000.  Thus, the average today is somewhat inflated.  By our calculation, the inclusion of REITs in the calculation could provide a distortion of close to a P/E point.   Using 16, only slightly above the historic median, times $165 yields a value of 1640.  That is virtually where the S&P is today.

Another valuation measure I use is to take the yield on high-grade junk bonds, add one percentage point to account for the added risk of owning stock, and use the inverse to calculate a P/E that is equivalent to where high grade junk yields are today.  That number calculates to the same P/E of 16.

Thus, trying to be perfectly rational, which is difficult in a market that is very emotional at the moment, I come to the conclusion that stocks at this moment are fairly valued.  Said another way, the 10% correction was natural and rational. The catalyst no doubt was Fed Chairman Jerome Powell’s strong assertion at the September meeting that he wants to see Fed Funds rates return to neutral.  Or, said in a different way, he believes the economy today is strong enough to withstand the central bank’s effort to stop propping up asset prices in order to stabilize the economy or allow it to grow at acceptable rates.

There are many who blame the Fed for the correction itself.  While I explained that taking away the cookie jar or excess and free money was a catalyst for the correction, that was an inevitable step that was going to happen sooner or later.  If a brief 10% correction is all investors are going to have to suffer in return for steps taken to save the economy, cure the financial crisis, and restore growth to something above 2% without excessive inflation, I would call it a fair trade. As for the talk that rates might have to go to 3% or higher, I would suggest don’t listen to conjectural game plans 12-18 months out.  The Fed has and always will respond to data at the moment of each rate decision.  If inflation, which is currently below 2% without any signs of moving higher, stays subdued and economic growth starts to slide from the 3-4% rates currently, it would seem obvious, that the Fed will achieve its goal of balance will before reaching 3.0-3.5%.  I think we will see a rate increase again in December.  As for the next possible increase, probably in March, whether that happens or not depends of data between now and then.  While everyone, including members of the FOMC, have their thoughts about whether there will be a rate increase in March or not, nothing is written in ink nor will it be until the March meeting itself.

Another consideration in trying to just fair value for this market is the value of the dollar relative to other currencies around the world.  The currency market serves as a stabilizer.  It balances economic values worldwide.  When the dollar is strong, as it is now, it means the U.S. is the best or one of the best games in town.  Not only are we growing faster than virtually all other developed nations but anyone investing in the U.S. will get a higher return, expressed in dollar terms since our interest rates are higher.   Because of the cost to hedge back into local currencies, not every international investor can take advantage of that.  A strong dollar attracts capital.  Why wouldn’t anyone want to invest in a nation with faster growth opportunities?  But it also has negative implications.  Foreign earnings get translated back into fewer dollars.  It also weakens commodity prices.  Oil, all other factors being equal, will fall in price as the dollar rises.  The same will be true for metals and other commodities.  Thus, a strong dollar holds back the rate of inflation, good news as far as the Fed is concerned.  On the other hand, many emerging nations that need to fund debt in dollar terms are hit with added expenses.  We have seen serial problems in places like Turkey, Argentina, and lately even Mexico.   Sudden change is never a positive in financial markets.

Pulling this all together, stocks as a whole, after the correction, now seem close to fair value.  Growth from here will be tied to future changes in interest rates and earnings growth.  There is no current message from the market that suggests an imminent recession or even one out on the horizon.   The long term sustainable growth rate of our economy is a product of population growth (currently about 0.7%) times gains in productivity.  Productivity growth has been rather anemic for the past decade although there have been some signs of improvement in recent quarters.  With that said, the growth in investment spending of less than 1% in the third quarter is mildly disturbing. Based on data we see, it would seem sustainable growth is somewhere between 2% and 3%, a bit higher than in the Obama years but not anywhere near the 4%+ President Trump likes to talk about or the 3% built into budget estimates.  One corollary to a modestly slower rate of growth is the expansion of Federal debt requirements since tax revenues are less buoyant than expected.  The Treasury now plans to issue over $1 trillion in net new debt next year and probably the year after.  If anything, that will put upward pressure on rates and downward pressure on stock prices.

There is nothing wrong with 2-3% growth and 2% inflation.  We lived with that through most of the recovery years since the Great Recession and equity investors did just fine.  Sharp market moves as we have experienced in October get prognosticators all worked up and emotional but, if shares today are roughly fairly valued, then markets should begin to calm down shortly, perhaps after the mid-term elections.  Economically, I am not sure whether the mid-terms mean a whole lot.  Mr. Trump wants to cut taxes further but, until there is a plan to do that without expanding the deficit, there won’t be serious consideration.  Democrats in the House, should they win a majority, might press forward with an infrastructure bill but here again it won’t go anywhere if the costs aren’t paid for in some manner.  Any ideas of raising taxes to fund infrastructure will die a quick death in the Senate, almost sure to remain in Republican hands.   And even if the Senate also flips, such a measure would be vetoed.

In my mind, the biggest near term economic risk is a further and rapid increase in the value of the dollar.  I have no reason to expect that to happen other than a body in motion tends to stay in motion.  In 2014 and early into 2015, the trade-weighted dollar index rose by about 25% as Europe entered a recession caused, in part, by the rising costs of imports.  The recent move in the dollar has only been 10% although it is quite a bit higher against certain emerging market currencies.   In 2015, the U.S. experienced a decline in corporate profits caused mostly by the reduced translation of foreign earnings.   At this juncture, the weak dollar might limit grow for the next two quarters but it shouldn’t stop it entirely unless the dollar moves significantly higher.

In summary, stocks today are reasonably valued.  A violent correction has created some individual bargains while other stocks remain overvalued.  85 stocks within the S&P 500 now trade at less than 10x estimated 2019 earnings. I have no idea when the FANG correction might end but I can make a case that some of the more egregiously valued names are still overvalued.

