/perspectives/weekly-viewpoint/bottoms-tend-to-be-more-of-process-than-a-pivot

Bottoms Tend to Be More of Process Than a Pivot

The major market indices finished the holiday shortened week modestly higher as a late-week rally outpaced earlier losses.

February 26, 2018    |    By Mike Schwager

Performance for Week Ending 2/23/18:

The Dow Jones Industrial Average (Dow) added 0.36%, the Wilshire 5000 Total Market IndexSM (Wilshire 5000SM) gained 0.24%, the Standard & Poor’s 500 Index (S&P 500) rose 0.55% and the Nasdaq Composite Index (NASDAQ) tacked on 1.35%. Sector performance was mixed with 7 of the S&P sector groups finishing higher while 4 finished lower. The Technology sector (+1.90%) was the best performer while Telecom (-2.41%) was the laggard.

Index* Closing Price 2/23/2018 Percentage Change for Week Ending 2/23/2018 Year-to-Date Percentage Change Through 2/23/2018
Dow 25309.99 +0.36% +2.39%
Wilshire 5000 28411.20 +0.24% +2.20%
S&P 500 2747.30 +0.55% +2.76%
NASDAQ 7337.39 +1.35% +6.29%

*See below for Index Definitions

MARKET OBSERVATIONS: 2/19/2018 – 2/23/2018

The major market indices finished the holiday shortened week modestly higher as a late-week rally outpaced earlier losses. Stocks started the week on a negative note reflecting worries over the backup in bond yields and concerns that the Fed may embark on a more aggressive rate hike campaign due to the strengthening economy and signs of firming price pressures. Trepidation over rates faded and investors used the weakness as a buying opportunity.

FOMC Meeting Minutes: The focal point of last week was the release of the January FOMC meeting minutes on Wednesday. Stocks initially rallied as the minutes were viewed as less ‘hawkish’ than expected. However, gains proved short-lived and the markets finished the day down sharply. While the minutes did acknowledge "substantial underlying economic momentum," officials also maintained that the path forward will be “gradual.”

With that said, the FOMC minutes hinted that members are clearly focused on the potential for upside risk and left the door open to alter the rate hike path by stating that the path for the fed funds rate would depend on the economic outlook as informed by the incoming data. What seemed to worry investors is that the meeting occurred before the payroll report that showed wages growing at a 2.9% year-over-year pace, the highest rate since early-2009. In addition, the minutes pre-date the recent congressional agreement to boost both military and non-military discretionary spending, which means the overall mix of fiscal stimulus will be significantly bigger over the next 18 months than was assumed at the January FOMC meeting.

The potential for an uptick in the economic momentum has led to many economists and strategists (including Guggenheim) thinking the Fed will need to move rates four times this year, to temper the pace of growth. If economic data over the coming months remains strong, the Fed may have to adjust its so-called “dot plot” by the June meeting.

The unease over aggressive Fed policy faded a bit during the latter half of the week as the Fed “telegraphing machine” went into overdrive following the negative market reaction to the meeting minutes. St. Louis Fed Reserve President James Bullard cautioned that investors may be "getting ahead of themselves" in anticipating four rate hikes from the central bank this year. Bullard added that "one hundred basis points in 2018 seems a lot to me." Fed Governor Randal Quarles, speaking in Tokyo, said "the U.S. economy appears to be performing very well and, certainly, is in the best shape that it has been in since the crisis and, by many metrics, since well before the crisis." He added "with a strong labor market and likely only temporary softness in inflation, I view it as appropriate that monetary policy should continue to be ‘gradually’ normalized." Lastly, Dallas Fed President Robert Kaplan reiterated his call for three hikes this year, although he did add that higher inflation could affect his outlook.

Market bottoms tend to be more of a process than a pivot. While the market has recovered about half its losses since the low reached on February 8, the violent pace of the correction has damaged investor psyche and therefore, the markets may need to bounce around a bit, within a narrow range, before confidence is restored.

We also have to remember that higher rates tend to be a byproduct of a better growth outlook and by historical standards equity markets, more often than not, have done well in a rising rate environment – at least to a point. Historically the equity markets don’t hit a significant headwind until the yield on the 10-year Treasury moves into the 5%-plus range. However, because the starting point this time was so low, headwinds are likely to become evident at a lower rate.

