Covenant Weekly Market Synopsis for April 27, 2018

April 30, 2018

In a week where the 10-year bond yield breaching 3% made countless headlines, yields on bonds maturing in 10 years or more actually declined on a week-over-week basis.  The decline was modest, but it appears there is demand for longer-dated bonds with a 3% yield (vs. a dividend yield of less than 2% for the S&P 500). Equities began the week on their back foot but largely recovered in the latter half of the week. The S&P 500 ended the week virtually unchanged, while small-cap and technology stocks recorded modest declines of 0.5% or less. Internationally, Japan’s Nikkei Index led the way, continuing a strong run of performance gaining 1.7% on the week and 4.7% month-to-date. European stocks are also having a good run with a gain of 0.8% on the week, pushing the BE500 Index to a monthly increase of 4.2%. Despite the disparate monthly geographic performances, most regional indices are close to flat for the year (inclusive of dividends), while China’s main stock index stands out with a -6.8% performance year-to-date.i

The Federal Open Market Committee meets this week on Tuesday and Wednesday, for the third of eight scheduled meetings this year. There will be no press conference following the meeting, and hence expectations of a rate hike are low. The Fed has fallen into a pattern in which rate changes are limited to meetings involving a press conference, and the next one of those meetings is June 12 – 13th. Although it is unlikely, if the Fed raises rates this week, it will catch the market offsides, and the reaction will be adverse for both fixed income and equity investments.

For more detail on weekly, month-to-date and year-to-date asset class performance, please click here.

Q1 GDP – Although below the 3% annualized rate of the last three quarters, Q1 2018 GDP growth was solid. Against a consensus forecast of 2.0%, the first estimate of Q1 real, annualized growth was 2.3%. Key takeaways from the report include:

Consumption: Comprising approximately 70% of the domestic economy, consumption’s importance in economic growth is self-evident. On a quarter-over-quarter basis consumption in the first quarter declined from 4% to 1.1%, which initiated heartburn amongst some casual observers. However, the growth rate in Q1 was made to look weak only by the comparison to above-trend growth in Q4. Consumption in Q4 was juiced by reconstruction and replacement spending (estimated at $50 billion) as consumers recovered from the three hurricanes in August and September, setting a high bar for the quarter-over-quarter comparison. As the chart below shows, Q4 consumption growth was well above trend, and the slower growth in Q1 is a return to the longer-term trend.

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Source: Bureau of Economic Analysis and FTN Financial

Inflation: The quarterly core Personal Consumption Expenditures (PCE) rose at an annualized rate of 2.5%, the highest level since 2011. Importantly, the Employment Cost Index (ECI), a measure of wages, rose 0.8% (vs. the consensus estimate of 0.7%) as companies are finally willing to offer more to attract workers in a tight labor market. Homing in specifically on “wages and salaries,” this component of the ECI rose 1.0%, which is the fastest pace since 2003.

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The effects of higher wages and lower taxes are starting to show up in paychecks. The following chart includes aggregate payroll direct deposit data from Bank of America customer accounts. The sharp spike on the far right of the graph represents year-over-year after-tax wage increases of 5.2% in March and 7.5% in April.

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Sources: Bank of America and The Wall Street Journal

With consumer confidence elevated, wages moving higher and the positive effects of tax reform beginning to filter into paychecks, consumption is set to bounce higher in Q2 and GDP growth along with it.

Be well,

Justin