Covenant Weekly Market Synopsis for March 9, 2018

March 12, 2018

A combination of reduced geopolitical tensions and economic data that was neither too cold nor too hot created a healthy environment for global risk assets. Domestic equities were the largest beneficiaries, as the S&P 500 rose 3.6% and is now only 3% below its January record level. The technology-laden Nasdaq Index rose 4.2% and hit a new high on Friday. Developed international markets (as represented by the MSCI EAFE Index) gained 1.7% while emerging and frontier market equity indices gained a little more than 1% each. As the appetite for risk increased through the week, bonds sold off, with yields on 2-, 10- and 30-year US Treasuries rising 0.02% – 0.03%. The yield on the 2-year bond ended Friday at 2.26%, while a bond that matures 28 years later offers less than 1% more in annual yield as the 30-year bond yields a scant 3.16%. Precious metals barely budged on the week, and WTI Crude gained 1.3% to $62.04 per barrel.

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

Some weeks are uneventful and others…. well, others are like last week when there were a number of market-moving events. Here is a chronological summary of last week’s significant developments.

Outta’ Here: Gary Cohn resigned as President Trump’s chief economic advisor. It’s worth noting that Cohn was making more than $20,000,000 per year at Goldman, and, reportedly, received a severance package worth $285,000,000 when he left to join the administration for a $30,000 annual salary. Perhaps the conversation between President Trump and Mr. Cohn went something like this:

  • Cohn: So you’re really going to impose steel and aluminum tariffs, Mr. President?
  • President: Yes, I am Gary. I made a campaign promise to protect our manufacturers, and I intend to stick to it…believe me.
  • Cohn: You know I’m an advocate for free markets, and these tariffs are counter to everything I believe about governments staying out of the way and allowing markets to function efficiently. With all due respect, if you go through with these tariffs Mr. President, I’m outta’ here.
  • President: Well, Gary, don’t let the door hit you on the way out. By the way, even though you’re a globalist, I still like you. And I have a feeling you’ll be back.

Market Reaction: The announcement was made after the market closed on Tuesday, but S&P 500 futures fell 42 points in about 15 minutes. Shares of Goldman Sachs declined the following day by 0.6% as, apparently, investors were worried that Cohn’s departure damaged Goldman Sachs’ long-rumored influence on government policies.

Inflation? Yes please: Last week’s synopsis highlighted the change underway at the Fed with regards to inflation as one of several regime shifts reverberating through the financial markets currently.

  • In a policy speech on Tuesday evening, Fed Governor Lael Brainard clarified Fed Chair Jerome Powell’s congressional testimony from the prior week.
  • In sum, Brainard suggested that changing the Fed’s planned gradual pace of rate hikes even as economic headwinds have swung around to become tailwinds remains prudent. The Fed’s current view is that stronger economic growth will push the inflation path closer to their target 2% inflation rate, which has thus far remained elusive.
  • Brainard also made it clear that the inflation target is symmetric, meaning that the Fed will tolerate inflation in excess of 2% since it has remained below 2% for so long. Brainard’s comments are another public indication of the Fed’s shift from inflation-targeting to price-level targeting.
  • The Fed is willing to tolerate higher inflation because they are hoping to reverse the trend of declining long-term inflation expectations. Lower long-term inflation expectations keep real interest rates low and, effectively, handcuffs the Fed’s ability to counteract slower growth in recessions using only traditional monetary policy measures (i.e., cutting interest rates as opposed to engaging in another round of QE).

Market Reaction: This one’s tough to discern. Although it was an important speech regarding future monetary policy, it’s difficult to determine if investors picked-up on it immediately.

Tinder: Kim Jong-un “swiped right” and extended an invitation to President Trump to meet and discuss North Korea’s nuclear weapons program. There is some speculation that China had a hand in getting Jong-un to come to the table, but it was South Korean President Moon Jae-In who made the announcement. Relations between the two Koreas have warmed of late, including their joint participation in the recent Olympic games in South Korea. The timing, location, and specific details have yet to be worked out, and there will no doubt be controversy ahead of this meeting. But, agreeing to direct talks is a significant shift from a couple of months ago when the two leaders were comparing the size of their nuclear buttons and trading insults (President Trump nicknamed Jong-un “Rocket Man” and Jong-un responded by calling Trump a “mentally deranged U.S. dotard”).

Market Reaction: The KOSPI Index (South Korea’s main stock index) jumped 1.1% on the potential for reduced tensions between North Korea and the U.S. The invitation to speak about denuclearization also helped boost the global risk-taking appetite on Friday (even before the release of the February employment report, described below).

Goldilocks: The February employment report delivered precisely what bullish investors wanted.

  • Nonfarm payrolls rose by 313,000 (vs. expectations of 200,000 new jobs). It was the strongest payroll report since July 2016, when 325,000 new jobs were added.
  • Yet, the strong job growth did not engender wage inflation, as many feared. Average hourly wages rose just 0.1%, reducing the year-on-year rate of wage inflation from 2.9% to 2.6%.
  • The unemployment rate remained at 4.1%, for the fifth consecutive month.
  • The labor participation rate increased from 62.7% in January to 63.0% in February, counteracting the strong job growth to keep wage inflation low and the unemployment rate stable. According to the household employment survey, the labor force expanded by 806,000 and employment rose by 785,000. In other words, the surge in new hires drew in an almost equal number of people who were previously not considered part of the labor force.

Market Reaction: The employment report smashed concerns about the departure of Garry Cohn, potential trade wars and a misperception of a more hawkish Fed. Equity markets rallied, with the S&P 500 rising 1.74% to close out a strong week. If ever there was a “Goldilocks” employment report, this was it.

Be well,

Jp.