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This holiday season we’re excited to grant another Christmas Wish through STAR 102.5’s Christmas Wish, on behalf of Silvercap and our clients.   There are so many incredible people in our community who are making a difference; it gives us great joy to have the ability to assist those who are helping others. 

Please take a moment to listen to the clip below of Ken & Colleen interviewing Donna about a Christmas wish she has for her husband Mike, who served as a Paratrooper in the ARMY (12th Special Forces Group) for 24 years.

We are very grateful for our clients’ long-term support and confidence as this would not be possible without you.

Sincerely,

Joshua, Paul, Brent & Danielle

November provided the equity markets a bit of relief following the volatility spike in October.  China (trade, growth), oil (bear market),and Fed (tightening) remained the dominant macro themes.  A double-barreled hope rally on positive indications on U.S.-Sino trade negotiations and less hawkish Fed narratives fed a respectable recovery.  Diverging fundamentals between U.S. and International markets became more evident with non-U.S. economic results in a more established decelerating trend while U.S. fundamentals remained relatively robust.  Bond yields fell on reduced inflationary concerns due thanks to falling commodity markets, led by a 22%decline in oil prices.

Market Anecdotes

•  Midterm elections largely produced the expected result.  Equity markets rallied on the diminished likelihood of market-adverse legislation like tax cut and regulatory rollbacks.
  • POTUS investigation(s), debt ceiling/border wall showdown, and NAFTA/USMCA trade agreement angst are the likely takeaways with a new Democratic House.
  • This was the largest swing in the House toward the D’s in an R Presidency since 1974.
  • This was the highest turnout for a midterm election since 1914.
• For all the talk of trade wars and tariffs, they had little impact on corporate earnings or guidance.  S&P 500 3Q earnings growth hit 25.9%, the mark since Q3 2010.  78% of companies exceeded EPS estimates, tied for the second highest percentage since FactSet began tracking this data point in 2008 and 61% exceeded sales forecasts.
• It seems as if the U.S. views tariff posturing more from a simple bargaining tactic perspective while the Chinese see it more as a long-term policy decision.  This (and growth) may factor into why Chinese markets are down over 30% while U.S. markets are only 10% off their highs.
• The high profile G20 meetings in Buenos Aires at month end produced a welcomed 90-day tariff truce which ushered in a welcomed, albeit brief, macro rally.  Developments include the signing of a new NAFTA deal, Chinese concessions on auto tariffs and increasing LNG imports, and U.S. European pledge to work through auto trade negotiations.
• The spread between investor and Fed rate hike expectations is growing increasingly wider, helping produce higher risk asset volatility.  Overall hawkish Fed rhetoric has faded but individual speeches have revealed divergent views.  Through year end 2019, BCA is forecasting five hikes (contrarian), a Bianco Fed speech model is implying 3.5 hikes, and markets are only pricing 40bps over the same period.
• Bespoke offered a few anecdotal reminders on yield curve inversion.  The 3m/10yr slope is the best recession indicator (0.45% today), inversions lead recessions by approximately 18-24 months, and equity markets peak approximately 6 months before a recession.  Since 1990, with the curve slope around this level, returns have been in the mid-teens (15%-23%) for the following year.
• A Bianco model using a blend of economic data and U.S. Treasury curve spreads since 1962 forecasts only a 5% probability of recession in the next 12 months.
• Brexit took a step forward in November as U.K. and the EU reached a withdrawal and post exit agreement which now goes to U.K. Parliament for approval.  The March 2019 deadline looms.
• As potential evidence of a rotation to value, the quantitative momentum factor has underperformed value by over 3.5% since the relative performance peak back on October 1st.

Economic Release Highlights

• Inflation data has remained relatively subdued with core PCE of 1.8% and core CPI of 2.14%.
• A 59.3 November ISM Manufacturing Index reading accelerated to unusually strong levels driven by strong new orders (62.1) and building backlogs.  An easing in input costs was a welcomed anecdote.
• A 60.7 November ISM Non-Manufacturing Index beat the high end of estimates and posted a third consecutive 60+ monthly reading.  Elevated cost pressures and stretched delivery times pointed again to capacity stress.
• November jobs report of 155,000, an unchanged 3.7% unemployment rate, and a modest 0.2%/3.1% average hourly earnings result were welcomed and very pedestrian figures.  
• The BLS November JOLTs survey showed a drop in job openings but no change in the quit rate which, at 2.7%, is at the highest level since the introduction of the survey in 2000.
• November U of M Consumer Sentiment held steady at a robust 97.5 level, an encouraging metric for the upcoming holiday shopping season. November U.S. consumer confidence ticked down slightly to 135.7, still not far from the all-time high of 144 reading back in 2000.
• The November U.S. Housing Market Index buckled lower to 60 (68 expected) to post its lowest reading since August 2016.  Current sales, future sales, and traffic all moved lower. 
• Housing market indicators continued to miss expectations in November but are more likely reflective of subdued activity than precursor to contraction.  MoM annualized prices have slowed from mid-6% to mid-4% levels while sales and construction activity have stalled.

