Market Update: Monday, February 5, 2018

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Market Recap

  • U.S. equities off sharply. S&P 500 Index -3.8% on the week; advancing interest rates, inflation, political concerns cited as drivers. Friday’s performance capped off poor showing as all major indexes closed lower; S&P 500 -2.1%, Dow -2.5%, Nasdaq -2.0%, Russell 2000 -2.0%.
  • All equity sectors fell; utilities (-0.7%), consumer discretionary (-0.9%) held up best; technology (-3.0%), energy (-4.1%) most notable laggards.
  • Market breadth broadly lower; NYSE (-9.3:1), Nasdaq (-5:1); NYSE trade volume above 30-day avg. (~115%).
  • Treasury yield curve steepened; 10-yr. note +5 basis points (+0.05%) to 2.85%.
  • Commodities: WTI crude oil -1.1% to $65.06/bbl., COMEX gold slumped as well (-1.0% to $1334/oz.), industrial metals mostly higher.
  • Economic data: Solid headline read on nonfarm payrolls (200K vs. 180K expected), unemployment rate unchanged (4.1%); wage growth (+2.9% MoM) at highest level of current expansion.

Overnight & This Morning

  • U.S. equities opened lower as Friday’s slide carries over amid interest rate jitters.
  • European stocks down hard in midday trading, as U.S. weakness spilling over. Merkel efforts to build a coalition government missed Sunday’s deadline but could come together shortly. STOXX Europe 600 -1.1%, DAX -0.5%, FTSE 100 -1.1%.
  • Asian markets tracked U.S. losses. Nikkei -2.5%, Hang Seng -1.1%; China’s Shanghai Composite bucked the trend (+0.7%).
  • Treasury yields holding steady; 10-yr. yield slightly lower at 2.83%; will be closely watched today.
  • Commodities: Oil -0.5% to ~$65/bbl. after another rise in the rig count reported Friday, gold (+0.3% to ~$1336/oz.) on dollar weakness; copper higher.
  • Economic releases: Today’s economic calendar includes Purchasing Managers’ Index (PMI)/Institute for Supply Management services data.
  • Congress continues to work on a short-term funding bill today to avert a government shutdown by Thursday’s deadline. Differences on immigration may preclude longer-term agreement, leading to more kicking of the can.

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Key Insights

  • Did stocks just melt-up and are now melting down? Friday’s sharp decline, the biggest since the Brexit vote in June 2016, might have some of us forgetting that just a few days ago the stock market was considered by some to be melting up. The strong finish to 2017, followed by big gains in January, certainly left some investors feeling like last week’s 3.8% pullback in the S&P 500 Index was a market meltdown. We, however, do not see the makings of a significant stock market top or major downturn. In fact, we view last week’s decline as a normal, healthy, and overdue pullback. While we suspect market weakness could persist in the coming days (or even weeks), we continue to believe stocks are well supported by strong fundamentals, expect gains over the rest of 2018, and maintain our fair value S&P 500 range of 2850-2900. Please refer to this week’s Weekly Market Commentary, due out later today, where we discuss our views and expectations in more detail.

Macro Notes

  • Revenue upside and big jump in 2018 estimates highlight excellent earnings season. With about half of S&P 500 companies having reported results, fourth quarter earnings are tracking to a 13.6% year-over-year increase. A solid 78% of S&P 500 companies have beaten consensus earnings estimates for the quarter, which is above long-term averages. Growth has been particularly strong in the energy, financials, and technology sectors. Perhaps most impressive is the revenue upside, with 80% of companies beating consensus forecasts, well above recent and long-term averages in the 50s; while companies are generating 0.7% more revenue growth for the quarter than was expected when earnings season began (revenue growth for the quarter is tracking to +7.7% YoY).

