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Goldilocks Joins Team Trump -- Barrons.com

4 Feb 2017 5:13 am
By Randall W. Forsyth 

The first two weeks of the Trump presidency have been nothing if not eventful. An immigration ban, a Supreme Court nomination, testy phone calls to foreign leaders, an attempt to dismantle Dodd-Frank -- all in a week's work. Plus feuding with Arnold Schwarzenegger.

It's a wonder that the new administration had time to react to trivial matters, such as Iran's launch of a ballistic missile in apparent violation of the landmark nuclear deal, Israel's West Bank settlements, North Korea's nuclear threat, or the surge in violence in Ukraine.

On the last score, the nation's new United Nations ambassador, Nikki Haley, took a sterner tone toward Russia than her boss, blaming that country for the increase in fighting in Ukraine and vowing to keep in place U.S. sanctions for the 2014 annexation of SHYCrimea. As a candidate, Donald Trump suggested that he might lift the sanctions and recognize Vladimir Putin's hostile takeover of the region.

What has been clear is who has come out ahead in this episode. From his digs in Palm Beach, Fla., near the new Winter White House, Doug Kass of Seabreeze Partners slyly observes that even though the U.S. stock market has been up smartly since the November election, the Moscow bourse has done nearly three times as well.

Not exactly Russkie business.

Given all of these myriad distractions, it's a good thing that the main point of contention in last year's presidential race -- the U.S. economy and, specifically, the status of the American working woman and man -- has been a blessed island of tranquility, compared with the political scene at home and abroad.

The latest readings of the labor market could have been conjured by Wall Street's favorite fairy-tale character, Goldilocks, with numbers that weren't too hot or too cool. The benign figures should help keep not only bears, but also the Federal Reserve, at bay.

The January employment report, released on Friday, wasn't the first of the Trump era, but rather the final one to cover the Obama administration. And befitting important releases, its components made one long for Harry Truman's proverbial one-armed economist.

On the plus side, nonfarm businesses expanded payrolls by 227,000 last month, about 50,000 more than the median guess from forecasters. But after taking into account revisions that took 39,000 from the prior two months' tally, the overall report was close to what economists' Ouija boards had indicated it would be.

The jobless rate, which comes from a separate survey of households, ticked up by one-tenth of a percentage point, to 4.8%, but that wasn't totally a bad thing. The civilian labor force grew, and the labor force participation rate edged up to 62.9%, still near a generational low but above December's 62.7%.

The composition of the workforce was troubling, however. Lynx-eyed Peter Boockvar, chief market analyst at the Lindsey Group, noted a 305,000 drop in prime-age (25 to 54 years old) workers, partially offset by a 195,000 increase in the grizzled 55-plus SHYcontingent on the job.

Pay, however, was disappointing, with only a 0.1% rise in average hourly earnings. That was less than expected, given that 19 states increased their minimum wages last month.

After seasonal adjustment, which assumed a more frigid January than most of the nation experienced, construction payrolls expanded by 36,000, while retail employment increased by 46,000 (which means there actually were fewer layoffs than usual after the holidays).

Finally, the so-called underemployment rate (U6 to SHYlabor data aficionados) rose to a three-month high of 9.4% from 9.2% in December. David Rosenberg, chief economist and strategist at Gluskin Sheff, notes that the rise reflects a "huge" 242,000 surge in the number of folks working part-time for economic reasons. That's "a metric near and dear to Janet Yellen's heart," he added, referring to the Federal Reserve chair.

Prior to the jobs report, the Federal Open Market Committee made no change in interest rates at its regular meeting. There were minimal changes in the panel's policy statement, mainly to note that "measures of consumer and business sentiment have improved of late." Among the latter, the Institute of Supply Management's manufacturing gauge rose to 56 from 54.5 in December, while the ISM service-sector measure slipped marginally to 56.5 from 56.6. (A reading above 50 indicates economic expansion.)

That should keep the central bank from raising its SHYfederal-funds target at the March FOMC meeting. The fed-funds futures market currently is pricing in a quarter-point hike (from the current 0.5% to 0.75% target range) in June and another by December. Perhaps more importantly, longer-term yields have remained subdued, with the benchmark 10-year Treasury note staying south of the 2.5% mark.

