Economic Heatwave: What Could Go Wrong in 2018?

Economic activity in the manufacturing sector expanded in November, and the overall economy grew for the 102nd consecutive month, say the nation’s supply executives in the latest Manufacturing ISM® Report On Business®.

The PMI increased to the highest level since March 2011. Furthermore, increases in production (best in 34 years), New Orders, Backlogs and Unfilled Orders.

Of the 18 manufacturing industries, 14 reported growth in November.

Sounds pretty hot, right?

On December 10th, before the tax bill passed, the Financial Review published an article titled, “The US economy may be getting too hot.”

Interesting idea, as the tax bill came thereafter. Many economists believe that the fiscal stimulus is “very poorly timed.”

In a conversation we had with Ellen Zentner, chief economist for Morgan Stanley, she said that tax cuts are most effective when the economy is floundering and not necessarily effective at this late stage.

My takeaway from that conversation is that not only might the impact prove potentially impotent, it could lead to inflation that outpaces economic growth.

With a new Federal Reserve chairman, one that Ms. Zentner says is competent and a team player, what could possibly go wrong?

The theory behind the tax cuts are that with corporate rates falling from 35 to 21%, corporations will use the extra money for new investments.

However, companies now spend about $71 billion a month, a level virtually unchanged since late last year.

Passage of the tax cuts have pushed Wall Street to boost its forecasts faster than corporations have increased their actual spending.

The gap between the projections and actual outlays is now the widest since August. (Blomberg 12/28/17)

On the other hand, about 36 percent of corporate executives say they plan to increase capital investment in 2018, which is four times more than in 2016.

It’s too soon to know what corporations will do-use the boon to buy back their own stocks or invest in growth.

Therefore, we look back to the Federal Reserve, never to be underestimated in setting monetary policy that directly impacts the economy and markets.

If Powell follows in the footsteps of Janet Yellen, his focus will be on employment numbers and inflation data.

How will we know if the economy is overheating?

  1. Rising rates of inflation which could lead to rising interest rates.
  2. Abnormally high levels of consumer confidence.

Inflation is a lagging indicator. For example, in a 2-year span between 2004-2006, the Fed raised the rates 17 times. However, by 2008, inflation hit a cycle high. We all know what happened next.

Presently, inflation is at 2.2%. Energy prices rose at a fast pace, which led to the stronger than expected number.

Consumer confidence in December, slid a bit off its 17-year highs. However, despite the decline, expectations remain at historically strong levels.

In 2000, the consumer confidence index was over 140%. Currently, it’s at 122.1%. Highest it’s been since 2000, but not quite at euphoric levels yet.

So, what can we investors look for?

Gold and silver, basing over the last 3 weeks, will react first. If metal investors see more proof of rising inflation, that could serve as a warning that the economy is too hot.

Incidentally, the US dollar impacts this as well. A lower dollar and higher rates is a huge red flag.

Keep focus on the Modern Family. Particularly watch the small caps, Russell 2000, Transportation and Retail (brick and mortar). IYT, Transportation, is tantamount and must hold recent gains.

Watch for any reversal of trend in employment numbers. 2 consecutive upticks in unemployment will not be perceived well.

Finally, completely out of investor control-geopolitical risks. Besides the ongoing Russian investigation, North Korea and the Middle East continue to bubble. War, what is it good for?

This is the last Daily for 2017. After the new year, I will write a lot more about investment trends and favorite picks.

Have a healthy and a happy New Year. Thanks for all of you support!

S&P 500 (SPY) 267 pivotal support

Russell 2000 (IWM) 153 key support now

Dow (DIA) 247 pivotal support

Nasdaq (QQQ) 157.21 resistance

KRE (Regional Banks) 59.25 pivotal

SMH (Semiconductors) Through 99 better

IYT (Transportation) Runaway gap well intact if does not trade down to 190.31

IBB (Biotechnology) Through 107.50 see 110 at least. Under 105 some trouble.

XRT (Retail) 46.00 pivotal number. 45 pivotal support

IYR (Real Estate) 80.00 now support

GLD (Gold Trust) A bit overbought so expect some digestion

SLV (Silver) If good, should close week over 15.74

XME (S&P Metals and Mining) Looks explosive

USO (US Oil Fund) $60 a barrel a barrier to clear

XOP (Oil & Gas Exploration) 37.00, a new leg and now place to hold

TAN (Solar Energy) looking good

TLT (iShares 20+ Year Treasuries) 124.50 -127 new range

UUP (Dollar Bull) 24.24 now resistance with 24.06 support