HIGHLIGHTS:
- Stocks flat, but the value style outperformed. Bonds yields at a tipping point?
- The economic data was better than expected.
- Q1 earnings growth is half complete and the results are impressive so far.
- Policy developments were mixed to positive.
- Coming Week: More earnings. FOMC meeting. Trade negotiations with China. April jobs report.
Stocks flat, but the value style outperformed.
The stock market was quite volatile amid a plethora of economic, earnings and political news, but finished relatively flat for the week, with the S&P 500 off less than a point. Bonds also had their share of excitement, as the yield on the 10-year Treasury note rose briefly above 3% before closing at 2.99% on Friday. The 3% level, while not high, is psychologically and technically significant for investors, because it is something of a tipping point between the extended period of ultra-low yields associated with easy monetary policy in recent years, and the gradual return to a more “normal” interest rate environment.
Turning back to stocks, an interesting shift during the week was the outperformance by the “value style” (cheaper valuations / higher dividend yield) over the “growth style” (faster sales and revenue growth / more expensive valuations). The growth style performance more than doubled that of the value style during the past year, and bested value by nearly 5% on average in each of the past three years. These periods of one-sided outperformance do not last forever. One week’s outperformance does not make a trend, but if economic growth accelerates closer to 3% as many expect and interest rates continue to trend higher, the lagging value style may attract renewed interest.
The economic data was better than expected.
The job market remains healthy, based on the latest data, and that strength appears to be pushing wages higher, raising consumer sentiment and spending. Initial jobless claims fell to the lowest level since 1969, and gains in employment helped lift the measure of consumer sentiment back up near a 14-year high. Both new and existing home sales exceeded estimates in March, as did new business orders for capital goods. However, with that strength has come a gradual increase in inflation pressures, as measured by a higher than expected increase in the first quarter employment cost index. Inflation levels remain relatively low, but they are rising and will likely support the planned rate hikes by the Federal Reserve this year.
First quarter GDP increased at an annualized rate of 2.3%, above consensus, but below the 2.9% growth rate in the fourth quarter. In recent years, GDP growth in the first quarter has been persistently soft, only to rebound in the second quarter on average. As a result, drawing conclusions from the details of the GDP report is a bit hazardous. Growth is forecast to accelerate to a roughly 3% rate in the remaining quarters of 2018, which is good for spending and profits, but the faster growth may put additional upward pressure on inflation and interest rates.
Q1 earnings growth is half complete and the results are impressive so far.
Optimism regarding first quarter profits growth continued to soar in the latest week. At the beginning of the year, analysts forecasted a 12% increase in first quarter corporate profits. This week, 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 process are all playing a role in the gains. The energy sector is forecast to report the biggest percentage increase in earnings, followed by technology and financials.
Some are asking if 25% growth is as good as it gets. Caterpillar spooked the market on Tuesday when, after reporting very strong profits and sales growth, the chief financial officer said the first quarter performance was the company’s “high-water mark for the year.” The stock plunged 10% on the remark. Fortunately, few other companies suffered the same slip of the tongue.
Policy developments were mixed to positive.
Russian Sanctions: The Treasury department gave Russian aluminum producer Rusal some wiggle room regarding sanctions, if it would cut ties with oligarch Oleg Deripaska, who is on the sanctions list. The company complied, and aluminum prices dropped sharply on the news that aluminum supplies will increase.
France and Germany: It was obvious that French President Emmanuel Macron and German Chancellor Angela Merkel did not see eye to eye on international matters with President Trump in their visits to Washington, but the comments in the post-meeting press conferences suggested some areas of common agreement regarding Iran. Both the French and German leaders do not want to walk away from the current Iran deal, but acknowledged that it could be a starting point for additional needed improvements. Merkel announced that Germany would increase its defense spending in the coming year, and that her nation should move into a more mature role within NATO.
North Korea: North Korea’s Kim Jong-un and South Korean President Moon Jae-in held a historic meeting at Panmunjom, where the pair promised to try to reduce tensions, normalize relations, and formally end the war, which began in 1950. Over the weekend, Seoul said that North Korea will shut down a nuclear test site in May.
Coming Week: More earnings. FOMC meeting. Trade negotiations with China. April jobs report.
It’s going to be a very full week. While we are half way through earnings season, there are plenty of companies left to report. So far, the news has been very good. The Federal Open Market Committee (FOMC) holds their third meeting of the year May 1st and 2nd .There will be no post-meeting press conference, which suggests low odds of another interest rate hike. However, investors are placing 93% odds that the FOMC will raise rates at the June meeting. The post-meeting statement will be the focus for investors. On the trade front, Treasury Secretary Steven Mnuchin, NEC Director Larry Kudlow, trade adviser Peter Navarro and USTR Bob Lighthizer are slated to head to Beijing to talk with Chinese officials about ways to avoid a trade war between the world's two largest economies. Finally, the April jobs report due Friday is expected to show a solid gain of around 185,000 compared with the modest 103,000 increase in March.