Stocks were mixed last week; the Nasdaq and Russell 2000® Index of small companies posted gains for the week while the Dow Jones Industrial Average, S&P 500® Index, and Russell Midcap® Index declined slightly. Earnings continued to dominate headlines (more on this below) although impressive corporate results have not yet led to broad-based gains. Still, the relative outperformance of small cap stocks may indicate a growing preference for riskier assets; historically, this area has rallied strongly in the latter stages of bull markets. Also, later in the market cycle, as interest rates rise in response to accelerating economic activity, value strategies tend to outperform. Over the past five years, value has materially lagged growth; the Russell 3000® Growth Index rose 87% compared to a 45% gain in the Russell 3000® Value Index. The 2014-2016 Energy bear market, which had a disproportionate impact on value strategies, certainly contributed to the underperformance. Now, oil prices have recovered to late-2014 levels, and demand for energy resources across the industrial economy is increasing; value stocks could be poised to rally. Record mergers and acquisitions (M&A) activity also suggests a growing appetite for risk-taking; so far in 2018, corporations have announced $1.7 trillion of global M&A deals. At the same time, this week’s trade discussions between the Trump administration and Xi Jinping’s economic team suggest that each side is taking a ‘hardline approach’ to negotiations, though talks are ongoing. Also, President Trump’s upcoming decision whether or not to remain in the Iranian nuclear deal (May 12th deadline) could provide a near-term flashpoint.
The April jobs report was broadly positive; the unemployment rate fell to 3.9%, the lowest since December 2000. The favorable employment outlook should continue as retiring “baby boomers” provide opportunities for younger workers. More importantly, the year-over-year growth in wages was unchanged at +2.6%. The apparent stability in wage growth should provide some breathing room for the Federal Reserve’s timetable for interest rate increases. Meanwhile, first quarter earnings season continues: thus far, 81% of companies in the S&P 500® Index have reported results; of these, 77% have met or exceeded analysts’ sales estimates and 83% have met or exceeded analysts’ earnings per share (EPS) estimates. The expected EPS growth rate now stands at 24.3%, its fastest pace of growth since 2011, and up from 17.3% at the beginning of the reporting period. Companies are citing strong demand across areas such as transportation, construction, manufacturing, and oilfield services. Nevertheless, investors seem somewhat skeptical of the impressive results; questions regarding the transitory impact of tax reform have emerged in conference calls. To be sure, tax reform has helped boost company results; a significant portion of the proceeds, though, is being used to hire more workers, build new plants, and make strategic acquisitions. These investments should, in turn, sustain corporate and economic growth at least through the remainder of the year.
*Source: 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. Manufacturing expanded in April as the PMI® registered 57.3 percent, a decrease of 2 percentage points from the March reading of 59.3 percent. “This indicates strong growth in manufacturing for the 20th consecutive month, led by continued expansion in new orders, production activity, employment and inventories, with suppliers continuing to struggle delivering to demand,” says Fiore. A reading above 50 percent indicates that the manufacturing economy is generally expanding; below 50 percent indicates that it is generally contracting. A PMI® above 43.2 percent, over a period of time, generally indicates an expansion of the overall economy. Therefore, the April PMI® indicates growth for the 108th consecutive month in the overall economy and the 20th straight month of growth in the manufacturing sector. “The past relationship between the PMI® and the overall economy indicates that the PMI® for April (57.3 percent) corresponds to a 4.3 percent increase in real gross domestic product (GDP) on an annualized basis.”
2. Private sector employment increased by 204,000 jobs from March to April according to the April ADP National Employment Report®. Broadly distributed to the public each month, free of charge, the ADP National Employment Report is produced by the ADP Research Institute® in collaboration with Moody’s Analytics. The report, which is derived from ADP’s actual payroll data, measures the change in total nonfarm private employment each month on a seasonally-adjusted basis.
3. The Board of Governors of the Federal Reserve System voted unanimously to maintain the interest rate paid on required and excess reserve balances at 1.75 percent, effective May 3, 2018.
4. The nation's international trade deficit in goods and services decreased to $49.0 billion in March from $57.7 billion in February (revised), as exports increased and imports decreased.
5. Nonfarm business sector labor productivity increased 0.7 percent during the first quarter of 2018, the U.S. Bureau of Labor Statistics reported today, as output increased 2.8 percent and hours worked increased 2.1 percent. (All quarterly percent changes in this release are seasonally adjusted annual rates.) From the first quarter of 2017 to the first quarter of 2018, productivity increased 1.3 percent, reflecting a 3.6-percent increase in output and a 2.2-percent increase in hours worked.
6. Total nonfarm payroll employment increased by 164,000 in April, and the unemployment rate edged down to 3.9 percent, the U.S. Bureau of Labor Statistics reported today. Job gains occurred in professional and business services, manufacturing, health care, and mining.
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