- Via Nova’s perspective.
- Stocks struggled against some disappointing economic reports and political turmoil.
- A tale of two economies?
- Will we have 20% earnings growth in 2018?
- Tariff tone and Trump team turnover.
- The Fed takes center stage in the coming week. Jerome Powell holds his first press conference as Chairman. Will we see “rookie” mistakes in the Q&A?
Via Nova’s Perspective:
Via Nova believes the underlying strength in the domestic and global economies, augmented by the stimulus from tax reform, will help companies generate 20% or more in earnings growth in 2018. This environment will likely be an important support to the continuation of the nine-year bull market, and we favor stocks over bonds. However, while the backdrop is positive, a shift to a less accommodative monetary policy, building inflation pressures, increased international tensions (partly self-inflicted), and mid-term elections may introduce a continuing element of volatility to the markets that has been absent in recent years.
Stocks struggled against some disappointing economic reports and political turmoil.
The S&P 500 lost -1.20% in the latest week, trimming the first quarter gain to 3.38%. Ten of the eleven sectors lost ground, paced by materials and financials, while the more defensive utilities sector gained 2.64%. However, small cap stocks slipped just -0.65%, while international and emerging market stocks posted modest increases.
In fixed income markets, the yield on the 10-year Treasury note slipped to 2.85% from 2.89% the previous week. Softer economic reports, lower inflation and political uncertainty helped limit the recent uptrend in rates. 2.90% seems to be an important technical level for the 10-year Treasury note, and attempts to break through it have been short lived, so far. In other markets, real estate and oil improved as did Treasury Inflation Protected Securities (TIPS), while gold prices fell.
A tale of two economies?
The economic calendar was full of reports covering numerous sectors, and from Via Nova’s perspective, the data painted two somewhat divergence pictures of the economy. Early in the week, February retail sales declined for the second consecutive month, raising questions about consumer strength. The weak retail sales report was followed by a relatively tame 0.2% rise in the consumer price index. The two reports, combined, suggested softer economic growth and modest inflation pressures in the first quarter, but also eased fears that the Federal Reserve might see a need to hike interest rates faster than planned. Adding fuel to the weak economy argument, the Atlanta Fed’s first quarter GDPNow indicator, which tracks growth based on data as it is reported, dropped from a high of 5.0% early in the year to just 1.8% by Friday.
While some reports were soft, other reports measuring confidence were quite healthy. The NFIB small business survey rose to a near record in February, and the University of Michigan consumer sentiment survey jumped in March to its highest level since April 2004. In trying to make sense of the divergence data points, many analysts concluded that, because of seasonal adjustment problems in the first quarter in recent years, the confidence surveys may be a better reflection of current economic strength. Indeed, job openings in January rose above six million, suggesting fresh economic momentum.
Globally, the OECD raised its forecast for world economic growth to almost 4% in 2018 and 2019.
One final economic report worth mentioning showed strengthening consumer balance sheets in the fourth quarter. The CoreLogic fourth quarter Homeowner Equity Insights report estimated that homeowners with mortgages (roughly 63% of all properties) saw their equity increase by a total of $908.4 billion over the past year, an increase of 12.2% year-over-year. Importantly, in the wake of the Great Recession and Financial Crisis that centered around housing, the percentage of mortgaged residential properties with negative equity (“underwater”) decreased to 4.9% from a peak of 26% in the fourth quarter of 2009. Two important points stand out to us at Via Nova. First, consumers have more equity in their homes, which boosts confidence and supports spending. Second, since homes with positive equity can be sold more easily, “frozen” homeowners may now be able to move to new opportunities, which, in turn, increases the potential number of homes for sale in what has been a tight housing market.
Will we have 20% earnings growth in 2018?
Thomson Reuters estimates that S&P 500 operating earnings in the first quarter will increase 18.2% from a year ago. Given that companies usually beat estimates, don’t be surprised if earnings increase over 20% for the quarter. Second quarter earnings growth is estimated at 19.6%, third quarter 21.9%, and fourth quarter 18.8%. Full year 2018 earnings are currently estimated to increase 19.5% following an estimated 12.8% in 2017. Healthy corporate earnings in a strengthening global economy could be a key support for stock prices this year into next.
Policy: Tariff tone and Trump team turnover.
“Calm” and “boring” are two words NOT associated with the Trump presidency, and political uncertainty has been a cloud hanging over the markets.
Regarding tariffs, the Trump administration toned down the rhetoric on trade, saying the tariffs are intended to bring trade partners to the negotiating table and help level the field for global trade. That said, don’t expect countries with favorable trade deals to give in easily.
Staff turnover in the Trump administration has been high by historical standards, and that observation was punctuated with the surprise firing of Secretary of State Rex Tillerson. Some assume Tillerson’s departure will clear the way for President Trump to make good on his promise to withdraw from the Iran nuclear deal, which is theoretically bullish for oil, as sanctions would be reinstituted against the Islamic Republic. Perhaps this move could be bullish for oil, but Saudi Arabia is estimated to have ample spare capacity.
Coming Week: The Fed takes center stage in the coming week. Jerome Powell holds his first press conference as Chairman. Will we see “rookie” mistakes in the Q&A?
The Federal Reserve will hold its second FOMC meeting of the year on Tuesday and Wednesday. The meeting is important for several reasons that could affect markets. First, the FOMC is expected to raise its target for short term interest rates by one quarter percent from 1¼% - 1½% to 1½% - 1¾%. Will recent low inflation reports and political turmoil cause them to stay on hold, or will they, conversely, feel a need to ramp up the amount and pace of rate increases due to tax reform stimulus? Via Nova believes we will see the consensus quarter point hike, which is mostly priced into the market. We will also see updated forecasts from the FOMC members on expected growth, inflation and the required level of short term interest rates, commonly referred to as the “dot plot.” The question is whether the committee will raise the long term neutral rate. Finally, Chairman Powell will hold his first post-meeting press conference Wednesday afternoon. While Powell is a seasoned policy maker and capable spokesman, it is not uncommon for new Fed Chairs to have a verbal stumble when answering the myriad of reporter questions. Bring popcorn.