Last Week’s Market Activity
- S&P 500 Index and the Nasdaq closed at new record highs last Friday; seventh consecutive gain for S&P 500 and 20th record close year to date.
- The combination of positive sentiment and low volatility suggests stocks may continue to absorb challenging headlines. Investors weathered potential risks from last week’s news, including: fallout from Comey firing, growing investigation into Administration/Russia ties, White House’s 2018 budget proposal, terrorist bombing in Manchester, Moody’s China debt downgrade, CBO’s score for AHCA, and minutes from last Federal Open Market Committee (FOMC) meeting suggesting higher interest rates ahead.
- Markets also handled disappointing economic reports, specifically weakness in new home sales, durable goods orders; instead focusing on longer-term trends such as positive global data (Germany, Japan), upward revision to U.S. gross domestic product (GDP) in the 1st quarter.
- Orders for durable goods fell in April, but good news in the details. Drop (-0.7%) in orders bested expectations (-1.0%) and March revision was strong (details below).
- Orders ex-transportation showed a similar pattern. Nondefense capital goods shipments ex-air, a proxy for business spending, fell slightly (-0.1%) but better than forecast, following four consecutive monthly gains.
- For the week, stocks rose +1.5% to +2.0%, powered higher by the unusual combination of utilities and technology sectors, each up >2.0%. Investors likely hedging their bets, counting on growth prospects of technology, but not necessarily buying into Fed’s rate outlook as “bond proxy” utilities sector rose.
- Weakness in energy (-2.0%) as markets appeared to have already priced in extension to OPEC production cuts, but investors wanted deeper cuts and pushed WTI crude oil down by >1.5% last week (after rising for three weeks) to ~$49.00/bbl.
- Action in U.S. Treasury market also points toward less Fed activity after expected June hike, with 10-Year Treasury yield hovering in the 2.25% range, on track for fourth straight monthly gain.
- U.S. dollar firmed slightly (+0.1%) on the heels of solid GDP revision.
- Stocks in Europe basically flat Friday; euro & pound sterling weakened as Conservatives’ lead over Labour has narrowed considerably in recent weeks.
Emerging markets stocks +2.0% on the week, maintaining year to date leadership globally.
Overnight & This Morning
- Stocks in Asia little changed amid shortage of overseas leads.
- Yen strengthened for a third day against the U.S. dollar (USD/JPY -0.3% to 110.9)
- In Europe, shares down fractionally (Euro Stoxx 600 -0.1%); bank stocks, weakness in business & consumer confidence weighing
- European Central Bank (ECB) Head Draghi was critical of U.S. trade proposals in speech to European Parliament yesterday. He also reaffirmed commitment to maintaining ECB stimulus, placing pressure on the euro.
- Euro down -0.1% to $1.11
- Commodities – Mostly lower, led by weakness in precious metals and agriculture, with WTI oil holding below $50.00/bbl. COMEX gold (-0.2%) to $1265 and copper (-0.6%).
- U.S. stock, Treasury yields down slightly in muted, post-holiday trading.
- U.S. dollar weak vs. yen but stronger vs. euro and other major currencies
- U.S. Personal Income and Spending for April met expectations after two consecutive shortfalls. Inflation metrics in this report are. Its preferred measure of price growth, the Core PCE deflator, key inflation metric for the Federal Reserve, at 1.7% from 1.6%.
- The trend for business spending/capital investment is improving. After years of hoarding cash, paying yield, and buying back shares, the business cycle has returned with upward shifts in pricing and U.S. monetary policy. Businesses can no longer simply attempt to maintain market share, but rather, they must grow market share as the recovery/expansion enters its ninth year.
- While personal consumption is still the primary driver of U.S. economic growth, we believe the rate of growth in the coming quarters/years will be driven by capital investment, which is taking up a larger portion of GDP contribution (details below).
- 1Q earnings per share (EPS) (+15% year over year) faced the easiest comparisons and we look for remainder of 2017 quarterly EPS gains to hover in the mid-high single digit range. These are smaller percentage gains than what we’ve become accustomed to these past couple of quarters, but still indicative of sustained, late cycle growth accompanied by still low interest rates and inflation (details below).
- We recognize current trading range is of concern. Despite the flattening yield curve, which could partly be the result of global sovereign credit valuations, there appears to be little stress evident in the credit markets (details below).
Fixed Income Notes
- Despite equity markets at/near record levels, bond market continues to hang in there. Constant maturity 10-year Treasury note up four consecutive months, Barclays Aggregate (+2.0%) and Barclays High Yield (+4.0%) providing positive returns year to date.
- After 1.35% low last June, 10-year Treasury yield surged to 2.65% in late February/early March of this year. Since then, several factors have conspired to push yields lower, despite Fed’s plans to raise interest rates (see below). First, failure of the first vote on ACA repeal placed a great deal of uncertainty on likelihood of President Trump’s pro-growth policy agenda being fully enacted. Second, weak Q1 GDP enabled flattening of the yield curve. Third, some are projecting higher short-term borrowing costs will curb lending and growth, making it tougher for Fed to sustain 2.0% inflation target. Fourth (less sinister) reason has to do with relative valuation. With Fed moving in a different direction from ECB and BOJ, those sovereign bonds trading at very expensive valuations, increasing attractiveness of U.S. government bonds.
- This can be a blessing and a curse: curse is that a bid for U.S. Treasuries from global investors helps mask our spending profligacy. The blessing is global investors appear confident slow growth with low inflation likely to be sustained in U.S., without signs of excessive upside, or downside risks.
