HIGHLIGHTS:
- The S&P 500 finished nearly flat in April. Bonds continued to struggle.
- The facts are positive: economy, earnings.
- The fears are persistent: trade, Fed policy.
- Via Nova’s outlook for the economy and stock market remains positive, but fears are likely to persist near term. Climbing the “wall of worry.”
The S&P 500 finished nearly flat in April. Bonds continued to struggle.
Stocks bounced up and down throughout April, as investors reacted to positive economic and earnings reports as well as concerns over escalating trade frictions and a tighter Federal Reserve interest rate policy. The S&P 500 gained a modest 0.38% for the month led by a surge in energy stocks, which was offset in part by weakness in industrials and consumer staples. Market volatility measures remained elevated.
However, outside of the large cap S&P 500, equity performance was better. Small cap stocks gained 0.87%, and international equities added 2.39%. Oil prices rose to multi-year highs due to rising demand and concerns that Middle East tensions and the turmoil in Venezuela might hamper supply. Of potential interest to investors, the value of the dollar, which has declined for over a year and benefited exporters, bounced up just over 2% during the month. The dollar rise in April was not enough to reverse the longstanding downtrend, but if it persists, it could be a potential negative for large cap exporters and a relative positive for small cap stocks.
In the fixed income markets, bond returns continued to fall due to a further rise in interest rates. The yield on the 10-year Treasury note briefly rose above 3% before closing out the month at 2.94%, up noticeably from the rate at the beginning of the year and a year ago. Higher interest rates translate into lower prices for existing bonds. As a result, the benchmark Bloomberg/Barclays Aggregate Bond Index slipped another -0.78% during the month and has fallen -2.31% so far in 2018.
The facts are positive: economy, earnings.
The latest round of economic reports showed a pickup in consumer income, confidence and spending. There was a rise in home sales and home construction. On the business side, industrial output, capital spending and optimism all increased more than expected.
Investors want to see companies grow sales and profits, and the first quarter earnings reporting season has been outstanding. At the beginning of the year, analysts forecasted a 12% increase from the previous year. At the end of April, with over half of the companies in the S&P 500 reporting, that estimated growth rate shot up to nearly 25%, with almost 80% beating consensus estimates compared to the long-term average of 64%. Tax reform, a weaker dollar and firming energy prices all played a role in the gains.
The fears are persistent: trade, Fed policy.
The aggressive efforts of the Trump administration to negotiate more favorable terms with our major trading partners continued to keep investors on edge. While the initiatives may prove successful, there is also a risk of a tit-for-tat escalation that could lead to a trade war. As a result, the markets reacted to the potential impact of each nuance and announcement from Washington, Brussels and Beijing.
The other worry is the pace of Federal Reserve interest rate increases. The Federal Open Market Committee (FOMC) raised the overnight fed funds rate (the Fed’s primary policy tool) in March, and surveys of the FOMC members point to two more rate increases this year. The Fed has been consistent in its communication that it will raise rates only gradually, but if the strength in the economy continues or the acceleration in inflation persists, the FOMC could decide to increase rates three more times instead of two.
The effect of these fears, lower sales growth in the event of a trade war, higher inflation, and a more aggressive pace of FOMC tightening could affect investor willingness to bid stock prices higher despite very strong earnings growth. Stock investors are interested in the growth of future sales and profits. Higher inflation and increasing interest rates tend to erode the value of those expected gains and put downward pressure on stock prices.
Via Nova’s outlook for the economy and stock market remains positive, but fears are likely to persist near term. Climbing the “wall of worry.”
Via Nova remains positive on the economy and the equity markets in 2018, but bonds are likely to be facing steady headwinds.
The current expansion appears to be on a firm footing, and the risks of a recession over the near term are low; employment and spending are higher as are production, earnings and investment. Forecasts for corporate profits growth have increased significantly since the beginning of the year. Equity valuations have fallen in recent months, making stocks more attractive. These forces should help support stock prices, and we favor stocks over bonds.
However, there are several risks to the markets that could keep downward pressure on stock prices for a time. First is the risk of a trade war and the damage that could exert on foreign sales and the domestic cost of goods. We do not believe that a trade war is the most likely scenario, and recent events and announcements suggest that outcome can be avoided. Still, it is an unresolved issue. A second risk is that the FOMC might raise rates faster than expected, which would raise the cost of borrowing and lower the discounted value of future corporate earnings. We view this risk as also relatively low, because FOMC Chair Jerome Powell has said the Fed would be willing to tolerate above target inflation for a time without feeling pressed to raise rates faster than the current plan.
Over the near term, we expect continued market volatility while the markets react to positive facts and unresolved fears, and that major stock market averages could remain rangebound while the various uncertainties are addressed. Bond yields could also remain in a trading range. Still, Via Nova’s most likely scenario, if there is progress addressing the current concerns, is that the markets will climb over the “wall of worry” raising the potential for higher stock prices and bond yields.