The October Narrative  

Talk about a change in narrative.  When it comes to financial markets, the last few weeks of October provide a great example of how quickly gains can vanish but also a reminder of how normal such occurrences are historically.  Entering October, the S&P was up nearly 10% YTD, 3Q earnings expectations were superb, and the U.S. economy was on point. By month end, we had tied the longest streak of consecutive down days (28) for the S&P 500 in the post WWII period and booked the worst monthly performance since September 2011.  Regardless, equity selloffs of this nature are not abnormal and the absence of any notable change in fundamentals or exogenous shock led us to a clear and resounding message: stay the course.

Market Anecdotes

• Risk markets capitulated near correction territory on a blend of trade conflict, rising interest rates, and concerns surrounding peak earnings/economic growth.  Debate ensued as to whether the volatility is garden variety correction or end of the business cycle.  We favor the former.
• Both swiftness (24 days) and size (-9.3%) of the drawdown have been notable.  In the history of the S&P 500, declines of over -7.5% in less than five weeks has happened only 19 times.
• Despite White House narratives, we expect U.S.-Sino trade conflict to persist into 2019 based on recent hard line speeches from President Xi which make it complicated for him to compromise.
• Markets are grappling with rising interest rates, but we remind clients it is not the direction of interest rates so much as the absolute level of interest rates that tend to impact markets.
• Strong earnings growth and two market corrections in the past 12 months has 2018 currently ranking as the third greatest decline in P/E multiples since 1976.  As of November 2, the S&P 500 forward 12mo P/E ratio was 15.6 with blended earnings and revenue growth of 24.9% and 8.5%.
• U.S. manufacturing PMI featured a 5-month high level of new orders but slowed from highly elevated readings over the past six months.  Cost pressures from higher input costs and tariff-related pressures on metals were frequently cited.
• October saw inflation expectations decline as evidenced by 10yr B/E yields falling from 2.17% to 2.5% at month end and high yield spreads widened by 21% from 316 bps to 381 bps.
• Despite headlines touting a 14-month low in Chinese Treasury holdings, their reduction ($10b) was actually smaller than Japan’s ($30b) and overall relatively inconsequential in the context of their $1.165t in overall holdings.
• With the November elections looming, we thought it would be a good time to offer some historical election cycle observations:
  • Data since 1949 show the ‘prime the pump’ year three of a first-year Presidential term averages 19.2%, far and away the best of the 4-year cycle.
  • Since 1950, the S&P 500 has been positive 100% of the time in all 6-month and 12-month periods following midterm elections.
  • The 1950-2014 average 12 month return for the S&P 500 following midterm elections is 15.3%.
  • The average correction in a midterm election year is 19% and the average return 12 months thereafter is 31%.

**Past performance is not indicative of future returns**

Economic Release Highlights

• Third quarter GDP beat expectations at 3.5% backed by robust consumer spending growth of 4% (Q2 3.8%) which contributed 2.7% to GDP, strong 3.3% growth in government spending which contributed 0.6% to GDP, and a material $76.3b rebuild in inventories which contributed 2.1% to GDP.  Business investment, housing, and trade deficit data were disappointing.
• October wage growth of 3.1% marked the highest annual growth since 2009 but the metric was impacted by a depressed 2017 readings and the month/month rate slowed to 0.2% from recent monthly readings of 0.4%/0.3% levels.
• 250,000 new jobs in October far exceeded estimates of 190,000.  Headline unemployment registered 3.7% and annual wage growth climbed 0.3% to 3.1%.
• September headline and core PCE both came in right at the 2% Fed target.  This metric has moved notably higher from summer 2017 levels but has been relatively flat since March 2018.
• October consumer confidence held strong at 137.9, despite financial market volatility.  The index is near an 18 year and all time high of 144.7 reached back in 2000.  The strong job market is translating to no concern in consumer-ville.
• October Manufacturing PMIs, while still expansionary, revealed slowing conditions particularly out of Europe and EM Asia which are notably to the downside.  Services PMI readings remained healthy with a global average of 53.3.  Composite readings remained expansionary with Global (52.2), U.S. (54.9), Eurozone (53.1), and Japan (52.5).
• October’s ISM non-manufacturing index slowed slightly from September to 60.3 but carried strong new orders (61.6) and export orders (61.0).  September and October were the first every back to back > 60 readings in the history of ISM Services Index.

