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First Quarter 2017 Client Newsletter

Before we get into our periodic discussion about the markets and our investment/economic outlook we would like to provide a brief update on the military events that occurred last night (4/6).  

As many of you know, the United States has officially entered the military conflict in Syria.  The current line of thinking is that these targeted strikes are a ‘one‐off’ event that will not escalate into broader US military involvement.  

After a short‐lived negative move in global stocks overnight, the markets have stabilized.  And if the prevailing expectations hold, the market should be quick to refocus its sights on the growth expectations for the United States Economy (which is the subject of this newsletter).

We will continue to vigilantly monitor these international developments over the coming days and weeks and will not hesitate to reduce exposure to the market if conditions warrant.

On Counting Your Chickens:

No matter your personal politics, the resurgence in broad confidence measures and economic expectations since the cessation of the brutal 2016 presidential election is irrefutable.

Some may point to the ‘turn’ in global survey data that began in the summer of 2016 (see our March newsletter).  Still others may put the transformation at the feet of the new administration and the still forthcoming deregulation and corporate/personal tax reform (see our February newsletter).

Either way, the truth is as stark as it is apolitical:   ‘We are still waiting for optimistic survey and sentiment data to filter through to the real economy.’

For this month’s newsletter I asked (our analysts) Austin Harrison and Mark Gibbens to detail the growing divergence between what we refer to as ‘soft’ and ‘hard’ data.  

A quick primer before turning to their analysis: Soft Data refers to survey data that focuses on how samples of the economy either feel, or what their expectations are for growth.  Hard data refers to actual economic data such as retails sales, gdp, wage growth, etc.  

CEO Confidence and Capital Spending

Below, we compare CEO Economic Outlook, a proxy for business optimism, with yearly growth of Capital Spending. Over the past 15 years, the two indicators have been positively correlated, although there is often a time lag between the optimism survey and actual dollars being spent. Both data sets trended lower after the drop in oil prices that began in 2014, with Capital Spending falling from 8% growth to 1.5% contraction. More recently, CEO Outlook has risen dramatically as business leaders anticipate the potentially pro‐growth policies of our new administration. It remains to be seen whether executives will “put their money where their mouths are” and turn that confidence into investment spending. If they do, it will lend credit to the strength of the domestic economy going forward. If not, it could be a cause for concern.

Consumer Confidence and Spending

Now we turn to another crucial component of economic growth: consumer spending.  In the graph below, the dark blue line represents the 3‐month average of real consumer spending and the light blue line represents consumer confidence expectations for 6 months in the future.  A typical market observer might expect these gauges to track one another relatively closely.  However, as shown in the accompanying graph, a significant divergence has opened recently between real consumer spending and consumer confidence expectations.  Consumer confidence is breaking out from its high in 2005 and is considerably greater than 100.  On the other hand, real consumer spending has not broken out from its 2005 high and is currently growing at a moderate pace between 2% to 4%.  As consumers have become increasingly optimistic, possibly as a result of a new administration, this shift has not yet resulted in changes to their actual spending patterns.

In conclusion, the swift and decided upswing in confidence measures has been a welcomed development and could be a sign of positive things to come.  That said, it is critical that these robust ‘soft’ data points translate to a sustained expansion in the underlying ‘hard’ economic data.  

Should this scenario of broad US economic strength play out, we are confident that there is more upside left in this market.  On the other hand, if there is lackluster follow‐through in real economic activity, it is reasonable to expect a continuation of the volatile and choppy market that we have endured over the past 3 years.  

The most likely scenario, of course, probably lies somewhere in‐between the plainly positive and painfully negative.  As we continually assess the data as it becomes available, we will not yet count our eggs as chickens until they’ve hatched.   As always, please do not hesitate to reach out if you have any questions about the content of this newsletter or our overall outlook.