In turn, corporations have taken advantage of salubrious capital-market conditions by bringing bonds to market by the boatload. Last week, old-tech stalwarts Microsoft (ticker: MSFT) and Apple (APPL) issued $17 billion and $10 billion, respectively. Microsoft was following up a $19.75 billion offering last summer, which will help pay for its $26 billion acquisition of LinkedIn.

AT&T (T) earlier raised $10 billion, which could go toward its proposed acquisition of Time Warner (TWX). And Broadcom (AVGO) raised $13.55 billion to buy out Brocade Communications Systems (BRCD).

Apple, meanwhile, continues to borrow cheaply to fund its share buybacks, despite having $246 billion in cash; most of that is overseas, and Cupertino isn't waiting for Washington to ease repatriation taxes.

And the availability of cheap capital facilitates other possible deals. On Friday, The Wall Street Journal reported that Macy's (M) was approached by Canada's Hudson's Bay (HBAYF) about a possible acquisition. The Canadian company, which owns Saks Fifth Avenue and Lord & Taylor, is valued at 1.9 billion Canadian dollars ($1.4 billion) -- far less than Macy's $10 billion stock market value and $7.5 billion debt load. The assumption apparently is that the capital markets would willingly accommodate the deal.

It isn't news that cheap debt has funded the repurchase of equity, but JPMorgan economist Nikolaos Panigirtzoglou puts it in some perspective. For the first time, global net equity issuance turned negative, which created support for stock prices, despite SHYreduced demand from individual investors.

Pundits like to call profits mother's milk for stock prices. Perhaps, but the equity SHYbabies are being fattened on artificial formula from the capital markets. As long as the economy remains just right, that flow of SHYliquidity should continue.

THE ECONOMIST ROBERT SOLOW once commented at a conference where Milton Friedman presented a paper that "another difference SHYbetween Milton and myself is that everything reminds Milton of the money SHYsupply; well, everything reminds me of sex, but I try to keep it out of my papers."

Readers might notice that while sex is kept out of this column, there is an unnatural obsession with closed-end funds. That's because the sector is chronically mispriced, which can yield investing pain, as well as pleasure.

On the latter score, a number of Pimco CEFs felt the double sting of dividend cuts and resulting steep losses. Among them was the Pimco High Income fund (PHK), which plunged 11% on Thursday SHYafter its payout was pared by 22%.

The reason for the severe hit was that the shares had commanded an incomprehensible 50% premium to their net asset value. (To review, CEFs issue a fixed number of shares, which can trade in the aftermarket at a premium or discount to the value of their underlying holdings.)

If this sounds familiar, it should be to Barron's readers. Going back at least five years, we've been warning about the SHYunwarranted prices accorded some of the firm's CEFs (See the Focus on Funds blog, " The Pimco Premium -- Totally Gross?" Jan. 23, 2012, and succeeding accounts.) But SHYbefore the bad news of the payout cut hit, following Wednesday's close, the High Income fund sported a distribution yield of 12.5%. That apparently was enough to get investors to overlook the unpleasant reality that, of the 10.35-cent monthly payment per share, 6.19 cents consisted of income while the remaining 4.16 cents were a SHYreturn of shareholders' capital.

After Thursday's hit, Pimco High Income still traded at a 34% premium to net asset value. At the reduced payout, the SHYindicated yield was 10.96% -- huge but not necessarily worth paying $1.34 for a buck's worth of assets.

At the other end of the spectrum, SHYDoubleLine's bond king, Jeffrey Gundlach, picked an attractively cheap bond CEF, the Putnam Premier Income Trust (PPT), in the second installment of this year's Barron's Roundtable ("Manual for a Mixed-Up Market," Jan. 21). Unfortunately, after readers followed his lead, the Putnam fund wasn't quite the bargain that it had been when Gundlach recommended it. The shares still trade at a discount -- some 5.72% on Thursday -- but one well below its 52-week average of 9.73%. (All of these data come from cefconnect.com.)

A sharp-eyed reader points out that a corporate cousin, the Putnam Master SHYIntermediate Income Trust (PIM), has the same managers and a similar portfolio. But it trades at a slightly wider discount (6.71%) and higher yield (6.6% versus 5.92%).

None of these plays will pay like a hot SHYinitial public offering. But hey, they keep your mind out of the SHYgutter.

Email: randall.forsyth@barrons.com

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February 04, 2017 00:13 ET (05:13 GMT)

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