 

At the time of this writing, we are experiencing some interest rate anxiety which manifested itself in equity market volatility.  As for September, owning the dubious historical distinction as the worst month of the year for equity markets, it bucked the trend delivering modestly positive returns on risk assets.  Unlike October to date, September was a relatively quiet month where constructive U.S. economic data and progress on trade negotiations outweighed inflation/rate trends, Italian budget deficit debate, U.S.-Sino trade conflict, and global oil market volatility.  While trade negotiations will continue to make headlines, we feel Chinese growth and central bank monetary policies are the key drivers to monitor closely.

Market Anecdotes

• Fed policy came as advertised with a 0.25% rate hike.  Strong growth and capacity constraints colored the statement leaving their rate hike forecasts the same at 2019 (3), 2020 (1), and 2021 (0) – still higher than current market pricing.
• The ECB announced it would cut its QE in half next month and halt all purchased by year end and the Fed balance sheet is shrinking according to schedule.  ECB balance sheet hit a fresh high last month at €4.6t – 41.4% of Eurozone GDP.  Fed balance sheet at $4.2t is 20.7% of U.S. GDP.
• The U.S. inked a trade deal with South Korea and came to an agreement with North American trade partners (USMCA).  Negotiations continue with Europe, Japan, and China, the latter looking more likely to remain in flux well beyond the midterms.
• A McKinsey Global Institute report valued global government debt at $169t, up from $97t in 2007, a notable figure given concerns surrounding strong USD implications for highly leveraged emerging markets.
• 28 different EM currencies made new 52-week lows in September.  Debt holders are under scrutiny i.e. Spanish banks are carrying over $82b of Turkish loan exposure.
• U.S. confidence and sentiment remain very high.  Gallup’s U.S. consumer polling for ‘concern’ about the U.S. economy was only 12%, the lowest reading in over 30 years.  However, European confidence fell for the fourth month in a row, touching its lowest reading since May 2017.
• Iranian sanctions were felt across the global oil markets with significantly reduced Iranian supply outlets.  Meanwhile, the EIA announced U.S. crude oil production surpassed Russia.  We are again the world’s #1 oil producing nation for the first time since 1973.  Daily domestic crude oil production has been averaging 11mbpd, up 18% over last year’s levels.

Economic Release Highlights

• Inflation metrics (CPI and PCE) remained in a firm but reasonable uptrend in September.  Most recent headline and core PCE readings were tame at 2.2% and 2% respectively while September headline and core CPI registered 2.3% and 2.2% respectively.
• The final 2Q GDP estimate of 4.2% was highlighted by robust 3.8% consumer spending and 8.75% growth in non-residential fixed investment (capital expenditures).  3Q economic activity looks set to slow slightly but estimates are currently in the 3.5%-3.8% range.
• September’s unemployment rate fell even lower to 3.7%, a record low last seen in 1969.  Data on wage growth (2.8%) reinforced the upward trend but is not yet at alarming levels.  The 3m/3m annualized wage growth rate is at levels not seen since coming out of the GFC in 2009.
• The most recent JOLTS report was a monster.  Job openings surged, and the hire rate has fallen three months in a row.  Quit rates are climbing which signals employee willingness to seek higher paying jobs – the current rate suggests something closer to 4.5% annual wage growth.
• September ISM non-manufacturing index hit 61.6, the second highest composite reading since the data began in 1997 and has logged the highest two-month surge on record.  Key drivers were a record high in employment and a 14-year high in business activity.
• Global PMIs for September confirmed a decelerating global economy.  DM (53.3), EM (50.8), and global average (52) are all in expansionary territory but have cooled from one year ago levels of 56, 52.1, and 53.9 respectively.  Most notable decelerations were in China and Italy.
• The Conference Board consumer confidence reading spiked to 138.4, closing in on the all-time high of 144 in 2000.  U of M consumer sentiment climbed to 100.1 from August’s 96.2 level.
• The U.S. housing market continued to show signs of slowdown.  Price gains, new home starts, existing/new home sales, and building permits all point to slowing momentum.  The housing market index registered 67, sustaining a yearlong low level of confidence among homebuilders.

