HIGHLIGHTS:
- Stocks post gains, but policy concerns remain a key focus.
- Inflation shows signs of modest acceleration.
- It’s early, but Q1 earnings season off to a good start.
- Trade tensions eased a bit, but Syria strike executed. TTP? Facebook faced Congress. Ryan retiring.
- FOMC minutes suggest growing consensus around future rate hikes.
- Coming Week: Tax day. Lots of economic and earnings reports due.
Stocks post gains, but policy concerns remain a key focus.
Stocks ended a positive week on a disappointing note, as investors, once again, elected to trim equity positions ahead of the weekend. Policy concerns appear to outweigh favorable economic and financial fundamentals at present, as the balance of commentary below will attest.
The S&P 500 rose 2.04%, more than offsetting the -1.35% decline in the prior week led by gains in energy and technology stocks. International equities also improved 1.49%, but an increase in bond yields pushed the Barclays Aggregate Bond Index down -0.19%. Tensions in Syria helped lift oil prices to the highest level in over three years, and the magnitude of the increase over a year ago helped boost oil company revenues but also inflation. The value of the dollar slid -0.31% and was -10.91% below the year-ago level. A weaker dollar makes exporters more competitive, but it also increases prices for imported goods adding to inflation.
Inflation shows signs of modest acceleration.
A modest decline in the consumer price index (CPI) was the major economic report for the week. The market was expecting a slight increase. The CPI was lower than the consensus due to a -2.8% drop in energy prices. However, the CPI increased 2.4% from a year ago, and rose 2.1% excluding food and energy – both above the Federal Reserve’s 2% inflation target. However, while overall inflation appears to be accelerating, the sources of the acceleration are limited, according to Via Nova’s research. Indeed, more sectors showed decelerating inflation during the past three months than accelerating inflation in the latest report. The data suggests inflation is rising, but not rapidly, which may allow the Fed, for now, to stick with its plan to increase rates just two more times this year.
It’s early, but Q1 earnings season off to a good start.
The first quarter earnings season got off to a good start. With a bit less than ten percent of the companies in the S&P 500 reporting in the latest week, 70% of those firms beat earnings estimates, and 77% exceeded revenue forecasts. Combining reported earnings with expected earnings due in the weeks ahead, S&P 500 operating earnings are forecast to increase 18.6% over the first quarter of 2017, according to Thomson Reuters. Companies in the energy sector are expected to lead, and all sectors are forecast to show positive earnings and revenue growth. Lower tax rates (increases profit margins), fiscal stimulus (boosts revenue), and a weaker dollar (makes exporters more competitive) are all expected to contribute to the improvement.
Trade tensions eased a bit, but Syria strike executed. TTP? Facebook faced Congress. Ryan retiring.
While the economy and earnings look favorable, policy risks have taken center stage with investors for the time being.
Tariffs: Stock markets responded very positively to a major speech by Chinese President Xi Jinping on Tuesday, in which he avoided escalating the tit-for-tat that has characterized U.S. efforts to revise current trade policies and practices. Xi promised foreign companies greater access to China’s financial and manufacturing sectors, pledging Beijing’s commitment to further economic liberalization. The speech does not eliminate the risk of a trade war, but the more measured tones from President Xi suggest hope for continued trade negotiations, which is the Via Nova baseline scenario. The Dow closed up 429 points on Tuesday.
TPP: Also, on the trade front, Mr. Trump announced that he has asked Robert Lighthizer, U.S. trade representative, and Lawrence Kudlow, the director of the White House National Economic Council, to study the possibility of re-entering the Trans-Pacific Partnership (TPP) negotiations. Many in the group welcomed the U.S. move, but most are reluctant to make major concessions.
Syria: While there was a glimmer of hope on the trade front, investors worried about the possibility of a dramatic escalation in the U.S. response to the alleged chemical weapons attack last week that killed at least 43 civilians and injured hundreds. Friday night, U.S., U.K. and French forces launched airstrikes targeting sites associated with Syria’s chemical-weapons capabilities, while avoiding other military-related targets. The response was proportionate, according to government officials, but additional strikes could be forthcoming. Russia objected.
Facebook: Facebook founder Mark Zuckerberg testified before Congress for two days after news that a data outfit gained access to information on 87 million Facebook users. Zuckerberg admitted errors and promised a series of data-protection measures. We mention this company-specific news because Zuckerberg and members of Congress believe some form of consumer protection / regulation is needed going forward. We believe consumer protections are positive, but establishing regulations on social media could be tricky and have unintended consequences. If new regulations are too onerous, it could raise a barrier to entry for potential new competitors (remember Facebook began in a college dorm room) and leave Facebook with a near monopoly. The EU model on consumer protections may be a starting point for negotiations.
Ryan: Lastly, House Speaker Paul Ryan announced he will not run for re-election and will leave the House in January 2019. Lawmakers had expected he might leave if the GOP were to lose the House this fall. Congressman Ryan endorsed Majority Leader Kevin McCarthy as his replacement after he retires. While it is unclear that the announcement will hurt the Republicans going into the mid-term elections, it is unlikely that the news is positive. The odds makers see no better than a 50-50 chance that the Republicans will retain control of the House after the November elections.
FOMC minutes suggest growing consensus around future rate hikes.
Federal Reserve Open Market Committee (FOMC) meeting minutes are often quite dry, but they can be useful in assessing the direction of thinking by its members. At the March 20-21 meeting, Fed officials signaled greater confidence in reaching their 2% inflation target over the coming year and affirmed plans to keep raising interest rates gradually. “All participants agreed that the outlook for the economy beyond the current quarter had strengthened in recent months. In addition, all participants expected inflation on a 12-month basis to move up in coming months.” The minutes mentioned concerns about the impact of possible tariffs from their business contacts, but all agreed that tax changes enacted at the end of 2017 would provide a “significant boost to output over the next few years.” The bottom line for Via Nova is that the Fed is very comfortable with its plan to raise short term interest rates at least two more times this year. These moves will likely exert upward pressure on longer term interest rates and put downward pressure on bond returns. If the FOMC moves only gradually as planned, we believe stocks can continue to move higher.
Coming Week: Tax Day. Lots of economic and earnings reports due.
Tuesday is Tax Day.
The coming week will see updates on a wide variety of economic sectors including retail sales, housing starts, industrial output and leading economic indicators. All are expected to be positive. Earnings season kicks into high gear, with 60 S&P 500 companies reporting profits.