Durables Miss In Big Way
The slow growth/low inflation story gained additional traction Tuesday when
durable goods orders came in well below expectations. From The
Wall Street Journal:
U.S. businesses broadly cut capital spending in the final months of
2014, raising red flags about the economy's ability to sustain momentum
amid troubles around the globe. Orders for durable goods -- products
like cars and kitchen appliances designed to last at least three
years -- fell 3.4% in December from a month earlier, the Commerce
Department said Tuesday. Orders have fallen four of the past five
months.
Bonds Win In Two Of Three Scenarios
From an investment perspective, there are three major scenarios likely facing
investors. Scenario one is an ongoing period of slow growth and low inflation,
which can be favorable for both stocks and bonds. Scenario two, slower growth,
has gained some momentum with the recent trends in earnings and economic
data. Scenario three involves a stronger economy and a shift toward higher
inflation. You can see a larger and economically-broader version of the flow
diagram below via this link.
The least likely outcome in the short run appears to be scenario three (stronger
economy). Given the stock market has not broken down in a meaningful way
yet, it seems reasonable to assign the highest probability to scenario one,
which is more of the same (slow growth and low inflation). The broader market's
failure to make a new high over the last seven months tells us scenario two
(slower growth/recession) is creeping higher on the probability ladder. The
video below puts some additional fundamental and historical context around
the three scenarios.
Strong Dollar Hits Earnings
The fundamental backdrop includes increasing fear of deflation, which has
helped increase demand for the world's reserve currency, the U.S. dollar
(UUP). A strong dollar has some negative consequences for U.S. corporations.
From Bloomberg:
The dollar's surge is reducing earnings at American companies from
Procter & Gamble Co. (PG) to Pfizer Inc. (PFE) and DuPont Co.
that make a large portion of their revenue abroad. P&G, the world's
biggest consumer-products maker, today reported profit that missed
analysts' estimates in the quarter ended Dec. 31 after what Chief
Executive Officer A.G. Lafley called "unprecedented" foreign-exchange
rate fluctuations reduced sales by 5 percentage points. DuPont and
drugmakers Pfizer and Bristol-Myers Squibb Co. (BMY) all posted annual
forecasts that trailed predictions, in part because of the dollar.
Investment Implications - The Weight Of The Evidence
In two of the three scenarios described above, bonds can perform well. Consequently,
we have been slowly been ratcheting up our fixed income (TLT) exposure in
recent weeks. Until the broad stock market breaks down, we can afford to
remain patient with our equity-based ETFs (SPY).
Wednesday brings the latest from our friends on the Federal Reserve's Open
Market Committee. If we are willing to pay attention with a flexible and
open mind, the market will guide us in the coming days and weeks.
