While we are unsure of what the next few weeks look like for the stock market as we work through putting in a tradeable low, we feel confident that when the fog clears, the trend will ultimately resume higher. The average S&P 500 decline in midterm election years is 18%. Midterm election sell-offs have proven to be great buying opportunities with stocks up an average of 36% one year later.
We are very bullish on the economy, moderately bullish on equities (the economy could outperform the market), and more cautious on bonds. The end of "goldilocks" is much worse for the bond market than it is for the equity market. A little inflation would actually be a good thing for stocks. Price stability is defined as a 2% inflation target, not 0%, for a reason. The risk to the economy may actually be to the upside which should result in an earnings boom. We are adding a lot of fiscal stimulus to an economy that is already at full employment and have a Fed that is normalizing gradually. We have to be careful, but the odds we go from deflation to the 1970's in a matter of months are extremely low. We think we are much earlier in the business cycle than the calendar would have you believe.
Markets finished modestly higher during the holiday-shortened week as a relatively quiet economic and corporate earnings calendar allowed investors to catch their collective breath. The CBOE Volatility Index (VIX) declined from 19.46 last week to 16.49; the VIX has now fallen more than 50% from its February 5th peak of 37.32. The downward trend in the VIX indicates a return of investor confidence. Large cap technology stocks continue to lead the market; the Nasdaq-100 Index finished 1.9% higher, led by Amazon (+3.5%) and Facebook (+3.3%). Oilfield service stocks also performed well; the PHLX Oil Service Sector Index rose 3.2% on higher oil prices and increased activity in major offshore fields, including the Gulf of Mexico and North Sea. Meanwhile, Consumer Staples stocks underperformed due primarily to Walmart?s 11.4% decline following disappointing earnings results; the company?s gross margins and e-commerce sales fell short of expectations. Overall, though, fourth quarter earnings results have been impressive; earnings for companies in the S&P 500? Index are expected to grow 14.9%, the fastest pace in more than six years.
Last week, the Federal Reserve released minutes from its January 30-31 Federal Open Market Committee (FOMC) meeting. The minutes indicated that ?substantial underlying economic momentum? would warrant further rate hikes this year. Several FOMC members revised their forecasts for GDP growth higher based upon ?a reassessment of the recently enacted tax cuts, along with higher projected paths for equity prices and foreign economic growth.? The Committee also expects core inflation to reach its 2% target by 2019. Notably, the meeting occurred prior to the release of the January jobs and CPI reports which showed unexpectedly high year-over-year increases in both wages (+2.9%) and prices (+2.1%), respectively. The positive appraisal of the economy and the recent increase in inflation are likely to inform the Fed?s March 20-21 meeting discussions; current Fed Fund Futures indicate a greater than 80% probability of a 25 basis point hike. The more important question for investors is, ?How many more rate hikes are in store for 2018?? The statement that economic conditions may warrant ?further gradual increases in the federal funds rate? stoked intense debate over the addition of the word ?further? to the standard phrasing. Some economists now anticipate four rate hikes this year rather than the three expected at the beginning of the year. The January meeting was Janet Yellen?s final meeting as Fed Chair; Jerome Powell now takes the helm as the institution attempts to guide the economy through a rising interest rate cycle.
The pace and trajectory of interest rate and inflationary increases have received a great deal of attention over the past few weeks. Many companies, though, have recently commented on the potential benefits of rising interest rates and inflation. Inflation may enable them to raise prices, a difficult move when interest rates remained low. Higher interest rates will also provide an important competitive advantage to some: the better financed companies can increase market share as weaker competitors face higher financing costs or reduced credit availability. The recovery from this month?s correction will likely be somewhat choppy in the near-term as investors evaluate the strength of economic growth versus interest rate and inflationary pressures. Over time, as evidence builds that these factors can coexist, the market should reward the growth initiatives of individual companies.
Source: Strategas, Pacific Global Investment Management Company
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.
Last Week's Headlines
1. Home sales have slowed over the winter months, as existing home sales fell 3.2% in January following a 3.6% drop in December. According to the National Association of Realtors®, sales of existing homes are 4.8% below a year ago, which is the largest annual decline since August 2014. The NAR suggests that a lack of inventory has driven prices higher, pushing some potential buyers out of the market. Nevertheless, total housing inventory at the end of January rose 4.1%, which is still 9.5% lower than a year ago. Unsold inventory is at a 3.4-month supply (3.6 months a year ago). The median existing-home price for all housing types in January was $240,500, up 5.8% from January 2017 ($227,300).
2. In the week ended February 17, there were 222,000 initial claims for unemployment insurance, a decrease of 7,000 from the previous week's level, which was revised down by 1,000. The advance insured unemployment rate slipped to 1.3% for the week ended February 10. The advance number of those receiving unemployment insurance benefits during the week ended February 10 was 1,875,000, a decrease of 73,000 from the prior week's level, which was revised up 6,000.
Eye on the Week Ahead
The week opens with the January report on new home sales, which slid in December. The second report on the fourth-quarter gross domestic product is out mid-week. The first installment showed annualized economic growth at 2.6%, with consumer spending up a strong 3.8%. This week's report is based on more detailed information and may change noticeably from last month's account.
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