August delivered robust U.S. equity returns concentrated in small cap and growth stocks. Non-U.S equities, particularly emerging markets struggled while bonds benefited from falling rates and tighter spreads. It seems the incremental shift in the U.S. economy from low inflation and moderate growth to moderate inflation and strong growth has taken hold while currency stresses and weaker economies overseas pose challenges. The S&P 500, NASDAQ, and Russell 2000 all notched new record highs as the MSCI World ex/U.S. index closed in on a 52 week low. Overall, U.S. fiscal policy remained very stimulative and fundamentals encouraging throughout the month. Key risk considerations include the liquidity backdrop, emerging market stress, inflation trajectory, trade conflicts, and upcoming midterms warranting a cautiously constructive outlook overall.

Market Anecdotes

• The S&P 500 posted a fifth consecutive positive month and is up 27 of the last 30 – a 90% success rate. This is meaningfully higher than the historical 62% success rate since 1962. Return and risk over this period of 20.1% and 7.7% dwarfs the historical average of 9.7% and 14.9%.
• Second quarter earnings season delivered 25% growth, strong forward guidance, and robust beat rates. Forward guidance, buoyed by tax cuts and growth, was more positive than any time in the past two decades and the 81% beat rate has only been surpassed one time (Q1 2007).
• Businesses flush with tax cut cash? 4Q17 (pre-cut) after tax profits were $1.817t while 2Q18 (post cut) after tax profits were $2.013t, a 10.8% increase annualized.
• Equity markets and corporations clearly aren’t worried about the POTUS trade conflicts, banking on either an eventual resolution or that the overall cost to the U.S. economy will be relatively negligible. A BIS paper estimated total costs of less than $100b combined across the U.S., Canadian, and Mexican economies with the majority falling to Canada and Mexico.
• Liquidity is fading. Fed balance sheet ($4.229t) has shrunk nearly $250b since balance sheet reductions began in October 2017. Additionally, the ECB announced that they will halve their QE purchases next month and end the program at the end of 2018.
• Emerging market currency turmoil has pulled EM equities into bear market territory (-20%) but contagion concerns have been limited to Turkey, Argentina, Brazil, Indonesia, and South Africa. European banks with loan exposure, particularly Spain, are watching closely.
• In Europe, Greece exited its third bailout program with a debt/GDP ratio of 190% and 4% annual emigration rate – not good prospects. Also, the official Brexit day of March 29, 2019 is fast approaching with a backdrop of infighting among Britain’s Conservative Party.
• Record bull market? There is debate as to whether the 90’s bull began at market bottom in ‘87 or after it clawed back those losses in ‘90. The current bull has lasted approximately 3,250 days (+324%) which, if you subscribe to the former, falls short of the 1987-2000 run which lasted 4,494 days. Regardless, we are double the length and strength of the average post WWII bulls.

Economic Release Highlights

• Death, taxes, and record-breaking jobs reports. August’s 201,000 jobs (3.9% unemployment) revealed 2.9% y/y wage growth, a level not seen since 2009. For the first time in history (since March) there are more people looking for work than there are jobs while jobless claims, 4-week average claims, and continuing jobless claims are all at or near 50-year lows.
• JOLTS data revealed rising quit rates which suggest job seeker confidence in seeking higher paying jobs which historically correlates to a more alarming level of wage growth (4.5%).
• August inflation readings, outside of labor costs, remained tame. Headline and core CPI registered 2.7% and 2.2% while PCE is manageable at 2.3% and 2.0%.
• August monthly retail sales increased 0.1%, missing expectations due to soft auto sales but July’s number was revised sharply higher and annual growth in retail sales is still a healthy 6.6%.
• Consumer confidence (133.4) and sentiment (96.2) measures are at or near multi-year highs and small business optimism has surged – indicating robust expected growth in consumer spending and business capital expenditures.
• August housing market releases showed declines in pending home sales (-0.7%), new home sales (-1.7%), and existing home sales (-0.7%) all confirming signs of a slowdown in housing.

 

U.S. equity markets in June brushed aside developing global trade conflicts, evolving hawkish tilts from several global central banks, and persistent political noise instead focusing on sound economic and earnings backdrops. Non-U.S. markets struggled in the face of a strong U.S. dollar and China’s slowing economy. Shorter term interest rates and credit spreads crept slightly higher in June on inflation and trade conflict narratives respectively. The market outlook remains cautiously constructive in the near term with trade conflict and monetary policy posing the biggest risks to an otherwise encouraging fundamental backdrop.

