Capital Market Commentary First Quarter 2018
April 1, 2018
The Stock Market
The stock market started the New Year on a strong note, posting a 7½% gain to new all-time highs in the first four weeks of trading. In late January, a sharp selloff saw the S&P 500 sink just over 10% on a closing basis in just two weeks, sparked by an especially robust, and potentially inflationary, jobs report that saw average hourly earnings rise 2.9%. Additionally, a comment from Secretary of the Treasury Steven Mnuchin indicating he favored a weak US dollar and later walked back on, did nothing to help the market. Sensing a buying opportunity, investors stepped in and the market recouped much of the loss.
In late March concerns about a potential trade war sent the market into another swoon of just over 6% before recovering into the close of the quarter. Q1 earnings are on tap at this point, and likely will dictate near-term market action.
After a year of extreme calm, it is safe to say that market volatility has returned with a vengeance in the first quarter. As an example, in 2017 there were only eight days when the S&P 500 was up or down 1%. This year, stocks have moved 1% 23 times and 21 of those came in February and March. It certainly appears that this heightened level of volatility may stick around for awhile. This is more of a return to normal than the subdued volatility action of 2017. It is during these times that we stress the importance of focusing on the long-term strategy rather than the day-to-day market swings.
The Scoreboard for 2018
S&P 500 -1.2%
Dow Jones Industrials -2.5%
NASDAQ Composite +2.3%
Technology stocks were market leaders in the first quarter, despite some bumps in the road for some companies due to security concerns and the use of, or perhaps misuse of, personal data. The use of social media has exploded, and blowback from incursion incidents has heightened scrutiny and fostered the prospects for tighter regulation. On the other hand, companies providing security services had a good quarter, and present solid investing opportunities.
The 10-year US Treasury note ended the quarter yielding 2.74% after flirting at times with the 3% level. The March FOMC meeting was the first with the new chairman, Jerome Powell. Mr. Powell’s kick-off meeting was a success, as he is widely viewed as a capable and steady hand to lead this important monetary policy setting committee. As widely expected, the benchmark fed funds rate was raised a quarter point, and the expectations are for at least two, and possibly three more increases this year.
A 3% plus GDP for 2018 looks very doable as the first quarter closes. ISM (Institute for Supply Management) manufacturing data for 2017 came in at a robust average of 59.7, indicating strong factory output, (anything above 50 is expansionary) so it is fair to say that US factory’s are humming.
ISM Manufacturing Index (TTM)
The economic outlook was further bolstered by last week’s upward revision of fourth quarter GDP. Previously reported at 2.5%, the revision up to a bullish 2.9% annual rate was only a slight moderation from Q3’s brisk 3.2% pace.
The inventory build that is underway clearly contributed to the labor wage increases previously mentioned, as companies compete for qualified employees. The labor force participation rate is an important gauge of economic trends, and has been stymied at the 63% level for the past four years. Punching through this level would bode well for further wage gains.
The tax reform act passed last year will change the tax rates paid by many companies starting in 2018. The benefit of lower rates will vary from industry to industry, but the end result will be substantially higher earnings for the S&P. At this writing, analysts’ consensus forecast is that S&P 500 earnings for 2018 will show a year over year increase of 19.4%, with a subsequent 10% gain in 2019.
S&P 500 Earnings (Yardeni Research, Inc.)
Earnings have increased nicely since bottoming out in the 2008 financial crisis. However, a differentiating factor in the quality of earnings since mid-2017 is that companies are now showing solid revenue growth as the economy picks up steam.
When the rhetoric subsides, earnings ultimately drive the stock market. Projected gains are based on three major components; pretax income growth (aka organic growth), tax benefits, and stock repurchase/M & A activity. The contribution of each should be in the neighborhood of 45, 40, and 15 percent respectively.
A Picture is Worth a Thousand Words
The chart below shows corrections in the current bull market in percentage decline and duration in days. The stock market bottomed out in March 2009, and since then other than brief dips during corrections the S&P 500 has stayed nicely above the long term 200 day moving average.
Stock Market Corrections (Yardeni Research, Inc.)
There are many indcators used by investors to gauge the potential of a future recession. One widely watched indicator is the yield curve, a slope of bond yields vs. maturity dates, currently positive although flattening somewhat due to short term rate hikes. Another is the index of leading indicators that is flashing economic expansion. Residential investment and measures of consumer expectations are in positive territory, further bolstering confidence.
On a side note, we want you to know that Abbot is committed to providing you with excellent customer service. This often means getting those emergency funds to you with very little notice. It also means we must be vigilant against fraud and “bad actors” who might try to divert funds. To that end, Abbot has a firm policy that no funds will be wired out of your account without verbal confirmation from you. We also stongly encourage you to set up standing instructions so that we can more easily and safely fullfill your money requests.
As always, Bill, Andrew, and Bob are always available to further discuss the financial markets or your portfolio at your convenience.