The Economy
Real gross domestic product (GDP) increased at an annual rate of 2.6% in the fourth quarter of 2017, according to the “advance” estimate released by BEA. In the third quarter, real GDP increased 3.2%. Real GDP increased 2.3% in 2017 compared with an increase of 1.5% in 2016 and 2.9% in 2015.
Consumer spending accelerated to a 3.8% annual rate of growth, the fastest in almost two years. Businesses also increased spending on equipment by 11.4%. However, companies slowed production in the fourth quarter and the value on unsold goods or inventories fell by 29.3 million. The one clear negative was a bigger trade deficit. Imports rose 13.9% to easily outpace a 6.9% increase in exports. The reduced inventories and the trade gap shaved 1.8 percentage points off fourth quarter GDP. The annual rate of inflation, measured by the PCE index, rose to 2.8% in the fourth quarter, the highest pace since 2011-yet inflation year over year was under 2% and less worrisome.
Total nonfarm payroll employment increased by 200,000 in January 2018 and the unemployment rate for January was 4.1% for the fourth consecutive month. Among the major work groups, the unemployment rate for Blacks increased to 7.7% in January while the rate for Whites dropped to 3.5%. Employment continued to trend up in construction, food and drinking places, health care, and manufacturing. A broader measure of unemployment that includes discourages workers and those holding part-time jobs for economic reasons edged higher to 8.2%, the highest level since September. In addition to the solid payroll growth, average hourly earnings were up 0.3 percent for the month, matching estimates and reflecting an annualized gain of 2.9 percent. That was the best since mid-2009 as the two-year economic slump was coming to a close. While job gains have been solid and consistent, salary growth has been elusive. This report, specifically the gain in wages, could change the narrative and might push the Fed to get more aggressive with interest rate hikes.
Existing home sales fell 3.6% in December after surging for the prior three months. For the full year of 2017, existing home sales edged up 1.1% to a 5.51 million sales pace, making it the best year for sales since 2006. Lawrence Yun, chief economist for the National Association of Realtors states, “Existing sales concluded the year on a softer note, but they were guided higher these last 12 months by a multi-year streak of exceptional job growth, which ignited buyer demand. At the same time, market conditions were far from perfect. New listings struggled to keep up with what was sold very quickly, and buying became less affordable in a large swath of the country. These two factors ultimately muted what should have been a stronger sales pace.” The median existing-home price for all housing types in December 2017 was $246,800, up from 5.7% in December 2016 and the 70th straight month of year-over-year gains.
More interesting is the total housing inventory which dropped 11.4% in December and is now 10.3% lower than a year ago. It has fallen year-over-year for 31 consecutive months. Unsold inventory is at a 3.2 monthly supply, which is down from a 3.6 month supply a year ago and is at the lowest level since the NAR began tracking the data in 1999. Properties typically stayed on the market for 40 days in December, which is unchanged from November and down from a year ago (52 days). 44% of homes sold in December were on the market for less than a month. The lack of supply appears to have helped push the price of homes to a doubling the pace of income growth despite strong job creation pushing wages higher.
According to Freddie Mac, the average 30-year mortgage rate for December 2017 was 3.95%, which was below the 2017 average rate of 3.99%. The 30-year mortgage rate dropped in 2017 from a high of 4.20% in December of 2016 to a low of 3.81 in September 2017. Since the low average rate in September, the 30-year rate has risen through the rest of 2017 and into 2018, up to a rate of 4.22% for the week ending February 1.
According to The Conference Board, the Consumer Confidence Index® increased in January, following a decline in December. The Index now stands at 125.4, up from 123.1 in December. In addition, Lynn Franco, Director of Economic Indicators at The Conference Board, said, “Consumer confidence improved in January after declining in December. Consumers’ assessment of current conditions decreased slightly, but remains at historically strong levels. Expectations improved, though consumers were somewhat ambivalent about their income prospects over the coming months, perhaps the result of some uncertainty regarding the impact of the tax plan. Overall, however, consumers remain quite confident that the solid pace of growth seen in late 2017 will continue into 2018.”
