Economic Update 2-05-2018

• Economic news for the week was highlighted by the FOMC keeping interest rates unchanged in their first meeting of the year, Manufacturing surveys showed a bit of a drop while remaining high, housing data showed gains, and the employment situation report came in stronger than expected.
• Global equity markets declined sharply on the week, led by weakness in the U.S. coupled with higher interest rates.  These same rates increases also punished bond markets, particularly on the long-term part of the yield curve.  Commodities also came in lower, due to a pareback in energy prices for the week.

U.S. stocks suffered their worst week since June 2016, due to a variety of factors, including wage gains noted above, and Fed chatter about expectations for higher inflation that sent bond yields sharply higher.  Higher interest rates can be challenging for a variety of assets, including stocks, as it changes the discount rate for future cash flows and raises opportunity costs for other assets (like bonds, which become more attractive as rates rise).  Then again, it’s important to keep this in perspective, as years like 2017 where all twelve months experienced positive returns, are highly unusual, as is volatility being as low as it’s been.

From a sector standpoint, more conservative telecom and utilities still lost ground, but to a far lesser degree to lead for the week, while energy and materials struggled with losses over -5%.  Thus far, per FactSet, half of the companies in the S&P 500 have reported earnings for Q4, with 75% reporting positive earnings surprises (at a blended growth rate of over +13%) and 80% reporting revenue surprises.  If the latter revenue figure holds up, it would be the best proportion in nearly a decade.  Estimates for Q1 earnings also rose significantly, with help from tax reform.

Markets were also thrown for a loop on Tuesday, with the announcement of a joint venture between Amazon, JPMorgan and Berkshire Hathaway in an attempt to reduce the epidemic of rising health care costs among their employees.  Consequently, several big insurers in the health care group, such as Dow member UnitedHealth, and similar firms, fell back sharply in response.  On Friday, weaker earnings from energy giants ExxonMobil and Chevron weakened sentiment.  It would be no surprise for volatility to continue, given that the Feb. 8 deadline for a budget deal is on the horizon, although this could be pushed out again to later February or March where it could overlap with discussions over increasing the debt ceiling yet again.

Foreign stocks declined as well, albeit to a lesser degree as domestic indexes, with good corporate earnings results being outweighed by higher interest rates—driven by yields in the U.S.  Emerging markets faring worse than developed and the dollar playing a minimal role in the week’s returns.

U.S. bonds suffered, to no surprise due to the spike in interest rates caused by increased inflation fears/expectations.  Broader government and investment-grade corporate indexes performed similarly, losing just short of a percent for the week, while long-term treasuries lost several percent due to the typical duration effect.  Floating rate bank loans actually gained ground on the week, serving their traditional anti-bond role.  Foreign bonds lost ground in local terms and offered mixed results when translated back into U.S. dollar terms.

Real estate investments fell several percent, as would be expected upon higher interest rates.  Returns in foreign markets in Europe and Asia were similar to those in the U.S., although domestic industrial/office fared a bit better, while retail/malls fared worse.

Commodities fell a bit along with risk assets, with little impact from the dollar for the week.  Lower prices for energy, industrial metals and precious metals were offset a bit by higher prices for agricultural contracts wheat and corn.  Crude oil bounced around during the week, finally declining by just over -1% to end the week at $65.45.  Notoriously volatile natural gas fell -10% as warmer forecasts were anticipated in coming weeks, following a spike in price from a variety of January snow events, as well as increasing production.

Sources:  LSA Portfolio Analytics, American Association for Individual Investors (AAII), Associated Press, Barclays Capital, Bloomberg, Deutsche Bank, FactSet, Financial Times, Goldman Sachs, JPMorgan Asset Management, Kiplinger’s, Marketfield Asset Management, Minyanville, Morgan Stanley, MSCI, Morningstar, Northern Trust, Oppenheimer Funds, Payden & Rygel, PIMCO, Rafferty Capital Markets, LLC, Schroder’s, Standard & Poor’s, The Conference Board, Thomson Reuters, U.S. Bureau of Economic Analysis, U.S. Federal Reserve, Wells Capital Management, Yahoo!, Zacks Investment Research.  Index performance is shown as total return, which includes dividends, with the exception of MSCI-EM, which is quoted as price return/excluding dividends.  Performance for the MSCI-EAFE and MSCI-EM indexes is quoted in U.S. Dollar investor terms.                                                                               

The information above has been obtained from sources considered reliable, but no representation is made as to its completeness, accuracy or timeliness.  All information and opinions expressed are subject to change without notice.  Information provided in this report is not intended to be, and should not be construed as, investment, legal or tax advice; and does not constitute an offer, or a solicitation of any offer, to buy or sell any security, investment or other product.