If I abide by my two-day rule, today’s action will tell us a lot.  Futures point to a higher open, a natural response to yesterday’s rally.  The key will be whether the market can withstand the inevitable midday attempts to sell into that strength.  Even if we get a recovery rally over the next few days or weeks, some retest of this week’s lows is a reasonable expectation.  If you accept my premise that stocks today are fairly valued, one shouldn’t expect a quick recovery to recent highs.

Today, Michael Collins, the pilot of the mission that first landed on the moon, turns 88.

James M. Meyer, CFA 610-260-2220

 

Additional information is available upon request.

* – Boenning and Scattergood may act as principal in buying this stock from or selling it to the public.

# – The author of this report or accounts under his management at Tower Bridge Advisors owns this security.

Additional information on companies in this report is available on request.  This report is not a complete analysis of every material fact representing company, industry or security mentioned herein.  This firm or its officers, stockholders, employees and clients, in the normal course of business, may have or acquire a position including options, if any, in the securities mentioned.  This communication shall not be deemed to constitute an offer, or solicitation on our part with respect to the sale or purchase of any securities.  The information above has been obtained from sources believed reliable, but is not necessarily complete and is not guaranteed.  This report is prepared for general information only.

Boenning & Scattergood, Inc. – Member FINRA / SIPC.

It does not have regard to the specific investment objectives, financial situation or the particular needs of any specific person who may receive this report.  Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed in this report and should understand that statements regarding future prospects may not be realized.  Opinions are subject to change without notice.

It was another wild session on Friday as markets reacted to the mixed earnings.

While the overall market ended up down a bit over 1%, parts of the market, notably focused on the FANG related stocks, fell by more than 3% for most of the session.  October has been a tough month so far with just three trading sessions left.  The Dow is down more than 6%, its worst October since 2008.  The S&P is down over 8%, its worst single month since the Great Recession.  The NASDAQ Composite is down over 11%.  But with that said a correction from recent highs approaching 10% isn’t an abnormality within the context of a bull market.  What one can say, however, is that the structure of markets themselves have changed.  With new technology serving to increase the percentage of total volume done by automated trading systems, especially in times of expanded volatility, corrections have become significantly sharper and more compressed into shorter time periods.

That has to change investor behavior.  In baseball, there are hitters’ parks and pitchers’ parks.  Teams that play in hitters’ parks load up on sluggers while teams playing half their games or more in pitchers’ parks focus on pitching.  I like to think of the market in terms of a metronome that moves slowly from left-to-right and triple speed from right-to-left.  The changes this requires are increased discipline that requires investors to focus on asset allocation and valuation.  If stocks become extended, the temptation is to let profits run.  But one never knows when an event will stimulate a one-day price drop versus the start of a 10-20% correction.  When prices get too high, one has to take some money off the table. In asset allocation terms, one has to sell stocks and either buy bonds or increase cash.   Nothing requires sudden movement. If a 60-40 asset allocated portfolio becomes 65-35 because stocks increased in value faster than bonds, then selling one or two stocks within a diversified portfolio would return the allocation to normal.

The same holds true in market corrections.  Suppose you started with $100,000, $60,000 in stocks and $40,000 in bonds.  Next, assume that the stock value falls to $50,000 in a correction.  Your asset allocation now is 55.6% in stocks and 44.4% in bonds.  To get back to 60-40 would require the sale of $4,000 of bonds and the purchase of $4,000 in stocks.   One doesn’t have to rebalance daily or even weekly.  You should look at least annually although there are many who do this quarterly.  Certainly a sharp move as we have seen so far in October dictates revisiting one’s asset allocation.

Friday, I noted that the market correction was a combination of a reaction to higher interest rates and reduced expectations for 2019 enforced by a GDP report on Friday that showed a sequential decline in GDP and a sharp drop in the growth rate for investment spending.  While no one is forecasting an imminent recession, the consensus for growth next year is now back below 3%.  Furthermore, growth is slowing worldwide.   Add in a dollar that, if it were to remain at its current value going forward, would result in a 7-8% headwind to foreign revenues in the first quarter of next year.  For those companies active in emerging markets, the headwind could be even greater.  A combination of sub-2% growth and a very strong dollar led to a decline in corporate profits in 2015.  The same could be in store at least through the first half of 2019.   Estimates have been cut accordingly during this earnings season.  The combination of higher interest rates and lower expected profits accounts for the market’s correction.  The good news is that bond yields have fallen over the past two weeks and most of the adjustment to profit expectations by now have been built into models.  Thus, I think it is fair to assume that most of the correction is behind us.  But, as I always note, (1) in the short run, emotions trump facts, and (2) one can’t get too optimistic until we get two good days back-to-back.

With the end of October coming Wednesday, Thursday and Friday will bring us a flood of data about October.  The big number, as always, will be the employment report due to be released Friday morning. As always, a focus will be on wage rates.  Any sudden increase would spook markets.  The number of jobs produced is also important.   A very high number, while good for GDP, would suggest that productivity is not improving significantly.  The Goldilocks number would be something close to 150,000.

Futures point higher this morning.

Today Gabrielle Union is 46.  Wynona Ryder turns 47.

James M. Meyer, CFA 610-260-2220

Additional information is available upon request.

* – Boenning and Scattergood may act as principal in buying this stock from or selling it to the public.

# – The author of this report or accounts under his management at Tower Bridge Advisors owns this security.

 

Additional information on companies in this report is available on request.  This report is not a complete analysis of every material fact representing company, industry or security mentioned herein.  This firm or its officers, stockholders, employees and clients, in the normal course of business, may have or acquire a position including options, if any, in the securities mentioned.  This communication shall not be deemed to constitute an offer, or solicitation on our part with respect to the sale or purchase of any securities.  The information above has been obtained from sources believed reliable, but is not necessarily complete and is not guaranteed.  This report is prepared for general information only.

 

Boenning & Scattergood, Inc. – Member FINRA / SIPC.

