Market Strategy Radar Screen Weekly September 25, 2017

As The World Turns

Voters in Germany opted for pragmatism versus populism in Sunday's vote

Sunday’s elections in Germany proved a victory for Angela Merkel and her party even as results showed a weakening in her base of support due largely to voter opposition to her policy on immigration. This resulted in some worrisome gains for the German right wing.

That said, Merkel’s winning a fourth term as Germany’s chancellor racks up a third victory for pro-EMU, pro-EU and pro-business constituencies in Europe. Notwithstanding concerns expressed at the beginning of the year the elections in the Netherlands, France and now in Germany have not resulted in a radical change.

So far 2017 has proven to be from an election perspective in our opinion positive with neither a “Nexit” (that could have come from elections earlier this year in the Netherlands) nor a ”Frexit” in France nor a radical change in Germany. We can’t help but wonder whether Britain’s Brexit vote outcome last year may have served as a model of “what not to do” for voters elsewhere in Europe this year.

From our perspective on the market radar screen we say that so far in 2017 voters in Europe have for the most part “passed” on populism and “opted” for pragmatism. More than likely the improvements in the European economic landscape have served as a bromide in the polling booth.

We’d say politicians of all stripes in Europe as well as in the US this year so far appear to have been put on notice by voters that radical ideological rants and stagnation are “out” and economic progress for business and labor are ”in.”

Nine months into the year the message from the markets appears to be that it likes what’s been “going on” at the polls. Market gains this year look to us at least in part to be a resounding “I like it” with stock markets rising around the globe reflective of improved economic conditions that have positively affected business and labor.

Perhaps things are not as good as some might expect they should be or even as good as they might be but at the end of the day things appear a lot better economically than they were over the course of the greater part of the last decade.

In the week ahead

Early this week the Administration in Washington is expected to present the framework of its tax overhaul. We remain skeptical of prospects for tax reform with so many vested interests and conflicted opinions represented in Congress. We consider tax reform to be nearly as contentious a topic as health care reform in the halls of Congress or around the Beltway.

That said we expect that the effort toward tax reform will morph more simply into tax cuts for corporates and individuals with the greatest benefits for the former. That should mean that any announcements this week could have at least some effect on the markets. The recent improved performance of small and mid-cap stocks has at least in some part signaled increased prospects for something to get done with the administration’s tax agenda.

On Tuesday the S&P/Case-Shiller housing price data and newhome sales numbers for August are due, along with consumer confidence for September.

Wednesday brings durable goods orders for August. On Thursday look for the final estimates on Q2 GDP.

Friday brings personal income and spending data.

Throughout the week “Fedspeak” will be an item for market observers and investors to focus on as Fed Chair Yellen and a number of Federal Reserve Presidents are slated to speak around the country.

The probability of a rate hike (as measured by Fed funds futures) increased last week to 63.2%. After the central bank’s FOMC policy meeting Fed Chair Janet Yellen announced that the Fed would begin to trim its balance sheet in October. She also suggested that the Fed would likely raise its benchmark rate in December (something we have been expecting).

Fed funds futures have been signaling a higher probability of a December rate hike since hitting a low of 25.5% on August 11. Since then an improved mix of economic data including an upward revision to GDP growth, positive earnings results in the Q2 earnings season along with improved prospects for tax reform or at least a tax cut have boosted sentiment and expectations for the Fed to make further progress on the path to interest rate normalization.

The stock market has thus far has been able to digest prospects of higher rates as inflation (particularly the Fed’s favored gauge, the personal consumption deflator) has remained shy of monetary officials’ 2% inflation target rate.

With wage growth remaining modest for now and likely to remain so (at least into the foreseeable future) and businesses concerned with lowered barriers of entry via technology and globalization the Fed is unlikely to be forced into making abrupt or rash decisions that could jar the markets.

For now at least, risks of worrisome inflation emerging are countered by the relentless march of technology (robotics and algorithms) and globalization.

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