Monthly Markets Memo - May 2018

World Money Small.jpgby Dan Zalipski, CFA & Scott Rosenquist, CFA

Market Update

The equity markets continue to be volatile.  Both the U.S. and international developed markets have had substantial moves this year yet remain relatively close to where they started.  Looking only at 2018, the S&P 500 was up nearly 7% at one point in January, only to find itself down 4% in early February.  It recovered to positive 4% in early March, only to find itself down 4% by the end of March.  At the time of this writing, the S&P 500 has had 32 trading days with moves of 1% or more in 2018 according to DataTrek’s Nicolas Colas.  An average year will see around 50 days with 1% moves in either direction, and with the historically volatile months of August and October still to come, it’s likely we will exceed that mark.

Some of the volatility within the equity markets is directly related to the volatility within the bond markets.  The 10-year treasury’s yield exceeded 3% for the first time in four years this past April.  The 3% threshold is more of a psychological mile marker than one of immediate tangible impact, but none-the-less the market responded by aggressively pushing down both equity and bond prices.  Equities have somewhat bounced back while the major bond indices remain negative on the year. 

Economic Fundamentals

As the markets seemingly struggle to find their footing amidst the volatility, now may be an appropriate time to check up on the underlying fundamentals of the economy to ascertain what the market is working with.  The U.S. Economy is primarily driven by consumption and government spending.  Consumers are upbeat about the economy as evident by various confidence and sentiment surveys.  This past quarter, the University of Michigan’s consumer sentiment survey reached its highest level in 14 years.  .  Unemployment is low, and a large swath of consumers just received a tax cut.  Retail sales growth is positive, and the manufacturing sector remains solidly in expansion mode.  In fact, some manufacturing sectors are having trouble filling orders, blaming strong demand that is pressuring suppliers.

Government spending is also poised to increase, further supporting the economy.  The omnibus spending bill passed in the 1st quarter substantially increased defense spending.  In addition to defense, there have been talks of an infrastructure bill as well, although details on the bill and its progress at this point are much more speculative.  Spending initiatives should be accretive to the U.S. GDP, but these actions carry their own risks. 

The risks converge in the form of rising interest rates.  Investors are paying close attention to what the Fed has to say, dissecting every statement and speech for clues as to the path forward.  Thus far, the Fed has been deliberate in effectively communicating their current campaign of rate increases in a way intended to reduce surprises and calm investors.  An abrupt deviation from this path by increasing the pace of rate increases would likely add fuel to the market’s volatility, pressuring both the equity and bond markets. 

Looking Forward

Triggers for such an action could come from either the consumer or government components discussed earlier.  Strong demand within the manufacturing sectors can contribute towards inflation; Suppliers overwhelmed with demand can drive prices higher.  Low unemployment increases labor costs as workers demand higher wages.  These higher costs are passed to consumers in the form of higher prices.  Furthermore, the government’s actions are expected to increase the deficit, a predictable outcome of higher spending and lower taxes.  As the deficit increases, the government must borrow more to fund itself, putting upward pressure on Treasury yields.  Whether driven by the Fed increasing rates to fend off inflationary pressures, or Treasury yields moving higher regardless of Fed action, a rapid rise in interest rates is more than enough to roil the markets.

The broad bond market losses year to date may have investors questioning their fixed income positioning.  Our view has been to overweight equities versus fixed income with the underlying economic fundamentals still supportive of this stance.  This comes with additional volatility which we’ve seen so far this year.  Within fixed income, being selective with exposure to minimize interest rate sensitivity has continued to be our preference. 

“History has demonstrated time and again the inherent resilience and recuperative powers of the American economy.” Ben Bernanke; former Chairman of the Federal Reserve

 
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendation for any individual. Although general strategies and / or opinions are revealed, this post is not intended to nor does it represent or reflect transactions or activity specific to any one account. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. All data and information is gathered from sources believed to be reliable and is not warranted to be correct, complete or accurate. Investments carry risk of loss including loss of principal. Past performance is never a guarantee of future results.

 

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