Stronger than expected growth. Gross domestic product (GDP) grew by a surprisingly stronger-than-expected annualized pace of 2.3% in the first quarter of 2018, representing the best first-quarter growth in three years. The Commerce Department’s flash report showed that solid inventory restocking and positive net trade paced the strength, reversing negative fourth-quarter trends in both of these categories. Housing was breakeven to start the new year. While positive, consumer and government spending and business fixed investment were all sequentially slower.
Jobs not too hot, not too cold. Despite April’s slight miss in terms of what was expected, upward revisions to prior months kept monthly job gains at a healthy 200K pace for the year. Many of the past month’s gains were in goods-producing industries as male participation rose—a sign of increased capex activity. Meanwhile, muted wage growth reinforced the Fed’s gradual approach to raising interest rates.
Manufacturing solid. April’s ISM manufacturing print of 57.3 slipped but stayed consistent with above-trend growth, with 94% of industries reporting increased activity, matching the highest share since May 2004. The services ISM was similar, dipping a bit but remaining consistent with above-trend economic growth as all 18 industries expanded last month. Markit’s separate manufacturing and services surveys improved, with the manufacturing PMI reaching a 3½-year high. March factory orders also surprised, up 1.6% a second straight month, while capex has risen 24% year over year (y/y) so far this earnings season.
Decline in construction spending. March’s 1.7% decline in construction spending was the most in nearly a year and the second most since January 2011. The drop-off was led by a 3.5% plunge in residential construction, the most since April 2009 and likely due to bad weather. However, nonresidential construction spending also slipped. Still, on a y/y basis, construction spending was up 3.6%, with both private and public sectors contributing.
Trade deficit takes a pause from widening trend. Did tough trade talk play a role? March’s trade deficit shrank the most in 18-years to a 6-month low, driven by a sharp narrowing in the trade gap with China, which fell to $25.9 billion from February’s $29.3 billion. Despite the monthly decline, on a 12-month basis, the trade deficit continued to widen, reaching $594 billion, its highest level since March 2009, with deficits with China and the European Union posting fresh records.
Inflation firming PCE prices advanced y/y in line with the Fed’s 2% target, with the roll-off of year-ago negative prints helping the higher comparisons. Reports elsewhere show pricing pressures building. ISM and Markit manufacturing prices were at or near 7-year highs and levels historically consistent with a pickup in consumer inflation, and retail gasoline prices have jumped 11% y/y. If gasoline prices continue to rise, it will negate the positive impact of tax cuts for the bottom 40%.
The Fed will continue a gradual pace of raising rates. Slack in the labor market—nearly 30% of the working-age population is either unemployed or not actively seeking work—may help explain why there has been little acceleration in wages even as the jobless rate fell below 4% in April and could dip as low as 3.5% this year. This would indicate there is no reason for the Fed to speed up the pace of rate hikes, as some had suggested after parsing its post-meeting statement Wednesday and finding that policymakers had conceded that inflation now approximates its 2% target.
EQUITY MARKET SUMMARY
April 2018 saw the S&P 500 index end 0.38% higher. Volatility continued in April and year to date the S&P 500 has a slightly negative return of 0.38%. Rising bond yields muted positive reactions to a strong start to the corporate earnings season as the 10-year Treasury yield broached the 3% level. U.S. stocks finished the month behind foreign developed equities as measured by the MSCI EAFE index, which advanced 2.28% for the month. Emerging market equities (MSCI EM) posted its third consecutive down month after being one of the strongest areas for the last year.
Strong corporate earnings for the first quarter of 2018 have helped to increase the expected earnings per share in 2018 to 23% from 17%. With over half of S&P 500 companies reporting, over 80% of companies have beaten their earnings estimates, the highest number since FactSet began tracking this since 2008. Sales growth has also come in ahead of expectations. Market reactions of many companies who are beating estimates have been muted somewhat, possibly because of uncertainty regarding trade tariffs.
Markets have reacted to climbing oil prices and the 10-year Treasury yield over 3%. Oil prices have soared to a 3-year high at $67 per barrel from a low of $29 in early 2016. While this is a positive for future earnings of energy companies, it remains to be seen what affect this will have on the global economy. The 10-year Treasury yield briefly went over 3% briefly before settling back to 2.97% at the end of the month. Many investors are concerned the continued increase in Treasury yields could prove difficult for the stock market.
- LARGE CAPS OUTPERFORM SMALLER CAPS YTD:
Dow Jones -1.63% S&P 500 -0.38% Russell 2000 0.78% NASDAQ 2.68%
GROWTH OUTPERFORMING VALUE YTD :
Large Cap 2.21% vs. -3.09% Mid Cap 1.20% vs. -2.02% Small Cap 2.38% vs. -0.92%
Best performers: Year to date through the end of April, the Consumer Discretionary sector has the best returns at 5.5% while the Technology sector has the next best returns at 3.6%. While both sectors have benefited from reasonable valuations, the growth expectations of both of these sectors have increased from an improvement in consumer sentiment over the last several months.
Worst performers: Consumer Staples (-11.1%) and Telecom (-8.4%) have had the worst negative YTD returns with large brand-oriented companies under pricing pressure and the Telecom sector under pressure as its high dividend payout ratios are suffering by being an income proxy with rising rates.
FIXED INCOME SUMMARY
The 10-year Treasury yield briefly climbed from 2.74% to just over 3.0% ending April at 2.96%. The US Treasury Department projects an additional issuance of $1.3 trillion in debt this year to finance tax reform and fund the budget deficit. US 10-Year Treasury yields have not lost sight, continuing to hover near the 3% level. Treasuries could potentially face further pressure when combining the pickup in issuance with normalizing monetary policy.
Curve flattening continues. The biggest change in yields came in the front end of the curve, with the long end of the curve increasing but not as much due to firming but still moderate expectations for inflation. We didn’t see spread compression between 2-year and 10-year notes, which stayed at 47 basis points (the same spread as the end of March). Still, this is the lowest spread since October 2007, so the curve is quite flat. Between 10 and 30 years we saw the spread compress from 23 basis points to 17, showing further flattening. We are not expecting the curve to invert (short-term rates higher than long term) as this could signal a recession in the future. A surprise tick up in inflation could move long-term rates higher, but for now, inflation expectations remain subdued.
U.S. fixed income investment performance is negative year-to-date except for cash (returning 0.3%). The Barclays Aggregate index was the worst performing dipping -2.19% YTD and high yield was the best performing U.S.-based asset class (Barclays High Yield Index) declining only -0.21%. Municipal bonds were off -1.46% so far for 2018 and U.S. Corporates have declined by 3.22% so far (the long end -4.68% while the intermediate portion was only -1.15%). Internationally, the Euro Aggregate was weaker month over month, but still the best performing asset class with an increase of 0.47%.
Year-to-Date Index Returns (as of 4/30):
Index YTD Returns Barclays Aggregate -2.19% Barclays Euro Agg 0.47% Barclays U.S. High Yield -0.21% Barclays Municipal -1.46%