Market Update: Thursday, January 4, 2018

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Market Recap

  • Stocks’ advance continued. Major indexes finished near intra-day highs with little downside pressure. S&P 500 Index +0.6%, Dow +0.4%, Nasdaq +0.8%.
  • Energy topped sectors for second day; technology outperformed on analyst upgrades to several big names; bond proxies (utilities, telecommunications) woes ongoing as rates rise.
  • Positive breadth on NYSE (1.5:1), Nasdaq (1.4:1); volume on NYSE ~95% of 30-day avg.
  • Treasury yields up again with some curve steepening, 10-yr. note yield +2 basis points (+0.02%) to 2.44%; dollar halted recent slide vs. major currencies.
  • Commodities: WTI crude oil spiked (+2.4% to $61.78/bbl.) to 2-yr. highs, COMEX gold (-0.4% to $1313/oz.), industrial metals pulled back after recent string of gains.
  • Economic data: ISM manufacturing, vehicle sales came in strong (details below).

Overnight & This Morning

  • U.S. equities open higher to new records. Major indexes opened modestly higher after Nasdaq, S&P 500, Russell 2000 posted record highs Wednesday.
  • European stocks higher on strong data, as Eurozone services PMI for December showing strongest activity since 2011. STOXX Europe 600 +0.9% Germany DAX +1.5%.
  • Asia up again. Nikkei up +3.3% on its first trading day of 2018. Strong Caixin services PMI in China supported global growth story. Shanghai Composite +0.5%, Hang Seng +0.6%.
  • Treasuries holding firm after Wednesday weakness.
  • Commodities: Oil +0.1% to ~$61.70/bbl. inching to a new 3-yr. high on Iranian tensions. Gold lower (-0.1% to ~$1317/oz.), industrial metals lower.
  • Economic releases: ADP Employment Report beat (+250.2k vs. 190k), weekly initial claims above consensus (+250k vs. +240.5k), December Services PMI beat (23.7 vs. 52.4).

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Key Insights

  • What’s the Fed thinking? Yesterday’s release of the minutes from the Federal Reserve’s (Fed) monetary policy meeting last month indicated that most participants reiterated their support for continuing with a gradual tightening cycle. However, there was disaccord around the appropriate pace of hikes in 2018. A few participants made it clear that they were not comfortable with three hikes in 2018, while others believed that the pace should be somewhat more aggressive, highlighting still-easy financial conditions, financial stability risks from low rates, and an increasingly tight labor market. Outside of monetary policy, the flattening yield curve seemed to receive more attention than expected. The big take away from that discussion was participants’ general agreement that the degree of flatness is not unusual by historical standards; and that recent rate hikes, reduced estimates of the neutral rate, lower long-term inflation expectations, and lower term premiums were all mentioned as factors behind the flattening trend. We continue to expect the Fed to raise rates three times this year, but considering the fiscal incentives from tax and an already solid economy that could finally spur a pickup in inflation, it may feel the need to be more aggressive this year; particularly if wage growth accelerates meaningfully.

