PMC Weekly Review - January 12, 2018
A Macro View: “Suspicious Minds”—Keeping the Bears at Bay
In honor of Elvis Presley’s birthday this week, we pay homage to the King of Rock and Roll by marrying the idea of money and music in our discussion of the stock market’s continued resilience. If investors are familiar with Elvis to any degree, then they most likely recognize “Suspicious Minds” as one of his top hits. We can draw parallels to the song on some levels as we contemplate the euphoria with which investors have embraced the stock market’s climb. The S&P 500, NASDAQ, and Dow Indices are off to a tremendous start in 2018, up 3.4%, 4.3%, and 3.3%, respectively, in the first eight trading days alone. The Dow surpassed 25,000 last week and is well on its way to 26,000. Additionally, despite a brief pullback on Wednesday, following concerns that the US may pull out of the North American Free Trade Agreement (NAFTA) and that China may cut back on its purchases of US Treasuries, the leading indices re-emerged Thursday unscathed. And they had renewed wind in their sails, as China dispelled rumors, oil inched higher, and earnings season kicked off with a strong start. An exhilarating energy is in the air, and it certainly seems unstoppable.
We can't go on together
With suspicious minds
And we can't build our dreams
On suspicious minds ---Elvis Presley, 1969
On the one hand, the bears caution that the sheer height of the indices alone should merit some pause. Among their peak worries, of course, are inflation and that central banks around the globe could tighten quicker than expected, wreaking havoc on bond prices and, potentially, even the equity markets. Bears are concerned that valuations are already frothy and many companies are overvalued. However, if investors are fearful regarding equities, they aren’t showing it—as evidenced by the CBOE Volatility Index (VIX) continuing to hover around 9.8, near its all-time historical low.
Bonds were ‘all shook up’ on Wednesday, as investors retreated from fixed income over fears of higher yields and falling bond prices. Treasury prices came under pressure, as the market showed sensitivity toward interest rate policy changes by the European Central Bank (ECB) and the Bank of Japan (BOJ), as well as a report that China may scale back its purchase of US government bonds. US bond prices retreated further on Friday in response to a higher-than-expected December Core CPI reading of 0.4%—with the yield on the 10-year US Treasury Note creeping up close to 2.6%—as investors demonstrated concern that inflation could put further pressure on the Federal Reserve’s speed and trajectory of interest rate hikes.
Among other leading indicators this week, Monday’s consumer credit reading from the Federal Reserve revealed the largest monthly increase since 2001, with outstanding consumer credit increasing from $20.6 billion in October to $27.9 billion in November. Retail sales showed continued strength, increasing 0.8% in November, up from an upwardly revised 0.5% increase in October, and rose an additional 4% in December according to the U.S. Department of Commerce. And, the US dollar decreased relative to a basket of major currencies, due to a lower-than-expected reading in December for US Producer prices. Initial jobless claims increased from 250,000 to 261,000. Also noteworthy, Walmart raised its minimum hourly wage this week to $11 per hour, and expanded employee benefits and bonuses.
Looking abroad, the ECB released minutes from its December meeting on Thursday, revealing the possibility of an announcement of a change in direction in its bond purchases as early as January, given strong growth in the region. The euro hit a three-year high on prospects of higher interest rates, and the yield on the German Bund rose, as Germany made progress in its coalition negotiations. Earlier this week, the BOJ announced that it would begin reducing its purchases of Japanese government bonds, sending its currency and bond yields higher on Tuesday. Bloomberg also released a report on Wednesday that suggested the Chinese government would look to cut back on its purchases of US government bonds, but China was quick to rebuff that suspicion as unfounded.
All in all, the preponderance of economic data appears to favor investors’ inclination to stay the course. For now, the US economy is doing well, and both business and consumer confidence are strong. Companies have cash on hand, and they’re spending it, bolstered by the prospective benefits of the new tax reform law. Bloomberg estimates that corporate profits will be up 15% in 2018. So, where are the bears? Well, it appears they’ve exited stage right faster than Elvis could leave the building. So, as the King would say, “Dry the tears from your eyes, let’s don’t let a good thing die.” It’s looking like the stock market will continue to ‘melt up’ long before it melts down.
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