For the last few years we have been lulled into a false sense of security that no matter what happened in the world, the Market would continue to go straight up. All you needed to do is look at the VIX Index over the last few years to confirm my comments. VIX is the ticker symbol for the Chicago Board Options Exchange (CBOE) Volatility Index, which shows the market's expectation of 30-day volatility. It is constructed using the implied volatilities of a wide range of S&P 500 index options. The VIX index is between 15% – 18% in a normal market. However over the last few years the VIX has been historically low in the 10% neighborhood and with everything that has happened over the last year in the economy, de-regulation, Politics, Russia and the Middle East nothing could get the market nervous enough to sell off to usher back volatility. No matter what the headline was, the market shrugged it off because the Federal reserve was there to stand behind slow predictable constrained economic growth.
We now have a new Federal reserve Chair, a new tax plan andthe markets have sprung back to life. The Economy is in great shape and the Federal Reserve is looking at a healthy economic future. It is only natural that market volatility would pick up. As Martha Stewart says “That is a good thing” in the longer term. However, it can seem painful in the short term. Market volatility is back to a historical range and we think this is good for the current Bull Market.
Stocks fell last week on concerns of escalating trade disputes and mixed economic data. All major indices declined, with areas associated most closely to economic growth underperforming. The Dow Jones Industrial Average returned to negative territory for the year; small and mid-cap stocks also fell below break-even. The Nasdaq Composite remained a relative outperformer, up 5.1% year-to-date, as investors continue to prefer faster growing technology companies. Treasury yields fluctuated throughout the week, but ended roughly where they began. Meanwhile, the CBOE Volatility Index (VIX) jumped 19% to 19.59; despite the increase, the VIX is still down more than 50% from its intraday peak last month. Last Weeks announced tariffs on steel (25%) and aluminum imports (10%) primarily drove the unrest; the plans sparked complaints from companies which would incur higher materials costs, especially in the automotive and consumer packaged goods (CPG) industries, as well as wider concerns of retaliation from China, Canada, and Europe. The threat of a tit-for-tat trade war could weigh on market sentiment until the administration clarifies the proposal.
Somewhat mixed economic data contributed to investor unease last week as well. The 7.8% decline in new home sales, partly due to inclement weather, followed last week’s 3.2% decline in existing home sales. The pending home sales index decreased 4.7% in January; realtors noted that low inventory and higher mortgage rates negatively impacted activity. The 3.7% decline in durable goods orders, the largest pullback in six months, also disappointed. And,second quarter GDP growth was downgraded slightly to 2.5%, from an initial estimate of 2.6%; still, consumer spending rose 3.8% while residential investment, which includes new construction and home improvement activities, rose 13.1%. Also, the February ISM Manufacturing Index increased to its highest reading since 2004. The report is consistent with recent comments from earnings conference calls which indicate that companies are moving forward with investment and growth initiatives. Elsewhere, China’s manufacturing and non-manufacturing indices pointed to slowing growth in the world’s second largest economy; the composite PMI declined from 54.6 to 52.9. And, industrial production in Japan fell 6.6% in January, while a 1.6% increase in retail sales fell short of analysts’ estimates. That said, January and February economic data are typically distorted by unpredictable weather and the lunar New Year holiday.
New Fed Chair Jerome Powell testified before the House Financial Services Committee and the Senate Banking Committee; he highlighted the strength of the economy and benefits of tax reform and deregulation. Analysts interpreted the upbeat outlook to suggest a possible fourth rate hike this year, up from the three originally planned. And yet, the January 1.5% year-over-year increase in the Fed’s favored gauge on inflation, the core PCE price index, was in line with expectations and below the official 2% target. This week’s release of the February jobs report will indicate whether January’s strong wage increase was a trend or an anomaly. Markets may remain unsettled as investors balance concerns over inflation, interest rates, and trade against robust corporate earnings and growth prospects.
