Resnick Advisors Weekly Update – February 5, 2018
February 5, 2018
The labor sector continues to be strong entering the new year. January saw 200,000 new jobs added, while the unemployment rate remained at 4.1%, according to the latest report from the Bureau of Labor Statistics. Employment continued to trend up in construction, food services and drinking establishments, health care, and manufacturing. There were 6.7 million unemployed, yielding a labor participation rate of 62.7%, unchanged for the fourth consecutive month. The employment-population ratio was 60.1% for the third month in a row. The average workweek declined by 0.2 hours in January to 34.3 hours. Average hourly earnings rose $0.09 to $26.74, following an $0.11 increase in December. Over the year, average hourly earnings have risen by $0.75, or 2.9%. The drop in the average workweek could be an indication of a lack of available workers, which would likely hold down production.
The Federal Open Market Committee met last week for the first time in 2018, which also marked the final meeting over which Janet Yellen would preside as chairperson. The Committee did not increase the federal funds rate, noting that the labor market has continued to strengthen and that economic activity has been rising at a solid rate. Gains in employment, household spending, and business fixed investment have been solid, and the unemployment rate has stayed low. Nevertheless, both overall inflation and inflation for items other than food and energy have continued to run below 2%. The Committee still expects three rate adjustments over the course of the year. Also, the Committee unanimously approved the selection of Jerome H. Powell as chair.
Personal income increased $58.7 billion, or 0.4%, in December, according to estimates released by the Bureau of Economic Analysis. Disposable (after-tax) personal income (DPI) increased $48.0 billion, or 0.3%, and personal consumption expenditures (PCE) increased $54.2 billion, or 0.4%. Showing little inflationary pressures, prices for consumer goods and services bumped up 0.1% (1.7% from a year ago), while prices excluding food and energy rose 0.2% for the month (1.5% from a year ago). Wages and salaries climbed a noteworthy 0.5% for the month. On the other hand, consumer savings dipped 0.1 percentage point to 2.4%, possibly an indication that consumers may have dropped into savings for purchases.
The IHS Markit final U.S. Manufacturing Purchasing Managers’ Index™ (PMI™) registered 55.5 in January, up from 55.1 in December. The latest index reading indicated a strong improvement in business conditions across the manufacturing sector. Moreover, the index signaled the strongest upturn in the health of the sector for over two and a half years. The rate of manufacturers’ growth accelerated at the fastest pace in 12 months. As demand increased, manufacturers raised their selling prices at the second-steepest pace since September 2014. At first blush, the Manufacturing ISM® Report On Business® appears to contradict Markit’s report. However, a closer reading reveals that new orders are increasing, but a slowing in employment may be an indication that there aren’t enough workers to meet the accelerating demands of manufacturing and product shipment.
Consumer confidence in the economy has cooled from earlier last year, yet it rose a bit in January, according to The Conference Board. Consumer confidence in the present economic situation decreased slightly, while consumers were more optimistic about economic improvement in the short term.
In the week ended January 27, initial claims for unemployment insurance was 230,000, a decrease of 1,000 from the previous week’s level, which was revised down by 2,000. The advance insured unemployment rate remained 1.4%. The advance number of those receiving unemployment insurance benefits during the week ended January 20 was 1,953,000, an increase of 13,000 from the prior week’s level, which was revised up by 3,000.
DJIA: 25,520.96, down 4.12%
Nasdaq: 7,240.95, down 3.53%
S&P 500: 2,762.13, down 3.85%
Russell 2000: 1,547.27, down 3.78%
Global Dow: 3,214.56, down 3.25%
Fed. Funds: 1.25%-1.50%, unchanged
10-year Treasuries: 2.83%, up 17 bps
Stocks recorded their first weekly loss of 2018, with the large-cap S&P 500 Index suffering its worst weekly drop in two years. Energy stocks led the declines due to a plunge on Friday following lower-than-expected earnings results from Chevron and ExxonMobil. Health care shares were also especially weak after tumbling Tuesday on news that Amazon.com, Berkshire Hathaway, and JPMorgan Chase were planning to cooperate in establishing a health care system for their U.S. employees. Financials fared better, helped by rising bond yields, which augur well for improved lending margins.
