Monday Morning Minute 040317
Stocks (S&P 500) returned 6.3% in the first quarter and long-term U.S. Treasuries (+20 years) returned 1.25%. Cash generated a 0.22% return (T-Bills). Investor sentiment was strong during the quarter and market volatility was below normal.
Our second quarter outlook discusses our take on the economy and markets at this point. We continue to see the economy on a growth path, but fundamental conditions are expected to ease in the months ahead. It is important to recognize that much of the “reflation trade” that began last year is now largely reflected in market prices.
Consider the table below. We see that corporate spreads are already tight, inflation expectations are back above 2%, and commodity prices have rebounded. These factors are helping to support near-term economic growth and fostering higher earnings expectations. S&P 500 earnings for the first quarter and full year are forecast to grow 9%, for example.
|The "Reflation Trade" since June 2016|
|June 2016||March 2017||Comment|
|S&P 500 Earnings Forecast||Measure of anticipated corporate profits||$123||$133||8% increase|
|Term Spread||Measure of compensation for risk of holding longer term bonds||108.5 basis points||161.5 basis points||53 basis point increase|
|10 yr.TIPS Breakeven||Market implied long run inflation expectation||1.6%||2.1%||(1.5-2.5% "normal" range)|
|Baa Corporate Bond Spread||Measure of compensation to investors for assuming default risk||220 basis points||170 basis points||(150-250 basis point "normal" range)|
|Commodity Price Index||Price change on basket of commodities (CRB Index)||264||330||25% Increase|
However, there is less consensus among economists over near-term growth. The Atlanta Fed’s “GDP Now” forecast and Macroeconomic Advisors’ forecast for first quarter GDP are both just below 1%. On the other hand, the Federal Reserve Bank of New York’s GDP “Nowcasting” service pegs growth near 2.6% for the first quarter and 2.9% for the full year. Last week’s second monthly decline in personal consumption expenditures was also a break from the otherwise positive stream of data we’ve enjoyed lately.
With the initial move from the “reflation trade” now in the rear view mirror, and with questions over the pace of growth, we are paying close attention to what comes next.
ECONOMIC RELEASES THIS WEEK
|Monday, Apr 3:||ISM Manufacturing Index||Mar||57.0||57.7|
|PMI Manufacturing Index||Mar||—||53.4|
|Construction Spending M/M||Feb||1.0%||-1.0%|
|Tuesday, Apr 4:||International Trade Balance||Feb||-$46.4B||-$48.5B|
|Domestic Vehicle Sales||Mar||—||13.65M|
|Total Vehicle Sales||Mar||17.43M||17.47M|
|Factory Orders Ex Trans||Feb||—||0.3%|
|Wednesday, Apr 5:||FOMC Meeting Minutes||Mar|
|ADP Employment Report||Mar||180K||298K|
|ISM Non-Mfg Index||Mar||56.5||57.6|
|Thursday, Apr 6:||Weekly Jobless Claims||Apr 1||—||258K|
|Friday, Apr 7:||Change in Nonfarm Payrolls||Mar||172K||235K|
|Average Hourly Earnings M/M||Mar||0.3%||0.2%|
|Average Hourly Earnings Y/Y||Mar||2.6%||2.8%|
|Average Weekly Hours||Mar||34.3||34.4|
|Labor Force Participation Rate||Mar||—||63.0%|
ASSET ALLOCATION PORTFOLIO POSTURE
Based on shorter-term expectations, the “tactical” allocation within portfolios is underweight bonds / overweight stocks.
Kevin Caron, CFA, Portfolio Manager
Chad Morganlander, Portfolio Manager
Matthew Battipaglia, Analyst
Suzanne Ashley, Junior Analyst
WCA Fundamental Conditions Barometer Description: We regularly assess changes in fundamental conditions to help guide near-term asset allocation decisions. The analysis incorporates approximately 30 forward-looking indicators in categories ranging from Credit and Capital Markets to U.S. Economic Conditions and Foreign Conditions. From each category of data, we create three diffusion-style sub-indices that measure the trends in the underlying data. Sustained improvement that is spread across a wide variety of observations will produce index readings above 50 (potentially favoring stocks), while readings below 50 would indicate potential deterioration (potentially favoring bonds). The WCA Fundamental Conditions Index combines the three underlying categories into a single summary measure. This measure can be thought of as a “barometer” for changes in fundamental conditions.
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