 

It does not have regard to the specific investment objectives, financial situation or the particular needs of any specific person who may receive this report.  Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed in this report and should understand that statements regarding future prospects may not be realized.  Opinions are subject to change without notice.

Yesterday’s sharp rallied faded at the close.  Futures suggested another downturn until Boeing reported strong earnings.

Was yesterday the bottom?  We can all take a guess but the end of the correction should be near at hand.  Q4 is seasonally strong but markets have corrected for legitimate reasons that need to be understood.

Stocks got pummeled yesterday morning, partly in reaction to a sharp drop overnight in China, partly due to a sharp drop in oil prices and a Saudi minister stated that its nation was ramping up production, and partly due to weaker than expected earnings from two Dow components.  But they clawed their was back throughout the day and finished only moderately lower.  At the day’s worst levels, the leading indices were at their lowest level since March.  Some think a double bottom was set and the correction is over.  Others are not so sure.

I am not going to weigh in directly other than to make the following points:

 

  1. By now most of our readers should know about my simplistic two-day rule. A trend (in this case down) isn’t broken until we have two meaningful up days in a row.  While yesterday looked like it actually had a chance to finish higher, the rally petered out in the last half hour.  Futures were sharply lower again overnight but were rescued to some extent by strong pre-market earnings from Boeing.  Even if stocks rally today and finish higher (I said if), I won’t be convinced a bottom has been put in if there is no follow up tomorrow.  The logic behind a two-day rule is that traders in a volatile market can create a short sharp rally that initially looks very encouraging. But a real rally requires investors, not just traders, to step in.  That becomes evident on the second day.
  2. With that said, I have seen more V-shaped corrections in early October than in all other time periods combined during my career. There are reasons.  First, corporations that report on calendar quarters cannot buy back stock in the first half of October in front of their earnings reports.  Second, October is the end of the mutual fund year.  Mutual funds wanting to mitigate capital gains distributions will sell their losers in early October.  Most think tax loss selling hits a peak in December but, actually, the peak is right now.
  3. Fundamentals matter. Initially, a 40+ basis point increase in long term interest rates, combined with some hawkish commentary from the Federal Reserve suggesting it might take short term interest rates up to as far as 3.5% before the current cycle of rate increases is over ignited the correction.  It had been hoped that when companies began to report third quarter earnings that the correction would end.  But, so far, while the earnings themselves have been OK, the forward looking guidance has been mixed at best.  A strong dollar, tariffs, and other factors are slowing demand.  When companies with a very broad international customer base warn of tepid demand and customer indecision, one should take that to heart.
  4. At last night’s closing price of 2740 for the S&P 500, the index now sits at a level approximately 15.9x 2019 estimated earnings. Given that interest rates and inflation remain a bit below long term averages, that appears to be a reasonable price. If inflation picks up a bit, however, as we expect, and interest rates return to historic norms, stocks will trend toward historic average P/E ratios.  Depending on one’s level of optimism, after the recent correction, stocks look fairly priced.  To some, they still might be a bit overpriced based on historic averages.  It is hard to make the case they are cheap.   In a fairly priced market, there will still be winners and losers.  The winners will be those companies that can grow and that can match or exceed expectations.

As I noted, we are hearing more caution this earnings season than we have for some time.  Banks have been reporting very low levels of loan growth in the 0-3% range.  Homebuilders, which were experiencing strong order growth until this summer, now report growth in the low single digit range as well.   Order rates for semiconductors are falling and swelling inventory levels mean prices are destined to fall until balance is restored.  Chinese tariff issues are beginning to cause some to redirect supply chains elsewhere in Asia.  That isn’t a simple or inexpensive process.  More and more we are hearing companies saying that they plan to take price action to offset added costs of tariffs, energy and transportation costs.  What that says to me is that companies feel that they now have some pricing power.  That is actually good news if it proves to be true.

Earnings per share are growing 20%+ each quarter this year largely related to the cut in corporate tax rate.  Clearly, that rate isn’t sustainable once we anniversary the implementation of tax cuts in early 2019.   Everyone knows that and it is already factored into stock prices.   But even if the year-over-year growth rate slows, companies will still benefit from lower taxes, keeping more cash to invest or to distribute in some fashion to shareholders.  But there are other factors at work besides taxes.  GDP growth probably peaked in the second quarter.  Third quarter through (and we will get a first peak on Friday) was probably about 3.3%.  It should stay close to 3% in the fourth quarter.  But headwinds are increasing. Tariffs is one.  The stronger dollar could help exports but it will also mean foreign earnings of multi-nationals get translated back into less earnings.  Higher interest rates are beginning to hit home.  That is best seen in the housing market where existing home sales have declined for seven straight months.  Despite sharply rising household formations, buyers are hitting an affordability wall as mortgage rates rise to 5%.   Higher rates are beginning to hurt auto sales as well.   Americans are saving more.

The key question, obviously, is whether the economy is simply slowing back to a more normal sustainable pace of growth or is on a path toward recession in 2-3 years.   A lot obviously depends on the Fed which has a long history of starting to increase interest rates too late and then going too far.    Given the Fed’s most recent commentary, the latter became a rising fear after the September meeting.

But it is far too early to reach any conclusions.  This Fed, under Jerome Powell’s lead, is going to be a very pragmatic Fed.  He is a businessman, not an economist.  He isn’t theoretical; he seems to be practical.  He sees exactly what you and I see.  Rates have been increased six times so far in 2017 and 2018 with one more increase coming in December.  There is a lag before the increases bite.  Perhaps that is why housing started to tip over in late winter and has continued to weaken.  The Fed almost certainly doesn’t want to pull the rug complete out from under the housing market.