*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. The net value of goods and services produced in the United States, as measured by the gross domestic product, increased at an annual rate of 2.5% in the fourth quarter of 2017, according to the second estimate released by the Bureau of Economic Analysis. In the third quarter, the GDP increased by 3.2%. The price index for gross domestic purchases (a measure of price changes in goods and services) increased 2.5% in the fourth quarter, compared with an increase of 1.7% in the third quarter. The personal consumption expenditures price index (which measures the increase in prices paid for personal consumption) increased 2.7%, compared with an increase of 1.5%. Excluding food and energy prices, the PCE price index increased 1.9%, compared with an increase of 1.3%. Consumer spending increased 3.8% compared to the third quarter, as purchases of durable goods jumped 13.8%.
2. Personal (pre-tax) earnings rose 0.4% in January, the same increase as December, according to the latest report from the Bureau of Economic Analysis. After-tax income surged ahead by 0.9%, which matches the largest such gain since December 2012, reflective of the tax-law changes taking effect in January. Despite increased income, consumers didn't spend significantly more, as personal consumption expenditures rose by only 0.2% over December's rate. Instead of spending, consumers apparently added their newfound income to savings, which jumped 3.2% in January.
3. Manufacturing output expanded in February, but at a slightly slower pace than January, according to the IHS Markit final U.S. Manufacturing Purchasing Managers' Index™ (PMI™). The PMI™ registered 55.3 in February, down slightly from 55.5 in January. The advance in production was attributable to greater client demand. New business expanded at a faster pace, while input prices increased at the fastest pace since December 2012.
4. The Institute for Supply Management's Report On Business® reported similar results as Markit's submission. The ISM® Purchasing Managers' Index registered 60.8% in February, an increase of 1.7 percentage points from the January reading. However, ISM® respondents reported a slight decrease in new orders and production. Employment increased substantially, as did prices.
5. New home sales fell 7.8% in January and 1.0% below their pace from a year ago. The median sales price of new homes sold in January was $323,000. The average sales price was $382,700. The seasonally adjusted estimate of new houses for sale at the end of January was 301,000. This represents a supply of 6.1 months at the current sales rate. While new home sales were soft in January, inventory increased 10.9% and the average sales price fell 3.1% — factors which should help spur sales in February.
6. Orders for long-lasting products (durable goods) slipped in January, according to the latest report from the Census Bureau. New orders decreased $9.2 billion, or 3.7%, for the month following two consecutive monthly increases. Unfilled orders, down following four consecutive monthly increases, decreased $3.1 billion, or 0.3%, to $1,140.9 billion. On the plus side of the report, both shipments ($0.6 billion, or 0.2%) and inventories ($1.3 billion, or 0.3%) increased in January over December.
7. The advance report on international trade in goods saw the deficit increase by $2.1 billion in January over December. Exports of goods for January were $133.9 billion, $3.1 billion less than December exports. Imports of goods for January were $208.3 billion, $0.9 billion less than December imports. Wholesale inventories increased 0.7%, while retail inventories advanced 0.8%.
8. The Conference Board Consumer Confidence Index® increased in February, following a modest increase in January. Coming in at 130.8, this is the highest level since November 2000. According to the report, "despite the recent stock market volatility, consumers expressed greater optimism about short-term prospects for business and labor market conditions, as well as their financial prospects."
9. In the week ended February 24, there were 210,000 initial claims for unemployment insurance, a decrease of 10,000 from the previous week's level, which was revised down by 2,000. This is the lowest level for initial claims since December 6, 1969, when it was 202,000. The advance insured unemployment rate inched up to 1.4% for the week ended February 17. The advance number of those receiving unemployment insurance benefits during the week ended February 17 was 1,931,000, an increase of 57,000 from the prior week's level, which was revised down by 1,000.
Eye on the Week Ahead
The important monthly employment report for February is out this week. Pay close attention to wage appreciation as another sign of building inflationary pressure. Also, the international trade report for January is out. It is expected to reveal an expanding goods and services trade deficit.
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