Technically both the S&P 500 and Dow have “corrected” as the indices are more than 10% off their late January highs. The three major domestic equity indices all declined more than 5% last week. The sell-off was prompted by investment managers reassessing inflation expectations and exacerbated by the trading of volatility (i.e. trading of the VIX).
While action in the equity markets typically garner the lion’s share of media exposure the real story lies within the fixed income markets. The benchmark 10-year Treasury yield was up again last week rising slightly, closing at 2.86%. It has risen nearly .5% since the beginning of the year. As noted above, the rise is driven by the perceived reappearance of inflation. We would argue that this is not a bad thing nor is the acceleration in global and domestic economic growth, corporate profits, and the move towards global normality in central bank monetary policy. In other words, the reassessment of interest rates and their rise, though painful, is happening for all the right reasons. Consequently, we continue to believe this is a healthy pullback that is overdue. We believe market fundamentals continue to improve and the equity markets will move higher. In the bond markets rising yields imply falling bond valuations and returns will be challenged. That said, the dominant reason for bond allocations in portfolios is risk reduction not return enhancement.
What wasn’t highlighted last week was the strength in corporate earnings. Q4 earnings season is now 2/3 complete. Both earnings and revenues have come in above historic norms. Earnings growth for S&P 500 companies is running around 14% (very high) and the expectation is earnings growth in 2018 of 15%+. Further, with the market pullback the current forward P/E multiple is now around 16X, slightly high within a historical context but much more reasonable than the recent 18X-19X.
The release next week of gauges on producer and consumer prices may weigh heavily on activity in the domestic capital markets.
The economic calendar next week includes Wednesday’s release of the Consumer Price Index and Retail Sales for January. Thursday the Producer Price Index is reported with January’s numbers. Friday the University of Michigan releases consumer sentiment numbers.
Next week continues a heavy reporting calendar for corporate earnings:
Monday – CNA Financial, First Data, FMC, and Lowes
Tuesday – Occidental Petroleum, PepsiCo, Under Armour, and TransUnion
Wednesday – Agilent, Applied Materials, and Cisco Systems
Thursday – CBS, Spotify, Waste Management, Incyte, and Zoetis
Friday – Campbell Soup, Coca-Cola, Deere, Newell Brands, and VF
Indices for the week and YTD are as follows:
S & P 500 down 5.16% for the week; YTD index return is -2.02%
NASDAQ Composite down 5.06% for the week; YTD index return is -.42%
Dow Jones Industrial Average down 5.21% for the week; YTD index return is -2.14%
Benchmark 10-year Treasury bond yield stands at 2.86% - advancing 2 basis points on the week