Increasingly there are voices outside the Fed call for it to pause after the December increase and spend a few months or more to assess the true impact of the increases to date.  It may well do just that but only if inflation remains tame.  If inflation surprises to the upside for any reason, the Fed may add one or two more increases in early 2019.  But if the CPI or the PCE index the Fed likes better stays in the 2% area or even a smidge more, look for a policy adjustment this winter.  Slowing growth toward 2-3%, if it keeps inflation level, would be a good thing, not a bad one, in the Fed’s eyes.  President Trump can do all the Fed bashing he wants; it won’t mean a thing if the data supports the Fed.

As for markets, Q4 is usually a very good one for stocks.  Whether yesterday was the bottom or it sits a few days in front of us, I think seasonal patterns will provide a lift soon.  But remember that stocks are not cheap.  They only look cheap compared to 30 days ago. A sustained rally requires real increases in expectations.  Without some resolution to the China tariff issues or a surge in capital spending, that seems difficult.  In some ways we have been in a rolling bear market this year.  At the start of the year, energy stocks were getting killed along with consumer staples, utilities and REITs. They have since recovered a bit. The same goes for media stocks.  Early cycle stocks like housing, autos and banks, have been walloped with many down 20+%.  These now look pretty washed out.  Many homebuilders are now down to book value or less.  Industrial stocks got clobbered as soon as tariffs became a weapon and are still searching for a bottom.  Semiconductor stocks have rolled over as slowing demand growth has led to an aforementioned increase in inventories.  The high flying tech stocks have taken a bit of a hit recently in the current correction but, so far, have held up pretty well. There are very few groups that haven’t been hit.  In a sense, we have been rolling through a stealth bear market all year masked by some extraordinary performance by just a handful of stocks, mostly tech related.  This is actually healthy.

Summing up, there have been valid reasons for this correction, one that seems to have run its course to a large extent.  Whether it is over or not remains to be seen.  If you want to be secure, wait for two strong up days to feel confident.  There are bargains out there but all stocks are not bargains.  This is an aging bull market.  That doesn’t mean it has to end soon but it does mean that every once in a while  excess exuberance has to be wrung out.   Earnings are up 20%+ this year while prices are roughly flat. That is how one squeezes out exuberance.   Next year earnings will be up closer to 5%.  If stocks are roughly fairly priced today, they could move higher in line with earnings.  A 5% move with a 2% dividend isn’t a bad total return.

Today, Ryan Reynolds is 42.  Weird Al Yankovic is 59.  Pele is 78.

 

James M. Meyer, CFA 610-260-2220

 

Additional information is available upon request.

* – Boenning and Scattergood may act as principal in buying this stock from or selling it to the public.

# – The author of this report or accounts under his management at Tower Bridge Advisors owns this security.

Additional information on companies in this report is available on request.  This report is not a complete analysis of every material fact representing company, industry or security mentioned herein.  This firm or its officers, stockholders, employees and clients, in the normal course of business, may have or acquire a position including options, if any, in the securities mentioned.  This communication shall not be deemed to constitute an offer, or solicitation on our part with respect to the sale or purchase of any securities.  The information above has been obtained from sources believed reliable, but is not necessarily complete and is not guaranteed.  This report is prepared for general information only.

Boenning & Scattergood, Inc. – Member FINRA / SIPC.

It does not have regard to the specific investment objectives, financial situation or the particular needs of any specific person who may receive this report.  Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed in this report and should understand that statements regarding future prospects may not be realized.  Opinions are subject to change without notice.

Stocks have given back most of Tuesday’s rally and I wouldn’t be surprised if they probed the recent lows before today’s session ends

Over the past two sessions, stocks have given back most of Tuesday’s rally and I wouldn’t be surprised if they probed the recent lows before today’s session ends.  The catalysts for the decline was a very weak overnight market in China after talks between that nation and the U.S. relative to trade and tariffs broke off once again.  There is no reason for President Trump to give any ground before the mid-term elections and it is unlikely China will concede on the important issue of intellectual property rights before then.  Logically, when Presidents Trump and Xi are in Buenos Aires for the G-20 meeting in late November they can get together and probe whether there is room to find some common ground that could deescalate the trade war.  One day, when there is optimism that a breakthrough might be forthcoming, stocks rally.  Today, after news that talks broke off, they fall back.  Given the current state of heightened angst, volatility is high feeding the computer program trades that accentuate moves in either direction.

During this period of heightened volatility, it is easy for market pundits to aim criticism at the Federal Reserve.  Of course, the President has weighed in with his own characteristic bombastic tweeting to add to the criticism.  While it is unlike that the President will force the Fed’s hand, the FOMC members will watch all input factors.  Market reaction is one of them.  But volatile 4% moves in either direction is not the sort of input that will move the needle speeding up or slowing down the pace of rate increases.   Chairman Jerome Powell has indicated that he expects one more increase this year, almost certainly in December, and probably three more next year before the Fed either stops, slows down, or reverses course.

Those are current expectations. Even the December increase isn’t carved into stone.  The Fed will always be responsive to data.  Right now, demand is strong, unemployment is low and GDP growth is a healthy 3%+.  Those numbers virtually insure an increase in December.  As for early next year, if the numbers stay reasonably close to what they are today, there will be at least one more increase before spring.

There are lots of ways to interpret data but the only conclusion about an interest rate increase is that it raises borrowing costs and deters some level of borrowing.  It is a headwind to economic growth.  That doesn’t mean growth has to slow, however. If other forces, like expansionary fiscal policy, less regulation, etc. are strong enough, then small gradual rate increase won’t matter all that much.   We have had four rate increases over the past 12 months and growth has accelerated, for instance.  In the real world, there isn’t a pure linear relationship between interest rate changes and economic growth.  As I noted Wednesday, unwinding QE of the size implemented by the Fed and other central banks isn’t going to be easy and probably won’t be painless.  The Fed’s job isn’t made any easier by expansionary fiscal policy that will add roughly $100 billion to the deficit this year and more next year.  Congress is very good at spending, handing out the goodies.  It isn’t very good about creating ways (e.g. raising taxes) to pay for them.  Republicans wanted everyone to believe that the surge in growth associated with last year’s corporate tax cuts would result in a massive expansion in revenues that would pay for the tax cuts.  So far, which revenues are up, they have risen insufficiently to allow the deficit to decline.  Instead, it seems to be going in the wrong direction fast.

