Week of August 13, 2018
Current economic events
Last week, U.S. investors focused on inflation data, which showed consumer and producer prices trending higher in July. Consumer inflation is firming to levels not seen since 2012, likely a go-ahead signal for the Federal Reserve (Fed) to continue hiking short-term interest rates in the near term. The Fed has also likely gained confidence from the continued strength of the labor market, and near all-time high job openings should only serve to increase its conviction. Even as activity-based economic data has stayed firm, June’s leading indicators from the Organization for Economic Cooperation and Development (OECD) again pointed to slowing economic momentum in the United States, though to a lesser degree than many developed peers. The picture remains one of a robust expansion near the peak of the cycle in the United States.
International data showed a more mixed picture. According to gross domestic product (GDP) numbers, the United Kingdom and Japan shook off early year weakness with slight upticks in growth compared to the first quarter. However, the OECD’s leading indicators forecasted a further slowdown in Europe, Japan and most emerging countries. Geopolitical risk crept into emerging markets, with Turkish assets selling off in response to the Trump administration announcing increased tariffs on Turkish steel and aluminum. Investors are concerned that some European banks may be overexposed to weakening Turkish lira-denominated debt. However, given the relatively small size of Turkey’s economy, risks to the global economy seem limited at this point. For now, the U.S. economy should continue to outperform; momentum is slowing more quickly internationally than in the United States.
U.S. equities ended last week fractionally off in a relatively quiet week of trading, with the S&P 500 posting its first weekly decline in six weeks. On balance, equities may have entered a “go nowhere fast” zone that could extend to mid-October, when third quarter results are released. For now, second quarter reporting period is drawing to an end, the markets are navigating the waning days of summer, the S&P 500 is flirting with all-time highs and trade tensions linger. The S&P 500 retreated 0.2 percent last week, closing at 2,833, roughly 1.5 percent below all-time highs reached in January.
Earnings continue to provide valuation support and the basis for stocks to trend higher. Roughly 90 percent of S&P 500 companies have posted second quarter results; another 9 percent are slated to release results this week. By most metrics, second quarter results have been superb. On balance, both sales and earnings are exceeding expectations, with sales advancing 10 percent and earnings 25 percent over year-ago levels, according to Bloomberg. Equally telling, the favorable results have been broad based. Four of 11 S&P 500 sectors have posted year-over-year sales growth above 10 percent; all 11 sectors are posting positive year-over-year earnings growth, with 10 of 11 sectors posting earnings growth above 10 percent, led by Energy, Materials, Information Technology and Financials. Broad-based sales and earnings growth are typically indicative of a favorable economic backdrop and an equity market that is poised to trend higher.
Tariffs and the associated impact on business strategies, consumer confidence, company earnings and inflation remain an unknown. At present, consensus earnings growth estimates for the third and fourth quarters are similar to what was experienced in the first and second quarters. The estimated year-over-year pace of earnings growth in 2019, however, is a more modest 10 percent versus the 20 percent projected growth rate for 2018. Clearly, there is room for disappointment should the trade war rhetoric escalate. Tariffs have the potential to disrupt the global supply chain, resulting in economic weakness and slower-than-expected earnings growth, both of which would likely weigh on equity prices.
Fixed income markets
Investors sought safety in U.S. Treasuries last week amid growing economic issues in Turkey. The damage has been largely contained thus far despite the Turkish lira falling 21 percent in recent days. We maintain a neutral view on emerging market debt, although trade sanctions could weigh on the market further. Our neutral position resulted in modest recommended tactical weightings. As such, typical portfolio weights to Turkish debt are no more than a fraction of a percent.
Domestic economic data still suggests a stable recovery, with the July Consumer Price Index remaining at recent highs and consumer confidence surveys reaching new peaks. We expect stable economic fundamentals, declining central bank purchases and robust Treasury issuance to gradually push yields higher. Geopolitical uncertainty could create temporary headwinds, however. We recommend shortening maturities for now, but we would consider longer duration targets if an economic downturn appears imminent.
Central bank policy continues to present upside risk to bond yields. The Bank of England raised its target rate 25 basis points to the highest level since 2009. Bank of Japan (BOJ) policy rates remain unchanged, but 10-year Japanese government bond (JGB) yields have moved higher. The BOJ widened the band around the JGB target to allow the yield curve to steepen. The Fed expects to maintain gradual rate hikes for the foreseeable future amid strong domestic economic conditions. Global central banks are still expected to reduce net purchases of long-term bonds.
Investment products and services are:
NOT A DEPOSIT • NOT FDIC INSURED • MAY LOSE VALUE • NOT BANK GUARANTEED • NOT INSURED BY ANY FEDERAL GOVERNMENT AGENCY
This information represents the opinion of U.S. Bank Wealth Management. The views are subject to change at any time based on market or other conditions and are current as of the date indicated on the materials. This is not intended to be a forecast of future events or guarantee of future results. It is not intended to provide specific advice or to be construed as an offering of securities or recommendation to invest. Not for use as a primary basis of investment decisions. Not to be construed to meet the needs of any particular investor. Not a representation or solicitation or an offer to sell/buy any security. Investors should consult with their investment professional for advice concerning their particular situation. The factual information provided has been obtained from sources believed to be reliable, but is not guaranteed as to accuracy or completeness. U.S. Bank is not affiliated or associated with any organizations mentioned.
Past performance is no guarantee of future results. All performance data, while obtained from sources deemed to be reliable, are not guaranteed for accuracy. Indexes shown are unmanaged and are not available for direct investment. The S&P 500 Index consists of 500 widely traded stocks that are considered to represent the performance of the U.S. stock market in general.
Equity securities are subject to stock market fluctuations that occur in response to economic and business developments. International investing involves special risks, including foreign taxation, currency risks, risks associated with possible differences in financial standards and other risks associated with future political and economic developments. Investing in emerging markets may involve greater risks than investing in more developed countries. In addition, concentration of investments in a single region may result in greater volatility. Investing in fixed income securities are subject to various risks, including changes in interest rates, credit quality, market valuations, liquidity, prepayments, early redemption, corporate events, tax ramifications and other factors. Investment in debt securities typically decrease in value when interest rates rise. This risk is usually greater for longer-term debt securities. Investments in lower-rated and non-rated securities present a greater risk of loss to principal and interest than higher-rated securities. Investments in real estate securities can be subject to fluctuations in the value of the underlying properties, the effect of economic conditions on real estate values, changes in interest rates and risks related to renting properties (such as rental defaults). There are special risks associated with an investment in commodities, including market price fluctuations, regulatory changes, interest rate changes, credit risk, economic changes and the impact of adverse political or financial factors.
©2018 U.S. Bank