Country singer Chris Ledoux put it adroitly, “Some men look forever and still they never find, They don’t know that freedom is a state of mind”. Well, I’ve never been more wrong than in my tome when I posited, “where are interest rates going, zero?” Of course that was slathered in sarcasm.  I should have left off the sarcasm and I would have been crowned a genius as rates went exactly to where I believed was impossible. Then as a second slap to my mockery of interest rate policy, rates dipped below zero and went negative. Luckily, we adapted to the new normal and maintained our aggressive posture to both equity and fixed income markets.

We appear to be living in a somewhat surreal monetary policy era where anything goes. Being fiscal policy has been neutered by our inept politics, we’re left with the only tool to fend off any global economic weakness, free money.  Free and Freedom both can offer great riches; as well both can carry great responsibility.  

Investors are chasing dividends. Since treasuries as measured by the 10 year note yield a paltry 1.60%, the rush to a quasi-bond surrogate, equities, is stretching valuations. This behavior is dangerous and creates bubble-like traps. I.e., 1. Buy stock yielding 2 ½%.  2. The Federal Reserve hikes rates.  3. Stock price tanks 10% = -7 ½% total return.  

There is a well known scenario when investing in beaten down stocks referred to as a value trap. I coin the chase for yield as a “yield trap” trade. Investors are drawn to the relative high yield of equities, the price of their stocks takes a hit, leaving investors trapped.  Equities, unlike bonds or CDs, do not have a maturity date.  So holding them to a maturity that doesn’t exist to recoup one’s principal becomes a case of hope and desperation rather than based on good fundamental investing. TRAPPED.

Where we’re at:

Gross Domestic Product (GDP).  Second quarter GDP was revised down -.1 to +1.1%. The drivers to growth were personal consumption and exports. The detractors came from the drawdown in inventories along with a slowdown in state and local government spending.  Second quarter GDP will be revised one more time but we don’t anticipate any large revisions. Current quarter GDP is tracking in the +3%-+4% range.  Very positive.

Employment.  July’s Non-Farm payroll figures caught most off guard with another strong showing, + 255,000, while July’s number was revised up +5,000 to +292,000.  Wages ticked up +$.08 to a +2.6% annual increase while the work week inched higher to 34.5 hours.  The next release will come this upcoming Friday, with consensus right around +185,000.  Yesterday’s release of the monthly ADP jobs report tallied +177,000 would suggest a Non-Farm number closer to 190,000-200,000.  Even coming in at the low end would give us a three-month average of +245,000 which potentially could lead to a rerating of upcoming economic growth, pouring into corporate revenues and earnings. Solid. 
 
Housing. Existing homes sales fell for the first time since November 2015, dropping -3.2% to a 5.39 million annual run rate.  Reasons for the slowdown point to the familiar culprits, lack of inventory and the stair stepping higher of pricing.   On the flip side New Home sales popped +12.7% to a +654,000 annual run rate.  Demand remains robust supported by an improving employment picture and ultra-low mortgage rates.  Both very positive. 
 
Industrial Production (IP). IP rose +.7% in July following June’s +.4%.  This was the best showing since November 2014.  Breaking this figure down a bit we see manufacturing growth of +.5%, the best in a year.  The Utilities Index add on +2.1% and even the Mining Index contributed +.7%.  All in all a solid number. 
 
Consumer Confidence. The Consumer Confidence Index for August surged +4.4% to +101.1% vs. July’s +96.7%.  This was the best reading in nearly a year.  Contributors to this positive reading were consumer views on employment along with personal income prospects.  Being consumption supports over 2/3  of US output, this confidence reading is very supportive to the continued economic expansion and market rally thesis. 
 