Back to the market.   The recent correction and rise in volatility has all of us looking for something or someone to blame.  Since the President never accepts any blame, the Fed is a convenient target.  But the Fed didn’t pass a spending bill that boosted expenses without commensurate offsets of higher revenues.  The Fed didn’t enact open ended entitlement programs.  No, the Fed simply has to act as the counterweight and protect against runaway inflation.  Of course, we don’t have runaway inflation and, perhaps, we never will.  But, given that it takes 6-12 months for interest rate increases to work their way through the economy, the Fed cannot simply be backwards looking.  It must make its best guess and move accordingly.  Wednesday, I offered three possible alternatives;

  1. The Fed could overshoot, cool the economy too much and have to reverse course.
  2. It could be too slow to move, find inflation accelerate and be force to raise interest rates even faster
  3. It could hit the bulls eye and get it right.

I will leave it to others to set the odds but hitting the bulls eye is hard and the odds of being perfect are low.  At the same time, the odds of being reasonably close are good and that will allow the economy to continue expanding and the bull market to continue.

The stock market has been issuing caution flags.  Among this year’s worst performing groups have been banks, housing stocks and auto companies.  These are all early cycle companies.  But markets are also famously wrong predicting many more recessions than actually occur.  Rising mortgage rates do impact affordability.  But the majority of potential buyers can still afford to buy a home.  I see no reason for a housing collapse.  I do see a period when price increases pause, or even reverse a bit, and buyers then resume purchases.  Markets like New York or Southern California went from hot to cold.  After a period of rebalancing, growth can resume.  It won’t take a 2008-style crash to do that.  We aren’t talking about a market of excess speculation and massive flipping (buying homes when then go up for sale and selling them for a profit at closing).  It’s just an old fashioned mid-course correction.

We can’t let the market dictate.  We have to think for ourselves.  There are clearly disruptive influences including higher interest rates and tariffs.  But there are major positives as well. Millennials have jobs and are having babies.  If you don’t watch CNBC and don’t fester about politics, life today is good.

In the end, that is what matters.  This correction will run its course.  After earnings season, corporations will resume stock repurchases and be active buyers.  By the end of next week, about half of corporate America will be buying once again.  I give this correction another week to flush itself out.  It could be a nasty week or it could have ended last night.  Emotions are tougher to predict than rational behavior.  Build your buy list.  Take advantage of major brakes.  And stay calm and disciplined.  Heck, it even stopped raining!

Today, Evander Hollyfield is 56.  John Lithgow is 73.  One of the great character actors of all time, Michael Gambon is 78.

 

James M. Meyer, CFA 610-260-2220

 

Additional information is available upon request.

* – Boenning and Scattergood may act as principal in buying this stock from or selling it to the public.

# – The author of this report or accounts under his management at Tower Bridge Advisors owns this security.

 

Additional information on companies in this report is available on request.  This report is not a complete analysis of every material fact representing company, industry or security mentioned herein.  This firm or its officers, stockholders, employees and clients, in the normal course of business, may have or acquire a position including options, if any, in the securities mentioned.  This communication shall not be deemed to constitute an offer, or solicitation on our part with respect to the sale or purchase of any securities.  The information above has been obtained from sources believed reliable, but is not necessarily complete and is not guaranteed.  This report is prepared for general information only.

 

Boenning & Scattergood, Inc. – Member FINRA / SIPC.

 

It does not have regard to the specific investment objectives, financial situation or the particular needs of any specific person who may receive this report.  Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed in this report and should understand that statements regarding future prospects may not be realized.  Opinions are subject to change without notice.

There are three possible outcomes to current Fed policy. While only one leaves us with a big smile, none seem catastrophic.

Stocks staged a sharp rally yesterday cutting losses to date in October to less than 4%.

One needs to understand that computer generated trading accelerates as volatility increases.  One measure of volatility embraced by Wall Street is the VIX which keys off of the size of put and call premiums.  It is associated with risk in that premiums rose as volatility increases.  They are highly correlated. Thus, while the VIX doesn’t measure volatility directly, it is deemed to be as true an indicator of volatility as exists, at least in simple form.   While logic might suggest the VIX can spike in both up and down markets, it only seems to do so during market corrections or the steepest part of bear markets.   The broad buy and sell programs generated by computerized traders accelerate as volatility increases.  When multiple programs hit the market at the same time, you see the spikes we saw last week on the downside and yesterday on the upside.  While market pundits might be able to attach a fundamental reason for these spikes, computers are not basing buy or sell programs on Fed policy or geopolitics; they simply kick in based on technical factors that algorithms say have a high probability of generating a short term trading profit.  Of course, there might well be a connection between Fed policy and the fundamental deterioration that led to the spike in volatility and the sharp selloff last week.  But the actual reaction was all technical.

When these downward spikes occur, trading and price movements often accelerate into the close of trading, especially in the last half hour.  Thus, what we have is a rather slow steady move up mixed in with sharp corrections keyed off of volatility.  For all of 2018, that has come to net an overall market increase of 0-5% with the lower end of the range relevant for value-oriented portfolios and the top end for growth oriented accounts.  That coincides with a year where earnings are up close to 25% offset by the impact of an approximate 75-100 basis point increase in interest rates.  At this juncture next year promises much smaller increases in earnings. The key, therefore, will be what happens to interest rates.

That leads me to Fed policy.  Jerome Powell has laid current strategy out rather explicitly.  There are likely to be approximately 3-4 more rate increases between now and mid-2019 to return short term rates to what the Fed deems to be normal.  Normal is the rate that allows the economy to continue to grow along side an inflation rate that is at or a bit over 2%.  Given there is a lag between the time rates are increased and their impact on the economy, the Fed has to rely on any forward looking data it can find to estimate the future impact of current rate increases.