In December 2017, as anticipated, the Federal Reserve (FED) chose to raise the Fed Funds rate target by 25 basis points to a range of 1.25 to 1.50%. Commenting on the decision, the FED noted, “The labor market has continued to strengthen and that economic activity has been rising at a solid rate. Averaging through hurricane-related fluctuations, job gains have been solid, and the unemployment rate declined further. Household spending has been expanding at a moderate rate, and growth in business fixed investment has picked up in recent quarters. On a 12-month basis, both overall inflation and inflation for items other than food and energy have declined this year and are running below 2 percent. Market-based measures of inflation compensation remain low; survey-based measures of longer-term inflation expectations are little changed, on balance.” It is expected that the FED will continue to raise rates in 2018. However, the big question is how many times and by how much.
The Stock Market
The broader equity markets repeated the first, second and third quarter rallies and again ended up for the fourth quarter of 2017. For the quarter, the S&P 500 underperformed the Dow with gains of 6.1% and 10.3%, respectively. For all of 2017, the S&P 500 was up 19.4% while the Dow was up a greater 251%. The NASDAQ Composite however showed the smallest gains with fourth quarter increase of 6.3%, and an out-performing full year increase of 28.2%. Of the 10 sectors represented in the S&P, 9 sectors saw positive performance for the quarter, as measured by the SPDR sector ETFs. The best performing sector was, Consumer Discretionary (9.81%) followed by Financials (8.57%), Technology (8.45%), and Industrials (7.02%). Other gainers for the quarter were Materials (6.97%), Consumer Staples (6.10%), Real Estate (3.2%), and Energy (6.04%). While all sector saw positive returns, performance for the Health Care and Utilities sectors were mediocre with returns of 1.42% and 0.22%, respectively. For the year, all sectors but one experienced positive performance. Only the Energy sector saw negative performance with a return of -1.06%. Of the 10 sectors in the S&P, 6 sectors exceeded 20% returns, with the Tech sector experiencing a stellar performance of 34.28% for 2017. The 3 sectors with-good but lower than market-performance were the Consumer Staples, Financials and Utilities sectors with returns of 12.92%, 10.7%, and 12.02%, respectively.
In Fixed Income, for the first nine months of 2017, the 10-year note fell slightly to end the third quarter at 2.33%. However, the 10-year note then rallied through the fourth quarter to end the year at 2.40%. Through the fourth quarter, the long end of the yield curve continued to flatten as the 30-year bond also decreased (13 bps), ending the quarter at 2.74%. In 2018, 10-year Treasury bond yields have been rising sharply-as they have been since late last year-because of strong economic data, signs of higher inflation, and concerns about the Fed tightening policies. The 10-year bond has risen from 2.40% at the end of 2017 to 2.91% in mid- February. We expect the Fed will continue to raise short-term interest rates as inflation pressures are building. The Fed is also tightening policy by shrinking its balance sheet, which means the market will need to absorb about $400 billion more in Treasury bond supply this year than in 2017. Thus, yields will likely need to rise to attract buyers to the market. That said, when stocks selloff sharply, Treasury bonds tend to rally because they serve as safe haven investments in times of heightened volatility.
Inflation pressures continued to increase through the first nine months of 2017 but moderated in early September. Gold rallied to $137.4 per ounce from July 7th to September 8th when the price spiked at $1346 per ounce. However, gold prices then fell dramatically into the fourth quarter, bottoming in mid-December at $1248.5 per ounce. From there, gold rallied to $1362.11 in late January2018 not seen since mid-2013. After peaking in mid-2014 at about $107.94 per bbl, the oil markets slid until early 2016 to meet the long-term bottom of $29.32 per bbl. Oil markets then rallied through the remainder of 2016 and then accelerated in price in the second half of 2017, to end the year at about $60.46 per bbl. After peaking in early 2017, the WSJ Dollar Index declined through the first nine months of 2017, bottoming in September at about 84.49. The index rallied into November, but then retreated to end the year at about 85.98.
