Cliggott: Here's the $64,000 Question Right Now

Editor's Note: Below is a Guest Contributor note written by our friend Doug Cliggott. Cliggott is a former U.S. equity strategist at Credit Suisse and chief investment strategist at J.P. Morgan. He is currently a lecturer in the Economics Department at UMass Amherst. 

Cliggott: Here's the $64,000 Question Right Now - Bull and bear extra cartoon

 

On markets...

 

My views on bonds haven't changed a whole lot from six months ago. But I was wrong on 2017 earnings ... I thought they would be down quite a bit this year, but it does not look that way now.  Profit growth has turned positive. 

 

1) I think the 10-year yield is heading higher.

 

Why? Faster inflation caused by rising unit labor costs.  

 

Non-farm productivity growth remains dismal:  0.2% in 2016, following 0.9% in 2015 and 0.8% in 2014.  With hourly compensation growing at 2.9%, BLS reports unit labor costs rose 2.6% in 2016, up from 2.0% in 2015.  A  2.5% 10-year yield seems unsustainable when unit labor costs are rising at 2.6%. 

 

Non-residential fixed investment remained stagnant in 2016, even as after-tax cash flow edged up, so it is hard to see what will push productivity growth higher in the near-term.  The focus of corporate America remains returning cash to shareholders rather than investing in the future.  

 

Share buybacks and dividend payments equaled 53% of cash flow in the non-financial corporate sector in 2016 -- that compares with a 35-year average of 34%. {This is based on Fed data, Cliggott calculation from Table F.103 in the Z1 release - new Fed website looks pretty cool, btw}

 

Meanwhile, cap ex by non-financial corporations equaled 73% of cash flow in 2016 -- that compares with a 35-year average of 84%.  The two numbers combined {shareholder payments of 53% + cap ex of 73%} still looks high relative to the long-term average combined total of the two -- 34% +53% = 117%.

 

So if US corporates slow their borrowing for some reason {higher rates?}, my guess is cutting cap ex will come before cutting payments to shareholders.

 

2) Most LEI's around the world bottomed last summer - including the U.S. 

 

That was a big surprise to me. This data tends to fit well with the U.S. corporate profit cycle.  Hence my change in view on 2107 profit growth.

 

I guess now the $64,000 question is -- Is this the beginning of a new cycle or "noise" on the way down?  I honestly don't know ... but given leverage levels and interest rate trends I am VERY SKEPTICAL that this is the beginning of a new credit / profit cycle. 

 

So my guess is renting {with a short-term lease} rather than owning US equities makes the most sense at this stage. I would note that the IWM hasn't made any net progress in three months ... and the next OECD LEI data release is April 10th!


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