The Fed, therefore, can lead us down one of three paths.  Behind window number one (as in Let’s Make a Deal), short rates get to 3% but the economy slows more than anticipated, due to some combination of tariffs, weak housing, slower growth overseas, etc.  Under this scenario, they yield curve might even invert.  Inflation almost certainly be less than expected.  In hindsight, the Fed would have done too much, too fast and could even sow the seeds for recession.  This is the fear that Donald Trump shows every day he chastises the Fed’s actions.

Behind window number two, the Fed gets to the same 3% but it can’t move fast enough to stop the accelerating freight train we all call inflation.  With wages rising, higher oil prices, etc. inflation starts to push toward 3% amid stronger than expected growth.  Central banks worldwide slow or ease QE programs.  The 10-year Treasury yield moves over 4%, maybe well over 4%.  The Fed would have to keep raising rates well beyond 3% to try to limit the impact of inflation.

Then there is window number 3.  That’s going to be the one with that holds the fancy car or the vacation package.  It is the one where the Fed gets it right.  3% turns out to be just about the perfect guess for normal inflation combined with steady sustainable growth.   Under this scenario, the Fed can stop raising short term rates at 3% and the 10-year only rises a bit more, perhaps into the 3.5-4.0% range.  Growth goes on for many more years and everyone smiles.

Obviously, we all want the last outcome.  I can’t put odds on which will be right.  Given the size of quantitative easy programs promulgated by central banks worldwide, the unwinding process this time around will be very tricky.  Stopping a car going 5 mph is much easier than stopping a car going 105 mph.  So, far there are no signs of going way off course.  Yes, housing is slowing in response t higher rates but it isn’t a disaster like in 2008.  Debt outstanding is high and there are some signs that credit quality is deteriorating a bit, especially in the shadow banking areas.  Sovereign deficits are rising and debt service is becoming a noticeable issue.  Thus, there are some clouds aloft but no obvious rainmaker yet.

As I say to everyone, tell me S&P earnings for 2019 and the year end 10-year Treasury rate and I will tell you where the stock market will be a year from now.  I suspect it will be easier to be close to forecast on the earnings front than on the interest rate front.  Up to the start of 2017, the Fed only instituted two rate increase in 10 years.  Since then there have been six and we know, barring sudden changes in the economy, 3-4 more are on their way.  Simply said, the hard part of QE unwinding is right in front of us.  Therefore, forget the tariffs, the mid-term elections and geopolitics.  For the next 12 months or so, it’s all about how well the Fed does its job.   So far, it is on course.  That offers some comfort.   The tricky part lies just ahead.

With that said, there are no obvious disasters behind any of the three windows.  The worst outcome is a modest mid-course correction, maybe even a short mild recession.  At the same time, none of the world’s leads to an investor’s version of Shangri-La.  The bull market is simply too far along for that to happen soon.  Forward looking returns are going to be more moderate than they have for the past decade.   That’s an outlook we all can live with.

Today, Eminem is 46.  Ziggy Marley is 50.  Today is also the 100th anniversary of the birth of Rita Hayworth.

James M. Meyer, CFA 610-260-2220

Additional information is available upon request.

* – Boenning and Scattergood may act as principal in buying this stock from or selling it to the public.

# – The author of this report or accounts under his management at Tower Bridge Advisors owns this security.

Additional information on companies in this report is available on request.  This report is not a complete analysis of every material fact representing company, industry or security mentioned herein.  This firm or its officers, stockholders, employees and clients, in the normal course of business, may have or acquire a position including options, if any, in the securities mentioned.  This communication shall not be deemed to constitute an offer, or solicitation on our part with respect to the sale or purchase of any securities.  The information above has been obtained from sources believed reliable, but is not necessarily complete and is not guaranteed.  This report is prepared for general information only.

Boenning & Scattergood, Inc. – Member FINRA / SIPC.

It does not have regard to the specific investment objectives, financial situation or the particular needs of any specific person who may receive this report.  Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed in this report and should understand that statements regarding future prospects may not be realized.  Opinions are subject to change without notice.

Last week’s correction is entirely connected to the recent rise in long term interest rates.  The bull market is in tact and should remain so without signs of recession or market excesses.

Stocks staged a modest recovery on Friday and futures only show a small decline this morning signaling that maybe the worst of the decline in now behind us.  But it will probably take another day or two for markets to regain any sort of equilibrium if, indeed, the major part of the correction is over. Earnings season gets going in earnest this week.  Expectations are high for good third quarter results, but, as always, managements forward looking comments will count more than the earnings themselves.  We all know that, because of the tax cuts, there is one more quarter of 20%+ earnings growth to come.  But it is the 2019 outlook that now becomes paramount.  Any clarity in that regard will be market moving.

But before discussing earnings and the economic outlook, I think we need to examine what happened last week in the context of the Federal Reserve Fed Funds rate increases that began in December 2015.  That increase was the first since the great recession.  It was only 25 basis points but it was a start.  It signaled to markets that the Fed finally felt the economy had recovered enough since the Great Recession to begin to accept the beginning of a movement toward normalization.  The Fed moved very slowly at the start.  There was only one rate increase in 2015 and the next one didn’t come until the end of 2016.  But as the economy healed, the pace of the increases started to increase.  We witnessed three in 2017 and appear on a path to four this year.  Four may seem like a lot but in past economic cycles the Fed more often than not raised rates at every FOMC meeting or 8 times a year.  In some instances, the increases were 50 basis points or half a percentage point at one meeting.