Macro Notes

  • Hits and misses. 2017 was a year like few others in history. It was a steady bull market with historically low volatility. So how did LPL Research do? Have a look at our 2017 stock market hits and misses on the LPL Research blog. And later today we will share our hits and misses in fixed income.
  • More new highs. The S&P 500 closed at another new all-time high yesterday, making that two days in a row of new highs to start the year. The last time that happened was in 1964. Both days this year gained more than 0.5%, which is how 2017 started as well. The best win streak to start a year ever is seven days in a row in 1976 and 1987.
  • Global economy continues to surge. ISM manufacturing rose to an unexpected 59.7 in December, making the 2017 average of 57.6 the best in 13 years. It isn’t just the United States that is improving though; in China, the December Caixin Services PMI rose to its highest level since August 2014 and has many already re-evaluating their Chinese gross domestic product (GDP) forecasts for this year. Last, European data this morning showed better than expected services data as well, as the Eurozone December PMI came in at its best level since 2011. Looking under the surface, only France missed estimates while Spain and Italy both comfortably beat estimates.
  • Global economy. We look for the global economy to expand at a healthy rate of +3.7% in 2018 as the return of the business cycle plays out in policy, economic, and investment decisions across developed and emerging markets. Accommodative monetary policies have propelled both employment and consumption in developed markets, but we believe businesses are now forced to increase investment or risk losing market share; while most emerging economies continue to draw investors in, especially commodity exporters as expectations for a pickup in global growth potentially drive prices higher.
  • Developed markets. We forecast GDP growth of approximately 1.8% as elected officials and monetary policy makers look for a set of policies that may also turn international developed economies to more traditional business cycle drivers. Growth in the Eurozone gained traction over the past year, however, we suspect European Central Bank (ECB) President Mario Draghi will only modestly reduce stimulus by purchasing fewer bonds over a longer period in the coming year, leaving changes to policy rates on hold until 2019. Though GDP growth in Japan is expected to hover around 1.0%, growth finally pulled higher for six consecutive quarters, the best performance in a decade, and inflation is projected to remain well below the Bank of Japan’s 2.0% target, likely keeping the zero percent target for the 10-year Japanese government bond in place for the next year or two. The Japanese yen should therefore remain within a range we consider supportive for export growth.
  • Emerging markets. We look for growth of +4.8% in 2018. India’s role as “the new China,” given its size and growth potential, and potential rebounds in Latin American economies will be among the stories to watch, but the return of the business cycle will likely be most evident from the lenses of China and the U.S. dollar. Despite the slowdown in the pace of output growth in China, emerging economies have held up well, and we look for Chinese GDP to expand in the range of 6.5% in 2018, supported by the powerful combination of gains in retail sales and industrial production, while demand from China remains strong for commodities and inputs from emerging nations, many of which remain export-driven.
  • Global fixed income. Foreign developed bonds could find themselves under pressure, like domestic high-quality fixed income. Relative to Treasuries, valuations are even more expensive in foreign government bonds, such as Germany and Japan. The ECB has announced plans to begin tapering bond purchases, which may put upward pressure on foreign interest rates. Emerging market debt (EMD) is also expensive on a valuation basis, with spreads over comparable Treasury bonds at multi-year lows. The continued global expansion should provide support for EMD, along with still accommodative global monetary policy; however, ECB tapering could create a headwind here as well. In general, we prefer dollar-denominated EMD, as local currency EMD is more volatile due to the currency fluctuation for U.S.-based investors.
  • Global equities. From a regional perspective, we favor the United States and emerging markets over developed foreign markets for their more favorable risk-reward profiles, although the improving outlook in Japan is noteworthy. We also suggest considering hedging currency exposure in developed markets, which would make these markets more attractive to us given our expectation that the U.S. dollar will rise.

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Click Here for our detailed Weekly Economic Calendar

Thursday

  • Challenger Job Cuts (Dec)
  • Weekly Jobless Claims (Dec 30)
  • Markit Services PMI (Dec)
  • Bullard (Dove)
  • France: Markit France Services PMI (Dec)
  • Germany: Markit Germany Services PMI (Dec)
  • UK: Markit UK Services PMI (Dec)
  • Eurozone: Markit Eurozone Services PMI (Dec)
  • UK: Money Supply & Bank Lending (Nov)
  • Japan: Monetary Base (Dec)
  • Japan: Nikkei Japan Services PMI (Dec)

Friday

  • Change in Nonfarm, Private & Manufacturing Payrolls (Dec)
  • Unemployment Rate (Dec)
  • Average Hourly Earnings (Dec)
  • Average Weekly Hours (Dec)
  • Labor Force Participation & Underemployment Rates (Dec)
  • Trade Balance
  • Factory Orders (Nov)
  • ISM Non-Manufacturing (Dec)
  • Durable Goods Orders
  • Cap Goods Shipments & Orders

Past performance is no guarantee of future results.

The economic forecasts set forth in the presentation may not develop as predicted.

The opinions voiced in this material are for general information only and are not intended to provide or be construed as providing specific investment advice or recommendations for any individual security. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly.

Stock investing involves risk including loss of principal.

Investing in foreign and emerging markets securities involves special additional risks. These risks include, but are not limited to, currency risk, political risk, and risk associated with varying accounting standards. Investing in emerging markets may accentuate these risks.

Because of its narrow focus, sector investing will be subject to greater volatility than investing more broadly across many sectors and companies.

Commodity-linked investments may be more volatile and less liquid than the underlying instruments or measures, and their value may be affected by the performance of the overall commodities baskets as well as weather, disease, and regulatory developments.

Government bonds and Treasury bills are guaranteed by the U.S. government as to the timely payment of principal and interest and, if held to maturity, offer a fixed rate of return and fixed principal value. However, the value of fund shares is not guaranteed and will fluctuate.

Investing in foreign and emerging markets debt securities involves special additional risks. These risks include, but are not limited to, currency risk, geopolitical and regulatory risk, and risk associated with varying settlement standards.

Currency risk is a form of risk that arises from the change in price of one currency against another. Whenever investors or companies have assets or business operations across national borders, they face currency risk if their positions are not hedged.

This research material has been prepared by LPL Financial LLC.

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