Stocks got off to a poor start this week, although traders observed that a spike in volatility (as measured by the VIX index) to multi-month highs was more notable than the actual movement in the indexes. Some consolidation and profit-taking before the end of January appeared to be behind the declines, as was a climb in Treasury yields. The potential disruption in the health care sector also cast a wide shadow, as investors worried whether drug companies and health care service providers would see their profits slashed if Amazon brings its cost-cutting techniques to the sector.
Some good economic news, including a positive unofficial reading on January private payroll gains and a rise in pending home sales, appeared to help the market stabilize at midweek. The same data also helped build up pressure under long-term bond yields, however, and the threat of higher interest rates seemed to boil over into equity markets on Friday. Before trading began, the Labor Department announced that employers had added 200,000 non-farm jobs in January, a bit better than consensus estimates. Investors seemed to take more notice of data on average hourly earnings, which increased at their best year-over-year pace since 2009. The figures posed a dual threat to equity investors, suggesting that the tight labor market was feeding through into increased labor costs while also providing the Federal Reserve with a reason to increase its pace of interest rate hikes.
As they sought to absorb the jobs data, investors also had to digest several important earnings reports that were released after the close of trading on Thursday. Tech giants Apple, Alphabet (parent company of Google), and Amazon, which collectively represent over $2 trillion in market capitalization, reported mixed results, with investors punishing the first two for revenue and earnings misses, respectively, while rewarding Amazon for an earnings beat. Data and analytics firm FactSet raised its estimate for overall fourth-quarter earnings growth for the S&P 500 to 13.4% (on a year-over-year basis).
The steep rise in bond yields — the yield on the 10-year Treasury note jumped to its highest level in about four years — corresponded with a sharp drop in bond prices. (Bond prices and yields move in opposite directions.) Municipal bond prices fell with Treasuries, but analysts noted that muni demand remains strong and easily able to absorb new supply.
Steady demand also helped the investment-grade corporate bond market, along with subdued issuance. The segment was also better able to absorb the rise in rates, and credit spreads — the additional yield offered over similar-maturity Treasuries — tightened. Bank bonds performed particularly well, but the health care segment came under pressure, and spreads widened following the Amazon, Berkshire Hathaway, and JPMorgan Chase announcement. Looking ahead, analysts expect manageable issuance to contribute to favorable near-term technical conditions.
High yield bonds experienced some weakness due to outflows from the asset class and lower commodity prices. Crude prices fell as the number of U.S. rigs drilling for oil reached the highest level since last August, suggesting that increased domestic output could impede further gains in oil prices. The stronger U.S. dollar also weighed on commodity prices. Many commodities are priced in U.S. dollars and become relatively more expensive on world markets — reducing demand — as the dollar appreciates.
A broad-based retreat pushed European equities lower for the week as key regional indexes, including Germany’s DAX 30, France’s CAC 40, and the pan-European STOXX Europe 600, posted losses. The UK’s blue chip FTSE 100 Index lost almost 3% for the week, its worst performance since November. A rise in bond yields, which tend to make stocks look relatively riskier, was one of the underlying reasons for the equity sell-off. Corporate earnings were generally solid, and many investors seemed to believe that stock markets were repricing given a strong January performance.
The economic recovery in the Europe Union (EU) continued to strengthen, as annual gross domestic product (GDP) rose to 2.5% in 2017 — the strongest level in a decade — and EU growth outpaced both U.S. and UK GDP growth in 2017. Statistics agency Eurostat also noted that EU growth in the third quarter of 2017 was revised upward to 0.7% from 0.6%.
Rowe Price’s Chief International Economist Nikolaj Schmidt notes that the strong recovery is supported by low interest rates, continued implementation of quantitative easing, cheap currency, low commodity prices, and rising equity prices. He expects the growth to continue as Europe is early in the business cycle, and he sees a beneficial pattern currently forming in the eurozone: Investment is picking up as business confidence starts to come back, prompting companies to hire people, who use their salaries to increase their spending, resulting in higher profits for companies. Those higher profits are, in turn, used by companies to increase investment.
Eurozone core inflation came in at 1%, as expected, but still far below the roughly 2% level that the European Central Bank (ECB) has targeted. ECB Chief Economist Peter Praet said that because inflation is weak, stimulus measures need to remain in place.