Next, we must recognize that all financial markets are intertwined.  Investors at all times have the option of holding cash, investing in fixed income instruments or buying stocks.  And that only takes into consideration the liquid asset classes.  I could add in real estate, art and gold among others.  When one class is repriced to be relatively cheap, money will flow to it. As rates rise, the attraction of cash and bonds could increase.  Of course, rising rates is a double-edged sword to bonds.  On one hand, the higher coupons mean more interest income.  But, on the other hand, existing bond prices fall as rates increase.  Thus, as short term rates rise, while cash returns rise, longer dated bonds might have negative returns as the decline in bond prices more than offset higher coupon rates.  In either case, however, higher rates, all other factors being equal, make stocks less attractive.

The other point to note is that higher rates serve to slow economic growth with a lag effect.  It takes time for a series of rate increases to impact the overall economy.   As I noted before, changes in interest rates may not be the only factor weighing on the economy.  In 2018, the cut in the U.S. corporate tax and a more expansionary fiscal policy were certainly offsetting tailwinds to headwinds created by rising rates.  As a result, growth in the U.S. accelerated.  However, growth elsewhere didn’t benefit as much.  Worldwide synchronous growth that seemed to be setting up in 2017 started to be less synchronous in 2018.  Europe wobbled a bit, some nations around the world ran into country specific problems, like Argentina, Turkey, Brazil and Russia, while China began to feel the impact of a budding trade war with the United States.

In February 2018, U.S. stock markets fell 10% in just six trading sessions following the three FOMC rate increases in 2017 and a 45 basis point rather sudden increase in longer term rates in January.  As long rates started to flatten in February and March, stocks regained their footing and resume their advance.  But in September, the long rates rose another 40 basis points or so setting the table for a second correction witnessed last week.

That correction was simply related to changes in interest rates.  The 10-year Treasury yield today is about 10 basis points below recent peaks and, therefore, the correction in stock prices might be near an end.  However, one shouldn’t assume that 3.25% 10-year Treasury yields are a new ceiling.  Two pressures are destined, at least in my opinion to move them higher.  First, are slowly rising inflationary pressures led by rising wages, tighter capacity utilization and tariffs.   Second, the support from central banks around the world stepping forward and persistently buying bonds on the open market is coming to an end.  The obvious conclusion, therefore, is that rates are going to go higher providing a persistent headwind to stock prices.

Let me stop there and make one point perfectly clear.  I am not predicting an imminent bear market.  Rising rates will slow the rate of increase but as long as world economies grow and earnings continue to rise, stocks should do OK.  OK means that they should do better than bonds. Obviously, the pace of increased earnings versus the pace of rising interest rates will govern whether stocks make modest gains in the coming year(s) or not.  What I can conclude, with some conviction, is that the pace of stock price gains in a period of rising interest rates will be slower than the pace of gains when central banks are actively in the market pushing rates lower.

There are some who will argue that the grand QE experiment of massive central bank intervention will be prove in the end to be a massive failure and stock markets are destined to decline as central banks withdraw and start selling assets off their balance sheets.  I disagree strongly with that conclusion.  First, even if stocks stop going up for a relatively short period of time, that is a very small price to pay for saving our financial system and allowing for almost a decade of sustained growth.  Second, nothing requires central banks to start selling assets they hold.  Just by letting bonds mature, they can get the job done in a rather non-disruptive manner.

Thus, last week, as in February, the market correction makes perfect sense.  It is and was a response to a short term pop in long term rates.  It was a simple repricing of assets.  Stocks so far in 2018, after last week’s correction are now flat to up slightly for the year.   Earnings are up more than interest rates suggesting the market’s price-earnings ratio has fallen this year as it should with rising rates and slowly rising inflation expectations.  Next year, I would expect more of the same.  Moreover, I expect the pattern of gradual increases in stock prices followed by short and sharp corrections to be repeated.  In a market that, in the short term, can see spikes in volatility with trading dominated by a relatively few quantitative trading firms, when all the major players are selling simultaneously, markets behave as they did last week.  For that reason, investors have to stay disciplined.   If stocks rise slowly but steadily to levels that appear not only fully valued but even a bit overvalued, some profit taking may be in order to protect gains. For longer term investors, less may be more.  A characteristic of these sharp sell offs is that the subsequent recoveries are almost as sharp for most stocks.

With that said, I expect the pattern of slow increases and brief but sudden contra contractions to continue until the Fed has reached the point where further rate increases are no longer necessary.  True bear markets, however, don’t start as long as the economy continues to grow.  Unless you believe that Fed policy is going to create a recession in 2019-2020, then the worst assumption is that markets stay relatively flat until the Fed slows its pace of rate increases.  That could happen as soon as the end of 2019.

There are three bull market killers to watch out for.

  1. The economy stops growing
  2. Inflation begins to accelerate meaningfully forcing the Fed to be more aggressive about raising rates
  3. Stocks become significantly overvalued as investors get euphoric as they did near the end of many bull market cycles.

At the moment, I see no signs that any of the three are relevant and, therefore, my base assumption is that the bull market remains in tact with periodic valuation adjustments necessitated by rising interest rates.

Today, Sarah Ferguson is 59.  Penny Marshall turns 75.

 

James M. Meyer, CFA 610-260-2220

 

Additional information is available upon request.

* – Boenning and Scattergood may act as principal in buying this stock from or selling it to the public.

# – The author of this report or accounts under his management at Tower Bridge Advisors owns this security.

 

Additional information on companies in this report is available on request.  This report is not a complete analysis of every material fact representing company, industry or security mentioned herein.  This firm or its officers, stockholders, employees and clients, in the normal course of business, may have or acquire a position including options, if any, in the securities mentioned.  This communication shall not be deemed to constitute an offer, or solicitation on our part with respect to the sale or purchase of any securities.  The information above has been obtained from sources believed reliable, but is not necessarily complete and is not guaranteed.  This report is prepared for general information only.

 

Boenning & Scattergood, Inc. – Member FINRA / SIPC.