Where we’re going:
 
Seasonality suggests volatility should pick up in the current month. Which means the markets may get a bit dicey. We’re entering the final month of the quarter.  We have an election outcome that is far from certain and a DC remaining deadlocked.  The domestic economy appears to be, by near any indices we follow, growing at a more robust pace than is captured in the GDP figures. Take in collectively the following:  Employment additions should top two million for 2016.  Housing and auto sales continue to perform at elevated levels and remain near post-recession highs. Consumer spending and sentiment are holding steady in positive territory and recently we’ve witnessed a pickup in the missing link to jump start growth, corporate expenditures. This leads to our optimistic outlook albeit cautiously optimistic. 
 
What encourages our caution? Market historians would tell us this recovery is long in the tooth, overextended and due to end quickly and badly.   Statistically correct. But this time seems different.  How can I feel so confident?  Simple; they’ve been telling me this for the last three years. Start with the facts. The average recovery post-1945 has averaged 58 months. What if this time is different? History has a long memory, pain changes behavior.  The financial crisis inflicted Valium-worthy levels of pain on near everyone.  From investors to homeowners and of course to the previously employed. Severe pain like that doesn’t fade quickly and the memories have most likely changed behavior.  

That changed behavior is what I believe we’re witnessing currently.  Remember Detroit Lion Stephen Tulloch tearing his ACL after sacking Aaron Rogers doing his version of the Touchdown Double Check?  I feel pretty confident Mr. Tulloch will never TDC again.  Consumers prior to ’08 used their credit cards and home equity like a bottomless savings account.  They awakened one long morning that stretched 3 years to find they had no equity left in their homes, credit lines yanked and savings depleted.  If that wasn’t bad enough, it was followed up by a Friday 4:30 pm pink slip alerting them their services were no longer needed.   Swish that one around a bit like a fine wine before the swallow.  Only this bottle clearly has turned and left a horrible finish. That scenario would easily change behavior.

But, I believe while extremely painful we may be better off.  The “new normal”.   The US consumer is saving nearly twice the levels since ’08 at 5.5%. Americans are saving more for retirement. That would also mean we’re spending less, which is also good in that perhaps we’re not living beyond our means. But while we’re saving more, far too many youngsters are saddled with and spending a higher portion of their income on student debt.  A Mt. Everest worth of debt.  Again, behavior-changer.

Maybe, just maybe there is a dynamic  shift occurring here in the US. Consumers are more selective, frugal, educated and financially aware.   Corporations are adjusting to shifts in buying responding with inventory adjustments, lean headcount and focused tech investments.   This responsible behavior may account for the below-historical-rate-growth trend. It may also point to an extension of this economic cycle for at least another five years. If there is no boom, what brings the bust? Another way to look at it, if there are no extremes, where does the reversion to the mean come from? 
 
The Federal Reserve most likely will hike rates a fully 1/4 of 1% before the year is out.  So what? Clearly the Fed is in no hurry to move policy aggressively higher. The domestic economy can handle Fed Funds at .50% or ½ of 1%.  Even if calendar year 2017 sees this Fed lending rate at 1%, again so what.  We look for US output to remain pegged at this 2 ¼%-2 ½% rate of expansion due in part to overall lackluster global growth, a stable dollar and strengthening demand pushing energy prices higher.  In this environment a shift in market leadership should take hold, leading investors to dump utilities and healthcare and move into specialty tech, diversified energy producers and the financials.   

In the end we paint a picture of more of the same.  A domestic economy supported by low interest rates, expanding payrolls and robust demand for automobiles, homes, consumer discretionaries, restrained by overall global uncertainty regarding the growth of the Euro-zone and Asia. These headwinds may be somewhat offset by India’s reform-boosted economic expansion along with Central American economies regaining their footing.   This scenario pins us to our outlook for a stock market that continues to churn and grind grudgingly higher.

Ledoux finishes appropriately, "When the highway to nowhere has finally came to an end, Well they might think you're crazy when you tell 'em you’d do it again." Let's hope this one isn't on Fed Chair Yellen's playlist.  Because in the end nothing in life is free except love and happiness.  

For now we remained committed to the market patiently deploying our cash.   
 
Thank you again for your patience in these very challenging markets.