Market Anecdotes

• The U.S. economic expansion entered its 10th year, the second longest expansion on record, with robust estimates for 2Q GDP growth in the 3.5%-4.5% range. Strong business spending and fiscal stimulus are leading the way.
• Q2 earnings expectations are calling for a third consecutive double-digit quarter and over 20% for the second time since 2010 while revenue expectations are at their highest since 2011 and guidance is at its most positive in nearly 20 years. This is the environment where good results could be viewed as a disappointment.
• Everything is relative. What’s worth considering is that the est. $90b in tariff policies are dwarfed by est. $800b in fiscal stimulus (tax cuts, budget deficit spending, repatriation) and U.S. equity markets are trading roughly flat since the tax and budget packages were passed.
• Year to date, a flat S&P 500 and strong corporate earnings have compressed the trailing P/E multiple by approximately 1.8, from 22.4x to 20.6x. FAANGs have continued to rally. First half 2018 saw FAANGs add $523 billion to their collective market cap while the rest of the Russell 1,000 stocks added a total of $183 billion.
• The yield curve flattened in June with tariff related ‘risk-off’ bids keeping a lid on longer term (>10yr) rates while inflation indications pushed shorter term (<5yr) rates higher.
• Consensus opinion that Fed balance sheet unwind ($20b/mo) along with record U.S. Treasury issuance ($2.3t over next 2yrs), for tax cuts and budget deficit spend, are pressuring USD supply resulting in a strong USD and downward pressures on commodities and emerging markets.
• Central banks had an active June. The Fed hiked rates by 0.25% in a hawkish communique. The ECB announced plans to end QE in December but pledged to keep rates low. The BoJ reduced inflation expectations and pledged to maintain both QE and the yield curve control program. The BoC held rates steady given concerns about their slowing economy.
• Persistent global growth, Iranian sanctions rhetoric, supply disruptions in Canada and Libya, and tighter U.S. oil inventories pushed WTI oil prices up over 10% in June. U.S. Permian Basin oil production contributed 3.2 mbpd to a new record U.S. production level of 10.2 mbpd – the highest recorded figure since the government began keeping records in 1920.

Economic Release Highlights

• 4% unemployment remained near generational lows in June but edged up slightly due to a sharp rise in the number of unemployed persons actively looking for a job. June payrolls expanded by 213,000, a 93rd consecutive month of job growth.
• Core PCE registered 2% growth, officially hitting the Fed’s target level of inflation, a level briefly achieved in 2012 but not sustained since 2007. Headline PCE rose 2.3% yoy, the largest increase in over six years. Inflationary pressures seem to finally be building.
• Capacity stress was notable in June’s strong ISM Manufacturing report which surged back above 60 from last month’s reading of 58.7. The reading handily beat expectations and was the second highest reading of the expansion.
• NFIB Small Business optimism rose to its highest level in 35 years.

The May Narrative  

It was a memorable May to say the least.  Prospect of trade wars, European political theater, North Korean drama, and moderately positive global economic indicators ultimately netted positive results in the U.S. equity market led by growth stocks and small caps.  The S&P 500 climbed 2%, its best month since January, while small caps rallied close to 6%, their best month since September of last year. Europe, Pacific, and emerging markets were all down in May, pressured by political uncertainty in Europe, a renewed push toward global trade conflict, and a strong U.S. dollar.  The bond market benefited from lower U.S. interest rates during the month which overcame slightly wider spreads, resulting in most fixed income sectors registering modest gains.

Market Anecdotes

• U.S. interest rates fell in May given concerns surrounding trade wars, European political uncertainty, and the influence of falling oil prices on inflation (Fed rate hike concerns).   May delivered the biggest one-week rate decline since April 2017.
• In a surprising move, the U.S. removed steel and aluminum tariff exemptions on the EU, Canada, and Mexico which stressed markets and drew harsh criticism and promises of retaliation from trading partners.
• Italian political drama resulted in 2yr Italian yields spiking nearly 0.50% in a single day, the biggest one-day move since 2012 at the height of the Eurozone crisis.  Italian bonds later rallied on the back of Italy’s treasury moving to monetize €500B of its two-year notes.
• Italy’s two large anti-establishment parties in Italy ultimately struck a deal for a coalition government which provided some clarity but puts a Eurosceptic group in power of the Eurozone’s third largest economy.
• In a contrasting view of U.S. corporate profitability, S&P 500 companies reported 26% profit growth in Q1 while the BEA reported only 0.1% including the impact of the tax cuts and a profit decline of 6% excluding the impact of the tax cuts.
• Ben Bernanke signaled a cautious tone, regarding the timing of $1.5t in tax cuts and $300b of budget deficit spending which may pose challenges to the Fed when their effects wane in 2020.  Injecting heavy stimulus into an economy running at full employment may tie the Fed’s hands if the economy needs monetary stimulus while grappling with record tight labor markets.
• Referencing strong dollar challenges to emerging markets, Urjit Patel, the governor of India’s central bank, noted $20b/mo ($50b/mo in 2019) of Fed balance sheet unwind and a record $2.3t of U.S. Treasury issuance over next 2 years will put pressure on USD supply resulting in a strong USD and corresponding downward pressures on emerging markets.
• While U.S. markets have largely climbed back from the first quarter market correction, emerging market equities and debt have continued to languish.  A strong USD is a headwind to emerging markets but benefits U.S. small cap stocks because they carry lower international revenue exposure than larger cap multinationals.
• Oil production in the Permian soared to 3.2 million barrels per day in May, moving total U.S. production above 10.2 mbpd – surpassing the prior U.S. record of 10 mbpd in 1970.  This is the highest recorded U.S. oil production since the government began keeping records in 1920.
• According to the Baker Hughes report, the number of oil rigs drilling in the Texas Permian Basin has tripled in the past two years to 449. The Permian Basin rigs now represent 44% of all operating rigs in the U.S. and approximately 22% of operating rigs in the world.