Some Early Headwinds? The recent uptick in interest rates may already be acting as a headwind to the housing sector. Last week the Mortgage Bankers Association reported that mortgage applications plunged for a second straight week as the 30-year fixed rate mortgage rose to 4.64%, the highest level since January 2014. In addition, the National Association of Realtors (NAR) also reported that existing home sales (which account for 90% of housing market sales) in January, unexpectedly fell by 3.2% to an annualized pace of 5.38 million units.

While limited levels of inventory and higher home prices are also at work, the rise in borrowing costs also appears to be keeping would be buyers on the sidelines. Underscoring the affordability issue, the NAR pointed out that housing prices have risen by 41% over the past 5 years while wages have only risen by 12% during the same period.

Q4 Earnings Summary: Through Friday, 453 members of the S&P 500 have reported results with just under 80% surprising to the upside, solidly above the 5-year average of 69%. The biggest ‘beats’ are coming from the Materials and Consumer Discretionary sectors. Aggregate earnings growth is tracking at nearly a 15% rate while overall sales are up 7.7%. At the current pace, it will mark the third time in the past four quarters that the index has reported 10%-plus earnings growth.

Market View: Despite the recent “potholes” the road ahead still looks bright. While 2018 is still expected to deliver another year of positive returns, they are not likely to be as robust as what we saw last year. The macro environment remains supportive of equities based on; synchronized global growth, robust earnings growth and expectations the Fed will maintain its gradual approach to hike interest rates.

While the recent correction has provided a “reality check” to the ever-bullish crowd and additional selling pressure cannot be ruled out, assuming that macro fundamentals remain stable, market weakness would be viewed as an opportunity to add equity exposure to portfolios, especially for investors with a longer time horizon.

The Week Ahead: The focal point of the coming week will be the two-day testimony from Fed Chair Jerome Powell. The central bank head will give an update on monetary policy and the state of the US economy on Tuesday to the House Financial Services Committee followed by a repeat performance on Thursday to the Senate Finance Committee. Investors are expected to parse every word of Powell’s testimony in search of clues on the future path of rates. The earnings calendar continues to wind down with just 30 members of the S&P 500 scheduled to release results. On the data front, economic reports of interest include; January new home sales, January durable goods orders, the December S&P Corelogic Case-Shiller home price index, the Conference Board’s February consumer confidence survey, the first revision to fourth-quarter GDP, January pending home sales, January personal income and spending, the ISM’s February manufacturing index, January construction spending, and the University of Michigan’s February consumer sentiment survey. In addition to Fed Chair Powell’s testimony, St. Louis Fed president James Bullard and Fed Governor Randal Quarles are also scheduled to speak.

Definitions

The Dow Jones Industrial Average is a price-weighted average of 30 blue-chip stocks that are generally defined as the leaders in their industry. It has been a widely followed indicator of the stock market since October 1, 1928.

Wilshire 5000 Total Market IndexSM represents the broadest index for the U.S. equity market, measuring the performance of all U.S. equity securities with readily available price data. The index is comprised of virtually every stock that: the firm’s headquarters are based in the U.S.; the stock is actively traded on a U.S. exchange; the stock has widely available pricing information (this disqualifies bulletin board or over-the-counter stocks). The index is market cap weighted, meaning that the firms with the highest market value account for a larger portion of the index.

Standard and Poor's 500© Index is a capitalization-weighted index of 500 stocks. The index is designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.

The NASDAQ Composite Index is a broad-based capitalization-weighted index of stocks in all three NASDAQ tiers: Global Select, Global Market and Capital Market. The index was developed with a base level of 100 as of February 5, 1971.

Indices do not include any expenses, fees, or sales charges, which would lower performance. Indices are unmanaged and should not be considered an investment. It is not possible to invest directly in an index.

The individual companies mentioned in this piece were for informational purposes only and should not be viewed as recommendations.

The comments should not be construed as a recommendation of individual holdings or market sectors, but as an illustration of broader themes. This document contains forward-looking statements about various economic trends and strategies. You are cautioned that such forward-looking statements are subject to significant business, economic and competitive uncertainties and actual results could be materially different. There are no guarantees associated with any forecast and the opinions stated here are subject to change at any time and are the opinion of the individual strategist. Information in this report does not pertain to any investment product and is not a solicitation for any product. This material has been prepared using sources of information generally believed to be reliable. No representation can be made as to its accuracy.


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