As the third quarter earnings season draws to a close, approximately 90 percent of U.S. and European companies have now reported. Overall, earnings were largely in line or exceeded analysts’ estimates for the quarter. Yet, it appears some of the bloom may be coming off the “profits rose” as consensus estimates are no longer being raised for next year. “While they look good overall, the strong momentum apparent since Q1 is now fading” according to European banking behemoth Societe Generale. In other words, corporate earnings are healthy, but analysts are not seeing a catalyst for improvement. Perhaps, successful passage of the tax reform plan will serve as that catalyst.
It was a choppy week for equities in which the streak of consecutive days without a decline of 0.5% or more ended at 50 days (the longest since 1965) on Wednesday when the S&P 500 declined by 0.55%. Global equity markets largely followed the U.S. and Thursday’s rally of 0.8% created two-way daily-volatility that ultimately yielded flattish performance on the week for broad equity indices: S&P 500 (-0.1%) and MSCI All Country World Index (+0.1%). Within fixed income, concerns about high yield debt drove investors to sell the instruments. Yields pushed higher by 0.07% in a continuation of a trend that seen high-yield spreads widen by 0.43% month-to-date. The trend towards a flatter yield curve for US Treasuries also remains intact, as 2-year bond yields rose by 0.07% on the week, while 30-year bond yields declined by 0.1%. A large number of economists and investors watch the shape of the yield curve, as an inverted curve has been associated with the last seven recessions. The good news is that while the yield curve appears to be headed toward inversion, it is still 100 basis points away from being inverted and the trend could reverse at any time.
Precious metals gained on the week (gold +1.4%, silver +2.5%). Finally, OPEC issued a forecast for increased crude oil demand in 2018, which conflicted with the International Energy Agency’s forecast for slightly lower demand levels. Crude prices moved modestly lower on the week, though the decline was more prevalent in the international markets (-1.2% for Brent Crude) than here at home, where WTI Crude fell only 0.3%.
For more detail on weekly, month-to-date and year-to-date asset class performance please click here.
Inflation Shocks – Last week rampant inflation reared its head. Not in the broad Consumer Price Index, the widely-cited inflation metric tallied by the U.S. government’s Bureau of Economic Analysis. Rather, the inflation referenced here was surfaced by Christie’s Auction House and the vanguard in electric automobile development, Tesla. On Wednesday, Christie’s auctioned da Vinci’s 500 year-old “Salvator Mundi” for $400mm. Christie’s earned a $50mm commission, bringing the total transaction value for the portrait of Jesus Christ to $450mm. In 2005, this painting was acquired at an estate sale for $10,000 equating to price appreciation of 4,000,000% in a little more than 10 years. Setting aside the controversy surrounding the authenticity of the painting, the princely sum that was paid is yet another example of excess in the markets complementing historically high valuations in nearly every asset class, from equities to real estate to high-yield debt.
The second bout of inflation last week was promoted by Elon Musk on Thursday when he revealed Tesla’s new 18-wheeler, with a 1,000,000 mile warranty. Compared to today’s long-haul truck warranty plans of 300,000 miles, Tesla just created warranty inflation of 333%. Yet, this inflation is fundamentally different than price inflation. It represents improved efficiency, which leads to increased productivity and higher economic output.
We’ll take all the productivity inflation we can get, but the remarkable price paid for a single painting (which exceeded the total estimated $422mm cost of the new Whitney Museum of American Art in New York City) is yet another signal that asset valuations are pushing to worrisome levels.
Ivy Outlook – In a wide-ranging interview last week, David Swensen (the celebrated Chief Investment Officer for Yale University’s endowment) touched on his team’s outlook and portfolio positioning. Yale’s endowment is known for being an early adopter of “alternative” investments and is typically one of the top performing university endowments.
The endowment is incredibly important to Yale’s operating budget, providing 60-65% of the annual funding for Yale College, the graduate school and the professional schools. For the last 32 years, the assumed rate of return for the Yale Endowment has been 8.25% annually. However, in the interview, Swensen noted that based on the currently elevated level of global asset valuations, Yale’s forward expectations are closer to 5% – a 40% decline in expected returns that, if proven accurate, will directly impact Yale’s operating budget. Swensen’s team is also currently targeting a 32.5% allocation to assets with low correlation to equities, which includes short-term government bonds, cash and absolute return strategies (i.e. hedge funds). This is up from 15% at the lows of the Financial Crisis. Swensen joins a growing list of renowned investors forecasting tougher sledding ahead.
There will not be a Synopsis next week as I plan to take a week off from writing to enjoy the holiday with my family. Be well and Happy Thanksgiving to you and yours.