Conclusion
The markets took off in January 2018 with the Dow, S&P 500 and NASDAQ increasing by 7.67%, 7.45%, and 8.7% through January 26. From there, the market became more volatile with 1000 point swings, and in 2 weeks had erased all its January gain with the DOW, S&P 500 and NASDAQ falling by 10.4%, 10.2%, and 9.7%, respectively. The drop appears to have several catalysts which include:
- Rising inflations expectations, particularly from accelerating wage growth.
- The recent release from the Dept. of Labor showed average hourly earnings rose 2.9% on a year-over-year basis, the highest since June 2009.
- Rising interest rates (the 10-year Treasury yield rose above 2.8%).
- The Treasury Department announcement that it expects to borrow $955 billion this fiscal year, which is the highest borrowing in the last 6 years and a jump from the $519 billion the federal government borrowed last year.
- Growing market consensus that the Federal Reserve may raise short-term interest rates more than expected over the next 2 years. Also, the U.S. has a new Fed Chairman, Jerome Powell, who took over for Janet Yellen in early February. The market has a track record of “testing” new Fed chairmen which also may have accounted for some of the volatility in early February.
- Growing worries about fiscal/government spending and potential increases in the deficit from the tax cut and the recent budget package.
- Computer based program trading with time horizons in nanoseconds, which helped to add to the volatility of this market correction.
After this correction in early February, the market seems to have recovered all losses for 2018. We believe that the underlying fundamentals have not changed enough to warrant the end of the bull market. However, we believe that going forward, we will continue to see increased volatility in the market. Periods of market volatility are a normal part of long-term investing. However they can also be a wake-up call to make sure your portfolio is adequately diversified and that your risk tolerance is at an appropriate level for your portfolio. Market changes are a good time to rebalance your portfolio: i.e. selling some positions that have become overweight in relation to the rest of the portfolio and possibly increasing exposure in areas that experienced pullbacks, but still have sound market fundamentals and robust economic activity.
Disclaimer:
While this article may concern an area of investing or investment strategy in which we supply advice to clients, this document is not intended to constitute a complete description of our investment services and is for informational purposes only. It is in no way a solicitation or an offer to sell securities or investment advisory services. Any statements regarding market or other financial information is obtained from sources which we and/or our suppliers believe to be reliable, but we do not warrant or guarantee the timeliness or accuracy of this information.
Past performance should not be taken as an indicator or guarantee of future performance, and no representation or warranty, express or implied, is made regarding future performance. As with any investment strategy or portion thereof, there is potential for profit as well as the possibility of loss. The price, value of and income from investments mentioned in this report (if any) can fall as well as rise. To the extent that any financial projections are contained herein, such projections are dependent on the occurrence of future events, which cannot be predicted or assumed; therefore, the actual results achieved during the projection period, if applicable, may vary materially from the projections.
Sources for reference only:
https://www.nar.realtor/newsroom/existing-home-sales-fade-in-december-2017-sales-up-11-percent
http://www.sectorspdr.com/sectorspdr/sectors/performance/quarter
https://www.bls.gov/news.release/empsit.nr0.htm
http://www.bea.gov/newsreleases/national/gdp/gdpnewsrelease.htm
https://www.bls.gov/news.release/pdf/empsit.pdf
https://www.conference-board.org/data/consumerconfidence.cfm
https://www.federalreserve.gov/newsevents/pressreleases/monetary20171213a.htm
http://www.freddiemac.com/pmms/pmms30.htm
https://www.marketwatch.com/story/the-fourth-quarter-continued-2017s-streak-of-broad-based-stock-strength-2017-12-29
https://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=yieldYear&year=2017
https://www.bloomberg.com/quote/XAUUSD:CUR
http://performance.morningstar.com/Performance/index-c/performance-return.action?t=XIUSA000MC