Markets rebounded Last week on positive economic data and stable interest rates. The CBOE Volatility Index (VIX) fell 33% as a sense of calm followed the recent selloff in stocks. Already, the 10% market correction has been cut in half; the S&P 500? Index ended the week down just 4.9% from its January 26 high. The recent pullback was exacerbated by strategies betting on low volatility; the 250% spike in the VIX triggered trading algorithms to unload stocks. That selling pressure appears to have abated for now. All sectors rose with large cap technology stocks leading in performance. The Nasdaq-100 Index, which includes Apple (+10.3%), Netflix (+11.6%), and Amazon (+8.1%), rose 5.6% this week to outpace the major indices. Small cap value stocks rose 3.9% to modestly trail the Dow Jones Industrial Average and the S&P 500? Index. Since January 2017, the Nasdaq-100 has outperformed the Russell 2000? Value Index by roughly 35%. We anticipate this differential will contract over time, especially as tax reform should disproportionately benefit smaller, domestically-focused companies. Last Monday, the administration released its infrastructure proposal which calls for $200 billion in federal spending to be combined with $1.3 trillion in state, local and private investment over the next ten years. The plan was met with skepticism from members of Congress, particularly as it would impact the federal deficit, rely on public-private partnerships, sell federal assets, and ?streamline? environmental reviews. Lawmakers will now attempt to mold the proposal into legislation; notably, infrastructure spending has historically received bipartisan support.
The market is in the process of digesting the three - 3's: 3% Inflation, 3% 10-year Treasury yield, and 3 Fed rate hikes in 2018.
The 2003 tax cut seems like the most useful guide to current market conditions in response to the recently passed tax reform - stocks increased, the dollar weakened, gold and oil moved higher and 10-year yields surged from 3.1 to 4.6% as economic growth repriced (GDP hit 7% in 3Q03). In 2003, equities suffered a six week sell-off as yields increased, before moving 15% higher over the next four months as yields normalized. Yields are surging as growth reprices. Concerns about the fiscal health of the country seem to be reflected in the dollar.
While we don't want to "whistle past the grave yard" as far as the recent correction is concerned, it looks like a tradeable low has started to take shape. This is a process and we are likely to re-test the lows before ultimately resuming higher over the next several weeks. The bulk of the decline is probably behind us in terms of price, but corrections of this magnitude take time to repair. That being said, we are still more inclined to view recent weakness in the context of a durable bull market than anything more sinister. Volatility can persist in the framework of a bull market.
For all of the talk about tax reform over the last few months, the tax bill really just started to take hold last week. The adjustment of paychecks last week started the consumer portion and CSCO's repatriation announcement should kick off repatriation flows. Bonus announcements for employees helped sustain optimism until paychecks were adjusted, but to put things in context, companies announced $4bn of one time bonuses while the tax cuts on income are $120bn for 2018.
Economic data last week were broadly positive. The Small Business Optimism Index increased to 106.9, just shy of last November?s record 107.5 reading; businesses reported plans for expansion and investments in response to tax reform and deregulation. Consumer sentiment rose to a higher-than-expected 99.9 reading, the second highest since 2004; the report highlighted increased job security and higher incomes. And, new housing starts reached their second highest level since August 2007; single-family starts grew by 3.7%, while multi-family starts (apartments and condos) jumped 23.7%. Permits activity also increased 7.4% to signal continued strength in the residential housing market. Retail sales unexpectedly declined, though consumer-oriented categories, such as apparel, electronics, and appliances, increased. Meanwhile, the CPI rose 0.5% month-over-month, the fastest pace since January 2017, to reflect an accelerating economy and stoking concerns about inflation. Interest rates, though, remained relatively stable; the yield on the 10-year U.S. Treasury Note closed the week at 2.88%, up modestly from 2.83% last week, and the yield on the 30-year Treasury Bond ranged narrowly between 3.11% and 3.18%. Investors seem willing to accept that some inflation is appropriate given the strength of the economy.
* Source: Pacific Global Investment Management Company & Strategas Research
Chart reflects price changes, not total return. Because it does not include dividends or splits, it should not be used to benchmark performance of specific investments.
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Last Week's Headlines
1. Consumer prices for goods and services rose 0.5% in January, according to the Bureau of Labor Statistics. Over the last 12 months, the Consumer Price Index has risen 2.1%. Contributing to the price growth were increases in prices for gasoline, shelter, apparel, medical care, and food. The index less food and energy increased 0.3% in January and 1.8% over the past year. The energy index increased 5.5% and the food index advanced 1.7%. Rising consumer prices could spark fear of rising inflation (and interest rates) among investors, who may react by selling equity holdings, which, in turn, could drive down stock market values.
2. In yet another sign of potentially escalating inflation, the Producer Price Index increased 0.4% in January. Over the 12 months ended in January, producer prices are up 2.7%. The PPI less foods, energy, and trade services rose 0.4% in January, the largest advance since increasing 0.5% in April 2017.Retail and food service sales fell by their largest margin in almost a year in January, according to the Census Bureau report. Retail sales decreased 0.3% compared to December — the largest month-over-month decline since February 2017. January's drop was not as profound as it could have been, since December's sales figures were revised to show no gain from November following an initial report of a 0.4% increase. Notable drop-offs in January occurred in auto sales (-1.3%); building material, garden equipment, and supplies dealers (-2.4%); and health and personal care (-1.2%). Year-over-year, retail sales are up 3.6%. Nonstore (internet) retail sales showed no change in January, but advanced 10.2% from January 2017.
3. The monthly government budget for January saw a surplus of $49.2 billion. For fiscal 2018, the deficit sits at $175.7 billion compared to $158.6 billion over the same period in 2017. While government receipts are up 4.2% from the same period last fiscal year, government expenditures have increased 5.1%.
4. Industrial production edged down 0.1% in January following four consecutive monthly increases. Manufacturing output was unchanged in January for a second consecutive month, although the index has increased 1.8% over the past 12 months. Mining output fell 1.0%, while the index for utilities moved up 0.6%. Capacity utilization for manufacturing was unchanged in January at 76.2%, a rate that is 2.1 percentage points below its long-run average.
5. New residential construction, which finished 2017 in fine fashion, continued to surge in January. According to the Census Bureau report, building permits increased 7.4% from December and housing starts jumped 9.7%. Housing completions fell 1.9%, but are 7.7% ahead of their January 2017 pace.
6. Prices are rising in trade, both foreign and domestic. January saw prices for U.S. exports rise 0.8%, while import prices climbed 1.0%. The 1.0% advance (which also occurred last November) marked the largest one-month rise since the index increased 1.2% in May 2016. Import prices advanced 3.6% between January 2017 and January 2018. Exports have not risen by more than 0.8% since advancing 1.1% in May 2016.
7. In the week ended February 10, there were 230,000 initial claims for unemployment insurance, an increase of 7,000 from the previous week's level, which was revised up by 2,000. The advance insured unemployment rate remained 1.4% for the week ended February 3. The advance number of those receiving unemployment insurance benefits during the week ended February 3 was 1,942,000, an increase of 15,000 from the prior week's level, which was revised up by 4,000.