Stocks declined across the board last week leaving clients to ask is this still a healthy market? Last week was the first 5% pullback we have seen in the equity markets since January of 2016. A better-than-expected jobs report sent interest rates higher which, in turn, triggered Friday?s sharp selloff; the Dow Jones Industrial Average lost 666 points, a 2.54% decline. The yield on the benchmark 10-year U.S. Treasury Note rose 0.18% this week, to 2.84%, from 2.40% at the end of December and last year?s early September low of 2.05%; the yield on the 30-year U.S. Treasury Bond closed above 3% for the first time since May. Investors are concerned that rising rates may signal an end to the market rally. Bond yields, though, are moving higher in response to a combination of positive economic indicators including low unemployment, rising wages and high levels of consumer and business confidence. Basically Economic nirvana!! Interest rates, even after the recent increases, remain at historically low levels; most analysts believe that the economy will not be seriously impacted unless the yield on the 10-year U.S. Treasury Note approaches 4%. Moreover, most indications suggest that economic trends will remain strong, and perhaps accelerate. If This morning?s ISM (Manufacturing Report, Strongest report in the last 20 years) report is any indication we still are on a major economic upswing. January?s employment report is the latest data point: companies hired more workers than expected while wages grew at the fastest pace since 2009. The Atlanta Federal Reserve was out over the weekend suggesting that Q1 GDP will be more than 5%. Merger and acquisition (M&A) activity is another positive indicator; last week, Keurig Green Mountain announced an agreement to merge with Dr. Pepper Snapple and form a beverage giant that will challenge Coca-Cola and PepsiCo. Many expect that tax reform and the repatriation of cash held overseas may lead to record M&A activity this year.
Thus far, roughly half of the companies in the S&P 500? Index have reported earnings results; of these, 80% have exceeded analysts? sales estimates while 75% have exceeded analysts? earnings per share (EPS) estimates. These figures are significantly higher than the five-year averages of 56% and 69%, respectively. Alphabet (parent company of Google), Amazon, Apple, Facebook, and Microsoft highlighted the Technology sector results. With the exception of Alphabet, all of the companies reported EPS above analysts? expectations. Nevertheless, Apple sold off due to lower-than-expected sales of the latest iPhone models; Alphabet declined 5.3% after reporting lower earnings due to higher marketing costs. Amazon?s stock rose 2.9% following its earnings report; a day earlier, the company announced a partnership with JPMorgan Chase and Berkshire Hathaway to form an independent health care company for their employees. Amazon?s apparent entry into the pharmaceutical distribution industry led to a selloff in Health Care stocks. This week, earnings season continues; 90 companies in the Index, including media bellwethers Disney, Twenty-First Century Fox, Viacom, and News Corp report results. Investors will be paying attention to commentaries on how the companies are navigating the rapidly changing media landscape, as well as updates on Disney?s recent acquisition of Fox?s film and television studios.
January?s strong results marked the best start for the S&P 500? Index (+5.62%) since 1997. So a pullback of some sort should not be a surprise for most investors. In February?s two trading days, though, the Index fell 2.18% as investors reacted to higher interest rates. Many investors have never experienced a rising rate environment; the most recent interest rate cycle occurred over ten years ago. Indeed, rather than indicating weakness, the recent rise in rates suggests we have entered an accelerating growth phase. The healthy global economy, expanding corporate profits, and increased M&A activity should support stocks even as investors contemplate the impact of higher interest rates.
* Pacific Global Management
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Last Week's Headlines
- The labor sector continues to be strong entering the new year. January saw 200,000 new jobs added, while the unemployment rate remained at 4.1%, according to the latest report from the Bureau of Labor Statistics. Employment continued to trend up in construction, food services and drinking establishments, health care, and manufacturing. There were 6.7 million unemployed, yielding a labor participation rate of 62.7%, unchanged for the fourth consecutive month. The employment-population ratio was 60.1% for the third month in a row. The average workweek declined by 0.2 hours in January to 34.3 hours. Average hourly earnings rose $0.09 to $26.74, following an $0.11 increase in December. Over the year, average hourly earnings have risen by $0.75, or 2.9%. The drop in the average workweek could be an indication of a lack of available workers, which would likely hold down production.
- The Federal Open Market Committee met last week for the first time in 2018, which also marked the final meeting over which Janet Yellen would preside as chairperson. The Committee did not increase the federal funds rate, noting that the labor market has continued to strengthen and that economic activity has been rising at a solid rate. Gains in employment, household spending, and business fixed investment have been solid, and the unemployment rate has stayed low. Nevertheless, both overall inflation and inflation for items other than food and energy have continued to run below 2%. The Committee still expects three rate adjustments over the course of the year. Also, the Committee unanimously approved the selection of Jerome H. Powell as chair.
- Personal income increased $58.7 billion, or 0.4%, in December, according to estimates released by the Bureau of Economic Analysis. Disposable (after-tax) personal income (DPI) increased $48.0 billion, or 0.3%, and personal consumption expenditures (PCE) increased $54.2 billion, or 0.4%. Showing little inflationary pressures, prices for consumer goods and services bumped up 0.1% (1.7% from a year ago), while prices excluding food and energy rose 0.2% for the month (1.5% from a year ago). Wages and salaries climbed a noteworthy 0.5% for the month. On the other hand, consumer savings dipped 0.1 percentage point to 2.4%, possibly an indication that consumers may have dropped into savings for purchases.
- The IHS Markit final U.S. Manufacturing Purchasing Managers' Index™ (PMI™) registered 55.5 in January, up from 55.1 in December. The latest index reading indicated a strong improvement in business conditions across the manufacturing sector. Moreover, the index signaled the strongest upturn in the health of the sector for over two and a half years. The rate of manufacturers' growth accelerated at the fastest pace in 12 months. As demand increased, manufacturers raised their selling prices at the second-steepest pace since September 2014. At first blush, the Manufacturing ISM® Report On Business® appears to contradict Markit's report. However, a closer reading reveals that new orders are increasing, but a slowing in employment may be an indication that there aren't enough workers to meet the accelerating demands of manufacturing and product shipment.
- Consumer confidence in the economy has cooled from earlier last year, yet it rose a bit in January, according to The Conference Board. Consumer confidence in the present economic situation decreased slightly, while consumers were more optimistic about economic improvement in the short term.
- In the week ended January 27, initial claims for unemployment insurance was 230,000, a decrease of 1,000 from the previous week's level, which was revised down by 2,000. The advance insured unemployment rate remained 1.4%. The advance number of those receiving unemployment insurance benefits during the week ended January 20 was 1,953,000, an increase of 13,000 from the prior week's level, which was revised up by 3,000.
Eye on the Week Ahead
Equities continue to break records, as fourth-quarter corporate earnings reports remain relatively positive. This week is relatively quiet as to impactful economic reports. The December report on international trade in goods and services may reveal a shrinking trade deficit, as exports could increase following the dollar's slippage.