Economic Release Highlights

• Full employment?  May’s 223,000 jobs created maintained a record streak of 92 straight months of positive job creation, pushing the unemployment rate down to a multi-decade low of 3.8%.  We are in the 170th consecutive week of less than 300,000 claims (longest recorded) and the 35th consecutive week of less than 250,000 (longest such streak since 1970).
• May’s Job Opening and Labor Turnover survey (JOLTS) revealed a record number of job openings and for the first time in its history, more openings than there are available workers.
• Average hourly earnings increased 2.7% from a year earlier while real personal income of 1.8% yoy and real PCE spending of 1.25% 3m/3m, both relatively low again.
• May’s ISM Manufacturing report of 58.6 was a bounce from two straight m/m declines and beat expectations, registering an expansionary level of 58.6.
• May Consumer Confidence hit the consensus estimate of 128, which marks eleven straight months with an estimate greater than 120.  Since 1967, there have only been two other periods with comparable positive and sustained marks.

 

The March Narrative  

March marked the nine-year anniversary of the equity bull market as investors weighed the balance of bullish arguments (economy, earnings) and bearish arguments (tariffs, interest rates, valuations) against one another.  The month of March delivered the first consecutive monthly decline (-2.5%) in the S&P 500 since October 2016 and snapped a nine-quarter winning streak. Key market events included POTUS tariff proposals, Amazon business scrutiny, Facebook privacy breaches, and a 0.25% Fed rate hike.   Value and small cap-oriented strategies outperformed growth strategies due to performance headwinds experienced by some big technology companies. Bond yields fell slightly despite emerging signs of inflation momentum finally picking up.

Market Anecdotes

• Earnings come into focus now that Q1 is a wrap.  FactSet consensus earnings estimates see 7% quarter over quarter growth which would be the largest Q1 result since FactSet data began in 1996.  The year over year forecast calls for 17.3% growth, the fastest pace in seven years.
• Fed Chair Jerome Powell impressed Fed watchers at his first FOMC press conference.  He communicated an expected 0.25% rate hike and came off as relatively dovish on balance.
• Fiscal stimulus has the U.S. Treasury department ramping up debt issuance to record levels to pay for approved budget outlays and tax cuts which started taking effect in January.  A recent 4 week stretch saw a record $747b in treasury bill issuance and more records are most certainly coming down the road.
• There’s been a distinct shift in the volatility regime since January 26th.  There were zero 1% market moves in the 60 days leading to 1/26. In the subsequent 45 days we’ve seen 22 moves of over 1%.
• New Chief Economic Advisor, Larry Kudlow, is seen as a strong dollar and hardline China replacement to Gary Cohn.  Given his TV experience, he is also seen as a strong pitchman and a good match for POTUS but has markets somewhat on edge regarding U.S. trade protectionism.
• Nikkei lost 5.8% on the quarter, its worst performance in two years.  Culprits are a strong yen, trade policy uncertainty, and rising U.S. interest rates.
• Pipeline stocks fell 10% from the March high on a FERC ruling that MLPs can no longer recover a key income tax allowance.
• Italy’s elections in early March resulted in a “hung parliament” with no party attaining a majority.  Euro-skeptic parties collectively (League, Five-Star, Brothers of Italy) did much better than mainstream parties.  Due to vastly differing overall agendas, it is difficult to see an anti-Euro coalition taking shape, but League + Five Star is seen as the worst combo of the three.
• Headline unemployment has been less than 3.9% in only 1 month since 1970.