- As a result, we continue to look for the U.S. benchmark Treasury yield to trade within the 2.25% to 2.75% range in the second half of 2017.
- Corporate credit spreads (high yield & investment grade) remain narrow, credit default swaps (CDS) also held steady. If these critical market signposts (10-year Treasury yield, credit spreads, CDS) hold steady, financial markets likely to continue narrow trading range
- Geopolitics may periodically cause near term uncertainty, but like equity markets, next catalyst likely move the bond market will be clarity on U.S. fiscal policy
- S&P 500 currently at another record level, 2415, but technicals suggest move to 2450-2475 within reach in coming months.
- Bullish catalyst is necessary, could come in the form of: sustainable EPS growth, > expected GDP in Q2/Q3, less aggressive Fed in 2H17, corporate tax cuts, tax reform, global GDP etc.
- Unfortunately, move of this magnitude highly dependent on fiscal policy changes, where uncertainty narrows trading ranges until clarity emerges.
- Fundamentally, move toward this level can be justified, but anything above it would need more clarity on 2018 EPS increases, largely due to combination of repatriation tax holiday/reduction in corporate tax rate.
- Assuming $130.00 in S&P 500 operating EPS this year, stocks currently trading ~18.5x calendar 2017; a move >2450 would take market price-to-earnings ratio (P/E) >19x.
- Tax reform may be too big to achieve in current political environment, but corporate tax cuts still possible; if implemented, 2018 EPS could be >$140.00, which would bring target ranges for index 2500 to 2550 in 12 to 18 months
- U.S. Q1 Real GDP revised higher from +0.7% to +1.2%, helped by a more positive picture of business investment, which had already posted a strong quarter, and a slightly better picture of consumer spending. The improvement alleviates some concerns of Q1 weakness and increases the likelihood of a Fed rate hike in June. Looking at Q2 GDP, prospects are for much stronger growth, and could be in the +3.0%, as pent up demand in cap-ex, housing, and an inventory rebuild from Q1 weakness propels GDP higher.
- Though components of the durable goods report (airlines, transportation) can be volatile, the trend over the past year for orders (business investment) is still up approximately +5.0% year over year, despite last month’s weakness
- A host of European economic data was released overnight, generally showing that the economic recovery continues, but at a somewhat slower pace than expected. The highlighted number was German inflation, running at 1.4%, below forecast and previous readings of 2%, which is also the ECB target rate. This data reduces some pressure on the ECB to alter its current monetary policy.
- Politics continue to foil plans for European certainty. Just three weeks ago, the election of a Conservative government in the U.K. was seen as both a certainty and a boost for Prime Minister Theresa May. In the past few weeks, a Conservative victory, while still likely according to the polls, is now less certain. The British pound has also weakened, not coincidentally. In addition, there have been renewed calls for an early election, as soon as September 2017, as opposed to the 2018 election now expected. An early election would likely focus directly on the EU and the euro.
- Corporate Beige Book supports strong earnings outlook. Much like first quarter earnings results and management guidance, our measure of corporate sentiment based on our analysis of earnings conference call transcripts was better than we expected. We saw a sharp increase in strong and positive words over the prior quarter, with no change in weak and negative words. As discussed in today’s Weekly Market Commentary, we believe the positive tone from management teams supports a favorable earnings outlook in the quarters ahead.
- New highs and no volatility, more of the same. The S&P 500 Index closed at another new high on Friday, making it seven consecutive higher closes. It hasn’t been up eight days in a row since July 2013 and the previous two seven day win streaks ended at seven days. It also gained 1.4% for the week, avoiding its first three week losing streak since before Brexit. Last, the incredible lack of volatility continued, as the S&P 500 Index traded in a range of only 0.19% on Friday, the smallest daily range since March 1996 and the smallest daily range while also closing at a new all-time high since August 1991.
- June is a busy month for central banks. Summer is nearly here and historically that has meant lower volume, but potential market volatility. As we turn the calendar to June, the three big events this month are all from central banks: as the Fed, the ECB, and the BOJ all have meetings to decide interest rate policy. As discussed in today’s Weekly Economic Commentary, these events, along with a few others, could make for an eventful month in June.
- PCE (Apr)
- Conference Board Consumer Confidence (May)
- France: GDP (Q1)
- Germany: CPI (May)
- Eurozone: Consumer Confidence (May)
- Japan: Industrial Production (Apr)
- China: Mfg. & Non-Mfg. PMI (May)
- Chicago Area PMI (May)
- Beige Book
- France: CPI (May)
- Germany: Unemployment Change (May)
- Eurozone: Unemployment Rate (Apr)
- Italy: CPI (May)
- Eurozone: CPI (May)
- India: GDP (Q1)
- Canada: GDP (Mar)
- Japan: Nikkei Japan Mfg. PMI (May)
- China: Caixin China Mfg. PMI (May)
- Japan: Capital Spending (Q1)
- ADP Employment (May)
- Non-Farm Productivity (Q1)
- Initial Jobless Claims (May 27)
- Markit Mfg. PMI (May)
- ISM (May)
- Eurozone: Markit Eurozone Mfg. PMI (May)
- Italy: GDP (Q1)
- Brazil: GDP (Q1)
- South Korea: GDP (Q1)
- Canada: Markit Canada Mfg. PMI (May)
- Japan: Vehicle Sales (May)
- Change in Nonfarm, Private & Mfg. Payrolls (May)
- Unemployment Rate (May)
- Trade Balance (Apr)
- Eurozone: PPI (Apr)
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The economic forecasts set forth in the presentation may not develop as predicted.
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