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 (NYSE: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 (NYSE:PG) to Pfizer (NYSE:PFE) and Dupont (NYSE:DFT) 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 Company (NYSE: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 (ARCA:TLT) exposure in recent weeks. Until the broad stock market breaks down, we can afford to remain patient with our equity-based ETFs (ARCA: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.