Year End Outlook: Will Investors Get Hustled By The Pros In 2017?

It never pays to be an “afterthought.”

That was the word Jackie Gleason used to characterize the proposed reprisal of ‘Minnesota Fats’ in The Color of Money, 1986’s sequel to The Hustler. Chances are Paul Newman himself, who had at least 36 script conferences with the screenwriter, didn’t take offense to Gleason’s rebuff. “We desperately wanted the character to return,” Newman told the New York Times of Gleason’s ‘Fats,’ “but every time we put him in, it seemed like we were trying to glue an arm on a man and make it stick.”

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Will Investors Get Hustled?

Under the brilliant direction of Martin Scorsese, Newman would go on to win an Oscar for his role in Color. Still, as a whole, the sequel simply couldn’t stand up to the 1961 original. Hence the irony of Newman’s Oscar, which critics suggested was in belated recognition of his original performance as an ace pool player in The Hustler. In his young, glory days, Newman so deeply penetrated his characters’ roles that he literally vanished into them. His brilliance as an actor shined brightest in one scene when Eddie lost to Fats; rather than hostility or animus, his fascinated adoration for his idol was unabashedly on display, reflected in his bright eyes and amused expression. Now that’s Hollywood.

As for Wall Street, it’s recent performance has also laid the drama on thick and in perfect form as stocks pierce record highs. The investor community, the Street’s audience, couldn’t agree more. According to the latest survey from the Conference Board, retail investors’ enthusiasm for the stock market’s prospects is at the highest level since February 2007. A stroll down memory lane reveals that similar readings on the giddiness gauge were contrarian in nature, aka sell signals. That is, unless you’re referring to 1996 as a step-off point. In that case, today’s positive parallels suggest stocks’ 2017 sequel could best the original rally that culminated in the S&P 500 peaking in 2001.

What’s driving the train to stock market stardom? The singular theme since Trump was elected has been happiness bordering on euphoria. The overall December Conference Board survey hit a 15-year high. This echoed the most recent University of Michigan December survey, which hit a 12-year high. But it’s not just your average Joe on the street, as in Main Street. Small business confidence also witnessed its biggest one-month surge since 2009, while regional manufacturing surveys have uniformly topped forecasts. Based on an average of five regional Fed surveys, Morgan Stanley raised to a two-year high its expectations for the upcoming release of the national manufacturing survey.

The question is, can the economic fundamentals Trump the (over?)-heated hope? For that to happen, every bit of optimism has to be substantiated. And that supremely sublime stage has yet to be set.

The entirety of the Conference Board spike was due to expectations; current conditions, which remain high, actually fell on the month. Similarly, small business owners’ expectations for future sales rose smartly, which runs counter to actual sales, hiring and capital expenditures declining last month. And finally, one red flag that’s popped up in multiple places centers on the jobs market. While consumers’ expectations for income growth rose to the highest level in a decade, their perceptions of jobs being ‘plentiful,’ fell while those lamenting jobs were “hard to get” rose, affirming the recent drift upwards in jobless claims.

Some of the regional Fed surveys also showed employment had unexpectedly hit reverse gear, contrary to respondents’ effusive outlook for the future. Most surprising, perhaps, were the losses reported in Texas’ manufacturing sector in November; they defy the recent uptick in rig counts. Renmac’s chief economist Neil Dutta figures the number of operating rigs has surged 120 percent over the third quarter average. That puts the current number of drilling wells at the highest since January; oil maintaining its price gains implies more to come, reflected in Texas manufacturers’ outlook, which hit its highest level in 12 years. Presumably job growth will follow, according to the script, that is, and not just in the Lone Star State. Presumably.

Continuing along the contented motif, homebuilders are downright ecstatic – their optimism is ringing in the new year at the highest level since 2005. As per the National Association of Home Builders (NAHB):

“Builders are hopeful that President-elect Trump will follow through on his pledge to cut burdensome regulations that are harming small businesses and housing affordability. This is particularly important given that a recent NAHB study shows that regulatory costs for home building have increased 29 percent in the past five years.”

Potential homebuyers are also buying in to the potential for falling prices; the NAHB sub-index that measures Prospective Buyers Traffic registered its first print in expansionary territory since August 2005. There’s a good chance the cheery potential homebuyers overlap with the record number of consumers (18 percent) who the University of Michigan reported “spontaneously mentioned the expected favorable impact of Trump’s policies on the economy.” This figure is twice as high as its prior peak, recorded in 1981 as Reagan was taking office.

