Following a tumultuous seven days to kick-off the month of February, financial markets regained their footing in the second full week of trading and posted substantial gains. Domestic equities rose 4% or better, and the tech-heavy Nasdaq gained more than 5%. International developed markets appreciated by 3.4% (as measured by the EAFE Index) while Emerging Markets held the upper hand rising 5.3%. Fundamental corporate earnings look solid, with a nod to tax reform impacts, 2018 earnings estimates for the S&P 500 have been revised higher by 7%. While a portion of the tax savings is destined for capital expenditures, a decent chunk will also go to stock buybacks and dividends. Indeed, CNBC reported that corporate buybacks are now at a year-to-date record of $170.8 billion. Stock buybacks provide a tailwind to the equity markets as it reduces the number of shares outstanding (i.e., “float”), improving earnings per share. In the land of fixed income investing, yields at the front end of the curve moved higher, while the yield on the long bond (the 30-year treasury) fell modestly by 0.03%. Commodities, in general, enjoyed upward pricing pressure as gold rose 2.3%, silver 1.7%, copper 7.1% and WTI Crude 4.2% (to $61.68 per barrel).
Even as the initial bout of market volatility settled some last week, it is unlikely to be clear sailing from here. Events like those that took place the week of February 5th are rarely isolated. Another 100%+ rise in the VIX Index may not be in the cards, but the days of the VIX Index languishing around 10 (as it did for much of 2017) are most likely behind us. In other words, last week’s events were the first step into a new paradigm of elevated volatility.
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Economic Data Takeaways: Within the raft of economic data released last week, the key takeaways were higher inflation and lower consumption. The Consumer Price Index (CPI) rose 0.5% in January, which was 0.2% ahead of expectations. However, that was the same rate of growth in January of 2017, so the year-over-year growth rate in the CPI remained at 2.1%. Similarly, Core CPI (excluding energy and food prices) rose 0.3% in January but was unchanged at 1.8% year-over-year.
Source: Bureau of Labor Statistics and FTN Financial
The Producer Price Index also came in higher than expected with the headline index rising 0.4% and Core PPI increasing 0.4% (vs. 0.2% estimate). Much of this rise was likely due to a weaker dollar, which tends to push commodity prices higher. Regardless, the inflation data should keep the Fed on track to raise rates at least three times this year – any strengthening of the inflation data could push the Fed to raise rates 4x – a pace of rate hiking that is not currently priced into the market.
The retail sales report was just plain ugly. Not only did retail sales fall 0.3% in January (vs. the +0.2% consensus estimate), but the report for December was revised downward from +0.4% growth to unchanged at 0.0%. It’s too early to tell yet if this marks a trend toward lower consumption, but this is one of the risks to higher 2018 GDP growth we cited in our Q1 Economic Review and Outlook. For the last two years consumers, in aggregate, have spent more than they earned. Over this period consumption has been financed through increased borrowing and reduced savings. Consumer debt as a percentage of personal disposable income is at an all-time high and savings reached a new cycle low of 2.4% in December 2017 (vs. a long-term average of close to 7%). February is the first month in which the new tax reform deductions will be reflected in labor force paychecks. Lower tax rates will increase take-home pay for the majority of U.S. workers, so it will be interesting to see if February’s retail sales data improves as a result.