The Financial Times, citing weekly flow data by EPFR, reports that equity funds enjoyed their biggest monthly inflows on record in January, attracting about $100 billion. EPFR notes that $25.6 billion flocked into equity funds in the week ended January 31, lifting the month’s total above the prior record haul of $77 billion in January 2013. It added that exchange-traded funds (ETFs) dominated the inflows.
Eurozone government bonds, particularly in core countries, sold off this week, and yields climbed amid expectations of less accommodative monetary policy over the coming year. The yield on 10-year German bunds rose to 0.77% by the end of the week.
The large-cap Japanese stock indexes snapped a six-day decline on Thursday but fell for the week. Small-caps bucked the negative trend and ended marginally higher. The widely watched Nikkei 225 Stock Average fell 1.5% (357 points) and closed at 23,274.53. Year to date, the Nikkei is up 2.2%, the broader TOPIX Index is ahead 2.6%, and the TOPIX Small Index has advanced 2.9%. The yen weakened and closed Friday’s trading at ¥110.3 per U.S. dollar, which is about 2.1% stronger than ¥112.7 per U.S. dollar at the end of 2017.
January’s final Markit/Nikkei Japan Manufacturing Purchasing Managers’ Index (PMI) reading stood at a seasonally adjusted 54.8, up from December’s final reading of 54.0. The index remained in expansion territory (above 50.0) for the 17th consecutive month. Joe Hayes, economist at IHS Markit, which conducts the survey, said, “New business opportunities increased at the sharpest rate in four years, supporting the quickest rise in output since February 2014…businesses appeared to derive confidence from the robust economic backdrop that official data has depicted, with optimism strengthening to a four-month high.” At the same time, rising commodity prices pushed up input costs, which spurred the fastest output price increases since October 2008.
Coupled with the manufacturing gains, Japanese exports rose 9.3% year-over-year to ¥7.3 trillion ($66.3 billion) in December, according to the Ministry of Finance. Exports to China increased 15.8%, and shipments to the entire Asia region expanded 9.9%, paced by sales of semiconductor production equipment and electronic parts. Although slightly below analysts’ forecasts and November’s 16.2% export growth, Wednesday’s release came the day after the Bank of Japan’s (BoJ) positive take on inflation expectations. The BoJ confirmed its conviction in the economic recovery and expressed confidence that inflation is gradually rising toward its 2% goal. Taken together, the data point to another quarter of gross domestic product growth — an eighth consecutive quarter of Japanese economic expansion.
China’s official manufacturing gauge hit an eight-month low in January, a possible early warning sign of weakening growth momentum following unexpectedly strong growth in 2017.
China’s official manufacturing Purchasing Managers’ Index (PMI) came in at 51.3 in January, down slightly from December’s reading and analysts’ consensus forecast. A private survey, the Caixin/Markit manufacturing PMI, came in at 51.5 in January, unchanged from December’s level. PMI readings above 50 signal expansionary conditions, while those below 50 indicate contraction.
China’s official manufacturing PMI released by the government surveys mostly larger, state-owned enterprises, while the Caixin/Markit PMI polls smaller, export-driven companies. Economists scrutinize both PMI gauges each month for clues about economic activity in China, the world’s biggest exporter, and the strength of global demand. Meanwhile, China’s official nonmanufacturing PMI beat expectations and rose for the third straight month to its highest since September, reflecting the country’s transition to a services- and consumption-led economy from one driven by manufacturing.
The weakness in January’s official PMI could be a harbinger of a growth slowdown engineered by China, which is trying to clamp down on industries that pollute and excessive borrowing. Growth in China is expected to “moderate gradually” in 2018, the International Monetary Fund forecast in its latest world economic outlook. Investment managers project slower growth for the Chinese economy in 2018 as the country reckons with years of rapid credit growth and starts to crack down on shadow lending. Encouragingly, the absence of a forward-looking growth target at last October’s Communist Party congress signals that Beijing is placing less importance on headline GDP growth and focusing more on income growth and other measures.
Portions of the preceding information are reprinted with permission from Broadridge Investor Communication Solutions, Inc. Copyright 2018. Portions of the preceding information are shared from T. Rowe Price Weekly Market Wrap-Up.