Economic Release Highlights

• March ISM Manufacturing index eased off February’s 14 year high to a still outstanding level of 59.3.  New orders, backlog orders, export orders all suggest continued strength.
• March ISM Non-Manufacturing index came in as expected at 58.8, a robust level and near the prior two months.  Strong new orders and employment were both notable factors.
• March Consumer Confidence Index eased slightly to 127.7 from February’s level of 130.8.  Consumer sentiment hit its highest levels since 2004.
• Jobless claims remain in one of the most prolonged downtrends in history.  We are seeing the lowest weekly jobless claims since the early 1970’s and have seen 161 consecutive weeks below 300k claims – the longest streak on record.  Continuing jobless claims (1.8mm) also reached record lows relative to the size of the U.S. labor force. That said, March payroll growth of 103,000 widely missed expectations but unemployment remained at 4.1%.
• The March jobs report included annual and monthly wage growth of 2.7% and 0.3% respectively which did substantiate what has become a consensus call for upward wage pressures continuing.
• Citigroup Economic Surprise Indices suggest economic momentum around the world has slowed recently with the most pronounced relative trend reflecting a slowdown across the Eurozone.
• Final estimate of 4Q GDP was revised upward from 2.5% to 2.9%, driven by robust consumer spending.

 

The February Narrative

Just as Cal Ripken Jr. brought an end to Lou Gehrig’s consecutive game streak in 1998, equity market volatility in early February brought an end to a wide array of low volatility streaks and records.  U.S. equity markets experienced their first correction since 2015 while interest rates moved higher across the curve.  Most U.S. equity indices fell approx. 3% while foreign stocks fell closer to 6%.  REITs, telecommunication, and utilities stocks have felt the pinch of rising rates while technology, financials, and consumer stocks have held up relatively well.

Market Anecdotes

• The correction off the January 26th high set a record (448) for the most consecutive trading days without a +/-3% move, it was the second longest streak (578) without a +/-5% day and was in the top ten longest periods (715) without a -10% correction.
• Historically, equity markets experience corrections every 16-17 months.  Since 2009, the S&P 500 has experienced four corrections: a 16% decline in 2010, a 19% decline in 2011, a 12% decline in 2015, and a 14% decline in 2016.
• The speed of the correction was notable.  Since the 1950’s we’ve seen six corrections (>-10%) within a ten-day span.  This type of event is a 4-standard deviation type move and rarely happens outside of a recessionary period.
• DC Lawmakers broke through spending caps and suspended the debt ceiling to approve a massive $400mm budget.  It is estimated that combined tax and budget stimulus totals $3.3t in government borrowing over the next 10 years.
• Tax and budget stimulus have strategists upgrading growth forecasts and lowering unemployment forecasts.  Government deficit projections relative to GDP are expected to register 50-year highs (5.4%) while jobless rates hit 50-year lows.
• S&P 500 4Q earnings grew nearly 15%, the best mark in over six years.  69% beat earnings estimates, the best beat rate since Q3 2006 while 73% beat revenue estimates, the best beat rate since Q4 2004.   Earnings guidance (% raised vs % lowered) was the strongest since Q3 2010.
• FOMC minutes of Janet Yellen’s last meeting as Fed chair reflected a confident economic outlook and confidence that inflation will reach the Fed’s 2% target by 2019.
• M&A volumes have risen, likely due to tax policy clarity and reforms.  CEO Confidence Index is at its highest levels since 2006.
• Total consumer debt in 4Q17 rose $193b to a new all-time high of $13.15t – a fifth straight year of increase.  Important note is this number is not adjusted for inflation or population.  This is 67% of GDP, well below the 87% peak in 2009.
• Bank loan prices were generally stable while high yield bonds traded in sympathy with equities.  Five companies, totaling $18.3b defaulted in February, the highest volume of defaults since August 2004.  The silver lining is that iHeart Communications accounted for 90% of that number.
• POTUS talk of trade tariffs weighed on market sentiment but the reach of implementation is far from clear and likely is simple posturing for NAFTA and other trade negotiations.