The teensiest of caveats before continuing – all of this rhapsody is not free; it’s been more than reflected in higher interest rates which have notably manifested themselves in the highest mortgage rates since the bond market threw a taper tantrum in the summer of 2013. Not even Yale economist Robert Shiller can predict which way the winds will blow, good or bad, as he told Bloomberg News:

“I don’t know how people react to rising mortgage rates. One thought is they want to lock in right now. And that’s why we’ve had good home sales recently. And it might continue as mortgage rates rise. This thing could feed a boom. I’m not saying it will.”

Talk about measured!

Paradoxically, households’ inflation expectations looking out five years over the horizon sank to their lowest level on record in data going back to 1979, even as businesses whine about the highest input costs in years.

If you think you’re hearing a wee bit of a mixed message emanating from households and businesses, you’re not losing your marbles. Policymakers and politicians have a heck of a lot to make good on when Congress takes to the Hill and the new administration sets foot in the White House next month.

We can all hope that breaking the gridlock and freeing businesses to conduct business the old-fashioned American way will unleash animal spirits among employers. Job creation, of a meaningful, high-income-generating sort, would thus beget consumption. This in turn would spur the best sort of economic growth we can hope for, and at the same time reflect businesses carrying through on their stated confidence with actions, by expanding their payrolls, inducing a lovely, virtuous cycle that feeds on itself. How economically endearing indeed.

Would you be surprised to discover there are a few skeptics who doubt Goldilocks is primed to whip out those golden locks, validating, well, just about everyone’s cockiness?

Though other perpendiculars have already been posited, it’s fair to interject a friendly reminder that we are not in 1982, the last time stocks were trading at a single-digit price-to-earnings multiple and Baby Boomers were less than half their age. Is it relevant that productivity growth was running at eight times its current pace with the saving rate double where it is today and household debt to income half of where it is? Wait…won’t rising rig counts cap oil prices? And does it matter that Uncle Sam’s debt load has grown to 105 percent of GDP compared to 30 percent back then? Does this country and its inhabitants technically have to have a pot that’s growing in size to piss in?

Not according to the measured volatility on the stock market, which is near the lowest in recorded history. We have nothing to worry about and that’s that. Hence the perplexing pessimism among institutional investors. The State Street Investor Confidence Index (ICI) peaked in March of this year, and after a wimpy stab at a comeback, has retreated anew.

The developers of the ICI observed that 2016 ended on a downbeat note as institutional investors continued to shun the stock market, preferring instead to wait for follow-through from the incoming administration and greater clarity on just how serious the Federal Reserve is about hiking rates in 2017.

“While markets increasingly look to be ‘priced for perfection’ over the US economic outlook for 2017, it is interesting that institutional investors are more circumspect,” said Lee Ferridge, State Street’s head of North American strategy. “Most noteworthy for me is the decline in the North American index even as US equities and the US dollar continue to rise.”

If the stars don’t align perfectly, if the sequel doesn’t best the original, smaller investors might want to wise up to the fact that they’re being hustled by the equivalent of professional gamblers. Know that they’ve been at this game for long enough to cash out their winnings while they can still be put to good use. What’s the alternative? That would be investors finding themselves in naïve form, as Fast Eddie did, just before he lost to Minnesota Fats, asking, “How can I lose?

Article by Danielle DiMartino Booth, Author of Fed Up: An Insider’s Take on Why the Federal Reserve is Bad for America

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Called "The Dallas Fed's Resident Soothsayer" by D Magazine, Danielle DiMartino Booth is sought after for her depth of knowledge on the economy and financial markets. She is a well-known speaker who can tailor her message to a myriad of audiences, once spending a week crossing the ocean to present to groups as diverse as the Portfolio Management Institute in Newport Beach, the Global Interdependence Center in London and the Four States Forestry Association in Texarkana. Danielle spent nine years as a Senior Financial Analyst with the Federal Reserve of Dallas and served as an Advisor on monetary policy to Dallas Federal Reserve President Richard W. Fisher until his retirement in March 2015. She researches, writes and speaks on the financial markets, focusing recently on the ramifications of credit issuance and how it has driven equity and real estate market valuations. Sounding an early warning about the housing bubble in the 2000s, Danielle makes bold predictions based on meticulous research and her unique perspective honed from years in central banking and on Wall Street. Danielle began her career in New York at Credit Suisse and Donaldson, Lufkin & Jenrette where she worked in the fixed income, public equity and private equity markets. Danielle earned her BBA as a College of Business Scholar at the University of Texas at San Antonio. She holds an MBA in Finance and International Business from the University of Texas at Austin and an MS in Journalism from Columbia University. Danielle resides in University Park, Texas, with her husband John and their four children. In addition to many volunteer hours spent at her children's schools, she serves on the Board of Management of the Park Cities YMCA.