  • S&P 500 earnings estimates for 2018 rose an impressive 1.1% last week, reflecting a 17% increase over 2017-and amounting to a 5.3% rise since January 1, 2018. The improved earnings outlook, which continues to provide support for stocks at current valuations, has been driven primarily by the new tax law, but also by steady global economic growth and a weak U.S. dollar. Last week’s stock market decline has brought the S&P 500 price-to-earnings ratio down below 18 times 2018 estimates. This week, 93 S&P 500 companies will report fourth quarter results.
  • A not so warm welcome for Mr. Powell. Needless to say, it is an interesting day for new Federal Reserve (Fed) Chief Jay Powell to be sworn in given what’s going on in the bond market. Markets tested Greenspan in 1987 and Bernanke in 2007, and part of the jittery bond market may reflect a “test” for Powell. Rate hike expectations reflected in fed funds futures rose after Friday’s jobs report and now reflect a 93% chance of a March hike, 2.7 hikes this year, and 4.2 hikes in 2018 and 2019 combined.
  • Growth remains strong, but is inflation creeping in? Over the past two weeks, gross domestic product (GDP), personal consumption expenditures (PCE) inflation, and the January nonfarm payrolls report have been released; and, the data continues to paint a picture of a strong U.S. economy. However, the main takeaway for markets over the past week has been concerns that rising inflation could lead to a more aggressive Fed. Inflation expectations have been increasing in recent months with breakeven 10-year inflation readings (as measured by the difference between the 10-year Treasury and 10-year Treasury Inflation-Protected Securities yield) now at 2.1%–above the Fed’s 2% target. Increased expectations have so far not led to an increase in actual inflation though (as measured by PCE), which remains well below the Fed’s target. Also, while the 2.9% wage growth reading in the January employment report is at a cycle high, it remains below the 4% level that has historically led to a more aggressive Fed. We discuss these topics in more detail in this week’s Weekly Economic Commentary, due out later today.
  • Worst week since 2016. The S&P 500 fell 3.8% for the week, for the worst weekly decline since early 2016. Volatility continues to rule so far in 2018, as the S&P 500 has now gained or lost at least 2% for the week 3 of the 5 weeks so far this year. To put this into perspective, not a single week last year changed 2% up or down. The 2.1% drop on Friday was the single largest drop for the S&P 500 since September 9, 2016 when it fell 2.5%.
  • Week ahead. This week, a full slate of Markit Services PMI data is due out on Monday, including readings from the United States, Eurozone (Italy, France, Germany), China, and Japan. U.S. trade balance figures, job openings and labor turnover (aka Jolts), consumer credit, and wholesale inventories are due out over the rest of the week, along with a slew of Fed member appearances. Several European Central Bank members are scheduled to make appearances with the central bank’s Economic Bulletin on Thursday; and, a series of industrial production data is due out Friday for the Eurozone, Italy, France, and Germany. In Asia, Japan posts its leading index and money supply data, while data on foreign reserves, imports/exports, inflation, and trade are due out in China.

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Click Here for our detailed Weekly Economic Calendar

Monday

  • Markit Services PMI (Jan)
  • ISM Non-Mfg. (Jan)
  • France: Markit France Services PMI (Jan)
  • Germany: Markit Germany Services PMI (Jan)
  • Eurozone: Markit Eurozone Services PMI (Jan)
  • UK: Markit UK Services PMI (Jan)
  • Eurozone: Retail Sales (Dec)
  • ECB: Weidmann

Tuesday

  • Trade Balance (Dec)
  • Germany: Factory Orders (Dec)
  • China: Foreign Reserves (Jan)

Wednesday

  • Germany: Industrial Production (Dec)
  • France: Trade Balance (Dec)
  • Italy: Retail Sales (Dec)
  • ECB: Nuoy
  • Japan: Leading Index (Dec)
  • China: Imports & Exports (Jan)

Thursday

  • Germany: Trade Balance (Dec)
  • Germany: Imports & Exports (Dec)
  • ECB: Publishes Economic Bulletin
  • ECB: Weidmann, Velleroy, Mersh, Praet
  • BOE: Bank Rate
  • Bank of Mexico: Overnight Rate
  • Japan: Money Supply (Jan)
  • China: CPI & PPI (Jan)

Friday

  • Wholesale Sales & Inventories (Dec)
  • France: Industrial Production (Dec)
  • Italy: Industrial Production (Dec)
  • UK: Industrial Production (Dec)
  • UK: Trade Balance (Dec)
  • UK: NIESR GDP Estimate (Jan)
  • Canada: Unemployment Rate (Jan)
  • Bank of Russia: Key Rate

 

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