Economic Release Highlights

• Revised 4Q GDP registered 2.5% growth, not booming growth but personal consumption jumped to 3.8% and residential investment soared 13.1%, both encouraging levels looking forward.
• The job market rolled on in February registering 313,000 new jobs, a 4.1% unemployment, and the lowest four week moving average of jobless claims since 1967.  Soft wage growth of 2.6% suggests there is adequate slack in the labor market.
• February Manufacturing and Non-Manufacturing ISM reports came in very strong at 60.8 and 59.5 respectively.  It was the strongest Manufacturing ISM reading since May 2004.
• February Consumer Confidence beat already lofty expectations, registering headline 130.8 (versus expectations for 126.0), well above the long-term average of 94.2 and the highest level since November 2000.
• The Case Shiller home price index rose 6.2% YoY in February, a sign of the strong housing market.
• Capital expenditures from all five Fed manufacturing surveys around the country have been strong.  As confirmation, February capital expenditures data came in with record growth.
• After 11 consecutive weekly declines, crude oil inventories leveled out and began to increase in middle February.  Oil prices fell, and inventories stand roughly -17% below this time last year.

The December Narrative

December saw global equity markets continue their unprecedented streak of consecutive positive months, closing out at record highs in an 8th consecutive year of the bull market.  During the month, the DJIA added to its tally of over 70 record closes in 2017 – the most it’s had since 1995.  Synchronized global growth coupled with benign inflation, accommodative policy, and strong corporate profits pushed stocks, bonds, and commodities higher.  A significant influence during the month was the tax reform package which amounts to approximately $1.4t worth of fiscal stimulus.  Bonds overcame interest rates creeping slightly higher thanks to a further tightening of credit spreads.  2018 is setting up a what looks like a tug-of-war between improving economic conditions versus sustained low inflation with the ever-present backdrop of the catalysts brewing in Europe, North Korea, and monetary policy trajectory.

Market Anecdotes

• The tax reform bill, one of the primary driving forces behind the financial markets for the past two months, came to fruition towards the end of December.  The bill packed a bigger punch due to the front end loaded nature of the cuts – Wharton estimated companies will pay an average effective tax rate of 9% next year but in 10 years, baring changes, that will double back to 18%.
• Tax bill highlights include reduction of corporate taxes from 35% to 21%, eliminating tax-exempt nature of pre-refunded municipal bonds (23% of the market), elimination of personal exemptions/increase in standard deductions, reduction of SALT/mortgage interest deductions, reduction of individual marginal rates, and curtailing AMT exposure.
• The Fed hiked rates for a third time this year in December which was Janet Yellen’s final meeting as Fed Chair.  Of interest to markets was the non-unanimous 7-2 vote along with the discussion that the tax bill stimulus may elevate pressure to increase the pace of rate hikes in 2018.  They did, however, reaffirm their stated course for three hikes in 2018 and two in 2019.
• Still no volatility.  The S&P 500 finished the year during the longest streak without either a 3% or 5% correction on record.  Meanwhile, the 165-day trading range of 30-year U.S. Treasuries reached their tightest trading range in recorded history, a mere 31.4 basis points.
• The yield curve continued to flatten during the month as short-term yields priced in the Fed rate hike while long term yields continued to question growth and inflation outcomes.  The 10-yr UST finished the year nearly where it started at 2.4% while the 30-yr UST yield fell meaningfully from the 3.08% level where it started the year.  Both 3-month and 2-year yields moved notably higher for the month and calendar year 2017.
• Month end riots in Iran, tightening supply, and strong demand pushed oil prices above $60 for the first time since 2014.  The EIA has reported eight consecutive weekly crude oil inventory drawdowns, now at levels 13.2% lower than this time last year.
• The ECB started to trim its QE programme in 2017 and is expected to end it altogether in 2018. Even the BoJ is expected to raise its bond yield target slightly this year.  It seems there are few central banks available to pick up the monetary stimulus baton, setting up a potentially anxious year for the world’s bond markets.

Economic Release Highlights

• December retail sales came in slightly weaker than expected but were roughly the same as the past few months.  The 3m/3m rates in November (12.2%) and December (11.3%) are the strongest we’ve seen since 2009.
• CPI has started to tick higher after a serious soft patch in 2017.  December year over year headline and core CPI came in on the high end of expectations, increasing 2.1% and 1.8% respectively.
• December’s employment report was somewhat disappointing, registering 148k versus 190k expected.  A closer look however shows a BLS change in the seasonal adjustment figure for December accounted for a -133k influence on the result.
• December ISM manufacturing registered 59.7, headlined by a 14-year high for new orders.  New export orders also climbed higher to 58.5, a strong reading on overseas appetite for U.S. goods. The ISM non-manufacturing composite index declined to 55.9, missing expectations for 57.6.
• After posting back-to-back 17-year highs, the consumer confidence index cooled slightly in the December report, to 122.1 vs a revised 128.6 in November and 126.2 in October.