 

It does not have regard to the specific investment objectives, financial situation or the particular needs of any specific person who may receive this report.  Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed in this report and should understand that statements regarding future prospects may not be realized.  Opinions are sub

Stocks closed mixed yesterday. The recent selling left traders nervous but a late day recovery in some of the leading tech stocks soothed some of those fears a bit.

Bonds traded within a narrow range.  Remember that at the start of this year, a spike in long term rates of less than half a percentage point over just a few weeks sparked a 10% correction in stock prices.  This time, the spike, at least to date, has been similar but the negative reaction has been more muted perhaps because earnings growth has been so strong in the interim.

As we enter the fourth quarter of the year, and recognizing that equity prices reflect expectations 6-9 months ahead, investors are concentrating on the outlook for 2019.  There is little reason to expect companies to report disappointing third quarter earnings as they begin to report results later this week and continuing through the end of the month.  But it will be what managements say about the fourth quarter and 2019 that will get the most attention.

Right now, earnings for the S&P 500 for 2019 are forecasted to be $175 or slightly higher. With the S&P trading just below 2900, that works out to a forward looking P/E of about 16.5 or about 2 P/E points above historic averages.  One can tie that premium to two factors.  First, interest rates, despite recent increases, are still lower than historic norms.  However, as central banks normalize policy, rates should return toward historic averages putting downward pressure on P/E ratios.  Second, P/Es normally climb as bull markets mature and investor moods swing from skepticism to euphoria.  That process is ongoing.  The transition is always slower after a financial crisis but there is clear evidence of gradual P/E increases since 2011.  Whether the psychological lift from the improving mood is enough to offset the impact of higher rates is an open question.

As for earnings themselves, there are also two ways to look forward.  On the positive side, confidence is high, real wages are rising and increased investment spending should help to lift productivity.  On the negative side, cost pressures are increase as a result of tariffs, rising energy costs, and higher real wages.  Companies have generally lacked pricing power during this recovery and one has to question whether margins are going to be squeezed next year.

On balance, therefore, the outlook for 2019 should be more muted than it has been for a couple of years.  Interest rate increases take time to affect economic growth.  The Fed increased rates once each in 2015 and 2016, twice in 2017 and, prospectively four times this year.  Right now, consensus suggests at least two and possibly as many as four next year.  Thus, the pace of rate increases, while still moderate by historic standards has been increasing and one can see the effects via a roughly 75 basis point increase in rates along the yield curve in 2018.   While there are arguments for and against an acceleration of recent trends looking ahead, the safest guess is that rates will move higher next year.  Unless investors become truly euphoric for whatever reason in the interim, my best guess is that we will see some P/E contraction next year.

If I couple that with some revenue acceleration, a combination of continued solid real growth and some lift from inflation, with a modest squeeze on net profit margins, earnings can grow at a 5% rate or better.  5-7% earnings growth with a modest-to-moderate contraction in P/E ratios suggest a year of muted returns.

What can change that?  First would be much greater productivity improvement than we have seen.  One can make that case.  Recent evidence shows some improvement.  Perversely, we would see more if the rate of job gains, currently averaging just under 200,000 per month, slowed.  The move to the cloud and accelerated capital spending also provide optimism.   Second, rising real wages are putting more money in the hands of Americans likely to spend most of what they earn.

But there are other possible changes that aren’t all positive.  Population growth is slowing and the reduction in immigration will accelerate that decline.   If the U.S. continues to grow faster than the rest of the developed world despite higher than average interest rates, the dollar will continue to strengthen putting pressure on foreign earnings and causing increasing difficulty for developing nations with lots of debt.  Finally, the 800-pound gorilla in the room is China.  Clearly, the trade war is having some impact.  China is trying to combat that will free flowing money but that is only a short term solution.  It also greatly increases longer term risks if growth cannot be sustained and borrowers have problems servicing debt.

News doesn’t flow in a straight line.  Some days the sun shines and strong economic data sparks enthusiasm.  On other days, tariff fights and rising interest rates rule.  When the trend line is rising at a double digit rate, the negatives are relatively muted and are not long lasting.  But when there is more balance, when growth is only running at mid-single digit rates, the ups and downs tend to even themselves out.  Reasonably rapid 10% moves over the next year in both directions would seem more likely than in 2017 or 2018.

None of this is a reason to be negative.  We have all been spoiled a bit by strong markets over the past couple of years but nothing moves in a straight line.  At the same time, there are no signs of the economic or financial imbalances that suggest a recession or similar economic disruption is forthcoming.  Moreover, while the outlook for equities is more balanced than it has been in recent years, rising interest rates suggest very little return likely for bond holders.  Cash will provide returns that can offset inflation but not much more.  At least holding cash in 2019 is not likely to cause one to lose purchasing power.

What would make me more negative?  First relates to China.  China is still growing faster than the rest of the world, even with the tariffs.  But China accounts for about 15% of world GDP.  Thus, modest changes matter.  If growth took a more drastic negative return, that would hurt multi-national companies.  Second, for whatever reason, if interest rates climbed more quickly than anticipated, that would spark a quick and negative reaction in other financial markets.

What would make me more positive?  The ongoing absence of inflationary pressures would be number one on my list.  It is unclear how well investors understand the disinflationary pressures of the Internet.  If enhanced price discovery continues to limit future price increases, it would mean lower interest rates. While the same pressures would crimp profit margins, the positive impact of lower rates would be stronger.  Second, as noted earlier, investor euphoria often swells late in an economic recovery cycle.  If we see an IPO and merger wave beyond what we have seen so far, that will serve to lift prices.

For now, as we enter earnings season, the main focus will be on 2019 estimates.  If $175 for the S&P next year is wrong, is it too high or too low?  We may learn a lot relative to that question in the coming weeks.

Sean Lennon, son of John Lennon and Yoko Ono, is 43 today.  He was born on the same date as his father.  John Lennon would have been 78 today.

 

James M. Meyer, CFA 610-260-2220

 

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