I’m confused. We’re enjoying a highly unusual financial “cocktail” these days that combines one part low inflation, one part low unemployment, one part strong earnings and one part low interest rates. We should be happier – share prices should be moving up – but they’re not. Do you share my concerns?
First quarter real GDP growth came in at a respectable 2.3%, easing slightly from the robust growth experienced throughout 2017. Markets have experienced heightened volatility so far in 2018 compared to 2017. Geopolitical headlines continue to play a significant role in perceived risk, with particular focus on tariff negotiations with China and tensions in Syria. Coupled with uncertainty over the role of Iran in the international community, oil prices rose 7% over the month. As a result, commodities were the top performing asset class (up 2.2% YTD and 2.6% in April). The oil price rallied. The International Energy Agency announced that the excess oil inventories that had kept prices low have now disappeared thanks to the production cuts put in place by the Organization of the Petroleum Exporting Countries (OPEC) and the strength of global oil demand. According to consensus estimates the oil price could rise further, also boosted by the prospect of sanctions on Iran.
Despite market volatility, economic readings continue to support a healthy expansion (According to Bloomberg, 180 companies in the S&P 500 Index that have reported first-quarter earnings have seen their effective tax rate drop by an average of 6%). The consumer remains confident with the US consumer confidence reading exceeding analysts expectations in April, rebounding from a slight decline in March. The Department of Labor’s initial jobless claims report came in at 209,000, marking the longest sub-300,000 recording since 1967. Meanwhile, the unemployment rate held steady at 4.1% for the sixth consecutive month. The manufacturing side of the economy continues to perform well.
The S&P 500® Index followed two consecutive months of losses with a slim gain of 0.22% in April. While most of the 11 sectors of the S&P 500 had modest gains or losses, the Energy sector enjoyed one of its largest monthly gains in years. Energy was up 9.36% in April, as oil prices continued to stage a strong recovery. Investor fervor for “growth” stocks appears intact, as the technology-laden NASDAQ Index remains by far the best performing domestic index year-to-date. Investors also appear to be favoring companies less exposed to geopolitical concerns and tariff issues. As such, small-capitalization stocks (Russell 2000) posted a relatively strong April, while the Dow Jones Industrial Average is trailing year-to-date. Internationally, worries of a Eurozone economic slowdown eased in April, resulting in a rebound in the MSCI EAFE Index.
With the U.S. 10-year yield pushing past 3% and reaching its highest level since January 2014 investors are wondering why are yields rising now? As I highlight in the below chart for the last few years two anchohave been weighing down on the back-end of the yield curve: demand from international investors for U.S. fixed income and a lack of inflationary pressure. In 2018 both of these anchors have begun to lighten.
Rising hedging costs have eroded the relative attractiveness of U.S. fixed income to overseas investors. Falling demand from overseas has pushed U.S. bond prices down and forced yields higher. Inflationary pressure is driven higher by the falling U.S. dollar, which increases to the price of imports into the U.S. and oil prices moving higher. With inflation now back on investor’s radar, bond yields have begun to grind higher. The takeaway for investors is that higher bond yields are likely here to stay as both anchors continue to lighten in 2018. We encourage investors to remain flexible when managing duration, sectors and geographies during this tough time for fixed income markets.
Despite some risks related to trade restrictions, geopolitical noise and expectations of tighter monetary policy, markets remain on track thanks to signs that the global economy continues to expand, inflation is only rising gradually and earnings growth is healthy.