Friday, 27th of April 2018
Spring is well entrenched all around us. And, it is true, Spring is a time of renewal and growth. If you had a doubt, see the two Korean leaders planting a tree together, peek at the US Dollar which has taken off (at last!), with the DXY index shooting up to 91.56, oil at $68 for ETI and $74.70 for Brent. Then, there are the earnings for Q1 which have been coming in fast and furious – amazing how a monster such as Amazon [AMZN] can show results that beat expectations by almost 2X… Data on Thursday showed the economy remains on a strong footing. The number of Americans filing unemployment benefits dropped to the lowest level in more than 48 years last week and the goods trade deficit tumbled in March on strong export growth. According to a Reuters survey of economists, GDP growth likely slowed to a 2.0% annualized rate in the first three months of the year. The economy grew at a 2.9% pace in the fourth quarter. The government will publish its advance estimate of first-quarter GDP on Friday. The anticipated slowdown in economic growth is likely to be temporary against the backdrop of a robust labour market that is expected to underpin consumer spending. The economy is also expected to get a boost from the Trump Administration’s $1.5 trillion income tax cut package as well as increased government spending. Looking good, Spring 2018!
Corporate America is well on its way to what could be a record-breaking profit season, and investors don’t really care. First-quarter reports so far are turning one of the market’s most time-honoured truths on its head: that profits drive prices. Despite earnings growth of more than 18% and an 80% beat rate, the market is little changed since the season has accelerated. That was true again Tuesday, when a slew of high-profile beats couldn’t push the overall market much higher as traders hammered even some companies that beat expectations. In fact, as trading progressed, major averages turned decidedly negative, even as nearly three-quarters of the 23 companies that reported topped Wall Street estimates. “It is pretty amazing when you look at it, an earnings season that’s having an equal and opposite reaction to results,” said Art Hogan, chief market strategist at B. Riley FBR. “It’s a very difficult market to please right now.”
Companies that have topped earnings estimates have seen share price gains of just 0.1% in the two days after reporting, well below the typical average increase of 1.1% as tracked over the past five years, according to FactSet. Earnings misses have resulted in two-day declines of 0.9%, which is well below the typical 2.4% decline. Indeed, investors have been fickle, perhaps because they have more on their minds than just bottom-line profits. Among the concerns are: the looming possibility of a U.S. trade war with China, rising bond yields (the benchmark 10-year Treasury note yield briefly passed 3 percent on Tuesday), and a potentially more aggressive Federal Reserve that could raise rates as many as four times in total before the year ends. And there’s more: earnings reports are a look in the rear-view mirror, which is showing companies getting a lift from tax cuts that will level off over time. The big boost in quarterly earnings likely to continue through 2018 will be tough to top in 2019. That means investors are looking through the earnings reports and envisioning a potential deceleration ahead. Caterpillar, for instance, saw a sharp drop after its CFO said the company’s outlook assumed that the first quarter was the “high water mark” for the year. You just can’t please everyone all the time… but we retain the fundamental strength in the economic data and the results are just confirmation. Will this euphoria last forever? Probably not, but our best guess is that it has quite long legs still. Stay with equities: even the pessimists are starting to see the light- The VIX measure for risk is down… now at 16.25 and then U.S. Conference Board’s consumer sentiment index rose higher in April; in contrast to the moderation expectated. The sentiment index rose to 128.7 in the month, as compared with consensus expectations of falling to 126. The rebound in sentiment was spread evenly between the present situation and expectations indices. Consumer sentiment has continued to be resilient even in the face of the recent uncertainty stoked by anti-trade rhetoric and stock market volatility, and consumers’ perception of future economic conditions continue to be favourable. These augur well for consumption spending and GDP growth, stated Barclays.
The European Central Bank (ECB) held interest rates steady on Thursday, amid signs the Euro Area’s growth outlook may have softened. The ECB’s interest rate on its main refinancing operations and the interest rates on the marginal lending facility and the deposit facility will remain unchanged at zero, 0.25 and -0.40% respectively. Speaking from Frankfurt, ECB President Mario Draghi said “underlying strength” in the euro zone’s economy continued to underpin the bank’s confidence despite signs of “moderation” in recent weeks. He added an “ample degree of monetary stimulus” remained necessary over the coming months. “The Governing Council expects the key ECB interest rates to remain at their present levels for an extended period of time, and well past the horizon of net asset purchases,” the ECB said in a statement, repeating its long-standing guidance on interest rates. “The euro-zone economy remained stuck in a lower gear in April,” said Chris Williamson, chief business economist at IHS Markit. “Growth has downshifted markedly since the peak at the start of the year, but importantly still remains robust.”
All these Spring-time musings are all well and pleasing, but the “elephant in the room” this time is the yield on the US ten-year Treasury Notes which crossed 3%and are trading in a narrow band at this level. The government’s benchmark debt instrument saw its yield pass 3% on Tuesday, a four-year high that ostensibly helped to trigger a violent stock market reversal that saw the Dow close lower by about 425 points. The calculus behind fear of the 3% yield seems obvious: With the S&P 500 dividend yield at 1.9%, a risk-free investment like U.S. Treasuries yielding 3% makes more sense in a volatile environment. But that reasoning is weak. The play assumes holding the bond to duration and clipping coupons, and the stock market has never shown inflation-adjusted returns that low over a 10-year period. Absent a major crash and a deep recession, it likely won’t over the next decade as well. While everyone on Wall Street is pounding the table over the rising 10-year yield, the 2-year note rose above 2.5% Wednesday, a level it last closed at August 2008, just a month before the financial crisis imploded with the collapse of Lehman Brothers. A risk-free investment with a 2.5% yield over two years? That seems a little more reasonable.
Overall, we remain favourable to equities and shy of bonds. We are pleased the currency traders have found the green light again… And as we have all gotten used to Donald Trump, we are reminded of Napoleon Bonaparte’s quip “In politics, stupidity is not a handicap…”
Market Weekly Highlights
Currencies & Commodities
Fixed Income
Equities
Highlighted items are interesting data points for the week. Source: Bloomberg (26/04/2018)
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